Establishing Contractual

Establishing Contractual
1
Relationships

Relationships Notes

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Learning Objectives
1. Defining a contract 7. Illegal and unenforceable agreements
2. Contract, agreement, promise, and of- distinguished
fer 8. Defining an offer
3. Contract distinguished from agreement 9. Essentials of a valid offer
4. Essentials of establishing a valid con- 10. Acceptance; legal rules governing a
tract valid acceptance
5. Contracts classified 11. Communication of offer, acceptance,
6. Void and voidable contracts distin- and their revocation
guished 12. Contracts over telephone, fax, and
email

W e enter into contracts so frequently in our day-to-day life that the term ‘contract’ has become
an inseparable part of our lives. We incur a contractual obligation each time we purchase gro-
ceries, board a train or bus, get a television set repaired, hire a cab, or even consult a doctor or an
advocate. In business, the most common relationship is that of contract because business basically
comprises buying and selling of goods or services, and the sale or purchase of anything constitutes
an important contract. Traders enter into countless number of contracts in the usual course of their
business. The law of contract regulates all commercial activities by sorting out the promise that
are enforceable, and how they can be enforced.
The law relating to contracts in India is contained in the Indian Contract Act, 18721. The Act is
mainly based on the English Common Law and extends to the whole of India except the State of
Jammu and Kashmir2.

Contract Defined
An agreement enforceable by law is a contract [Section 2 (h)].
The above definition resolves that a contract is fundamentally an agreement that legally binds
the parties. Thus,
Contract = Agreement + Legal Obligation
Let us now examine these two crucial elements of a contract.

Agreement
Section 2 (c) of the Indian Contract Act defines the term ‘agreement’ as: ‘Every promise and every Self-Learning
set of promises, forming the consideration for each other’. Material 1
Thus, mutuality is the base of an agreement.
Legal and Regulatory What is a promise?
Environment of
The term ‘promise’ is defined in Section 2 (b), which says, ‘A proposal (offer), when accepted, be-
Business
comes a promise’. Thus, a promise implies an accepted offer.
Notes The term ‘agreement’ presumes the presence of at least two persons; as one person cannot enter
into an agreement with one’s ownself. Besides, identity of minds in respect to the subject matter
of the agreement is a must to form an agreement. The parties entering into an agreement must
agree upon a common purpose, i.e., they must mean the same thing, in the same sense, and at the
same time. This meeting or identity of mind is called consensus ad idem, i.e., consent to the matter.
Thus, the formation of a contract is a two-step process where one party makes a proposal and the
other responds to that proposal. The examples in Box 1.1 would help achieve a better understanding
of the concept.

Box 1.1 An Agreement in the Eyes of the Law

Example 1
A offers to sell his car to B for a price. B accepts the offer. It has become a promise and can be treated
as an agreement between A and B.
Example 2
A has two Maruti-800 cars, one being a 2005 model and the other a 2006 model. A offers
to sell his 2005 model to B for ` 50,000 while B is under the impression that he is being offered the
2006 model. This deal lacks identity of minds. The buyer and the seller are thinking about different
cars. Hence, there is no agreement, and therefore no consequent contract.

Legal obligation
The law of contract seeks to determine and define the promises to which legal effect is accorded,
whether by enforceability or by way of recognition of a duty of performance. Thus, to become a con-
tract, an agreement must have an accompanying legal obligation, i.e., it must be enforceable by law.
That is why all contracts are agreements originally, but all agreements may not necessarily turn out
to be contracts. In this context, the term ‘agreement’ has a wider scope than the term ‘contract’.
Only those agreements in respect of which a legal action can be brought in can be regarded as con-
tracts. The courts have recognised that some agreements, by their very nature, are not intended to
be legally binding. Agreements of domestic, social, moral, or religious nature cannot be regarded as
contracts, because they do not produce or are not intended to produce any legal binding between
the concerned parties.

Contract, Agreement, Promise, and Offer

On the basis of the above discussion, the following relationship can be drawn between contract,
agreement, promise, and an offer or proposal.
1. A contract, essentially, is an agreement.
2. An agreement is a set of two promises, one flowing from the offeror and the other from the
acceptor.
3. A promise is an accepted offer or proposal.
4. An offer or proposal is a promise of performance, which is, however, conditional upon a return
promise or an act or forbearance received in exchange for it.
The process of making a contract is shown in Figure 1.1.

Self-Learning Fig. 1.1 The process of making of a contract

2 Material
Contract distinguished from agreement Establishing Contractual
Relationships
The following are the main points of difference between an agreement and a contract:
Elements An agreement consists of an offer and its subsequent acceptance, whereas a contract
is composed of an agreement and its legal enforceability. Notes
Essence of a legal relationship An agreement may not create a legal relationship. Parties entering
into a contract essentially have a common intention of entering into a legal obligation.
Scope Every agreement does not give rise to a contract, but a contract is a kind of an agreement.
Simply stated, all agreements may not be contracts but all contracts are primarily agreements.
Enforceability by law A contract is legally enforceable, whereas an agreement is not necessarily
so.

Essential Elements of Establishing a Valid Contract

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
[Section 10].
Thus, to become a valid contract, an agreement has to meet certain requirements. These are briefly
discussed below.

Agreement
In order to ascertain whether a contract has come into being, it is necessary to establish that there
has been an agreement between the parties. An agreement comes into existence when one party
makes an offer and the other accepts it. The Act has laid down certain rules for making the offer and
its acceptance, which must be adhered to while entering into an agreement. For instance, in order to
be lawful, an offer must be definite, meaningful, and duly communicated to the other party, failing
which the agreement shall not be binding. Similarly, acceptance must be absolute and unconditional,
duly communicated, and must be in the mode prescribed by the offeror, if any.

Intention to create legal relation

Intention to create legal relation is a necessary and independent element in the making of a con-
tract. As far as the common law is concerned, the very presence of consideration often leads to the
inference that an intention to create legal relations exists. However, in some cases, a mere presence
of consideration does not automatically give rise to the presence of intention to create legal obliga-
tions. For example, an agreement between a husband and a wife, wherein the husband agrees to
buy his wife a bracelet if she types a manuscript for him, probably represents consideration in the
literal sense but lacks an intention to create legal obligations. Therefore, evidence should establish
clearly that the intention of the parties is to enter into contract. Thus, purely domestic or social ar-
rangements do not contemplate to give rise to legal consequences. For instance, an invitation to a
feast is not intended to create legal obligations and, therefore, does not result in a contract if the
invitation is accepted. Box 1.2 clearly explains this aspect of the law of contract in Balfaur vs Balfaur.

Box 1.2 Is Husband’s Promise to Wife a Legally Binding

Agreement?

A husband, native of England, was a Civil servant and posted in Ceylon. His wife could not
accompany him on his posting to Ceylon because of ill health. The husband had promised her to pay
£30 per month as maintenance during the time they were forced to live apart. However, he failed
to keep his promise. The wife filed a suit against her husband for breach of agreement. Her petition
was dismissed on the ground that it was an agreement of domestic nature and the parties never
contemplated to give rise to legal obligations [Balfaur vs Balfaur3 ].
Self-Learning
Material 3
Legal and Regulatory Legitimate consideration
Environment of
An agreement to be enforceable as a contract inter alia must be supported by consideration unless
Business
the agreement is by means of written deed. However, the consideration need not always be in terms
Notes of money. It may be an act (doing something) or forbearance (not doing something) or a promise to
do or not to do something. However, an act, forbearance, or promise will amount to consideration
only if the law recognises that it has some economic value. It must have such value even though the
value cannot be precisely quantified, and may be past, present or future. But in order to be valid, a
consideration must be lawful. As per Section 23, the consideration 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 is fraudulent
or is regarded as immoral by the court, or involves or implies injury to the person or to the property
of another person, or courts regards as immoral, or opposed to public policy. In short, an illegal
consideration renders the whole contract invalid.

Capacity of parties
The parties must be legally capable of entering into a contract. But how can the competency of con-
tracting parties be determined ? In this regard, Section 11 specifies that every person is competent to
contract who has attained the age of majority as per the law of his country, who is of sound mind, and
who is not disqualified from contracting by any of his domestic laws. Simply put, a minor; a mentally
unsound, or mentally challenged person; and a person otherwise disqualified from contracting by
any law, for example, an alien enemy, insolvent, and convicts are not competent to contract.

Free consent
The basis of a contract is an agreement, which presupposes manifestation of mutual consent be-
tween the contracting parties. The term ‘consent’ implies that the parties in a contract should mean
the same thing, in the same sense, and voluntarily agree to the same thing. When there is such an
evident meeting of minds, the law says that there is consensus ad idem between the parties [Noorbhai
vs Karuppan Chetty 4], or in short, that the parties are ‘ad idem’ [British Ceylon Corporation Ltd vs The
United Shipping Board 5].
Consent is not free if (i) coercion, (ii) undue influence, (iii) fraud, (iv) misrepresentation, or (v) mis-
take vitiates it. In the first four cases, the contract becomes voidable at the option of the aggrieved
party. But where an agreement is induced by mutual mistake, which is material to the agreement,
it would be void [Section 20].

Lawful object
As per Section 23, the object of an agreement must not be forbidden by law, fraudulent, immoral,
opposed to public policy, or must not involve or imply injury to the person or to the property of
another person. If the object is unlawful for any of the above reasons, the agreement shall be void.
Thus, if a person at the behest of another person threatens to kill someone for a ransom, he cannot
recover the sum through a court of law.

Form
The Indian Contract Act does not insist upon a written contract. For day-to-day transactions which
are in bulk, written agreements would be burdensome and time-consuming and simply redundant.
However, in some cases, certain formalities (writing, registration, etc.) must be observed. For in-
stance, an agreement to make a gift for natural love and affection must be contained in the form of
a deed, or else the agreement will be unenforceable.

Certainty
The terms of a contract must be reasonably certain. Section 29 provides that agreements, the mean-
ing of which is not certain or capable of being made certain, are void. Thus, in order to give rise to
a valid contract, the terms of agreement must be clear and not vague or uncertain. A contract may
also be declared void on the ground of uncertainty or ambiguity. For example, A agreed to sell 10
metres of cloth to B. Here, it is not clear what kind of fabric was intended to be sold. Hence, the
Self-Learning agreement is void for lack of certainty of the subject-matter.
4  Material
Possibility of performance Establishing Contractual
Relationships
The agreement should be capable of being performed. As per section 56, ‘an agreement to do an
act impossible in itself is void’. The agreement in question must be performable not only physically
but also legally, failing which it will not result in a contract. Impossibility of performance may arise Notes
from the very nature of contract or due to change of the law subsequently. For example, a promise
to double a given amount of money by magic is unenforceable due to the sheer impossibility of
performing such an act.

Agreement not expressly declared void

Certain types of agreements have been expressly declared void under the Act. These are: agree-
ments in restraint of marriage, trade, or legal proceedings, and agreements by way of wager [Sec-
tions 26–28 and 30].

Types of Contracts
All contracts may broadly be classified into the following categories:
1. Valid contracts, void contracts, and voidable contracts;
2. Unenforceable contracts and Illegal contracts;
3. Executed contracts and executory contracts;
4. Express contracts and implied contracts;
5. Unilateral contracts and bilateral contracts; and
6. Quasi contracts.

Valid contracts, void contracts, and voidable contracts

Depending on their enforceability and the extent to which they can be enforced, contracts can be
classified as valid, void, or voidable.
Valid contract
A contract that fulfils all the legal requirements, such as the existence of agreement, intention for
creating legal relations, certainty, etc., is said to be a valid contract. The absence of an essential ele-
ment will render the contract void, voidable, illegal, or unenforceable.
Void contract
A void contract has no binding effect on any party. According to Section 2 (j), ‘a contract which ceases
to be enforceable by law becomes void, when it ceases to be enforceable.’
A close examination of the above definition reveals that a contract may not be void from its incep-
tion. It might be valid and binding on the parties when originally made, but subsequent to its crea-
tion it may become legally unenforceable (and so treated as void) for certain reasons. A valid con-
tract may become void due to subsequent impossibility of performance, change of law, repudiation
of a voidable contract, etc. The conditions when a valid contract becomes void are given in Box 1.3.

Box 1.3 When does a Valid Contract Become Void?

Example 1
A promises to sell his luxury car to B. If B dies or goes mad before the money changes hands, the
contract would become void.
Example 2
A, a rice merchant based in Delhi, agreed to sell to B, residing in Agra, 100 bags of Basmati rice at the
rate of ` 1500 per bag. But before the delivery could take place, the government imposed a ban on
inter-state trading in rice. The contract becomes void.
The above instances make it clear that both the contracts were valid at the time of their incep-
tion but became unenforceable subsequently. Thus, they became void from the time they
became unenforceable.
Self-Learning
Material 5
Legal and Regulatory A void contract carries no contractual rights or obligations. If, for instance, goods have been
Environment of transferred under a void contract, ownership of goods will not pass and they can be recovered from
Business the person in possession of them at any time before being consumed. However, if somebody has
rendered his services under a void contract, he/she is entitled to reasonable remuneration, what is
Notes
known as the quantum meruit6 [Craven-Ellis vs Canons Ltd7].

Void contract vs void agreement

A void contract is different from a void agreement. Section 2 (g) says, ‘An agreement not enforce-
able by law is void’. Thus, in case of a void agreement, no contract comes into being. Such an agree-
ment does not give rise to any legal consequences. It is void ab-initio, i.e., unenforceable from its
very inception.
A void contract, on the other hand, is one which was valid when entered into, but subsequently,
because of some resasons ceases to be enforceable. It is not void from the very beginning. The
following are some instances of void agreements:
1. Where both the parties to an agreement are under a mistake of fact [Section 20].
2. Where the object or consideration of an agreement is unlawful [Section 23].
3. Where the agreement is made without consideration [Section 25].
4. Where the agreement is regarding restraint of marriage [Section 26].
5. Where an agreement is pertaining to restraint of trade [Section 27].
6. Where an agreement relates to restraint of legal proceedings [Section 28].
7. Where an agreement is by way of wager [Section 30].
8. Where an agreement is made with a minor [Section 11].

Voidable contract
As per Section 2 (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 other or others is a voidable contract. Accordingly, a void-
able contract is one, which is legally enforceable unless avoided, i.e., a party to the contract refuses
to abide by it. Contracts brought about as a result of coercion, undue influence, fraud, or misrep-
resentation, or agreements made by minors fall into this category. These contracts are voidable at
the instance or behest of the aggrieved party [Sections 19 and 19A]. It is important to note that the
option to repudiate the contract on this ground is not available to the party who has induced the
contract. However, unless the aggrieved party takes steps to avoid the contract, it may operate in
every respect as a valid contract. Furthermore, if the party having the right to repudiate the con-
tract does not exercise the right within a reasonable time, and before the rights of third parties get
involved, the contract will be binding and enforceable. Thus, a voidable transaction is valid for all
purposes until steps are taken to avoid it.
A contract is also voidable under the following two situations:
1. When a contract contains reciprocal promises, and one party to the contract prevents the
other from performing his promise, the contract becomes voidable at the option of the latter
[Section 53]; and
2. When a party to a contract promises to perform an obligation within a specified time but fails
to do so within the fixed time, the contract becomes voidable at the option of the promisee
[Section 55].
Examples of voidable contracts are given in Box 1.4.

Box 1.4 Voidable Contracts

Example 1
A agreed to sell his horse to B for ` 5000. The consent of A was obtained by the use of force. The
contract is voidable at the option of A.
Example 2
Self-Learning A threatens to shoot B if he does not sell his car worth ` 2,00,000 to A for ` 1,00,000. B agrees. The
6 Material contract is voidable at the option of B, as his consent has been obtained by coercion, provided B
 Establishing Contractual
exercises his option to set aside the contract within a reasonable period of time. However, if in the Relationships
meantime, A sells the car to C who acquires it after paying the price and in good faith, the contract
cannot be avoided or become voidable even at the behest of B.
Notes

Consequences of rescission of a voidable contract

The major distinction between void contracts and voidable contracts is summarised in Table 1.1.

Table 1.1 Difference between Void and Voidable Contracts

S. No. Point of difference Void contract Voidable contract

1. Definition A contract, which ceases to be A voidable contract is an agreement
enforceable by law, becomes which is enforceable by law at the
void when it ceases to be en- option of one or more of the parties
forceable. thereto, but not at the option of
the other(s).
2. Nature and validity A void contract is valid and A voidable contract is repudiatable
binding upon the parties when at the option of the aggrieved party.
entered into, but subsequent It remains a valid contract until it is
to its formation, it becomes set aside or rescinded by the party
unenforceable due to certain entitled to do so.
reasons.
3. Factors responsible A valid contract may become Coercion, undue influence, error,
void due to any supervening fraud, and misrepresentation are the
impossibility, change of law, a main factors responsible for rende-
contingent contract due to emer- ring a contract voidable.
gence of an uncertain event, etc.
4. Enforceability It cannot be enforced by either It can be enforced or set aside at the
party. option of the aggrieved party.
5. Relationship A void contract under no circu- When a voidable contract is repudiated
mstances results in a voidable by the aggrieved party, it results in
contract. in a void contract.
6. Rights of third A void contract confers no Rights acquired under voidable
party rights or legal remedies to the contract by an innocent third party
third party. are not wiped out by such subse-
quent avoidance of the contract.
7. Compensation In case of void contract, ques- In case of voidable contract, the
tion of compensation or dama- party rescinding the contract can
ges does not arise on the non also claim damages.
-performance of such contract.
8. Effect of lapse Lapse of reasonable time does If a voidable contract is not rescinded
of time not render a void contract enf- by the aggrieved, it would become
orceable. It always remains enforceable at the option of the
void and unenforceable. other party.

Self-Learning
Material 7
Legal and Regulatory Unenforceable and illegal contracts
Environment of
At times, some contracts may suffer from some technical flaws that may render them unenforceable
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by law. There could also be some contracts that are not permissible under the law of the land. Such
Notes contracts are termed as unenforceable and illegal.

Unenforceable contract
When a contract is valid otherwise, but cannot be enforced (i.e., in a court of law) by one or both
the parties because of some technical flaw, it is described as an unenforceable contract. Literally
and in a wider sense, this term would include voidable, void, and illegal contracts, but in a legal
sense, it means a contract which is good in substance but which fails to satisfy some technical
requirement, such as the need for registration, attestation, and payment of stamp fee. Similarly,
sometimes the law may require that a particular agreement must be in writing or executed within
a fixed period under the Limitation Act. If these formalities are not properly observed, the contract
becomes unenforceable. For instance, a contract of insurance is unenforceable unless evidenced in
writing.

Illegal or unlawful contracts

Technically, a contract cannot be illegal because the term ‘illegal’ indicates ‘contrary to law’ and a
contract implies ‘an agreement enforceable by law’. As such, the former contradicts the latter and
vice versa, because once the agreement is illegal how can it be enforceable at law and if the agree-
ment is enforceable by law how can it be termed as illegal or unlawful. Therefore, it sounds illogical
to speak of an ‘illegal contract’. An agreement, of course, may be illegal or unlawful. Hence, it will
be more appropriate if we use the term ‘illegal agreement’ in place of ‘illegal contract’.
An illegal agreement is one which the law specifically forbids. An illegal agreement is void ab
initio. In the eyes of law, not only illegal agreements are unenforceable as such, but any other agree-
ment collateral to or arising from such agreements is also unforceable. For example, A agrees to
pay B ` 1,00,000 for killing C. A managed the amount by taking a loan from X to pay B. X was aware
of the purpose of the loan. In this case, the main agreement between A and B is illegal and void ab
initio because its object is unlawful. Even if B kills C, he/she cannot recover the agreed amount from
A through a legal action. Besides the main agreement between A and B, the collateral transaction
between A and X is also void in the eyes of law.

Illegal agreement and void agreement distinguished

The term ‘illegal agreement’ has a wider connotation than the term ‘void agreement’. All illegal
agreements are void but all void agreements are not necessarily illegal. For example, an agreement
to marry a minor girl though is void but not illegal because the object of this agreement is not un-
lawful. However, an agreement to commit robbery or have an intercourse with a minor below 16
years of age in consideration of a gift would not only be illegal but also void ab initio. Apart from the
similarity between an illegal agreement and a void agreement that in both the cases the agreements
are void and unenforceable at law, the two differ from each other in the following ways.
Scope  An illegal agreement is narrower in scope than a void agreement. All illegal agreements
are always void, but all void agreements are not necessarily illegal. A legal agreement may become
void due to some other reasons. For example, an agreement whose object is uncertain is void but
not illegal.
Effect on collateral transactions  Collateral transactions to a void agreement may be enforced for
execution, i.e., they do not become void. Contrarily, collateral transactions to an illegal agreement
become illegal and thus cannot be enforced in a court of law as we saw in the example on ransom
killing earlier. The collateral transaction of A taking loan from X to give to B for killing C is also illegal
and cannot be enforced under law.
Restitution of benefit received  If a valid contract becomes void subsequently because of certain
reasons, then the party who has received benefit under such contract is bound to restore it to the
party from whom he has received it. But this is not so in case of an illegal agreement. The benefit
reached or money advanced in respect of an illegal agreement cannot be restored or claimed back.
Thus, in the example on ransom killing agreement, X cannot recover the loan advanced to A by the
Self-Learning
8  Material count of law.
Void ab initio  An illegal agreement is void since its inception, but under certain circumstances a Establishing Contractual
valid agreement may subsequently become void. Relationships

Executed and executory contracts Notes

Depending on whether all the obligations of a contract have been fulfilled or have remained to be
accomplished, contracts can be either ‘executed’ or ‘executory’ in nature.

Executed contracts
A contract is said to be executed, where both the parties have done all that the contract required of
them. A cash sale is an example of an executed contract.

Executory contracts
An ‘executory contract’ is one in which the reciprocal promises or obligations, which serve as con-
sideration, are yet to be carried out. In other words, contract in which one or both the contracting
parties have still to carry out their respective obligations is termed as an executory contract. For
example, A agrees to sell his scooter to B. The latter has paid the price but A has yet to deliver the
scooter. The contract is, thus, executory as the right to the goods is transferred but not the pos-
session.
Thus, an executed contract conveys a chose in possession, whereas an executory contract con-
veys a chose in action.

Express and implied contracts

A contract may be express or implied depending on how it is established.

Express contracts
An express contract is the one that very lucidly conveys the purpose of the agreement. An express
contract exists when parties state the terms and show their intentions in words. An express contract
can be either oral or written. The majority of real estate contracts are express contracts since they
are reduced to writing.

Implied contracts
Contrary to express contracts, an implied contract is one in which agreement is by non-verbal con-
duct. In an implied contract, the agreement of the parties is demonstrated by their actions and roles.
Such contracts are formed when one party accepts something of value knowing that the other party
expects compensation. For example, while visiting a doctor, a patient agrees to pay a fair price for
the service availed. If he/she refuses to pay after being examined, he/she has breached a contract
implied in fact. Generally, an implied contract has the same legal force as an express contract. De-
nial of an implied contract would be unfair and/or result in unjust enrichment to one of the parties.
However, it may be more difficult to prove the existence and terms of an implied contract, should
a dispute arise.

Unilateral and bilateral contracts

Unilateral and bilateral contracts are the terms used to describe the way in which contracts arise.
These terms are important because the unilateral or bilateral status of a contract may affect whether
or not, and how, the contract is enforced. It is sometimes difficult to distinguish between unilateral
and bilateral contracts.

Unilateral contracts
A unilateral contract is one in which one of the parties performs its promises at the time of making
the contract and the other party promises to perform in the future. Unilateral contracts often arise
in an offer to sell an item to another person. If A tells B, ‘I’ll sell you my car if you give me ` 50,000’.
A is unilaterally offering the car if B gives him that amount. The contract can be accepted only by the
payment of the money, not by a promise to pay the money. Ordinarily, A is not bound to sell the car
unless B hands him ` 50,000, and A can withdraw the offer to sell it at any time before B performs,
i.e, pays the money in this case. It is thus, the party to a unilateral contract whose performance Self-Learning
Material   9
Legal and Regulatory sought is not obligated to act, but if he or she does, the party that has made the promise is bound
Environment of to comply with the terms of the agreement.
Business
Bilateral contracts
Notes
A bilateral contract is one in which both parties are to perform their respective promises or obliga-
tions at some future time but not necessarily at the same time. This is sometimes referred to as
‘mutuality of undertaking’. If A tells B, ‘I’ll sell you my car if you promise to pay me ` 50,000, and
B agrees by saying OK, I promise to give you the ` 50,000 next Tuesday, and A agrees saying OK,’
then it is a bilateral contract. Ordinarily, under these circumstances, A has bound himself to sell the
car at that price. Unlike a unilateral contract, in which only one party promises, bilateral contracts
are more common in modern commerce. In these, both parties promise to do something for the
other and are bound together from a precise moment.

Quasi contract
A ‘quasi contract’ is the act of a person, permitted by law, by which he/she obligates himself/her-
self towards another or by which another binds himself/herself to him/her, without any agreement
between them. Thus, a quasi contract is not a ‘contract’ but an obligation created by law (in the
absence of any agreement) for certain relations resembling those that are created by contract. It is
based on the concept of equity.
An example of a quasi contract is the case of a delivery boy who, by mistake, delivers grocery to
a wrong address. The owner of the house consumes the supply. The question arises if the owner will
be held liable for payment. Surely, the man will be held liable for payment, as the law aims to create
an obligation upon a non-contracting party to avoid injustice.
Other examples of quasi contracts are (a) supply of necessaries [Section 68], (b) payment of law-
ful dues by interested person [Section 69], (c) person enjoying benefit of a gratuitous act [Section
70], and (d) finder of lost goods [Section 71].

Offer and Acceptance: Introduction

We have learnt that a contract is an agreement which is reducible to an offer by one party and its
acceptance by the other. An offer when accepted in its entirety and without any qualification results
in consensus ad idem or meeting of the minds of the concerned parties. This is termed as agreement
and a contract comes into being assuming that it would give rise to a legal commitment. Thus, for
a contract to conclude, it is necessary to establish that there has been an agreement between the
parties, which is possible through a definite offer and its unconditional acceptance. A proposal or
an offer and its subsequent acceptance is the universally acknowledged two-step process to form
a contract.

Defining an Offer
An offer is a medium through which a person expresses his intention to enter into a contractual ob-
ligation against a promise or an act or forbearance. Section 2(a) defines the term offer or proposal8
as: ‘When one person signifies to another person his willingness to do or to abstain from doing
anything, with a view to obtaining the assent of that other to such an act or abstinence, he is said
to have made a proposal’. This definition reflects three properties of an offer, namely, expression
of readiness, presence of second party, and intention of obtaining a response.
The person making the proposal or offer is referred to as the ‘proposer’ or ‘offeror’, and the
person to whom it is addressed is called the ‘proposee’ or ‘offeree’. When the offeree accepts the
offer, he becomes the ‘acceptor‘ or ‘promisee’. For example, A offers to sell his car to B for ` 50,000.
This is a proposal or offer made by A. He is the ‘offeror’ or ‘proposer’. B, to whom the offer has
been made, is the ‘proposee’ or ‘offeree’ and if he accepts the offer, he will become the ‘acceptor’
or ‘promisee’ and A will subseqently become the ‘promisor’.

Characteristics of a valid offer

Self-Learning In order to be legally enforceable, an offer must satisfy the following requirements.
10  Material
It must intend to create, and be capable of creating, a legal obligation  The foremost requisite Establishing Contractual
of a valid offer is that it must contemplate to give rise to legal consequences and at the same time Relationships
be capable of creating legal obligations. The underlying reason is that the very purpose of entering
into an agreement (i.e., accepting the offer) is to make it legally enforceable. Therefore, a domestic
Notes
or social invitation cannot constitute a valid offer in the eye of the law, because if such an invita-
tion is accepted, it will not create any legal binding on the part of offeror or offeree. For example, if
someone invites his friend to dine with him or offers to take him to a movie, it cannot be regarded
as an offer even though it was accepted and there was consideration, as the parties never intended
to create legal obligations.
Its terms must be certain  An offer must be clear, definite, absolute, and final. An offer with vague
or loose terms does not convey what it exactly means. In such a case, a court will presume that there
was no serious intention to establish a bond and, therefore, there is no contract. For example, if A
enters into an agreement with B to agree in future to sell to the latter his car, it cannot result into
a contract because the terms of agreement are not certain. They are yet to be settled. Similarly, a
promise to pay a further sum for a horse if it proved to be a harbinger of good luck for the purchaser
[Gunthing vs Lynn9], or an agreement that the plaintiff is to receive ‘a reasonable share of the profits’
[Way vs Latilla10] are all too vague to create a binding obligation in respect of the matters they cover.
It must be made to obtain the consent of the offeree  The proposal or offer must be made with
the intention that the offeree accepts it. For example, if A tells B that he desires to marry her by
the end of December 2008, it does not amount to an offer of marriage by A to B. Instead if A says,
‘I offer to marry you’ or ‘will you marry me?’, then it constitutes an offer. Thus, for an offer to be
enforceable in a court of law, expression of willingness must be made to obtain the assent of the
other party.
It must be communicated  An offer becomes effective only when it has been communicated to
the person to whom it was made (i.e., offeree) so as to give him an opportunity to accept or reject
it. The first part of the definition of proposal given in the Act emphasises upon the fact that the
willingness to make a proposal should be ‘signified’. Communication of offer is imperative to con-
clude an agreement because acceptance can be given only after one gets to know about the offer.
It may be conditional  An offer may be subject to any reasonable terms and conditions, and if a
person accepts the offer, he/she is bound by the terms and conditions attached to it. The question
of special terms and conditions arises in case of standard form contracts such as contracts made
with banks, hotels, railways, shipping, or insurance companies. Such contracts are entered into by
the delivery of a printed form agreement by one party to another party who is supposed to accept.

An offer distinct from a query

In the process of negotiating an agreement, many preliminary communications may be exchanged
between the parties before a definite offer is made. One party may simply respond to a request for
information (for example, by stating the price at which it might be prepared to sell a house [Gibson vs
Manchester C.C.11] or may make a similar request, such as, asking a prospective supplier whether he
can supply goods suitable for his purpose [Interfoto Picture Library Ltd vs Stiletto Visual Programmes
Ltd12]. An offer thus, must be distinguished from all such queries or supply of information.

Firm offer vs invitation to treat

An offer must be distinguished from an invitation to treat, which is an invitation to another person
to make an offer. An offer is different from an invitation to treat in that the former can be converted
into a contract by acceptance, provided the other requirements of a valid contract are present. How-
ever, an invitation to treat cannot be ‘accepted’ as offer. The following are some of the examples
of invitations to treat.
Auction sale  An advertisement of an auction sale, a request for bids, is an invitation to treat and
not an offer to hold it or sell to the highest bidder. At an auction, the general rule is that the offer
is made by the bidder and accepted by the auctioneer when he/she signifies his/her acceptance in
the customary manner, e.g., by the fall of the hammer. Before this happens, the bidder can withdraw
his/her bid, and the auctioneer his goods. An auctioneer is not liable to the people travelling up to Self-Learning
the venue of the auction, if the former changes his/her mind and does not hold the auction at all Material   11
Legal and Regulatory [Harris vs Nickerson13].
Environment of
Business
Display of goods for sale in a showroom The display of goods with a price tag in a shop window
is not an offer to sell, but an invitation to customers to make an offer to buy [Timothy vs Simpson14].
Notes Similarly, the display of goods on the shelves of a self-service store is merely an invitation to treat.
The customer makes an offer to buy when he presents the goods for payment, which the retailer
may accept or reject [Pharmaceutical Society of Great Britain vs Boots Chemists Ltd 15]. The rationale
behind such cases is that a shop is a place for bargaining, not for compulsory trading. An invitation to
treat is merely a statement of price and not an offer to sell.
An invitation for tenders A tender is an estimate submitted in response to a prior request. An
invitation for tenders does not generally amount to an offer in as much as the tenderer is not bound
to sell to the person quoting the lowest price [Spencer vs Harding16]. The offer comes from the per-
sons who submit the tender and there is no contract until the tenderer accepts any one of them.
Company prospectus A prospectus or advertisement inviting the public to subscribe for shares
or debentures is an invitation to treat and not an offer to sell the securities. Members of the public
make the offer by completing and sending in application forms. The company reserves the right
to decide about the number of shares or debentures to be allotted to each applicant [National
Westminster Bank Plc vs I.R.C.17], in case of over-subscription. The position is, however, different in
case of ‘rights issue’, where a company offers its IPO to its existing shareholders, entitling each
shareholder to subscribe a certain number of new shares in proportion to the shares he/she already
holds. Here the letter informing the shareholder of his/her right is regarded as an offer.
General advertisement of goods An advertisement appearing in the print or electronic media
that goods are for sale is not an offer. Also in Grainger vs Gough, it was held that the circulation of a
price list by a wine merchant was only an invitation to treat. However, advertisements for rewards
for return of lost or stolen items or promise to pay money in return for an act have been held by
courts as offers, for they clearly show an intention to be bound by without any further negotiation.

Types of offers
Depending on the manner in which they are made, or the kind of promises made, offers are of various
kinds. There could be express or implied offers, specific or general offers, or standing offers, etc. The
following are the different kinds of offers.

Express offer vs implied offer

An express offer is made by words—oral or written. Section 9 of the Indian Contract Act reads,
‘Insofar as the proposal or acceptance of any promise is made in words, the promise is said to be
express.’
An implied offer is the one that the law infers from the conduct of the parties or the circumstances
of the particular case. Section 9 of the Contract Act reads, ‘Insofar as such proposal or acceptance
is made otherwise than in words, the promise is said to be implied’.
Examples of express and implied ofers are cited in Box 1.5

Box 1.5 Express and Implied Offers

1. A says to B that he wants to sell his old computer for ` 5000. This is an express offer.
2. A writes to B that he offers to sell his computer for ` 10,000. This is also an express offer.
3. X steps into a restaurant and consumes some food. This act creates an implied promise to pay.
4. A porter picks up someone’s luggage and carries it from the railway platform to a taxi without
being asked to do so. It implies that he is offering his services for which he expects to be paid.
5. As soon as a shoeshiner starts cleaning someone’s shoes, without being asked to do so, he is
considered to have made an implied offer.

Self-Learning
12 Material
Specific offer vs general offer Establishing Contractual
Relationships
An offer is called specific or particular when it is made to a specific person or a group of persons.
Such an offer can be accepted only by that person or a member of the group, and by no one else,
for it to turn into a contract [Boulton vs Jones18]. For instance, A offers to sell his dog to B for ` 5000. Notes
This is a specific offer as B alone can accept or reject it.
On the other hand, a general or public offer is one that is made to the world at large. Any
person (i.e., competent to contract) with the notice of the offer may validly accept such an offer
by complying with the terms of the offer. An advertisement addressed to the public at large is a
common example of a general offer. Box 1.6 provides a case study making the understanding of a
general offer very clear.

Box 1.6 General Offer

In Harbhajan Lal vs Harcharan Lal19, a young boy ran away from his home. The father of the missing
boy, by issuing a handbill, offered a reward of ` 500 to anyone who would bring the boy home. The
plaintiff spotted the boy at Dharamsala railway station and took him to the police station. He then
informed the boy’s father through a telegram. It was held that the handbill was an offer open to the
world at large and the plaintiff, by tracing the missing boy, had substantially performed the condi-
tions of the offer and was thus entitled to the reward.

Cross-offers
‘Cross-offers’ refer to identical offers made by two persons or parties to each other, neither side
knowing of the other’s offer when they make their own. Cross-offers do not constitute acceptance
of each other because they tend to promote uncertainty and as such no contract is concluded. For
example, A writes to B offering to sell his bike for ` 5000 and B simultaneously writes to A offering
to buy his bike for the same price. The two mails cross each other. If no further communication takes
place in such a case, no contract can be concluded between A and B, as both sides have made offers
without knowing about the offer made by the other. Also, this does not amount to acceptance of
each other’s offer.

Standing offer
An offer that is kept open for acceptance over a period of time is termed as ‘standing’, ‘open’, or
‘continuing’ offer. Thus, a tender to supply goods at specified prices as and when required are of
the nature of standing offer. The tenderer must supply whenever an order is placed, but he cannot
insist on any order being made at all. The quantity to be supplied may or may not be specified. For
example, in the Secretary of State vs Madho Ram20, military authorities accepted M’s tender for the
supply of certain goods at a specified price. But no requisition was issued during the period of the
tender. M sued for breach of the contract. It was held that, ‘The military authorities were not bound,
by their acceptance of the tender, to purchase any or all of the said goods needed by them, from the
plaintiff in the absence of a covenant to that effect. If they would think fit and could buy the goods
from any other source without any reference to him’.

Counter-offer
Counter-offer refers to an offer to contract on terms materially different from the terms of the
offer. It is, thus, an alternative proposal made by the offeree in substitution for the original offer.
When the purported acceptance of an offer contains a counter-offer, it is no acceptance at all and is
corresponding to rejection of the original offer. Such a counter-offer may, however, be accepted by
the original offeror and can thus give rise to legal obligations. It is important to note that a simple
request as to whether or not other terms would be acceptable does not amount to a counter-offer,
since such a request does not, by itself, reject an offer.
Self-Learning
Material 13
Legal and Regulatory Revocation or termination of offer
Environment of
Business
Revocation of offer implies taking back, withdrawing, or cancelling an offer. As a general rule, an offer
can be withdrawn at any time before the offeree has accepted it.
Notes Section 5 states, ‘a proposal may be revoked at any time before the communication of its accep-
tance is complete as against the proposer, but not afterwards.’
Thus, revocation of offer is possible only up to a certain stage. An offeror can revoke his/her
offer at any time before the offeree has signified his/her acceptance or before he/she has posted
the letter of acceptance.
According to Section 6, an offer stands lapsed in any of the following circumstances:
1. Communication of notice of revocation
2. Lapse of time
3. Failure to fulfil a condition precedent to acceptance
4. Death or insanity of either party
5. Refusal or counter-offer
6. Acceptance differs from the prescribed one
7. Subsequent illegality or destruction of subject matter.
Communication of notice of revocation  Revocation is ineffective until communicated to the of-
feree. Section 6(1) says, ‘a proposal or an offer may come to an end by the communication of notice
of revocation by the proposer to the other party.’ Therefore, revocation by post is ineffective until
it reaches the offeree.
An offeror is free to withdraw his/her offer at any time before the offeree communicates his/her
acceptance. Here it is important to note that in order to be effective, notice of revocation must move
from the offeror personally or a duly authorised agent and not from a third person. For instance, at
an auction of a real estate plot, A makes a bid and is the highest bidder. But before the fall of ham-
mer, A comes to know of some defect in the title of the property in question, and he retracts his bid.
The offer (bid) made by A lapses as soon as it is retracted by him. Here no contract is concluded as
the offer has been revoked before acceptance of the auctioneer.
Lapse of time  An offer comes to an end with the lapse of the time for acceptance, if any, pre-
scribed in the offer. If no time is prescribed, the offer would come to an end by the lapse of a rea-
sonable time [Section 6 (2)]. Thus, an offer, which was expressly stated to last for a definite period
of time, terminates on the expiry of the stipulated time or if there was no such time limit, after a
reasonable time. What is a reasonable time would depend on the circumstances of each case.
Failure to fulfil a condition precedent to acceptance  Where the offer is subject to some con-
dition precedent to acceptance, the offer stands terminated if it is accepted without fulfilling the
condition. For example, A proposed to let out his house to B for a monthly rent of ` 5000 subject to
the condition that B should deposit with him ` 50,000 as security before a certain date. B accepted
the proposal but failed to provide the security money. In this case, the acceptance has no validity
and the offer stands revoked. Thus, if the offeror has imposed any condition, the acceptor’s failure
to satisfy the same shall lead to the lapse of the offer.
Death or insanity of either party automatically terminates an offer without notice if the offeree
knows this at the time of his/her purported acceptance. If the offeree has accepted the offer in igno-
rance of the information about the death or insanity of the offeror, the latter’s legal representatives
will be bound by the contract to the extent of deceased’s or insane person’s estate.
Ironically, the Indian Contract Act is silent about the effect of the death or insanity of the offeree.
But under the English Law, an offer made to a living person who ceases to be alive before the offer
is accepted is no longer an offer at law [Reynolds vs Atherton21].
Therefore, as a general rule, death or insanity of either party before accepting the offer shall put
an end to the offer, for a meeting of minds is obviously impossible when one of the parties has died
or become insane.
Refusal or counter-offer  An offer also comes to an end upon being rejected by the offeror. An
offeree may expressly reject an offer by indicating that he/she is unwilling to accept it. He/she may
Self-Learning also impliedly reject it by making a counter-offer. For instance, A says to B, ‘I can sell my house to
14  Material
you for ` 10,000.’ If B replies ‘I am not interested to buy your house at all’, it is an express rejection Establishing Contractual
of the offer made by A. However, instead of rejecting the offer outrightly if B replies, ‘I can purchase Relationships
it for ` 9,000,’ A’s offer has been met with a counter-offer that terminates the original offer. Once
an offer is rejected, it cannot be revived later. Suppose B subsequently changes his mind and wants Notes
to pay ` 10,000, no contract would come into being since it would be a case of a fresh offer and not
an acceptance of the original offer. The original offer will be deemed to have lapsed.
Acceptance differs from the prescribed one  The offer must be accepted in the very manner
prescribed by the offeror, if any, failing which it would deem to have lapsed. For instance, A offers
to sell his car to B and asks him to send his acceptance only by speed post. If B notifies A about his
willingness to buy the car by some other mode, i.e., telephone, etc., A is not bound by his acceptance.
Subsequent illegality or destruction of subject matter  An offer is also terminated if the per-
formance of the contract it proposes has subsequently become illegal or unenforceable before the
offer is accepted. For example, a firearms manufacturer offered to sell sophisticated weapons to
another country. But two days later, before the offer was accepted, the government placed a ban
on all such sales in the country of the purchaser. The offer thus stood terminated by the ban, as
the offer subsequently became illegal. Similarly, an offer may also lapse on account of destruction
of the subject matter of the offer before the acceptance. In some cases, subsequent illegality or
destruction of subject matter can also serve as a legal excuse for a party’s failure to perform his
obligations under an existing contract.

Acceptance
Once the presence of a valid offer has been acknowledged, the next stage in the formation of an
agreement is to find an acceptance of that offer. The acceptance must be made while the offer is in
force, i.e., still open. An acceptance is a manifestation of assent to the terms of the offer. An offer
per se cannot create legal relations between the parties unless accepted by the person to whom it
was made.
Section 2(b) defines acceptance 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.’
Thus, an offer becomes irrevocable upon its acceptance. Anson22 emphasizing the significance of
acceptance observed, ‘Acceptance to an offer is what a lighted match is to a train of gunpowder.’
Simply put, an acceptance brings the offer to an end because it then merges into the contract.
For instance, A offers to sell some goods to B for ` 500. B agrees to the price demanded by A and
conveys the same to A. This is an acceptance of A’s offer by B. Now A is bound to sell the goods to
B for the agreed price.
Acceptance of an offer may take place by express words—oral or written, or by conduct. For
instance, A offers to sell his scooty to B for ` 5000. B may communicate his acceptance of this of-
fer orally or by writing a letter to A (the offeror). In some cases, an acceptance may also be implied
from conduct. For instance, when a passenger boards a bus there is an implied acceptance on his/
her part to avail the service and is thus bound to pay the requisite fare.

Legal rules governing a valid acceptance

In order to be binding, an acceptance must fulfil the following conditions:
1. It should be made by the offeree.
2. It should be unconditional.
3. It should be communicated to the offeror.
4. It may be in any form, oral or written.
5. It should be in the mode prescribed by the offeror.
6. It should be given within a reasonable time, if no time limit is set.
7. It should be given while the offer is in force.
We shall study the significance and fall-out of each of these conditions that render an acceptance
legally binding.
Self-Learning
Material   15
Legal and Regulatory Acceptance by offeree
Environment of
Business
An offer made to a particular person (specific offer) can be validly accepted either by him or by
someone acting with his authority, and no one else. Likewise, an offer made to a group of persons
Notes (general offer) can be accepted by any member who belongs to that group provided he/she has
the knowledge of the offer. The general rule is that if X wants to enter into a contract with Y, then
a third person cannot substitute Y unless he/she has been so authorised. Thus, if an acceptance is
communicated by a third party, it will not give rise to legal relations.

Acceptance should be unconditional

In order to convert a proposal into promise, the acceptance must be absolute and unqualified, i.e.,
it must correspond directly with the terms of the offer [Section 7(1)]. Any alteration to the terms of
offer constitutes a counter-offer, which will reject and extinguish an original offer. That is, the same
cannot be revived by subsequent acceptance. Thus, to give a legal effect, an acceptance must conform
to all the terms of the offer. An acceptance with a slightest variation from the terms of the offer may
result in no acceptance at all. Besides, an acceptance must be in toto, i.e., for the whole of the offer.
If only part of the offer is accepted, then the acceptance will not be binding and enforceable at law.

Acceptance to be communicated
The definition of acceptance given under Section 2(b) emphasises that it should be signified. To
become a promise, the acceptance must be communicated to the offeror or to his/her authorised
agent. Mere mental assent to an offer, not expressed by words or conduct, does not lead to a binding
contract. The case of Brogden vs Metropolitan Railway Co23 is relevant at this point. In the above case,
B, who had been supplying coal to a railway company without any formal agreement, suggested that
a formal agreement be drawn up. The agents of both the parties met and a draft agreement was
drawn. The agreement was approved by B, and then sent to the railway company for acceptance. The
agent of the railway company, however, put the draft in his drawer and forgot. It was held that no
contract had been concluded as the acceptance was never communicated to the offeror.

Acceptance may take any form

An acceptance may take any form. It can be given either orally or in writing. Acceptance may also be
inferred from the conduct, for example, despatching goods in response to an offer to buy. Thus, when
a person performs the act intended by the proposer as the consideration for the promise offered by
him/her, the performance of the act operates as an acceptance, and no separate communication is
required. Similarly, if somebody makes an offer by supplying the goods or rendering service and the
other party chooses to consume them straight away, this also amounts to acceptance by conduct
[Weatherby vs Banham24].

Acceptance to be in the prescribed mode

The offeror, as the master of the offer, has the power to specify the precise time, place, and manner
in which acceptance must be communicated. The offeree, in order to form a valid acceptance,
must respond in the prescribed mode. Thus, the offeror asks for the acceptance to be sent to
a particular place, an acceptance sent elsewhere will not bind him/her [Frank vs Knight25] nor, if
he/she asks for an acceptance in writing, will he/she be bound by one that is oral [Financings Ltd
vs Stimson26]. If the offeree conveys his/her acceptance in a manner different from the prescribed
mode, it is up to the offeror whether to waive the stipulated mode or reject such an acceptance.
However, if the offeror fails to inform the offeree within a reasonable time that he/she is not bound
by his/her acceptance since it is not in the prescribed mode, he/she will be deemed to have accepted
the acceptance and the same will result in a contract. Where the offeror does not prescribe any
mode, the acceptance must be expressed in some usual and reasonable manner.

Acceptance to be given within a reasonable time

Self-Learning If the offeror has fixed some time within which the offer should be accepted, the acceptance should
16  Material be given within the stipulated time. On this account, the Calcutta High Court suggested that in such
 Establishing Contractual
Relationships
Bhagwandas Goverdhandas Kedia v. M/s. Girdharilal
Parshottamdas, 1966 AIR 543
(S.3 and 4, place of formation of contract, postal rule) Notes
Facts
Plaintiff offered to get certain goods supplied at Ahmedabad to defendants who accepted the offer
at Khamgaon. On defendants’ failure to supply requisite goods, plaintiff sued them at Ahmedabad.
Dispute arose as to where was contract formed—at Khamgaon where acceptance was given by
defendants or at Ahmedabad where acceptance was received by plaintiffs.
Contentions(s)
Defendants contended that according to Section 2, 3, and 4 of ICA, the place where the offer is ac-
cepted is the place where the contract is made and therefore, Ahmedabad trial court did not have
the jurisdiction to try the suit.
Held
When a contract is made by conversation on telephone, the place where acceptance of offer is
intimated to the offeror, is the place where the contract is made, and therefore the Civil Court at
Ahmedabad had jurisdiction to try the suit.
Court’s Observations
l The contract act does not expressly deal with the place where a contract is made. The conver-
sation over telephone is analogous to the conversation when the parties are in presence of
each other, wherein the negotiations are concluded by instantaneous speech and therefore
communication of the acceptance becomes a necessary part of the contract and the
exception to the rule on grounds of commercial inexpediency is inapplicable.
l Further, in case of correspondence by post or telegram, a third agency intervenes which is re-
sponsible for effective transmission of letters at every instance, however, in case of telephonic
conversation, once the connection has been established, there is no need of any third agency
to transmit the correspondence between the parties.
But the Court held that when a contract is made by conversation on telephone, the place
where acceptance of offer is intimated to the offeror, is the place where the contract is
made, and therefore the Civil Court at Ahmedabad had jurisdiction to try the suit.
Hence, as against cases of correspondence by post or telegram, in the present case where there was
correspondence by telephone, contract was formed when acceptance was duly communicated to
the offeror and hence, at Ahmedabad.

a situation it is enough if the acceptor has ‘posted the acceptance before the stated time’, even if
it reaches the offeror after the fixed date. If no time has been stipulated, then the acceptance must
be communicated within a reasonable timeframe. What is reasonable time, however, is a matter of
fact for the judge to decide keeping in view the facts and circumstances of the case. In Ramsgate
Victoria Hotel Co. vs Montefiore27, an offer to buy shares in June accepted in November was held
‘too late’.

The offer must be in force

An acceptance must succeed the offer, but it should be given before the offer ceases to exist. Once
the offer stands lapsed or has been withdrawn in some way before the offeree accepts it, the ac-
ceptance is ineffective for there is no longer an offer to accept.

Mere silence is not acceptance

Since the law of contract usually requires some objective indication that an offeree intends to Self-Learning
contract, the general rule is that an offeree’s silence, vis-a-vis the offer made, cannot amount to Material 17
Legal and Regulatory an acceptance. In addition, an offeree who simply does nothing on receipt of an offer is not bound
Environment of by the same. The underlying reason is that it is detrimental to impose on a person, who does not
Business wish to accept the offer, the trouble and expense of rejecting it, i.e., the duty to respond. Thus, the
offeror cannot unilaterally impose the term that silence shall be deemed to be assent. The offeror
Notes
can prescribe the manner of acceptance but not the manner of rejection.

Communication of Offer, Acceptance, and their Revocation

In order to be effective, offer and acceptance must be communicated, either orally or in writing or by
conduct. An offer cannot take effect until it is received, for unless the offeree knows about it he/she
cannot take any action. Similarly, an acceptance is ineffectual to conclude a contract until it is com-
municated to the offeror or his authorised agent. In other words, lack of communication of offer to
the offeree and its acceptance to the offeror does not create any legal relations between the parties.
Where both the parties transact face to face, either in person or over telephone or through Inter-
net, there is instantaneous communication of offer and its acceptance. The problem arises when the
parties are at a distance and the conventional mail is the proper method of communication between
them. In such a situation the moot question is whether the contract concludes when the acceptance
is posted (by the offeree), or when it is received (by the offeror). This is because the moment the com-
munication is complete, the parties lose the right of withdrawal or revocation.

Communication of offer
The communication of an offer is complete when it comes to the knowledge of the person to whom
it was made [Section 4].
Thus, when the letter containing the offer reaches the offeree, the communication of offer is
complete. For example, A proposes, by a letter, to sell a house to B at a certain price. The letter is
posted on 1st May and reaches B on 3rd May. The communication of the proposal is complete when
B, the offeree, receives the letter, i.e., on 3rd May. Suppose the letter containing the offer was lost
in transit, and B after knowing about the offer from some other source, mails his acceptance to A.
This will not amount to proper communication of offer and hence no contract will result in.

Communication of acceptance
Section 4 also provides that the communication of an acceptance is complete, as against/for
(a) the proposer, when it is put in a course of transmission to him, so as to be out of the power
of the acceptor.
(b) the acceptor, when it comes to the knowledge of the proposer.
Thus, the offeror is bound by the acceptance as soon as the letter of acceptance is properly mailed
or despatched to him/her by the acceptor. However, the acceptor (i.e., offeree) shall be bound by
his/her acceptance only upon its reaching the offeror. The consequences of the post rules can thus
be remarkable (see Box 1.7).

Box 1.7 When Post-malfunction Affects the Course of a

Contract

In Household Fire Insurance Co. vs Grant, 1879, the defendant applied for 100 shares in the plaintiff
company. The company received his application form, and its secretary consequently completed
and posted a letter of allotment to the defendant and entered the name of the defendant in the
register of shareholders.
The letter, however, never arrived. Sometime later, the company went into liquidation, and the
liquidator claimed the payment outstanding on the shares from the defendant. It was held that the
defendant was liable for this sum. The shares became his property as soon as the letter of allotment
was posted, even though he never received it, and was thereby unaware that he had becomea
shareholder.

Self-Learning
18 Material
 But the acceptor will not be bound by his/her acceptance until it is received by the offeror. For Establishing Contractual
example, B accepts A’s proposal through a letter sent by post. The communication of the acceptance Relationships
is complete as against
(1) A, when the letter is posted
Notes
(2) B, when A receives the letter
It is important to note that where acceptance is by word of mouth it is not enough that it be
spoken; it must actually be heard by the offeror.
Thus, if an acceptance is not received because of disturbance in a telephone line, or because the
offeree’s words are too indistinct to be heard by the offeror, there is no contract.

Communication of revocation of offer or acceptance

The communication of 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 put 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 4].
This means that the communication of revocation of offer is complete for the person revoking it
when the letter of revocation is posted, and for the person to whom it is made when the letter of
revocation reaches him.
For instance, A of Delhi offers by post to sell his car to B of Mumbai for ` 2 lakh. The letter is
posted on November 1 and it reaches B on November 3. B accepts the offer with a letter sent by
post on November 3, which is received by A on November 5. However, A revokes his offer with a
telegram sent on November 2. The telegram reaches B on November 3 after B has already mailed
his acceptance. The revocation of the offer is complete as against A, as the telegram had already
been despatched on November 2. It is complete as against B the moment the telegram reached him,
i.e., on November 3. B revokes his acceptance with a telegram sent on November 4. The telegram
containing B’s revocation reaches A on November 5. B’s revocation of acceptance is complete as
against B the moment he despatched the telegram on November 4, and as against A when it reaches
him, i.e., on November 5.

E-Contracts
E-commerce has undisputedly become a part of our daily life. One such justification for the popular-
ization of E-commerce would be immoderate technological advancement. E-commerce, as the term
suggests, is the practice of buying and selling goods and services online, i.e., by means of internet.
The ‘letter ‘E’ used before the word ‘commerce’ is a shortened form of ‘electronic’. The efficacy of
E-commerce is based on electronically made contracts known as E-contracts. Although E-contracts
are legalized by Information Technology Act but still majority feels insecure while dealing online.
The reason being lack of transparency in the terms and conditions attached to the contract and
the jurisdiction in case of a dispute that may arise during the pendency of a transaction with an
offshore site.

What are E-contracts

In the words of Sir William Anson, a contract is a legally binding agreement between two or more
persons by which rights are acquired by one or more acts or forbearance on the part of the other
or others.
E-contract is an aid to drafting and negotiating successful contracts for consumer and business
e-commerce and related services. It is designed to assist people in formulating and implementing
commercial contracts policies within e-businesses. It contains model contracts for the sale of prod-
ucts and supply of digital products and services to both consumers and businesses.
An E-contract is a contract modeled, executed and enacted by a software system. Computer pro-
grams are used to automate business processes that govern e-contracts. E-contracts can be mapped
to inter-related programs, which have to be specified carefully to satisfy the contract requirements.
These programs do not have the capabilities to handle complex relationships between parties to
an e-contract.
An electronic or digital contract is an agreement “drafted” and “signed” in an electronic form. An
Self-Learning
electronic agreement can be drafted in the similar manner in which a normal hard copy agreement
Material   19
Legal and Regulatory is drafted. For example, an agreement is drafted on your computer and was sent to a business as-
Environment of sociate via email. The business associate, in turn, emails it back to you with an electronic signature
Business indicating acceptance. An e-contract can also be in the form of a “Click to Agree” contract, com-
monly used with downloaded software: The user clicks an “I Agree” button on a page containing
Notes
the terms of the software license before the transaction can be completed. Since a traditional ink
signature isn’t possible on an electronic contract, people use several different ways to indicate their
electronic signatures, like typing the signer’s name into the signature area, pasting in a scanned
version of the signer’s signature or clicking an “I Accept” button and many more.
E-contracts can be categorized into two types, web-wrap agreements and shrink-wrap agree-
ments. A person witnesses these e-contracts everyday but is unaware of the legal intricacies con-
nected to it. Web-wrap agreements are basically web-based agreements which requires assent of
the party by way of clicking the “I agree” or “I accept” button, e.g., E-bay user agreement, Citibank
terms and conditions, etc. Whereas shrink-wrap agreements are those which are accepted by a user
when a software is installed from a CD-ROM, e.g., Nokia pc-suite software.

Evidentiary value under indian evidence act

It is pertinent to contextualize at this juncture that evidence recorded or stored by availing the
electronic gadgets is given the 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 witnessed sea change by elevating the status of the
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 assigning of the legal recognition to e-record or data message.
The evidentiary value of e-contracts can be well understood in the light of the following sections
of Indian Evidence Act. Sections 85A, 85B, 88A, 90A, and 85C deals with the presumptions as to
electronic records whereas Section 65B relates to the admissibility of electronic record. The above
mentioned sections can be explained as follows:
Section 85a  As regards presumption to electronic agreements, this section is incorporated. It says
that every electronic record of the nature of an agreement is concluded as soon as a digital signature
is affixed to the record. Section 85A has been added in order to ensure the validity of e-contracts.
But there are some restrictions as regards the presumptive value. The presumption is only valid to
electronic records that are five years old and electronic messages that fall within the ambit of Sec-
tion 85B, Section 88A and Section 90A of Indian Evidence Act.
Section 85b  Section 85B provides that the court shall presume the fact that the record in question
has not been put to any kind of alteration, in case contrary has not been proved. The secure status
of the record may be demanded till a specific time. The digital signature should also be presumed
to have been affixed with an intention of signing and approving the electronic record. Further it has
been provided that the section should not be misread so as to create any presumption relating to
the integrity or authenticity of the electronic record or digital signature in question.
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”.
This section is self-explanatory as it purports to follow the basic rules of a valid hard-copy agree-
ment. The words “may presume” authorize the court to use its discretionary power as regards pre-
sumption. Sections 85A and 85B contained the words “shall presume” which expressly excluded this
discretionary power of the court.
Section 90a  In case of an electronic record being five years old, if proved to be in proper custody,
the court may presume that the digital signature was affixed so as to authenticate the validity of
that agreement. The digital signature can also be affixed by any person authorized to do so. For the
purpose of this section, electronic records are said to be in proper custody if they are in the custody
of the person with whom they naturally be. An exception can be effected in case circumstances of
Self-Learning a particular case render its origin probable.
20  Material
Section 85c  As far as a digital signature certificate is concerned, the court shall presume that the Establishing Contractual
information listed in the certificate is true and correct. Inclusion of the words “shall presume” again Relationships
relates to the expressed exclusion of the discretionary power of the court.
Section 65b  Section 65b talks about admissibility of electronic records. It says that any informa- Notes
tion contained in an electronic record which is printed on a paper or stored/recorded/copied on
optical/magnetic media produced by a computer shall be deemed to be a document and is admis-
sible as evidence in any proceeding without further proof of the original, in case the following
conditions are satisfied.
The computer output was produced during the period over which the computer was used regu-
larly to store or process information by a person having lawful control over the use of the computer.
In case a combination of computers, different computers or different combinations of comput-
ers are used over that period, all the computers used are deemed to be one single computer.
The information contained should have been regularly fed into the computer, during that period,
in the ordinary course of activities. The computer was operating properly during that period and, if
not, it would not have affected the accuracy of data entered.
A certificate issued is also admissible if it contains a statement which identifies the electronic
record containing the statement and gives information about the particulars of the computer in-
volved in the production of record.
The certificate issued should be signed by a person officially responsible for the use of that device
in relation to the relevant activity. The information fed into the computer should be in appropriate
form as well as by appropriate device.
Conclusion  To end with, it can be said that electronic contracts are almost same as other hard
copy contracts as far as its evidentiary value is concerned and in case of any discrepancy there are
certain prerequisites that fill the lacunae. All electronic contracts are valid contracts as they are
legalized by the Information Technology Act and one could be made liable if there is any infringe-
ment with the terms and conditions. Subsequently many amendments have been made in order to
attain conceptual clarity.

E xercises
I. Objective-type Questions
1. Which of the following is not an essential element of a valid contract?
(a) Offer and acceptance
(b) Free consent and consideration
(c) Lawful object
(d) Performance
2. Which of the following contracts is based on execution?
(a) Express contract (b) Implied contract
(c) Unilatéral contract (d) Unenforceable contract
3. Which of the following is not a void agreement?
(a) Agreement in restraint of marriage
(b) Agreement in restraint of trade
(c) Agreement in restraint of legal proceeding
(d) Service rendered without mandate
4. A void contract is
(a) Not enforceable at all
(b) Enforceable at the option of either party
(c) Enforceable at the option of the aggrieved party only
(d) Enforceable at the option of the party who is not aggrieved
5. A valid contract becomes a void contract due to
(a) Supervening impossibility
(b) Change of law
(c) Repudiation of a voidable contract
(d) All of the above Self-Learning
Material   21
Legal and Regulatory 6. Identical offers made by two parties to each other, in ignorance of each other’s
Environment of offer are known as
Business (a) Counter offer (b) Cross-offers
(c) Standing offer (d) None of the above
Notes
7. An offer comes to an end
(a) By lapse of stipulated or reasonable time
(b) By death or insanity of the offeror or the offeree before acceptance
(c) By revocation by the offeror or rejection by the offeree
(d) In all the above cases
8. To make an effective acceptance, which of the following requirements must be
fulfilled?
(a) Acceptance must be absolute and unqualified
(b) Acceptance must be communicated to the offeror
(c) Acceptance must be in the prescribed manner
(d) All of the above
9. An offer which is allowed to remain open for acceptance over a period of time is
known as
(a) General offer (b) Specific offer
(c) Standing offer (d) Counter-offer
10. Which of the following rule does not apply to a valid offer?
(a) The offer must be capable of creating legal relations
(b) The offer must be certain, definite, and not vague
(c) The offer must be communicated
(d) The offer must be unconditional
II. Review Questions
1. ‘An agreement enforceable by law is a contract.’ Comment. Also enumerate the
essentials of a valid contract.
2. Distinguish between the following:
(a) Void contract and voidable contract
(b) Contract and agreement
(c) Executed contract and executory contract
(d) Illegal contract and unenforceable contract
(e) Unilateral contract and bilateral contract
3. Write short notes on the following:
(a) Voidable contract
(b) Intention to create legal relationship
(c) Executory contract
4. What is an offer? When does an offer become a promise? Explain the rules governing a
valid offer.
5. Distinguish the following with suitable examples
(a) Offer and an invitation to offer
(b) General offer and specific offer
(c) Cross-offers and counter-offer
(d) Express offer and implied offer
(e) Revocation of offer and rejection of offer
6. Define acceptance. Discuss the rules governing a valid acceptance.
7. Comment on the following
(a) E-Contracts (b) Standing offer
(c) Revocation of acceptance (d) Communication of offer

10. (d) 9. (c) 8. (d) 7. (d) 6. (b)

5. (d) 4. (a) 3. (d) 2. (c) 1. (d)
Self-Learning Answers to Objective-type Questions
22  Material
 Chapter
1 In Review
Learning Objectives l A contract is fundamentally an agreement that legally binds the parties. The for-
mation of a contract is generally a two-step process in which one party makes a
Defining a contract proposal and the other responds to that proposal. Agreements of domestic, social,
Contract, agreement, promise, and offer moral, or religious agreements cannot be regarded as contracts because they do not
produce, or are not intended to produce any legal binding between the parties.
Contract distinguished from agreement l All agreements are contracts if they are made by the free consent of parties com-

Essentials of establishing a valid contract petent to contract for a lawful consideration and with a lawful object and are not
hereby expressly declared to be void. Contracts may broadly be classified as Valid
Contracts classified
contracts, Void contracts, and Voidable contracts; Unenforceable contracts and
Void and voidable contracts distinguished Illegal contracts; Executed contracts and Executory contracts; Express contracts and
Illegal and unenforceable agreements distin- Implied contracts; Unilateral contracts and Bilateral contracts; and Quasi contracts.
guished l An illegal agreement is void ab initio. In the eye of the law not only illegal agreements

are unenforce-able as such but any other agreement collateral to or arising from
Defining an offer
such agreements are also unenforceable.
Essentials of a valid offer l An offer is a medium through which a person expresses his intention to enter into a

Acceptance; legal rules governing a valid contractual obligation in return for a promise or an act or forbearance.
acceptance l In order to be legally winning, an offer should be capable of creating legal obligations,

its terms must be certain, it must be made to obtain the consent of the offeree, it
Communication of offer, acceptance, and must be communicated.
their revocation l An acceptance is a manifestation of assent to the terms of the offer. An offer per se

Contracts over telephone, fax, and email cannot create legal relations between the parties unless accepted by the person or
group of persons to whom it is made. An offer becomes irrevocable upon its accep-
tance.
Key Terms l In order to be effective, offer and acceptance must be communicated, either orally

or in writing or by conduct. The law has given a chance to both the offeror and the
Contract: An agreement that legally binds acceptor to withdraw their proposal and acceptance respectively. Accordingly, an
the parties offer may be revoked at any time before the communication of its acceptance is
Agreement: Every promise or set of complete as against the proposer but not afterwards. An acceptance may be revoked
promises forming the consideration for at any time before the communication of the acceptance is complete as against the
each other acceptor but not afterwards.
Promise: A proposal, when accepted, l A contract over telephone, and presumably, by fax and e-mail operate on the same

becomes a promise footing as an oral agreement negotiated by the parties in the actual presence of each
Valid contract: A contract that fulfills all other.
legal requirements
Void contract: A contract that has no
binding influence on any party
Unenforceable contract: A contract which
is valid otherwise, but cannot be enforced
by one or both the parties because of some
technical flaw
Executory contract: A contract in which the
reciprocal promises or obligations, which Bilateral contract: A contract in which her, without any agreement between
serve as consideration, are yet to be carried both parties are to perform their them
out respective promises or obligations at Offer: It is a medium through which a
Implied contract: A contract in which the some future time but not necessarily person expresses his intention to enter
agreement is by non-verbal contract concurrently into a contractual obligation against a
Unilateral contract: A contract in which one Quasi contract: It is the act of a person, promise or an act or forbearance
of the parties performs its promises at the permitted by law, by which he/she Revocation of offer/acceptance: Implies
time of making the contract and the other obligates himself/herself towards taking back, withdrawing, or cancelling
party promises to perform in the future another or binds himself/herself to him/ an offer/acceptance

Establishing Contractual Relationships  23

Legal and Regulatory

Competency of Parties
2
Environment of
Business

Notes
and Free Consent

© iStock
Learning Objectives
1. Competency to contract 6. Undue influence; presumption of
2. Minor; position of an agreement with domination of will
a minor 7. Undue influence distinguished from
3. Effects of agreements made by a per- coercion
son of unsound mind 8. Misrepresentation: definition, classifi-
4. Free consent cation, essentials
5. Coercion: definition; effect, acts that 9. Fraud: definition, essentials, conse-
amount to coercion quences
10. Mistake: definition, types, effect

Competency Defined

C ompetency is an expression that describes a person’s aptness to do something. In the context of the
Indian Contract Act, it refers to the ability to enter into contractual relationships. Contractual
incompetence or disability on the part of either party may render an agreement void and unenforce-
able. Therefore, both the parties—the promisor and the promisee, must be legally capable of enter-
ing into a contract so as to translate the agreement between them into a legally binding contract.

Who is Competent to Contract?

Every person who has attained the age of majority who is of sound mind, and who is not disqualified
from contracting by any law to which he is subject is competent to contract [Section 11].
In the light of above provision, the following persons can be deemed to be incompetent to enter
into a contract:
1. Minors,
2. Lunatics, and
3. Persons disqualified by law.

Minor
As per Section 3 of the Indian Majority Act, 1875, a minor is a person, domiciled in India, who has
not attained the age of 18 years. Accordingly, every person, male or female, who is under 18 years
of age is a minor. However, in the following two cases, a person continues to be a minor until he/
she completes 21 years of age:
Self-Learning
24 Material
 (1) Where a guardian of a minor or his/her property or both has been appointed by a court of Competency of Parties
law under the Guardian and Wards Act, 1890, and and Free Consent
(2) Where his/her property has passed under the superintendence of the court of wards.
Thus, a person normally attains majority upon completing his/her 18 years of age. But in case a
Notes
person or his/her property is under the guardianship of someone, the former shall remain minor un-
less he/she attains 21 years of age. Also, a person whose property has been under a court-appointed
custodian cannot enjoy his independent rights as an adult unless he/she attains 21 years of age.

Position of agreements with a minor

A valid agreement requires that both the contracting parties must be able to understand the legal
implications of their conduct, i.e., they must have a mature mind. The legal yardstick to measure
maturity, according to the law of contract, is that both the parties must have attained majority.
Otherwise, the law would presume that they do not possess the capacity to judge what is good and
what is bad for them, hence, a bar on minors’ competency to contract.
The legal position of minor’s agreements In the eyes of the law, an agreement with a minor is
held void altogether. Besides, a minor can always plead minority despite entering into a contract by
falsely representing himself as a major. There could be many other cases related to the involvement
of minors in contractual obligations. The legal position of minor’s agreements may be studied under
the following heads.

An agreement by a minor is void altogether

The law has always sought to protect minors from the consequences of making transac-
tions detrimental to themselves. For example, if a minor agrees to buy something that he
cannot afford, cannot be compelled to pay for that. Thus, contracts with or by a minor are
held void altogether. The Act makes it essential that all contracting parties should be com-
petent to contract and expressly provides that no person is competent to contract who has
not attained majority. Hence, a minor is not bound by the promise made by him under an
agreement. The case of Mohori Bibi vs Dharmodas Ghose1 (Box 2.1) is a case in point.

Box 2.1 Minor Not Bound by Promise Made

In the Mohori Bibi vs Dharmodas Ghose case, the plaintiff, a minor, executed a mortgage in favour
of the defendant, a moneylender, to secure a loan of ` 20,000. A part of this amount was actually
advanced to him. Subsequently, the minor sued for setting the mortgage aside. The Privy Council
held that a minor had no capacity to contract and, therefore, the mortgage was not valid. Then,
the moneylender requested to refund a sum of ` 10,500 advanced as part of the consideration
for the mortgage. The Privy Council further held that the contract by the minor was void and he
cannot be compelled to repay the amount advanced to him.

Minor can always plead minority

Estoppel is an important principle of the Law of Evidence. In the words of Lord Halsbury, ‘Estoppel
arises when you are precluded from denying the truth of anything, which you have represented as
a fact, although it is not a fact’. But there is one exception to this general rule. A minor can always
plead minority and is not stopped from doing so even when he/she has procured a loan or entered
into some other contract by falsely representing himself/herself as a major, when in reality he/she
was a minor. The reason behind this is quite apparent. The policy of the law of contract is to protect
minors from contractual liability, and if such a thing is permitted, it would defeat that very policy.

No ratification on attaining the age of majority

Since the contract with a minor is void ab initio, the minor on attaining majority cannot ratify the Self-Learning
same. In Indran Rama Swami vs Anthoapa2, a promise made by a minor that the money advanced Material 25
Legal and Regulatory during his minority will be repaid by him/her after attaining majority has been held invalid. How-
Environment of ever, when a person on attaining majority actually repays the debt incurred by him/her during his/
Business her minority is regarded as a valid transaction. The reason for the same is that an agreement with a
minor is merely void and not unlawful and, therefore, the sum paid cannot be sued for subsequently.
Notes
Contract for the minor’s benefits
Despite the fact that a minor is incompetent to contract, nothing in the law prevents him/her from
becoming a promisee, transferee, payee, endorsee, and receiver of a benefit arising under a contract.
Accordingly, a minor is allowed to enforce a contract, which is of some benefit to him and under
which he/she is required to bear no obligation. Thus, a promissory note duly executed in favour of
a minor is not void because although he/she is incapable of contracting, yet he/she can receive a
benefit. On the same footing, it has been held that a minor is capable of purchasing immovable
property, and he/she may sue to recover the possession of the property purchased upon tender of
the purchase money [Thakur Dar vs Mt. Putli3].

Contract by a parent or guardian

A contract entered into by a parent or guardian on behalf of the minor is binding on the minor
provided that the contract
(a) is within the scope of the authority of the parent or guardian, and
(b) is for his/her benefit or is for legal necessity [Subramanyam vs Subba Rao4].
It should, however, be noted that all contracts made by guardian on behalf of a minor are not en-
forceable. For example, an agreement for service, entered into by a father on behalf of his daughter
who is a minor is not enforceable at law [Raj Rani vs Prem Adib5]. Similarly, the guardian of a minor
has no power to bind the minor by a contract for the purchase of immovable property [Mir Sarwarjan
vs Fakhruddin Mohd Chowdhury6].

Contract by minor and adult jointly

When a minor and an adult jointly enter into a contract with another person, the contract would be
void vis-a-vis the minor. But the contract (as a whole) can be enforced against the adult [Jamna Bai
vs Vasanta Rao7].

Minor as a partner
A minor cannot become a partner in a partnership firm. However, he/she may, with the consent of
all the partners, be admitted to the benefits of partnership (Section 30 of the Indian Partnership
Act). This implies that he/she can share the profits without incurring any personal liability for losses.

Minor as an agent
A minor can act as an agent and bind his/her principal by his/her acts done in the course of such
an agency. But he/she does not incur any personal liability towards the principal for his/her wrong
actions, negligence, or breach of duty, whatsoever.

Minor as a shareholder
A minor can become a shareholder, or a member in a company in respect of fully paid shares (e.g.,
in case of transfer or transmission of shares), if the articles of the company so permit. However, if a
minor is allotted partly paid shares, he/she being incompetent to contract, incurs no liability. Thus,
a company will not be able to recover the uncalled amount from the minor in future. In a Chennai
case [Palaniapa vs Pasupati Bank 8], shares were allotted to a minor under an application signed by
his guardian. Neither the minor nor the guardian was held liable when the company was wound up
subsequently. Hence, the bar on minor to become a shareholder.

Minor and insolvency

A minor cannot be adjudicated insolvent simply because he/she is incompetent to contract.
Self-Learning
26  Material
Contract of apprenticeship by the guardian of a minor Competency of Parties
and Free Consent
A contract of apprenticeship entered into on behalf of the minor by his/her parent or guardian is
valid and is binding upon a minor, as such a contract is protected by the Apprentices Act, 1961, pro-
vided that the minor is not less than 14 years of age at the time of making the contract. Notes

Minor’s liability for supply of necessaries

Any person would be entitled to be reimbursed from the property of the minor for necessaries sup-
plied to him or to anyone whom the minor is bound to support, i.e., his family [Section 60].
Thus, for the supply of necessaries, a minor is not personally liable; it is only his property which
shall be liable. If a minor owns no property, the supplier cannot recover the price of the necessaries.
Necessaries defined  The term ‘necessaries’ refers to basic requirements of one’s life. Neces-
sary goods or services are those without which an individual cannot reasonably exist [Chappel vs
Cooper9]. Accordingly, necessaries supplied must be according to economic and social status of the
minor in question and must be the goods or services, the minor actually needs to support himself/
herself. Necessaries as defined by Section 2 of English Sale of Goods Act refer to the goods suitable
to the condition in life of a minor and to his actual requirements at the time of sale and delivery. This
follows that an item will not come under the purview of necessaries if a minor is already sufficiently
supplied with things of that kind. Necessaries include not only goods—food, shelter, clothing, etc.
but also necessary services—education and instruction. In India besides the above things, the
costs incurred in successfully defending a suit on behalf of a minor in which his/her property was
in jeopardy, and expenditure incurred in defending him/her in a prosecution, and amount advanced
to a Hindu minor girl to meet her marriage expenses have also been held to be necessaries. Thus,
necessaries are not confined to basic necessities—things that one must have and cannot manage
without, i.e., important to all, such as food and clothings.
If the goods are deemed necessaries, the minor may be compelled to pay a reasonable price, and
not the contract price. However, a minor is not liable if the goods, though necessaries, have not
been delivered, or the service has not yet been rendered, i.e., there is no claim for breach of contract.
The burden of proving that the goods are necessaries lies on the seller. Therefore, the seller must
show that the goods are, in fact, necessary for the particular minor in question. For instance, a tailor
sued a minor for the price of clothes, including eleven waistcoats. His action failed because he could
not show that the minor was not already adequately supplied with the required articles. A minor is
not liable if he has an adequate supply, even if the supplier did not know this. His properties, thus,
could not be attached for the recovery of the price [Nash vs Inman10].

A minor’s liability in tort

A tort implies a civil wrong or a breach of duty other than under the contract leading to incurring
liability for damages. A minor is liable in tort unless his/her act is directly connected with the con-
tract and is the means of producing it. In Burnard vs Haggis11, the defendant, a minor, hired a horse
subject to the condition that he would not use it for jumping or playing any other stunt. The minor
lent the horse to a friend, who used it for jumping, with the result that the horse was injured and
ultimately died. The minor was held liable on the ground that he had done an act not contemplated
by the contract and had thus taken himself out of scope of the law of contract, and the protection
it affords to juveniles.
However, where the wrongful action is contemplated by the contract, the minor cannot be held
liable. Hence in Jennings vs Rundall12, where the defendant, a minor, had hired a horse for ‘riding’
and rode it so hard that it was injured, the defendant was not held liable. The court observed, ‘If a
minor in the course of doing what he is entitled to do under the contract is guilty of negligence, he
cannot be made liable in tort if he is not liable on the contract’.

Persons of Unsound Mind

A person is said to be of sound mind for the purpose of making a contract if at the time, when he/
she makes it, he/she is capable of understanding it and forming a rational judgment as to its effect
upon his/her interests [Section 12]. Self-Learning
Material   27
Legal and Regulatory Now on the basis of the above provision it can be interpreted that for the purpose of making a con-
Environment of tract, a person is deemed to be of unsound mind if at the time of entering into an agreement he/she is
Business 1. incapable of understanding its terms and
2. unable to form a rational judgment as to its effect or implications upon his/her interests.
Notes
Unsoundness of mind may be caused by various factors, viz., idiocy, lunacy or insanity, intoxica-
tion (either from alcohol or the use of narcotic drugs), mental festering due to old age, etc.

Agreement with person of unsound mind

A person of unsound mind, under the Indian Contract Act, is incapable of entering into a contract. In
Machaiman vs Usman Boari13, it has been held that, in India, a contract with or by a person of unsound
mind is, like that of minor, absolutely void. Section 12 further clarifies:
1. A person, who is usually of unsound mind, but occasionally of sound mind, may make a
contract when he is of sound mind.
2. A person, who is usually of sound mind, but occasionally of unsound mind, may not make a
contract when he is of unsound mind.
The circumstances where a such person can make a cotract are given in Box 2.2.

Box 2.2 When is a Person Capable of Making a Contract?

Example 1
A patient in a lunatic asylum, who is, at intervals, of sound mind, may contract during those in-
tervals.
Example 2
A sane person, who is delirious from fever, or who is so drunk that he/she cannot understand the
terms of a contract, or form a rational judgment as to its effect on his/her interest, cannot contract
whilst such delirium or drunkenness lasts.

Effect of agreements made by persons of unsound mind

The law recognises different levels of mental instability or unsoundness of minds, such as lunacy,
idiocy, and intoxicated persons. Accordingly, agreements with such persons have been dealt with
differently. The position of contracts and agreements with such people is discussed separately as
follows.
Agreements by idiots Idiocy, in the eyes of the law, implies extreme mental imbecility with no
interval of saneness called lucid intervals. Accordingly, an idiot is a mentally deficient person who is
permanently incapable of rational conduct. He/she has no lucid intervals (of saneness), so he/she
cannot make a valid contract. A case in point is the decision of the Patna High Court in Inder Singh
vs Parmeshwardhari Singh14. A property worth about ` 25,000 was agreed to be sold by a person for
` 7000 only. His mother proved that he was a congenital idiot, incapable of understanding the trans-
action. Holding the sale to be void, Sinha J. stated ‘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 judgment of his
own, as to whether the act he is about to do is in his interest or not. In the present case, he was
incapable of exercising his own judgment’.
Agreements by Iunatics As against idiocy, lunacy is not God-given. Hence, a person can become
a lunatic at any stage of his life. He/she is a person who is mentally disturbed on account of mental
strain or other personal experiences and, of course, he/she may have some lucid intervals of sanity.
Accordingly, he/she is bound for contracts entered into during lucid intervals of sanity. But he/she
shall not be liable as regards contracts entered into during bouts of lunacy, i.e., while he/she was
Self-Learning
28 Material
of unsound mind.
Agreements by intoxicated persons  An intoxicated person is placed in the same category as a Competency of Parties
lunatic. Therefore, a contract by such persons is altogether void. However, merely partial or ordinary and Free Consent
intoxication cannot deprive a person of capacity to contract. In order to avoid a contract on this
ground it must be shown that the person was so intoxicated that he/she was unable to understand Notes
the terms of the contract, or form a rational judgment, as to its effects on his/her interests.
Exceptions  If a contract, entered into by a person of unsound mind, is for his/her benefit, it can
be enforced (for his/her benefit) at law against the other party [Jugal Kishor vs Chedelu15]. A person
of unsound mind usually incurs no liability. But for necessaries supplied to such a person or to any
member of his/her family, from his/her estate, if any, he/she will be liable [Section 68].
Burden of proof  The presence or absence of mental soundness at the time of making the con-
tract in all cases is a question of fact to be decided by the court of law. Where a person is usually of
sound mind, the burden of proving that he/she was of unsound mind at the time of the execution
of a document lies on him/her who challenges the validity of the contract.

Persons Disqualified by Law

Apart from minors and persons of unsound mind, there are certain other catagories persons who
are disqualified from contracting under some statutes so that the contracts by such persons are
void. For example, the Indian Penal Code debars convicts from entering into contracts while they
are serving their sentence of imprisonment. Such persons are called ‘legally disqualified persons’.
Besides convicts, the term includes alien enemies, insolvents, foreign sovereigns and ambassadors,
corporations, etc. A brief account of these persons is summarised as under.
Alien enemies  A person who is the citizen of a foreign country is an alien. An alien may be either
a friend or an enemy. An alien friend or a foreigner, whose country is at peace with the Republic of
India, can enter into a contract with an Indian citizen subject to the provisions of the International
Law. But in case of contracts with an alien enemy, i.e., a foreign national, whose country is at war
with India, the position is different. Contracts, except by licence from the Central Government,
entered into during the outbreak of war become unenforceable and cannot be sued in Indian Courts.
As regards contracts entered into before the declaration of war, they stand suspended for the
duration of the war and can be revived after the war is over, provided they have not already become
time-barred under the law of limitations. However, the contracts (i.e., entered before the war breaks
out) that are against the public policy can never be revived and, hence, stand dissolved.
Convicts  All convicts are legally disqualified from being entered into the contract from the date
of imprisonment till the date of their release from the jail. They may, however, contract
(a) on the expiration of the period of s entence,
(b) during their parole, or
(c) on remission of the legal consequences of their crime.
Undischarged insolvents  If a person’s debts exceed his property, he/she is adjudicated as insol-
vent. An adjudged insolvent’s property stands vested in the official receiver or official assignee
appointed by the court. He/she cannot enter into contracts relating to his/her property and sue and
be sued until he/she obtains a certificate of discharge from the court.
Foreign sovereigns and ambassadors  Foreign sovereigns and accredited representatives of a for-
eign nation, i.e., Ambassadors and High Commissioners, enjoy special privilege in that they cannot
be legally proceeded against in Indian Courts. However, they can, in their personal capacity, enter
into contracts that may be enforceable in Indian Courts.
Joint stock companies and statutory corporations  A joint stock company and a statutory cor-
poration created by a special Act exist only in contemplation of law. They are artificial persons and
have no physical shape or form. The contractual capacity of a company is determined by its charter,
i.e., Memorandum of Association. Similarly, the statute creating a statutory corporation expressly
defines its contractual capacity. Any act by a company or a corporation, which is outside the lim-
its of contractual capacity is ultra vires (beyond the powers) and void. Moreover, no company or
corporation is allowed to enter into the contracts of personal nature such as contracts of marriage
and divorce. Self-Learning
Material   29
Legal and Regulatory Free Consent: Introduction
Environment of
Business The most basic requirement to reach a contract is the presence of an agreement. The agreement must
have been entered into voluntarily and involved a ‘genuine consent’. Consent is said to be ‘not
Notes genuine’ and disputable if caused by mistake, misrepresentation, undue influence, fraud, or coer-
cion. The presence of these elements may vitiate an otherwise enforceable contract. A person who
has concluded a contract under these conditions would be at liberty to rescind it.

Consent Defined
The term ‘consent’ indicates meeting of minds, i.e., contracting parties understanding the same
thing in the same sense. According to Section 13, ‘Two or more persons are said to have consented
when they agree upon the same thing in the same sense.’ Consequently, if there is any misunder-
standing between the parties about the subject matter of the contract, they cannot be said to have
agreed upon the same thing in the same sense. And, if they do not agree in the same sense there
can be no consent. For example, A has two horses, one is black and the other red. He offers to sell
his black horse to B for ` 5000. B who is aware of only A’s red horse, accepts the offer made by
the latter thinking it to be an offer for the red horse. The so-called agreement between A and B is
invalid on the ground that there is no consent. The two parties are not thinking in terms of the same
subject matter.

Free consent
According to Section 14, consent is said to be free when it is not caused by coercion, undue influence,
fraud, misrepresentation, mistake. Thus, consent is not said to be genuine when it would have been
given due to any of the above-mentioned reasons.
For maintaining the validity of a contract, not only consent is necessary, but it must also be a free
consent altogether. If the consent is not free, a contract is voidable at the option of the party whose
consent was not free. But where both the parties to an agreement are under a mistake as to a matter
of fact essential to the contract in question, the agreement is void. This is so because in case of a
‘bilateral mistake’, there is virtually no consent. A void agreement is not enforceable at the option
of either party. Figure 2.1 shows the various flaws in consent and their legal effect.

Fig. 2.1  Flaws in consent and their effect on contract validity

Coercion
The term ‘coercion’ simply means forcing or compelling (physically or mentally) a person to enter
into a contract. The consent to an agreement is said to be caused by coercion when it is obtained
by use of force or under a threat.
Section 15 says, ‘Coercion’ is the committing, or threatening to commit, any act forbidden by the
Indian Penal Code (45 of 1860) 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 any
agreement’.
The explanation to the section adds – ‘it is immaterial whether the Indian Penal Code [Section
45 of 1860] is or is not in force in the place where the coercion is employed.’
Simply put, doing anything that is contrary to law or forbidden by the Indian Penal Code (IPC)
is coercion, even though such an act is done in a place where the Code may not be in force. The
fundamental object of causing coercion is to induce or compel a person to enter into a contract. For
Self-Learning example, A, on board in an English ship on the high seas, induces B to enter into an agreement by an
30  Material act that amounts to criminal intimidation under the IPC. A afterwards sues B for breach of contract
at Kolkata. A has employed coercion, although his act is not an offence by the law of England, and Competency of Parties
although Section 506 of the IPC is or is not in force in place where the coercion was employed by and Free Consent
A, i.e., the ship.
Notes
What Amounts to Inducing Coercion?
The analysis of the definition of ‘coercion’ given under Section 15 shows that the following four
actions would amount to inducing coercion in the eyes of the law:
1. Committing any act forbidden by the Indian Penal Code
2. Threatening to commit any act forbidden by the IPC
3. Unlawful detaining of any property
4. Threatening to detain any property.

Committing any forbidden act

Indian Penal Code [Section 45 of 1860] has forbidden certain acts. Committing a murder, kid-
napping, causing hurt, rape, defamation, theft, giving wrong evidence are some of the examples
of such acts. If a party to a contract procures the consent of another contracting party by com-
mitting any such act, the consent is said to have been gained through coercion. For example,
A kidnaps B’s son to induce B to sell his house worth ` 5 lakh for ` 2 lakh in return of release
of his son. B agrees to do so. The consent of B is deemed an act of coercion forbidden by the
IPC. The case of Ranganaya Kamma vs Alwar Sette16 shown in Box 2.1 is illustrative on this point.

Threatening to commit any act forbidden by ipc

Coercion as defined under Section 15 implies not only committing an act, which is contrary to law,
but even threatening to commit such an act amounts to coercion. Thus, obtaining consent at gun-
point, or by threatening to cause hurt, intimidation, and by threatening to kidnap will amount to
coercion.
It is worthwhile to note that even a threat to third party, for example, A pressurizing B to sign a
document threatening to harm C (who is a relative of B) if B refuses to sign, would also amount to
coercion.

Unlawful detaining of any property

If a person induces someone to enter into a contract with him/her by detaining his property, the
former is said to have employed coercion. He cannot, therefore, enforce the contract. In the English
case of Astley vs Reynolds17, the plaintiff had pledged his silver plate with the defendant for £20. When
he went to redeem it, the creditor insisted that an additional £10 interest was also owed. The plaintiff
had to pay this to redeem his plate. He subsequently sued the creditor to recover it back. Holding
that money, which had actually been paid for such a purpose, could be recovered back.

Threatening to detain any property

If a person threatens someone to detain any of his property with the intention of compelling him to
enter into a contract, such an act also constitutes a clear case of coercion. In Bansraj vs The Secretary
of State18, the government gave a threat of attachment against the property of B, the plaintiff for the
recovery of a fine due from his son. B paid the fine and subsequently sued the government against
this recovery. The court held that the payment of fine was induced by coercion and, therefore, B was
entitled to recover the amount he had paid under coercion.

Acts outside the purview of coercion

Often a doubt arises on the types of actions that would amount to coercion. Does mere warning or
threat to filing suits also come under the ambit of forcing a person into a contract? Absolutely no.
Following are the actions that are not deemed as coercion in their legal interpretation.

Threat to file a suit

A doubt often arises whether a threat to file suit amounts to coercion. In this relation it must be Self-Learning
noted that a threat of civil or criminal prosecution does not constitute coercion, since the same is Material   31
Legal and Regulatory not an act forbidden by the Indian Penal Code. However, a threat to file a suit on false charge is
Environment of forbidden by the Indian Penal Code and, therefore, amounts to coercion. The case of Askari Mirza vs
Business Bibi Jai Kishori 19 is relevant to this discussion.
In the above-referred case, a minor, the plaintiff, having borrowed on mortgage deed, agreed to
Notes
a compromise decree though the mortgages were void. He compromised because he was under the
threat of being prosecuted for falsely misrepresenting his age and that this amounted to coercion.
The Privy Council observed, ‘The law as contained in Section 15 is much wider than anything found
in the English authorities (read law) and in India it is not correct to say that a contract is vitiated
merely by proof of a threat to bring a criminal charge. Of course, if the charge of cheating was a
true one, there is an end to the plaintiff’s case, for a threat to bring such a charge would not be an
act forbidden by the Indian Penal Code.’

Threat to commit suicide

A ‘suicide’ and a ‘threat to commit suicide’ are not punishable under the IPC. An attempt and abet-
ment to suicide are, however, offence under IPC and, therefore, punishable under it. Now the ques-
tion arises if a person obtains the consent of the other by threatening to commit suicide, would it
amount to coercion? Such consent is also said to be caused by coercion. In Ammiraju vs Seshamma20,
the Madras High Court observed, ‘The term “any act forbidden by the Indian Penal Code” is wider
than the term “punishable by the Indian Penal Code”’. Simply because a man escapes punishment, it
does not follow that the act is not forbidden by Indian Penal Code. For example, if a lunatic or a minor
may not be punished, it does not show that the Indian Penal Code does not forbid their criminal acts.
In the same case it was held by a majority (of judges) ‘that the threat to commit suicide amounted
to coercion within the meaning of Section 15 ... the man who commits suicide goes unpunished, not
because the act is not forbidden, but because there is nobody left to be punished.’ It may, thus, be
concluded that although a threat to commit suicide is not punishable under the Indian Penal Code,
it is deemed to be forbidden by that code.

Effect of coercion
The ultimate effect of coercion is that it renders the contract voidable at the option of the party
whose consent was obtained by coercion, called aggrieved party. The reference of Sections 19, 64,
and 72 is explanatory here.
According to Section 19, ‘When the consent to an agreement is caused by coercion, the agree-
ment is a contract voidable at the option of the party whose consent was so caused.’
In other words, the party whose consent is obtained by coercion can put an end to the contract,
if it so chooses. Thus, it is up to the aggrieved party whether to rescind the contract or perform it.
However, as per Section 64, if the aggrieved party decides to avoid the contract, it has to restore
any benefit received by it under the contract to the other party from whom it had been received.
Section 72 further provides, ‘A person to whom money has been paid, or anything delivered
under coercion, must repay or return it.’ For example, a railway company refuses to deliver certain
goods to the consignee except upon the payment of an illegal charge for carriage. The consignee
pays the sum charged in order to obtain the goods. He is entitled to recover so much of the charge
as was illegally excessive [Illustration (b) appended to Section 72].

Burden of proof
The onus of proof that the consent was caused by coercion indeed lies on the party who wants to
rescind the contract on the ground of coercion. Thus, it is for the aggrieved party to prove that its
consent was not free. Moreover, such a party has to prove that it would not have entered into this
contract had the coercion not been employed.

Undue Influence
The term ‘undue’ means excessive or beyond what is expected or required, whereas the term ‘influ-
ence’ refers a person’s indirect power over other people, events or things. Hence, when a person
makes excessive or improper use of his/her power over another person and obtains the latter’s
Self-Learning consent, the former is said to have used undue influence.
32  Material
 Undue influence, in effect, wipes out the intellect of a person and induces him/her to do some- Competency of Parties
thing, which is against his/her will. For example if A by virtue of his wisdom, wealth, force of char- and Free Consent
acter, or just his superior position obtains the consent of someone who is in a weaker position, such
consent is said to be caused by undue influence.
Notes
Section 16 (i) defines undue influence as follows:
‘A contract is said to be induced by “undue influence” where the relations subsisting between
the parties are such that one of the parties was in a position to dominate the will of the other and
used that position to obtain an unfair advantage over the other.’

Prerequisites of undue influence

The above definition highlights the following two essential elements of ‘undue influence’:
1. The relationship between the parties is such that one of them is in a dominant position, and
2. The dominant party uses his/her position to obtain an unfair advantage over the weaker
party.
For an undue influence to occur, both the above-mentioned factors should be concurrently
present. The presence of one without the other will not invalidate consent on the ground of undue
influence. Box 2.3 presents some examples of consent induced by undue influence.

Box 2.3 Illustrations of Consent Obtained by Undue

Influence
Example 1
A advanced money to his son, B, during his minority. Upon B’s coming of age, he obtained, by
misuse of parental influence, a bond from B of a greater amount than the sum due in respect of
the advance. A thus employed undue influence [Illustrations appended to Section 16].
Example 2
A, a devotee induced by her spiritual advisor (guru), gifted her entire property to him to secure
benefits to her soul in next world. It was held that the consent of A had been obtained by undue
influence [Based on Mannu Singh vs Umadatt Pande 21].

Presumption of domination of will

From the definition given under Section 16 (1), it is clear that to exercise undue influence it is necessary
to prove that one of the contracting parties was in a position to dominate the will of the other. This
gives birth to a fundamental question as to when can a person be said to be in a position to dominate
the will of the other. The answer to this is provided in Section 16 (2). According to the section, a
person is deemed to be in a position to dominate the will of another in the following circumstances.

Where he holds a real or apparent authority over the other Instances of such relations are rela-
tions between father and son, master and servant, police officer and detainee or accused, etc.

Where he stands in a fiduciary relationship to the other Fiduciary relationship refers to relation-
ship based on trust and confidence. Bond of trust and confidence presents a very good opportunity
to the person in whom confidence is placed to exploit it for his own benefits. Instances of this cat-
egory of affairs are relations between
1. Doctor and patient22
2. Trustee and beneficiary23
3. Solicitor and client24
4. Spiritual advisor (guru) and his devotee25
5. Woman and her confidential managing agent 26
6. Parent or guardian and child27.
Self-Learning
Material 33
Legal and Regulatory Where he makes a contract with a person whose mental capacity is temporarily or permanently
Environment of affected by reason of age, illness, mental, or physical distress. It is a common observation that
Business
a ‘person in mental distress’ can be easily persuaded to give consent to a contract, which may be
Notes unfavourable to him. Accordingly, if a contract is made with someone by taking advantage of his/
her distress, it is voidable on the ground of undue influence.

Effect of undue influence

The effect of undue influence is that it renders a contract voidable at the option of the aggrieved
party. Thus, if the consent of a party is induced by undue influence, the party can put an end to the
contract if it so chooses. Section 19 (A) substantiates the above effect of undue influence as under.
‘When consent to an agreement is caused by undue influence, the agreement is a contract void-
able 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 benefits there under, upon such terms and conditions as the court may seem just.
Some examples of undue influence are given in Box 2.4.

Box 2.4 Illustrations of Effect of Undue Influence

Case 1
A’s son has forged B’s name to a promissory note. B threatens to prosecute the son and obtains
a bond from A for the amount of the forged note. If B sues on this bond, the court may set the
bond aside if A approaches the court for the same [Illustration (a) appended to Section 19(A)].
Case 2
A, a moneylender, advances ` 100 to B, an agriculturist, and, by undue influence, induces B to ex-
ecute a bond for ` 200 with an interest rate of 6 per cent per month. The court may set the bond
aside, ordering B to repay ` 100 with such interest as may seem just [Illustration (b) appended to
Section19(A)].

Burden of proof
When the aggrieved party chooses to rescind the contract on the ground of undue influence, it will
have to prove the following two points:
l The other party was in a position to dominate its will, and

l By the use of such dominant position, the other party actually obtained an unfair advantage

over it.
Thus, it is not enough for a person to avoid the contract by showing that the other person was
his/her father who could have influenced him/her. He/she must go further and show that his/her
father actually did influence him/her.

Transactions with pardanashin woman

The expression pardanashin (veiled) implies complete seclusion; the state of being private and away
from other people. Thus, a pardanashin woman is one who observes complete isolation from people
other than her family members due to custom of her community. It may, however, be noted that a
woman does not become pardanashin simply because ‘she lives in some degree of seclusion’ [Shaik
Ismail vs Amir Bibi28]. The concept legally means a woman who is totally ‘secluded from ordinary
social intercourse’.
Accordingly, a woman who goes to a court and gives evidence, who fixes rents with tenants and
collects rents, who communicates when necessary in matters of business, with men other than
members of her own family would not be regarded as pardanashin woman [Ismail Mustafa vs Hafiz
Boo 29].
Self-Learning
34 Material
 The law grants a special protection to such pardanashin women on the ground of their being Competency of Parties
ignorant insofar as the worldly knowledge goes [Kalibaksh Singh vs Ram Gopal Singh30]. A contract and Free Consent
with a pardanashin woman is presumed to have been induced by undue influence. She can avoid the
contract unless the other party can prove that she freely consented to the contract. The principles to
Notes
be applied to transactions with pardanashin woman are founded on equity and good conscience and,
accordingly, a person who contracts with a pardanashin woman has to prove the following points:
1. The terms of the contract were fully explained to her,
2. She understood the implications of the contract,
3. She had free and independent advice, and
4. It was a deliberate and voluntary act based on her intelligence.

Undue influence distinguished from coercion

Both coercion and undue influence invalidate consent and cause the contract voidable at the option
of the aggrieved party. Yet, there are some basic points of difference between the two, as explained in
Table 2.1.

Table 2.1 Difference between Coercion and Undue Influence

S. no. Point of Coercion Undue influence

difference
1. Mode of operation It involves the physical force It involves moral or mental
or threat. pressure.
2. Relationship between Existence of relationship bet- Some kind of relationship
the parties ween the parties is immaterial. between the parties is
absolutely necessary.
3. Nature of act Coercion encompasses commi- Committing or threatning to
tting or threatening to commit commit any illegal act is not
an act forbidden by Indian Panel the subject matter of undue
Code, or detaining or threatening influence.
to detaining any property of
another person.
4. Third party Coercion may proceed from Undue influence is always
even a stranger, i.e, third party employed by one contract-
and need not be directed again- ing party upon the other
st the promisor. It can be direct- party.
ed against a third party in whose
welfare the promisor was
interested.
5. Presumption by law The law under no circumstances Law in certain types of relati-
presumes the use of coercion. onships can presume undue
influence, e.g,. in case of a
contract with a pardanashin
woman.
6. Rights available The contract is voidable at the In case of undue influence,
option of the party whose con- the court has the discretion
sent has been obtained by co- to direct the aggrieved party
ercion. But any benefit receiv- to return the benefit in
ed by the aggrieved party has whole or in part, or rescined
to be restored to the other the contract withoutany
party. such direction.
7. Nature of liability In case of coercion, not only is Undue influence involves
the contract voidable at the op- no criminal liability except
ion of the aggrieved party, but an action on the contract.
the party exercising it also ex- Self-Learning
poses itself to criminal liabilities. Material 35
Legal and Regulatory Misrepresentation
Environment of
Business Misrepresentation refers to a misstatement of fact made by one party to the other, which, whilst
not being a term of contract, induces the other party to enter the contract. Misrepresentation may
Notes be innocent, negligent, or willful. In law, when a wrong representation is made deliberately with
the intention to deceive the other party, the term ‘fraud’ is used. But, when it is made innocently
or negligently, it is termed as ‘misrepresentation’. Thus, when a person asserts something, which
is not true, though he/she believes it to be true, that assertion amounts to misrepresentation. A
contract, the consent to which is induced by misrepresentation, is voidable, i.e., valid and enforce-
able until avoided or protested.
According to Section 18, ‘misrepresentation’ means and includes the following:
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 that without an intent to deceive, gains an advantage of the person com-
mitting it, or anyone claiming under him, by misleading another to his prejudice, or to the
prejudice of anyone 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 subject of the agreement.

Essentials of misrepresentation
1. There should be a representation or assertion, made innocently, believing it to be true and
without an intent to deceive the other party.
2. The representation or assertion should be, of facts, material to the agreement. A mere ex-
pression of opinion or hearsay or commendation (reasonable praise) cannot be regarded as
misstatement of facts even if the same turn out to be untrue.
3. The statement must be untrue or turned out to be untrue but was made with an honest belief
in its truth.
4. The person to whom the misrepresentation was made must have relied on it in the sense
that it must have induced him to enter into the contract [as per explanation to Section 19]:
5. A party cannot complain of misrepresentation if it had the means of discovering the truth
with ordinary diligence [see Exception to Section 19].
The examples in Box 2.5 would help understand the point.

Box 2.5 Illustrations of Misrepresentation

Example 1
The directors of a company, while acting within their authority, discounted on the company’s
behalf a bill of exchange with a bank. On due date the bank failed to realise the amount of the
bill. The company denied liability on the bill. It was held that the bank was entitled to recover
the amount of the bill from the company.
Example 2
In the negotiations for a marriage contract, the relatives speaking for the girl failed to disclose
that she was suffering from epilepsy. The engagement was held to be voidable on the ground
of misrepresentation of a very material fact having been concealed [Haji Ahmad Yar Khan vs
Abdul Gani Khan31].

Effect of misrepresentation
The effect of misrepresentation is that the party misled by it can avoid the contract. Section 19
states, ‘when consent to an agreement is caused by misrepresentation, the agreement is a contract
Self-Learning voidable at the option of the party whose consent was so caused’.
36 Material
 A party to contract whose consent was caused by misrepresentation, may, if it deems fit, insist Competency of Parties
that the contract be performed, and that it be put in the position in which it would have been, if the and Free Consent
representations made had been true.
Thus, the aggrieved party has the following two alternate rights:
Notes
l It may rescind the contract, or

l It may continue with the contract.

The discussion ahead makes the repercussions of both the options clear.

When party rescinds the contract

The aggrieved party can avoid a contract on the ground of misrepresentation. However, this right
is not available to it in the following two cases.
(a) Where it (aggrieved party) had the means of discovering the truth with ordinary diligence
[as per Exception to Section 19]
For example, A, by misrepresentation, leads B erroneously to believe that 500 tons of sugar
is produced annually at A’s factory. B examines the accounts of the factory, which should
have disclosed, if ordinary diligence had been exercised by B, that only 300 tons of sugar had
been produced. After this B buys the factory. The contract cannot be repudiated on account
of A’s misrepresentation.
(b) Where it is not, in fact, misled by the misrepresentation [as per Explanation to Section 19].
For example, a person bought shares in a company on the faith of its prospectus, which
contained an untrue statement that one Grieve was a director of the company. The repres-
entee’s claim to set aside the contract and for damages was dismissed on the ground that
the statement was ‘immaterial’, as the representee had never heard of Grieve. It is more
appropriate to say that for this reason the representee did not rely on the statement, which
was clearly material in the sense that it could influence a reasonable person. That is, the
consent by the representee was given independently despite the misrepresentation [Smith
vs Chadwick32].

Party may act upon the contract

The aggrieved party, if it deems fit, may choose to act upon the contract and may insist that it be
put in the same position in which it would have been, if the representation made had been true. For
example, A, while selling his Cyber cafe that contains 20 PCs to B, describes that all the machines
are in working condition. A personally thinks so. Later on, B finds that two of the computers are not
functional. In the circumstance, B may either avoid the contract or may insist on its being carried
out after A agrees to get the non-functional computers repaired.

Damages for misrepresentation

Misrepresentation generally does not entitle the aggrieved party to claim damages. However, dam-
ages can be claimed in case of misrepresentation in the following exception cases:
1. Where the prospectus of a company inviting the public to subscribe for shares in the company
contains a misstatement about a material fact, and someone relying on the prospectus sub-
scribes shares and thereby suffers losses, he/she (the injured party) can claim damages from
the promoters or directors of the company.
2. Where an agent commits a breach of warranty of authority, he/she exposes himself/herself
to pay damages to the injured party.
3. Where the relationship between the parties is that of a confidential nature (e.g., relationship
between a doctor and patient) and one party suffers loss due to misrepresentation made by
another party, the former can claim damages from the latter caused by such misrepresenta-
tion.

Burden of proof
To avoid a contract on the ground of misrepresentation, the representee needs only to explain that
the misrepresentation was made, and that it was capable of inducing the contract. The burden then
passes to the representor to prove that the representee would have entered into the contract any-
way, even if the misrepresentation had not been made.
Self-Learning
Material   37
Legal and Regulatory Fraud
Environment of
Business Fraud indicates wilful misrepresentation. Section 17 defines the term as: ‘Fraud’ means and includes
any of the following acts committed by a party to a contract, or with his connivance, or by his agent,
Notes 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, and
5. Any such act or omission as the law specially declares to be fraudulent.

Essential elements of fraud

The analysis of the above section makes it evident that the following elements must be present in
the act in order to constitute it fraud.

False and willful representation or assertion

To constitute fraud there must be some representation or assertion that is untrue. In the absence of
representation or assertion, except in the following two cases, there can be no fraud.
(a) Where silence may itself amount to fraud, and
(b) Where there is active concealment of facts.
Furthermore, such representation must have been made either with the knowledge that it was
false or without belief in its truth or recklessly without caring whether it was true or false. In Derry
vs Peck33, Lord Herschell said, ‘Fraud is proved when it is shown that a false representation has
been made knowingly, or without belief in its truth, or recklessly whether it is true or false’. Thus,
the person making the representation should not believe it to be true, otherwise he/she will not
be guilty of fraud. Moreover, to constitute fraud, the false representation must have been made
wilfully or intentionally. For example, A, intending to deceive B, informs him that his estate is free
from encumbrance. B thereupon buys the estate. The estate is, however, subject to mortgage. The
contract is induced by fraud.

Perpetrator of misrepresentation
The false representation or misstatement must have been made by a party to the contract or by
anyone with its connivance, or by its agent. If a stranger makes the misstatement to the contract, it
cannot result in fraud. For instance, A suggests B to buy C ’s car, which according to A runs 15 kmpl.
Later on, B finds that the car runs only 8 kmpl. A was, however, acting neither on instance of C nor
was his agent; he was a stranger. The contract that took place between B and C cannot be stated to
be induced by fraud.

Intention to deceive
Intention to deceive the other party is the essence of fraud. In order to commit a fraud, a person
asserts or misstates the fact with the intention that it should be acted upon. As a matter of fact,
misrepresentation elevates to fraud when it is prefixed by the element of intention to deceive the
other party. For example, A, intending to deceive B, falsely represents that 1000 tons of sugar is pro-
duced annually at his factory, although A is fully aware that only 600 tons of sugar can be produced
annually. B thereby agrees to buy the factory. A has resorted to fraud to obtain the consent of B.

Representation must relate to a fact

The representation made by the party must relate to a fact, which is material to the formation of the
contract. A mere statement of opinion, belief, or commendation cannot be treated as fraud.
For instance, A states that the detergent produced at his factory washes whiter than whitest. The
statement made by A is merely a commendation of the product and not a fact. But if A describes
the ingredients, which the detergent contains, it becomes a statement of fact. And if that is found
incorrect it amounts to fraud, provided A does not believe it to be true.

Active concealment of facts

Self-Learning ‘Active concealment’ must be distinguished from ‘passive concealment’. Passive concealment
38  Material implies mere silence as to material facts, which barring a few cases, does not amount to fraud.
Whereas, active concealment results in when the party takes positive or deliberate steps to prevent Competency of Parties
information from reaching the other party and this is treated as fraud. For example, A sells a horse and Free Consent
to B in an auction despite knowing that the horse is unsound. A says nothing to B about the horse’s
soundness. This is a case of passive concealment of fact and cannot tantamount to fraud.
Notes
In another example, A, a horse dealer, sells a horse to B by inspection. A knows that the horse
has a cracked hoof, which he fills up in such a way as to defy detection. B subsequently discovers
the defect. There is a ‘fraud’ on the part of A on account of active concealment of material fact. B
can avoid the contract as his consent has been induced by fraudulently.

Promise made without intention of performing it

If a person while entering into a contract has no intention to perform his/her promise, there is a
fraud on his/her part, for the intention to deceive the other party is there from the very beginning.
For example, an English merchant appointed an Indian woman as his personal secretary and prom-
ised that he would marry her. Later she came to know that he was already married and had made
the promise without any intention to perform it. It was held that she could avoid the contract on
the ground of fraud [Shireen Mal vs J.J. Taylor 34].
On similar count, a purchase of goods without any intention of paying the price is a fraud and
the contract can be avoided on this ground.

Representation must have actually deceived the other party

The representation made with the intention to deceive must actually deceive. The party, induced by
fraudulent statement, must have relied on it to accord its consent. According to explanation append-
ed to Section 19 of the Contract Act, ‘A fraud which did not cause the consent to a contract of the
party on whom such fraud was practiced does not render a contract voidable’. Thus, an attempt to
deceive does not amount to fraud until the other party is deceived thereby. A case in point is the
following example based on Horse Fall vs Thomas 35. A had a defective cannon. With a view to conceal
the defect, he put a metal plug on it. B without examining it bought it. The cannon burst when used
by B. B refused to pay the price and accused A of fraud. It was held that B was bound to pay because
he was not actually deceived, as he would have bought the cannon even if the deceptive plug had
not been inserted.

Any other act fitted to deceive

The expression ‘any other act fitted to deceive’ obviously means any act that is done with the inten-
tion of committing fraud. This category includes all tricks, dissembling, and other unfair ways, which
are used by cunning and clever people to cheat others. For example, in Ningawwa vs B.S. Hirekura-
bar 36 case, a husband persuaded his illiterate wife to sign certain documents telling her that by the
papers he was going to mortgage her two plots of land to secure his indebtedness. But, in fact, he
mortgaged four plots of land belonging to her. This was held as an act done with the intention of
deceiving the wife.

Other acts or omissions specially declared void

This category includes the acts or omission that the law specially declares to be fraudulent. For ex-
ample, the Insolvency Act and the Companies Act declare certain kinds of transfers to be fraudulent.
Similarly, under the Transfer of Property Act, the transferor of real estate is bound to disclose to the
transferee the following details:
l Material defects, if any, in the property such as cracks in the wall or in beams, and/or

l Any defect or dispute as regards transferor’s title, such as property is subject to encum-

brance, i.e., mortgaged or is subject to some dispute pending in a court of law. An omission
to make such disclosure on the part of transferor amounts to fraud.

The party misled must have suffered some loss

The party deceived must have suffered some loss because as a general rule there can be no fraud
without damage and there can be no damages without an injury. The damage or injury may be some
loss in terms of money or money’s worth or some other detriment, which can be assessed with ease.

Self-Learning
Material   39
Legal and Regulatory Does silence amount to fraud?
Environment of
A person normally cannot be held liable for fraud when he/she simply observes silence over certain
Business
material facts relating to the subject matter of the contract.
Notes The explanation to Section 17 provides: ‘Mere silence as to facts likely to affect the willingness
of a person to enter in to a contract is not fraud, unless
1. The circumstances of the case are such that, it is the duty of the person keeping silence to
speak, or
2. Silence, is, in itself, equivalent to speech’.
Hence, ordinarily, mere silence is no fraud, even if its result in to conceal facts likely to affect the
willingness of a person to enter a contract. The analysis of the Explanation to Section 17 (mentioned
above) shows that silence amounts to fraud in the following two cases:
1. Where it is the duty of the person keeping quiet to speak, and
2. Where the silence is equivalent to speech.

Where ‘it is the duty of the person keeping silence to speak’

Duty to speak arises in contracts of uberrimae fidei, i.e., utmost good faith. These are the contracts in
which the law imposes a special duty to disclose all material facts. Failure to disclose such facts will
amount to fraud and render the contract voidable at the option of the aggrieved party. Examples of
contracts uberrimae fidei are as follows.
Contracts of insurance  In all contracts of insurance, it is the duty of the assured to disclose to the
insurer all material facts concerning the risks to be undertaken. And whatever he/she states must
be correct and truthful. If an assured misstates or conceals material facts (e.g., chronic illness, etc.),
it will render the contract voidable at the option of the insurer.
Contracts of family settlements  Where members of a joint family make agreements for the
settlement of family property, each member of the family must make full disclosure of every mate-
rial fact within his/her knowledge.
Fiduciary relationship  Duty to reveal truth also arises where one contracting party reposes trust
and confidence in the other. A father, for example, while selling a horse to his son, who has just
come of age, must tell him if the horse is unsound, for the son is likely to rely upon his father. The
relationships between a guardian and ward, trustee and beneficiary, and solicitor and client, etc.,
fall under this category.
Contract of share allotment  Where a company invites the public to subscribe to its shares, the
promoters and directors are under statutory obligation to disclose all material information regard-
ing the company.
Others  Full disclosure of material facts must also be made in contracts of marriage, engagement,
sale of immovable property, guarantee, etc.

Where silence is equivalent to speech

The silence of a person is equivalent to speech when he keeps silent irrespective of an enquiry made
by the other person in a positive manner. The person so maintaining silence is no less guilty of fraud.
For example, A sells a TV set to B for a price. The set apparently seems to be faultless. Even then B
says to A, ‘If you don’t deny it, I shall assume that the TV set is not defective’. A keeps mum. Here
A’s silence is equivalent to speech. And if B subsequently discovers any latent defect in the set, it
will amount to fraud.

Consequences of fraud
When consent to a contract is induced by fraud, the aggrieved party usually has the following
remedies:
l He/she can rescind the contract by filing a suit in a court of law and prove the fraud [Section

19].
l He may, if he thinks fit, insist that the contract be performed, and that he be put in the posi-

tion in which they would have been if the representation made had been true [Section 19].
For example, A fraudulently informs B that A’s estate is free from encumbrance. B thereupon
Self-Learning buys the estate. The estate is subject to a mortgage. B may either avoid the contract or may
40  Material insist on it being carried out and the mortgage debt redeemed [Illustration (c) to Section 19].
 l The party defrauded can also claim damages for the loss sustained by him if it is capable of Competency of Parties
assessment. Fraud is a civil wrong, hence compensation is payable. and Free Consent

Fraud distinguished from misrepresentation Notes

Fraud and misrepresentation have many points in common. For instance in both the cases,
(i) consent of one of the parties is not free,
(ii) there is a false representation of facts,
(iii) contract is voidable at the option of the aggrieved party, etc.
Yet the two differ in a number of respects. The major differences between fraud and misrepre-
sentation are summarised in Table 2.2.

Table 2.2 Difference between Fraud and Misrepresentation

S. no. Point of difference Fraud Misrepresentation

1. Nature of act Fraud is an intentional wrong. Misrepresentation is an innocent
The person making the false wrong. The person behind the
representation does not false representation believes it
believe it to be true. to be true.
2. Intention to There is intention to deceive There is no such intention.
deceive the other (contracting) party.
3. Silence In some cases silence may am- Silence can never be construed
ount to fraud, e.g., in the cases as an act of misrepresentation.
of contracts requiring utmost
good faith.
4. Remedies The party defrauded can rescind Misrepresentation merely enti-
available (i.e., cancel) the contract. tles the aggrieved party to res-
A person who suffers loss as cind the contract. Damages
a result of acting in reliance can not be claimed under mis-
on a fraudulent statement can representation.
recover damages in an action
of deceit.
5. Defence Excepting fraud by silence, the A person accused of misreprese-
defendant cannot take the plea ntation can be met with the def-
that the aggrieved party had ence that the misrepresentee
‘the means of discovering the had the ‘means of discovering
truth with ordinary diligence’. the truth with ordinary
diligence’.

Loss of right to rescind a Contract

We have seen that a contract induced by coercion, undue influence, misrepresentation, or fraud is
voidable at the option of the party whose consent was so caused. However, an aggrieved party loses
this right in the following circumstances:
1. Where the aggrieved party after becoming aware of its right of rescission
(i) Expressly affirms the contract, or
(ii) Acts in such a manner which shows that it has accepted the contract, or
(iii) Takes a benefit under the said contract.
2. Where the parties cannot be restored to their original position, e.g., where the subject mat-
ter of the contract has been destroyed or consumed.
3. Where the aggrieved party fails to exercise its right to rescind the contract promptly, i.e.,
within a reasonable time.
4. Where before the contract is rescinded, the third party acquires some right in the subject
matter of the contract of bona fide value.
Self-Learning
Material 41
Legal and Regulatory Mistake
Environment of
Business The term ‘mistake’ literally implies incorrect, or wrong idea or opinion about something caused by
lack of attention, skill, or knowledge, etc. In the context of the law of contracts, it may be defined as
Notes the erroneous belief or misunderstanding in the minds of the contracting parties concerning the law
or facts about the contract. It usually takes place when the concerned parties are not well acquainted
with the terms or subject matter of the agreement and they take the terms in a different sense.
An agreement made under a mistake is not valid for there is no consent.

Types of mistake
The mistakes in relation to contracts are of two types:
1. Mistake of Law
2. Mistake of Fact
The mistake of law can be classified into the following:
(i) Mistake of Law of the Country, and
(ii) Mistake of the Foreign Law
Similarly, the mistake of fact may be classified as follows:
(i) Bilateral Mistake, and
(ii) Unilateral Mistake

Mistake of law
One of the essential elements of a valid contract is that the parties must contemplate to give rise
to legal consequences and intend to create legal relations. Therefore, a person while entering into
a contract must have the knowledge of regulatory framework, i.e., law concerning the contract so
that he can bind himself and the other party legally.
Section 21 provides, ‘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’. Accordingly, mistake of law as stated earlier, may be (a) mistake of law of country or (b)
mistake of foreign law.
Mistake of Law of the Country  As per Section 21, ‘if there is a mistake of law of the country, the
contract is binding’. It is because everyone is deemed to have knowledge of law of the country and
there will be no excuse if he ignores the national law (Ignorantia juris non-excusat). Thus, a mistake
of Indian law will not invalidate the contract.
For example, A and B make a contract grounded on the erroneous belief that a particular debt is
time-barred by the Indian Law of limitation. The contract is valid and not voidable.
Mistake of Foreign Law  A person while entering into a contract with a foreigner should refer to
the law of that country. However, in this case the maxim ‘ignorance of law is no excuse’ does not
apply; the mistake of foreign law is treated as a mistake of fact. Accordingly, mistake of foreign law
renders the contract void.

Mistake of fact
Mistake of fact arises when the parties enter into a contract without understanding the terms and
conditions of the contract properly. It may occur on the part of either party or both the parties. Ac-
cordingly, mistake of facts may be classified further as (a) bilateral mistake, or (b) unilateral mistake.
Bilateral mistake  Where both the contracting parties are under a mistake of fact material to the
formation of the contract, it is called a bilateral mistake of fact. In such a situation there is no agree-
ment at all, for there being complete absence of consent. Bilateral mistake of material facts renders
an agreement void ab initio.
Section 20 provides, ‘Where both the parties to an agreement are under a mistake as to a matter
of fact essential to the agreement, the agreement is void.’ Thus, for declaring an agreement void
under this section, the following three conditions must be satisfied:
Both the parties must be mistaken  Here parties to the agreement assume that a certain state
of things exist which does not actually exist, or in their utter ignorance, the agreement means one
thing to one and a different to the other, and they enter into the contract subject to the assumption
or under that ignorance. For example, A who is having two sets of air conditioners, one imported and
Self-Learning another domestic, offers to sell the domestic one to B. B not knowing that A has two air condition-
42  Material
ers, thinks of the imported one and agrees to buy it. In this case, there is no consent whatsoever, Competency of Parties
and hence, the agreement is void. and Free Consent
Mistake must be of fact  As per explanation to Section 20, ‘An erroneous opinion as to the value
of the thing which forms the subject matter of the agreement is not deemed to be a mistake as to Notes
a matter of fact’. For example, A buys a secondhand TV set from B believing it to be worth ` 5000
and pays ` 5000 for it. While, in fact, it was only worth ` 2000. The contract remains valid. A cannot
blame B for charging exorbitant price for the goods. In fact, he himself is responsible for ignoring
the true value of the TV set and the contract cannot be avoided on the ground of mistake.
The fact about which the parties are mistaken must be essential to the agreement  The fact to
which mistake relates must be essential for the formation of the contract. In express words, mis-
take of only such facts renders the agreement void that goes to the very root of the agreement. For
example, A agrees to buy from B a certain horse. It turns out that the horse was dead at the time
of the bargain, though neither party was aware of the fact. The agreement is void [Illustration (b)
to Section 20].

Types of bilateral mistakes  A bilateral mistake of facts may be of two kinds.

l Mistake as to subject matter or

l Mistake as to the possibility of performance.

Bilateral mistake of facts as to subject matter  In such mistakes, both the parties to an agree-
ment are mistaken about the subject matter of the contract, and the agreement is void. A mistake
as to the subject matter may take various forms. This may relate to existence, identity, title, quantity,
quality, or price of the subject matter. A brief account of all these is given below.
Mistake as to existence of subject matter  Where both the parties at the time of making the
contract believe that subject matter of the contract existences, but in reality it does not, there is
a mistake and the agreement is void. For example, A agrees to sell to B a specific cargo of goods
supposed to be on its way from England to Bombay. It turns out that, before the day of the bargain
the ship conveying the cargo had been cast away and the goods lost. Neither party was aware of
the fact. The agreement is void.
Mistake as to identity  Where the parties to a contract have different subject matter in their
minds, i.e., one party intends to deal with one thing and the other with another; contract is void
there being lack of consensus ad idem. For example, A agreed to buy from B a cargo of 125 bales of
Surat cotton to arrive from Bombay. There were two ships called ‘Peerless’ sailing from Bombay,
one arriving in October and the other in December. A meant the earlier ship and B the latter. It was
held there was no agreement between the parties [Raffles vs Wichelhaus 37].
Mistake as to quantity  Where both the seller and the buyer have a misunderstanding about the
quantity or extent of the subject matter, this will render the contract void. For example, P inquired
about the price of rifles from H suggesting that he might buy as many as fifty. On receipt of the quo-
tation he wired, ‘Send three rifles’. But because of the mistake of the telegraph clerk, the message
transmitted to H was ‘send the rifles’. H dispatched fifty rifles. P accepted three rifles and returned
the remaining forty seven. It was held that there was no contract between the parties. However, P
was liable to pay for the three rifles, there being an implied contract entered into.
Mistake as to quality  If there is a mistake as to quality of subject matter on the part of both the
parties, the contract is void. For example, A offers to buy a race horse from B, a horse dealer. B ac-
cepts the offer believing it to be for a cart horse. The agreement is void.
Mistake as to title  Sometimes, the buyer already owns the property, which a person wants to sell
to him. But the concerned parties are not aware of the fact. In such cases the agreement is void.
For example, A agreed to take a lease of a fishery from B. A was already entitled to the fishery. But
neither party at the time of the transaction was aware of the true state of the title. The agreement
was held to be void [Cooper vs Phibbs38].
Mistake as to price  The agreement is also void where both the parties are mistaken about the
price of the subject matter. For example, A agreed to lease out his quarry to B at the rate of ` 1 per
cubic feet of stone extracted, subject to a minimum rent of ` 5000 per month. But in agreement,
the figure of rent was written as ` 50,000 by mistake. The agreement is void ab initio.
Bilateral mistake as to the possibility of performance  When parties to a contract enter into it Self-Learning
believing that it is capable of performance, while in fact it is not so, there is a mistake of facts as to Material   43
Legal and Regulatory the possibility of performance, and the contract is void on this ground, i.e., impossibility. The impos-
Environment of sibility to perform may arise due to physical reasons or legal reasons. For example, D entered into
Business a contract with R to play in a concert, on a particular day, to be organised by the latter. But D could
not participate in the programme due to illness on that day. The court of law held that the contract
Notes
became void on account of impossibility to perform [Robinson vs Davison 39].
Unilateral mistake When only one party to an agreement is under a mistake of facts, it is termed
as a unilateral mistake. A unilateral mistake is generally of no effect unless
(i) it concerns some fundamental fact and
(ii) the other party has the knowledge of the mistake.
For this reason, error of judgment on the part of one of the parties generally does not make the
agreement void. As per Section 22, ‘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’. The rationale behind enforceability
of a contract caused by a unilateral mistake is a person, who, due to his own misapprehension or lack
of reasonable care does not ascertain what he is contracting about, must bear the consequences.
In contracts of sale of goods, this rule is summed up in the maxim caveat emptor (let the buyer
beware). The seller is under no duty to reveal the defects of his goods to the buyer. For example, A,
a farmer exhibits oats in his farm for sale. B buys oats from A, a sample of which had been shown
to him. B buys the oats erroneously thinking that they were old oats. In fact they were new ones. B
wants to return the oats and refuses to pay the price. B cannot do so, their being an error of judg-
ment on his part, which has no effect, and the contract will remain valid.
However, in some cases, a unilateral mistake may be fundamental and may affect the validity of
the contract. The courts in India have established two judicial precedents, wherein even though the
mistake is unilateral, the agreements are void. They are as under.
Unilateral mistake as to the nature of the contract As a general rule, a person who signs an
instrument is bound by its terms, no matter whether he/she has not gone through its contents. But
a person, who without any fault of his/her own, signs a document under a fundamental mistake as
to its very nature, may avoid it provided the mistake was due to either
1. the blindness, illiteracy, or senility of the person signing or
2. a trick or fraudulent misrepresentation as to the nature of the document.
For example, B, an illiterate old lady with poor eyesight appointed M, one of her close relatives
to manage her property. M prepared a sale deed of all her property in his own name and obtained
her signature thereon, on the pretext that it was needed so as to legally authorise him to manage
the property. It was held that she can avoid the agreement on the basis of unilateral mistake of fact
as to the very nature of the transaction [Bala Devi vs Sante Mazumdar40].
Unilateral mistake as to the identity of the person contracted with A mistake of facts as to
the identity of the person with whom the contract is made will vitiate the contract, there being no
consensus ad idem. For example, where M intends to contract only with A but enters into contract
with B believing him to be A, the contract is void. It should, however, be noted that a mistake about
the identity of the contracting party will render the contract void only if
1. the identity of the party is of material importance to the contracts and
2. the other party knows that it is not intended that it should become a party to the contract.
The matter is best brought out in the case law illustration in Box 2.6.

Box 2.6 When Mistaken Identity Renders the Contract Void

A woman told a jeweller that she was married to one Vander Borgh, a millionaire (with whom she
was in fact living as his mistress), and that he wanted to give her a necklace, which he wished to
buy on approval. The jeweller let her have possession of the necklace and entered in his book as
being out on approval to Vander Borgh. She pledged the necklace with a broker, who in good
faith paid her some amount of money. It was held that there was no contract between the jew-
eller and the woman, since there was no consensus. And even the innocent buyer or a broker
did not get a better title. Accordingly, the broker had to return the necklace to the jeweller. The
jeweller thought that he was dealing with a different person, the wife of Vander Borgh… he never
intended to contract with the woman in question as such [Lake vs Simmons 41].
Self-Learning
44 Material
Effect of Mistake Competency of Parties
and Free Consent
A mistake as to error of judgment or omission on the part of any one or both the parties generally
has no effect on the validity of the contract. For example, if a seller charges excessive price for an ar-
ticle under a mistake as to its true value, it does not render the contract void on the part of the buyer. Notes
To be operative, a mistake must be, as to a matter of fact, essential to the agreement. The effect
of various types of mistakes can be summarised as under.
1. A bilateral mistake of fact, which is fundamental to the agreement, prevents the formation
of any contract at all and it will be declared void [Section 20].
2. A unilateral mistake usually does not vitiate the agreement in question. However, in case of
unilateral mistake of fact, as to the identity of the person contracted with or as to the nature
of the contract, the agreement is treated as void, there being absence of true consent of the
parties.
3. A mistake as to any law in force in India does not affect the validity of the contract. However,
where both the parties are under a mistake as to a foreign law, the contract is void. This is
so because a mistake of foreign law is treated as a mistake of fact [Section 21].
4. A person of whom money has been paid or anything delivered under mistake is bound to
return it, or to make compensation for the same, to the person from whom he had received
it.

Exercises
I. Objective-type Questions
1. Which among the following persons are not competent to contract?
(a) Minors
(b) Persons of an unsound mind
(c) Persons disqualified from contracting
(d) All of the above.
2. Who among the following are usually regarded as persons of unsound mind?
(a) Lunatics (b) Idiots
(c) Intoxicated persons (d) All of the above
3. Which of the following contracts can be enforced against a minor?
(a) Contract for the benefit of a minor
(b) Contract for supply of necessaries
(c) Both (a) and (b)
(d) None of the above
4. A minor was facing a criminal prosecution for smuggling drugs. He borrowed
` 5000 to hire an advocate to defend him in the court of law. What is the
remedy available to the creditor if the minor does not return the money on
his own?
(a) The creditor cannot recover the amount from the minor since a contract
with a minor is void ab initio.
(b) The amount of loan can be recovered from minor’s property since it is a
loan for necessaries.
(c) The creditor can recover his amount of loan from the minor on his (minor’s)
attaining the age of majority.
(d) The creditor can recover his amount from the parent or guardian of the
minor.
5. A minor can be
(a) A promisor (b) A promisee
(c) Both (a) or (b) (d) None of the above
6. Undue influence cannot be presumed between
(a) Guardian and ward (b) Husband and wife
(c) Both (a) and (b) (d) Doctor and patient
Self-Learning
Material   45
Legal and Regulatory 7. In which of the following cases, the agreement is void ab initio?
Environment of (a) Coercion (b) Fraud
Business (c) Bilateral mistake (d) Misrepresentation
Notes 8. ‘Misrepresentation’, means and includes
(a) 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.
(b) Any breach of duty which, without intent to deceive, gains an advantage
of 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.
(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
(d) All of the above
9. The party whose consent was caused by misrepresentation looses the right to
rescind the contract
(a) If he could discover the truth with ordinary diligence
(b) If his consent is not induced by misrepresentation
(c) In both (a) and (b) cases
(d) In none of the above cases
10. A person is deemed to be in a position to dominate the will of another where
(a) He holds a real or apparent authority over the other
(b) He stands in a fiduciary position to the other
(c) He makes a contract with a person whose mental capacity is temporarily or
permanently affected by reason of age, illness, or mental or physical distress
(d) In all the above circumstances
II. Review Questions
1. What do you mean by contractual disability? State and illustrate the law relating
to minor’s agreements.
2. Can a minor, though incompetent to contract, receive a benefit arising there
under?
3. Enumerate persons who are treated as persons of unsound mind. State the legal
position of agreements with such persons.
4. Name the persons disqualified of contracting under other laws for the time being
in force. State and illustrate the legal position of contracts made with them.
5. What do you mean by the term coercion? Describe the effect of coercion on the
validity of the contact.
6. Explain and illustrate the effect of undue influence on contracts. On whom lies
the burden of proving that the contract (i) was and (ii) was not induced by undue
influence?
7. Comment on the following:
(i) ‘Mere silence as to facts is not fraud.’
(ii) ‘An attempt to deceive which does not deceive is no fraud.’
8. What is fraud? Point out its effects on the validity of a contract.
9. Distinguish between:
(i) Coercion and undue influence
(ii) Fraud and misrepresentation
10. Define ‘mistake’. Explain and illustrate the consequences of a mistake on con-
tracts.

10. (d) 9. (c) 8. (d) 7. (c) 6. (b)

5. (b) 4. (b) 3. (c) 2. (d) 1. (d)
Self-Learning Answers to Objective-type Questions
46  Material
 Chapter
2 In Review
Learning Objectives l Every person who has attained the age of majority, who is of sound mind, and who
is not disqualified from contracting by any law to which he is subject is competent to
Competency to contract contract. Thus, minors, lunatics, and persons disqualified (from contracting) by law
Minor; position of an agreement with a minor to which they are subject are barred from making contracts.
l Despite the fact that a minor is incompetent to contract, nothing in the law prevents
Effects of agreements made by a person of him/her from becoming a promisee, transferee, payee, endorsee, and receiver of a
unsound mind benefit arising under a contract. Also, a contract entered into by a parent or guardian
Free consent on behalf of the minor is binding on him/her provided that the contract is within the
scope of the authority of the parent or guardian, is for his/he benefit, or is for legal
Coercion: definition; effect, acts that amount
necessity.
to coercion
l A person of unsound mind, under the Indian Contract Act, is incapable of entering
Undue influence; presumption of domination into a contract.
of will l Moreover, if a contract, entered into by a person of unsound mind, is for his/her ben-

Undue influence distinguished from coercion efit, it can be enforced (for his/her benefit) at law against the other party. A person
of unsound mind usually incurs no liability. But for necessaries supplied to such a
Misrepresentation: definition, classification,
person or to any member of his/her family, from his/her estate, if any, he/she will be
essentials
liable.
Fraud: definition, essentials, consequences l To be legally enforceable, a contract should be based on free consent. Consent is said

Mistake: definition, types, effect to be free when it is not caused by coercion, undue influence, fraud, misrepresenta-
tion, mistake.
l The consent to an agreement is said to be caused by coercion when it is obtained by

Key Terms use of force or under a threat. Committing or threatening to commit an unlawful act
is coercion. Consent induced by coercion renders a contract voidable at the option
Competency: In the context Contract of the party whose consent was so obtained. A makes B to sell his property worth
Law, it refers to one’s ability to enter into twenty five lakhs rupees for ten lakhs rupees by threatening to kidnap his son other-
a contractual relationship wise. ‘Sale deed’ executed by A in B’s favour is voidable at his option as his consent
Minor: A person, domiciled in India, who was induced by coercion.
has not attained the age of 18 years l A contract is said to be induced by ‘undue influence’ where the relations subsisting

Necessaries: Refers to basic between the parties are such that one of the parties is in a position to dominate the
requirements of one’s life will of the other and uses that position to obtain an unfair advantage over the other.
l Misrepresentation refers to a misstatement of facts. Misrepresentation may be inno-
Tort: Implies a civil wrong or breach
cent, negligent, or wilful. In law, when a wrong representation is made intentionally
of duty other than under the contract
or deliberately with the intention to deceive the other party, the term ‘fraud’ is used.
leading to incurring liability for damages
A contract, the consent to which is induced by misrepresentation, is voidable, i.e.,
Sound mind: A person, if at the time valid until avoided.
of making the contract, is capable l In the context of the law of contracts, mistake may be defined as some erroneous
of understanding it, and forming a belief or misunderstanding in the minds of the contracting parties concerning the
judgment as to its effects upon his/her law or facts about the contract.
interests l In cases of coercion, undue influence, misrepresentation, and fraud, an aggrieved
Idiot: A mentally deficient person who party loses its right to rescind the contract, if despite becoming aware of its right
is permanently incapable of rational of rescission, it expressly affirms the contract, or takes a benefit under the said con-
conduct tract. A bilateral mistake of fact, however can render a contract void.
Alien: A person who is the citizen of a
foreign country
Free consent: A consent that is not
caused by coercion, undue influence,
fraud, misrepresentation, or mistake which, while not being a term of Mistake: Implies incorrect, or wrong
Coercion: Forcing or compelling contract, induces the other party to idea or opinion about something
(physically or mentally) a person to enter enter the contract caused by lack of attention, skill, or
into a contract Fraud: Wilful misrepresentation of knowledge, etc.
Misrepresentation: A misstatement of material facts with intent to deceive
fact made by one party to the other, someone

Competency of Parties and Free Consent  47

Legal and Regulatory

Consideration and
3
Environment of
Business

Notes
Legality of Object

© iStock
Learning Objectives
1. Rules governing valid consideration 4. Circumstances under which the object
2. Validity of agreement without or consideration is deemed to be
consideration unlawful
3. Lawful object 5. Effect of partial illegality

Consideration: An Over view

I f the parties to a contract intend to show that their agreement is part of a bargain, each side must
promise to give or do something for the other. This is simply because a promise is not binding
unless it is made for something in return. The requirement of something in return is referred to as
‘consideration’. For instance, the seller of goods undertakes to transfer ownership in the goods and
specifies the price to be paid by the buyer for acquiring the ownership. Similarly, an employer indi-
cates the type of work the employee will be required to perform and promises remuneration for do-
ing it. Thus, consideration is fundamental to the formation of any contract unless not made by deed.

Consideration Defined
Consideration implies that both the contracting parties undertake to give something ‘of value’ to
each other.
Section 2 (d) states, ‘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 an act or abstinence or promise is called a consideration for the promise.’
The above definition shows that the term ‘consideration’ is used in the sense of quid pro quo,
meaning, thereby, something in return. It may involve a positive act (i.e., doing something), or some
forbearance (i.e., giving up something ). Thus, consideration may be in the form of some right, inter-
est, profit, or benefit accruing to one party, or some forbearance, detriment, loss, or responsibility
given, suffered or undertaken by the other. Nevertheless paying or promising to pay money in return
for the supply of goods or services happens to be the most common form of consideration. A few
examples of what is considered as consideration in the eyes of the law are given in Box 3.1.

rules Governing Consideration

The rules governing consideration in the context of the contract are as follows:
1. A contract must be supported by consideration
Self-Learning 2. Consideration must move at the desire of the promisor (promissory estoppels)
48 Material
 Consideration and
Legality of Object
Box 3.1 What is Consideration?
Notes
Example 1
A offers to sell his plasma TV set to B for ` 50,000. B accepts the offer. Here, B’s promise to pay
` 50,000 is the consideration for A’s promise to sell the TV and A’s promise to sell the TV is the con-
sideration for B’s promise to pay ` 50,000.
Example 2
A promises Y, his debtor, not to file a recovery suit against him on B’s agreeing to repay the amount
of loan along with a compound interest at the rate of 12 per cent, per annum within a year. Here,
abstinence on the part of A to file a suit is the consideration for Y based on B’s promise to pay.

3. Consideration may move from the promisee or any other person

4. Consideration must have some value
5. Consideration may be benefit or detriment
6. Consideration may be past, present, or future
7. Consideration need not be adequate, but it must be sufficient
8. Consideration must be legal.
These rules are eloborated in the following subsections.

Contract must be supported by consideration

In the absence of a valid consideration passing between the parties, the contract will be of no legal
effect. Section 25 provides that, subject to certain exceptions (which have been dealt with later in
the chapter), an agreement made without consideration is void. The purpose of the requirement of
consideration is to put some legal limits on the enforceability of agreements even when they are
intended to be legally binding otherwise and are not vitiated by factors, such as mistake, misrepre-
sentation, and illegality. Consideration acts as an aid in determining whether promises are worth
enforcing. The existence of a consideration implies that the parties have devoted some reflection to
the matter, and seriously desire their promises to have legal consequences. In English Law also, no
single promise is enforceable unless it is either made in a deed 3 or supported by some consideration.

Consideration must move at the desire of the promisor

Section 2(d) of the Act provides that consideration must move at the desire of the promisor. Ac-
cordingly, for a promise to be binding as a contract, it is not sufficient that it is supported by some
consideration but also that the consideration has been supplied at the desire of the promisor. This
follows that if an act4 is committed at the desire or request of a third person and not the promisor,
that act does not amount to a valid consideration. In other words, whatever is done must be done
at the desire or request of the promisor and not voluntarily or at the desire of a third party. For in-
stance, if A rushes to the rescue of B whose house has been trapped in fire, it is not a consideration
but a voluntary act on the part of A. A cannot ask B to compensate him for the services rendered by
him as B had never requested him to help. However, if A goes to B’s rescue at the latter’s express
request, this will be regarded as consideration as A did not wish to do the act voluntarily.

Consideration may move from the promisee

The second rule as to consideration as contained in the defi nition of Section 2(d) is that
the act, which is to constitute a consideration, may be done by ‘the promisee or any other
person’. This means that as long as there is a consideration for the promise, it is immaterial who has
furnished it. This is sometimes referred to as Doctrine of Constructive Consideration. It may proceed
from the promisee, or if the promisor has no objection, from any other person who is not a party
to the contract.
Self-Learning
Material 49
Legal and Regulatory Consideration must have some value
Environment of
Business Another notable feature of valid consideration is the idea of reciprocity. ‘Something of value’ must
be given for a promise in order to make it enforceable as a contract. An informal gratuitous promise,
Notes therefore, does not amount to a contract1. A person or body to whom a promise of gift is made from
purely charitable or sentimental motive gives nothing for the promise. Justice Patterson observed
in Thomas vs Thomas2 that consideration means something which is of some value in the eyes of the
law. It may be some benefit to the plaintiff or some detriment to the defendant.

Benefit and detriment

Lush J. in Currie vs Misa concentrated on the requirement that ‘something of value’ must be given,
and accordingly stated that consideration is either some detriment to the promisee (in that he may
give value) or some benefit to the promisor (in that he may receive value). Thus, payment by a buyer
is consideration for the seller’s promise to deliver and can be described as a detriment to the buyer,
or as a benefit to the seller. Conversely, delivery by a seller is consideration for the buyer’s promise
to pay and can be described either as a detriment to the seller or as a benefit to the buyer.

Past, present, or future consideration

Depending on the circumstances and facts of each case, consideration may be either past, present,
or future.
Past consideration In Section 2(d), the expression, ‘has done or abstained from doing’ is recogni-
tion of the doctrine of past consideration. Past consideration means a past act or forbearance that
took place and is complete (wholly executed) before the agreement is made. Past consideration
may consist of services rendered at request but without any promise at the time, or it may consist
of voluntary services. Box 3.2 presents some examples of past consideration.

Box 3.2 Past Consideration

Example 1
In Sindha vs Abraham3, the plaintiff rendered services to A, the defendant, at his desire when he was
a minor. These services were continued even after A attained the age of majority at his request. A
subsequently promised to pay an annuity to the plaintiff. The Bombay High Court held that services
rendered to a minor at his request and which were continued after attaining majority at the same
request were good consideration for his promise to pay.
Example 2
A finds B’s purse and gives it to him. B sent promises to pay A’s expenses in doing so. This is a contract
[Illustration appended to Section 25].

Present or executed consideration The expression in Section 2(d) ‘does or abstains from doing’
refers to present or executed consideration. It is an act or forbearance, which moves simultaneously
with the promise. In other words, a consideration, which consists in the performance of an act or
forbearance, is said to be executed at present.
For instance, A pays ` 1000 to B, and B promises to deliver a certain quantity of wheat the follow-
ing day. In this case, A pays the amount but B has merely made a promise. Therefore, the considera-
tion paid by B is executed, whereas the consideration promised by B is executory. If A pays the price
and B delivers the goods at the same time, consideration is said to be executed by both the parties.
Future or executory consideration The expression ‘promises to do or to abstain from doing’ in
Section 2(d) refers to future. Here the bargain consists of mutual promises. An example is an agree-
Self-Learning ment in which the seller promises to deliver goods next week, and the buyer agrees to pay for them
50 Material
on delivery. However, consideration on part of one party may be executed, and on part of the other Consideration and
executory. Consider the following illustration in this behalf. Legality of Object
In a contract of general insurance, the policy holder pays the premium, and the insurance com-
pany, in return, promises to make good the value of the insured property, if it is damaged or lost. Notes
Here the promise made by the insurance company is a kind of executory consideration and insur-
ance premium paid by the policy holder is a sort of executed or present consideration.

Consideration need not be adequate, but it must be sufficient

Sufficiency of consideration is not the same thing as adequacy of consideration, at least in law. The
word adequate in this context refers to fairly equal to the promise given. On the contrary, sufficiency
is used here as a legal term, and it means that what is promised must be real, tangible, and have
some actual value. The courts do not exist to repair bad bargains [Haigh vs Brooks4]. Adequacy will
be decided by the parties themselves. Explanation 2, added to Section 25 states, ‘An agreement to
which the consent of the promisor is freely given is not void merely because the consideration is
inadequate. . .’ Thus, if A promises to sell his car worth ` 2,00,000 for ` 50,000 only, transaction
shall not be invalid merely because it is not supported by adequate consideration. It is up to the
parties to fix their own prices. Justice Blackburn in Belton vs Madden5 observed that the adequacy
of the consideration is for the parties to consider at the time of making the agreement, not for the
court when it is sought to be enforced. Similarly, in case of a gratuitous bailment of goods, the fact
that the owner has parted with the possession of the goods is sufficient consideration for a promise
by the bailee to take reasonable care of the goods. However, the fact that the consideration is inad-
equate may be taken into account by the court in determining whether the consent of the promisor
was freely given (Explanation 2 attached to Section 25). For example, A agrees to sell a house worth
` 5,00,000 for ` 50,000 only. A subsequently denies that his consent to the agreement was freely
given. In this case, the fact that the consideration is inadequate may be taken into account by the
court in deciding whether or not A’s consent was freely given.

Consideration must be legal and genuine

Consideration may not be adequate but must invariably be legal, i.e., it must not involve an illegal
act. For example, promising to pay money to a witness to turn hostile. An illegal consideration makes
the whole contract invalid. It should be noted that attempting to enter into an illegal contract might
itself give rise to criminal liability.
Furthermore, consideration should not be physically impossible or illusory. For example, promise
to double the money by magic or to make a dead man alive, are impossible acts, and, therefore, such
promises constitute no consideration. Similarly, a son’s promise to his father ‘stop being a nui-
sance’, or an agree- ment to ‘perform an existing obligation’ made with the promisor being illusory
with no considerations.

‘Stranger to a Contract’ and ‘Stranger to Consideration’

A stranger to a contract is one who is not a party to the contract. The rule that consideration ‘may
move from the promisee or any other person’ implies that the consideration is permitted to be
supplied by a third person (i.e., stranger) as well, thereby need not necessarily be supplied by the
promisee himself. In other words, as long as there is a consideration in exchange of a promise, it is
immaterial who has furnished it. Thus, a stranger to the consideration may maintain a suit. But the
English Law on this point is different. In the United Kingdom, the rule is that consideration must
‘move from the promisee’, which means a person to whom a promise was made can enforce it only
if he himself provided the consideration for it. Nonetheless, a stranger to a contract cannot sue upon
a contract under both the British Law and the Indian Law. From this arises the Doctrine of privity of
contract, discussed ahead.

Privity of contract
The ‘Doctrine of Privity’ implies that, in general, a person who is not privy (i.e., having no personal
Self-Learning
interest or part in) to a contract, that is a third party, can neither sue nor be sued on the contract. Material   51
Legal and Regulatory The rule prevents the burden of a contract being imposed on a third party. Therefore, a stranger to
Environment of the consideration must be distinguished from a stranger to a contract. The instances in Box 3.3 will
Business help understand the concept better.
Notes

Box 3.3 Strangers to Contracts

Example 1
A is indebted to B. A sells his property to C who undertakes to discharge his debt vis-à-vis B. In case C
fails to keep his promise, B has no right to sue C because privity of contract exists between B and C.
C is a stranger to the contract (between A and B). The example is based on Jamna Das vs Ram Autar6.
Example 2
In the famous English case of Tweedle vs Atkinson7, A promised B to pay a certain amount to B’s son C
on C’s marriage to A’s daughter, as the young man was to take up the new responsibilities of marital
life. After the demise of both the contracting parties, C sued the executors of A (his father-in-law)
upon the agreement between A and his father. It was held that C could not maintain the suit against
the defendant, being stranger to the contract.

To sum up, in the eyes of the law, there can be a stranger to a consideration but not stranger to
a contract.

Exceptions to the doctrine of privity of contract

The rule that a stranger to a contract cannot sue on the contract is, however, subject to certain
statutory exceptions under both the Indian Law and the English Law. Thus, a person who is not a
party to a contract can sue upon it in the following cases:
1. Trust or charge
2. Assignment
3. Marriage settlements
4. Family settlements
5. Agency
6. Acknowledgement of liability.
Trust or charge In the case of trust or charge, the beneficiary can enforce an agreement, even
though he/she is not a party to it. For example, in Khwaja Muhammad vs Hussaini Begum8, K, the
father-in-law of H, executed an agreement with H’s father to pay ` 500 a month in perpetuity to the
bride (H) in the name of Kharchi-I-Pandan (betel-leaf expenses) which is equivalent of pin money,
in consideration of her marriage to his son. K also gave the charge of certain properties with pay-
ment to H and vested her (H) with the power to enforce it. However, H separated from her husband
following a quarrel. This resulted in stoppage of allowance by H’s father-in-law, K. H, the plaintiff
brought a suit against her father-in-law for the recovery of the arrears of the said annuity. The Privy
Council held that although H was not a party to the agreement (as the agreement was between K
and H’s father), yet, she was entitled, in equity, to enforce her claim.
Assignment In the case of assignment of a contract, when the benefit under a contract has been
assigned, the assignee can sue upon the contract for the enforcement of his rights, title, and inter-
est [Kishan Lal Sadhu vs Pramila Bala Dasi9]. However, a mere nominee cannot sue on the policy as
the nominee is not an assignee.
Marriage settlement In the case of certain marriage contracts, provision of marriage expenses
to female members of Hindu Undivided Family entitles a female member to sue for such expenses
on a partition of the family [Sunder Raja vs Lakshm10].
Family settlements In the case of a family settlement, if the terms of the settlement are reduced
to writing, the members of the family, who originally had not been parties to the settlement, may
Self-Learning enforce the agreement [Shuppu vs Subramanium11].
52 Material
Agency Agency is a major common law exception to the doctrine of privity. A contract of agency Consideration and
arises when one person (the principal) appoints an agent to make a contract on his or her behalf Legality of Object
with third parties. As a general rule, the principal, even if undisclosed, may sue the third party.
Acknowledgement of liability In case someone acknowledges liability to a third person, a binding Notes
obligation is thereby incurred towards the former. This exception covers cases where the promisor by
his conduct, acknowledgement, or otherwise, constitutes himself as an agent of the third party. For
example, A receives money from B for paying it to C, the creditor of B. A subsequently makes part
payment to C informing him that this was out of the money held for him. But A afterwards refuses
to remit the balance. In this case, C will be entitled to recover the same from A [based on Devaraja
vs Ram Krishniah12].

Contracts without Consideration

As a general rule, an agreement made without consideration is void [Section 25]. Consideration is
one of the essential elements to render a contract valid and enforceable. However, the Indian Con-
tract Act contains certain exceptions that make a promise without consideration valid and binding,
stated as under.
An agreement without consideration is valid if it is made out of natural love and affection, and if
(i) made in writing
(ii) registered
(iii) promise to pay a debt barred by limitation law [Section 25 (1)]
The case of Venkataswamy vs Rangaswamy13 is illustrative on this count. In this case, an elder brother,
on account of natural love and affection, promised to pay off the debts of his younger brother.
The agreement was put into writing and was registered. The court held the agreement as valid and
binding.
It should be noted that for an agreement to be enforceable under this clause, it is imperative
that it be made out of natural love and affection. Mere existence of near relation between the
parties does not necessarily import natural love and affection. For example, in Rajlukhy Daber vs
Bhootnath Mookerjee14, B the husband of R by a registered document, after referring to quarrels and
disagreements between them, promised to pay his wife a sum of money for her maintenance and
separate residence. It was held that the promise was unenforceable, as it was not made out of love
and affection.
Promise to compensate for past voluntary services As per Section 25 (2), a promise to compen-
sate, wholly or in part, to a person who has already done something voluntarily for the promisor, or
something that the promisor was legally compellable to do, is enforceable. Box 3.4 presents some
illustrations appended to Section 25 on this count.

Box 3.4 Compensation for Past Voluntary Services

Example 1
A finds B’s missing purse and gives it back to B. B promises to give A ` 50. This is a valid contract.
Example 2
A supports B’s infant son. B promises to pay A’s expenses in doing so. This is a valid contract.

Promise to pay time-barred debt A promise made in writing and signed by the person to be
charged therewith, or by his/her agent to pay a debt (wholly or in part) barred by the law of limita-
tion, is valid without consideration [Section25 (3)]. For example, loan agreements and insurance
contracts in which the promisor agrees to repay a debt or premium, respectively, fall in this category. Self-Learning
Material 53
Legal and Regulatory Completed gift Explanation 1 to Section 25 states that ‘Nothing in this section shall affect the
Environment of validity, as between the donor and donee, of any gift actually made.’ Thus, in case of completed gifts
Business (i.e., gifts actually made), the rule ‘no consideration no contract’ does not apply. Here nearness of
relation between the parties is immaterial even if there may not be any natural love and affection
Notes
between them.
Agency No consideration is mandatory to create an agency [Section 185].
Guarantee In a contract of guarantee, there is no consideration between the creditor and the
surety [Section 127].

Legality of Object: Introduction

Bearing a lawful object or aim is one of the essentials of a valid contract. As a general rule, even if all
other requirements for the formation of a contract are complied with, but the object of the contract
is illegal, the contract will not be enforceable. Section 10 of the Contract Act says, ‘All agreements
are contracts if they are made by the free consent of the parties competent to contract, for a lawful
consideration and with a lawful object, and are not expressly declared to be void’. In the absence
of a lawful object, an agreement is void and cannot become a contract. In this regard Section 23
specifically states, ‘Every agreement of which the object or consideration is unlawful is void’. Thus,
an unlawful object renders an agreement void ab initio.

What is Lawful Object?

The consideration, or object of an agreement, is lawful unless it
1. is forbidden by law, or
2. is of such a nature that, if permitted, it would defeat the provisions of any law, or
3. is fraudulent, or
4. involves or implies injury to the person or property of another, or
5. is regarded as immoral by a court, or is 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. Box 3.5 presents some illustra-
tions of agreements with unlawful objects which are appended to Section 23.

Box 3.5 Agreements with Unlawful Objects

Example 1
A, B, and C enter into an agreement for the division of gains acquired or to be acquired by them by
fraud. The agreement is void as its object is unlawful.
Example 2
A, an agent of a land proprietor, agrees to obtain for B a lease of land belonging to his principal, with-
out the knowledge of his principal. A also agrees on the money to be paid. The agreement between
A and B is void, as it implies a fraud by concealment, by A, on his principal.
Example 3
A agrees to live with B as a concubine. The agreement is void, because it is immoral, though the act
may not be punishable under the Indian Penal Code.

When is Object or Consideration Unlawful?

In the light of the above provision, the circumstances which would make a consideration as well as
object of an agreement unlawful, are discussed as under.

Forbidden by law
Self-Learning Where the object or the consideration of an agreement is the performance of an act which
54 Material is forbidden by law, the agreement is void. Acts or undertakings forbidden by law are those
punishable under any statute as well as those prohibited (expressly or implicitly) by special legis- Consideration and
lations of Parliament and state legislatures. For example, the Excise Act prohibits the production or Legality of Object
sale of excisable articles except upon a licence from the government. For this very reason, the sale
of liquor without licence is prohibited (under the Excise Act) and is, therefore, illegal. A contract Notes
entered into in contravention of a statutory prohibition will be null and void whether such prohibi-
tion is express or implied. To sum up, all agreements involving breach of laws enacted for the
protection or promotion of public interest are void. Box 3.6 provides examples of some void
agreements.

Box 3.6 Void Agreements Forbidden by Law

Example 1
A promises B to drop a prosecution which he instituted against B for robbery, while B promises to
restore the value of the things taken. The agreement is void, as its object is unlawful [Illustration (h)
appended to Section 23].
Example 2
Where a loan was granted to the guardian of a minor to arrange the minor’s marriage has been held
to be contrary to the enactment (Child Marriage Restraint Act) and, therefore, void. Therefore, the
money advanced cannot be recovered [Srinivas vs Raja Ram Mohan].

Defeat the purpose of provisions of any law

Sometimes the object of, or the consideration for, an agreement may be of such a nature that,
though not directly forbidden by law, it would, if permitted, defeat the purpose of the provisions of
the law. An agreement having such an object or consideration is void. Where a legislative enactment
provides penalty for an act or promise, the performance of such an act or promise would amount to
the defeat of that enactment, as it is implicit that the statute intends to forbid that act. For instance,
A’s estate is sold for arrears of revenue under the provisions of an Act of the Legislature, by which
the defaulter is prohibited from purchasing the estate. B, on an understanding with A, becomes the
purchaser and agrees to convey the estate to A on receiving from him the price, which B has paid.
The agreement is void, as it renders the transaction, in effect, a purchase by the defaulter and would
so defeat the object of the law [Illustration appended to Section 23].

Fraudulent
An agreement the object of which is to defraud others is void. Where the parties agree to practice a
fraud on a third person, not a party to the contract, their agreement is unlawful and void. The first
two examples in Box 3.5 fall under this category.
To render an agreement unlawful and void on the basis of fraudulent object or consideration,
the fraud must, however, be established beyond reasonable doubt and cannot be based on mere
suspicion and conjecture.

Injurious to person or property

If the object of an agreement involves or implies injury to the person or property of another, the
agreement is unlawful and void. For example, in Ram Saroop vs Bansi15, a person borrowed ` 100, and
in consideration, executed a bond in favour of the lender, also the plaintiff in this case. The person,
in the bond, promised to work for him for two years failing which he agreed to pay a very exorbitant
rate of interest and the principal amount at once. It was held that the contract was void since the
promise contained in the bond was tantamount to slavery on part of the defendant, which is both
Self-Learning
injurious to a person and illegal.
Material 55
Legal and Regulatory Immoral
Environment of
If the object or consideration of an agreement is opposed to morality, it is void. The following exam-
Business
ples in Box 3.7 would help understand the point better
Notes

Box 3.7 Agreements Based on Immorality Are Also Void

Example 1
A, a landlord, let his house on rent to B, a commercial sex worker, knowing that it would be used
for immoral trafficking. The landlord cannot recover the rent. Here, the object being immoral, the
agreement to pay rent is void [Pearce vs Brookes16].
Example 2
A agrees to let her daughter to B as a concubine. The agreement is void, because it is immoral,
though the letting may not be punishable under the Indian Penal Code (45 of 1860) [Illustration (k)
appended to Section 23].

Agreements opposed to public policy

The term public policy in a wider sense means restriction of freedom of persons from doing some-
thing in the larger interest or for the good of the community. In the context of the Indian Contract
Act, it restricts the freedom of persons to contract in certain areas which are detrimental to public
interest. An agreement is void if the law regards it as opposed to public policy. In law, the doctrine
of public policy covers many heads such as the following:
1. Trading with an alien enemy
2. Interference with administration of justice
3. Marriage brokerage agreements
4. Trafficking in public offices
5. Unfair or unreasonable dealings.
The ordinary function of the courts is to rely on the well-settled heads of public policy and to ap-
ply them to varying situations. For example, A, the manager of a firm, agrees to pass a contract to B
if the latter pays a sum of ` 5000 to the former privately. The agreement tends to create an interest
against obligation and is void on the ground of trafficking in public offices.

Box 3.8 What the Law Says on Partially Legal Agreements?

Example 1
A promises to superintend on behalf of B, a legal manufacture of indigo, and an illegal trafficker in
other articles. B promises to pay A a salary of ` 10,000 rupees per month. The agreement is void,
as the object of A’s promise, and the consideration for B’s promise, is in part unlawful [Illustration
appended to Section 24].
Example 2
A acquired a licence to sell opium and marijuana with the restriction that he would not take any
partner in his ganja business without permission from the collector. He, however, admitted B into
the whole business on receiving from him a fixed sum of money as his share of capital, without seek-
ing the collector’s permission. Later on because of some disagreement between the two, B sought
a dissolution and refund of his capital.
It was held that the contract as to partnership was void and B’s claim was dismissed. The court in its
verdict observed, ‘it is impossible to separate the contract or to say how much capital was advanced
Self-Learning for the opium and how much for the marijuana’ [Gopal Rao vs Kalllappa17].
56 Material
Effect of Partial Illegality Consideration and
Legality of Object
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 [Section 24]. Box 3.8
provides some examples in this regard. Notes
The working rule behind the enforceability of such agreements was explained by Justice Wiles
in Pickering vs Illfracombe18 as, ‘Where you cannot sever the illegal element from the legal part of
a promise, the contract is altogether void, but where you can sever them whether the illegality be
created by statute or by common law, you may reject the bad part and retain the good’.
In other words, where the illegal part can be severed or separated from the legal part (and, of
course, effect can be given to the legal part), the contract is not altogether void but is valid in regard
to that part of it which is legal. If, on the other hand, the different parts of the contract are so closely
interknit that it is not possible to separate the legal from the illegal parts without destroying the
whole, the contract is altogether void.

E xercises
I. Objective-type Questions
1. The expression ‘quid pro quo’ means adequacy of
(a) Consideration (b) Something in return
(c) Damage or injury to one’s interest (d) None of the above
2. Which of the following clauses is not mandatory as regards consideration?
(a) Consideration must move at the desire of the promisor
(b) Consideration may be past, present, or future
(c) Consideration must be legal
(d) Consideration must be adequate
3. In which of the following cases the rule ‘no consideration no contract’ does
not apply?
(a) Agreements in writing (b) Promise to compensate
(c) Creation of an agency (d) In all of the above cases
4. The doctrine of ‘Constructive consideration’ implies:
(a) As long as there is a consideration for a promise, it is immaterial who has
furnished it.
(b) Consideration must be real and not illusory.
(c) Consideration must be legal.
(d) Consideration must move at the desire of the promisor.
5. The term nudum pactum implies:
(a) Something of value (b) Bare promise
(c) Inadequacy of consideration (d) Stranger to consideration
6. An act or a promise is forbidden by law when
(a) It is punishable under the criminal law of the country or is prohibited by
special legislation derived from the legislature
(b) It defeats the provision of any law
(c) It is fraudulent
(d) It involves or implies injury to person or property of another
7. Consideration and object of an agreement are unlawful if
(a) It is forbidden by law
(b) It defeats the provisions of any law or it is fraudulent
(c) It involves or implies injury to the person or property of another or the
court regards it as immoral or opposed to public policy
(d) In all the above cases
8. Dealings with commercial sex workers are regarded as
(a) Immoral (b) Opposed to public policy
(c) Forbidden by law (d) Fraudulent
Self-Learning
Material   57
Legal and Regulatory 9. Which of the following does not fall under the ‘heads of public policy’?
Environment of (a) Trading with enemy (b) Illegal cohabitation
Business (c) Marriage breakage agreements (d) Trafficking in public offices
Notes 10. What is the general rule to decide upon a partially illegal agreement/contract?
(a) 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
(b) Where one cannot sever the illegal from the legal part of a covenant, the
contract is altogether void; but where one can sever them, the bad part can
be rejected and the good can be enforced provided the illegality is created
by common law and not by statute
(c) Where one cannot sever the illegal from the legal part of a covenant, the
contract is altogether void; but where one can sever them, the bad part
can be rejected and the good can be enforced provided the illegality be
created by statute and not by common law
(d) Where one cannot sever the illegal from the legal part of a covenant, the
contract is altogether void; but where one can sever them, the bad part
can be rejected and the good can be enforced whether the illegality be
created by statute or common law
II. Review Questions
1. Define the term ‘consideration’. Discuss in brief the legal rules governing valid
consideration.
2. ‘No consideration, no contract’. Do you agree? Explain. State exceptions to the
rule.
3. Discuss the rule that a stranger to a contract cannot sue. Are there any exceptions
to this rule?
4. Comment on the following:
(a) Consideration may be past, present, or future
(b) Consideration may move from the promisee or any other person on the lat-
ter’s behalf
(c) Stranger to consideration and stranger to contract
(d) Legality of agreements without consideration
(e) Consideration must be ‘something of value’
5. Under what circumstances is the object or consideration of a contract deemed
unlawful? Explain giving suitable examples.
6. Discuss and illustrate the enforceability of a partially illegal agreement.

10. (d) 9. (b) 8. (a) 7. (d) 6. (a)

5. (b) 4. (a) 3. (d) 2. (d) 1. (b)
Answers to Objective-type Questions

Self-Learning
58  Material
 Chapter
3 In Review
Learning Objectives l The term ‘consideration’ is used in the sense of quid pro quo, meaning, thereby,
something in return. It may involve a positive act (i.e., doing something) or some
Rules governing valid consideration forbearance (i.e., something given up).
Validity of agreement without consideration l There are certain rules governing consideration in terms of the formation of the con-

tract, foremost among them being the existence of a consideration in simple con-
Lawful object tracts. Second, consideration moves as per the desire of the promisor, although it
Circumstances under which the object or con- may be moved by the promisee or any other person. The next rule is that it must
sideration is deemed to be unlawful have some value and prove to bring some benefit to the promisor or detriment to
the promise. A bare promise (nudum pactum) is not binding.
Effect of partial illegality
l Consideration can be past, present, or future. It may not be adequate but must in-

variably be legal, i.e., it must not involve an illegal act.

l The cases wherein agreements made without consideration may be valid and en-
Key Terms forceable are those related to natural love and affection, promise to compensate for
Consideration: Something in return; a past voluntary services, promise to pay time-barred debt, completed gift, agency,
positive act or some forbearance and guarantee.
Stranger to a contract: One who is not l Illegality of object or consideration renders an agreement unenforceable. The con-

party to the contract sideration or object of an agreement is lawful unless it is prohibited by law, defeats
the purpose of any provisions of the law, is fraudulent, immoral, involves or implies
‘Doctrine of Privity’: A person who has no
injury to another person, and is opposed to public policy.
personal interest in a contract can neither
l The case of a partially illegal contract is different. Wherever illegal part can be disen-
sue nor be sued on the contract.
gaged from the legal part (and, of course, effect can be given to the legal part), the
contract is not altogether void but is valid and enforceable in regard to such part of
it as is legal. Conversely, if the different parts of the contract are so closely interknit
that it is not possible to sever the legal from the rest of the contract without destroy-
ing the whole, then the contract is altogether null and void.

Consideration and Legality of Object  59

Legal and Regulatory

Void Agreements and

4
Environment of
Business

Notes
Contingent Contracts

© iStock
Learning Objectives
1. Void agreement versus void contract 5. Essentials of a contingent contract
2. Void agreement versus illegal agree- 6. Enforcement of contingent contracts
ment 7. Contingent contracts distinguished
3. Agreements expressly declared void from wagering contracts
4. Restitution of benefits received under
void agreements

What is a Void Contract?

A n agreement enforceable by law is a contract1, but when it is not enforceable it is said to be

void2. Thus, the real test of voidness of an agreement lies in its enforceability at law. A void
agreement never matures into a contract. It is unenforceable from the very beginning and devoid
of any legal effect.

Void Agreement Versus Void Contract

A void agreement should be distinguished from a void contract. Some agreements are (legally)
unenforceable from their very inception. These agreements are called void ab initio. They have no
legal effect at all. A void agreement is a nullity and cannot be ratified even at the pleasure of the
aggrieved party. For example, an agreement with a minor is void ab initio. The minor on attaining the
age of majority cannot ratify it. On the other hand, there may be some agreements, which may be
enforceable at the time of their formation but at a later stage, due to certain reasons, may become
unenforceable. Since such agreements are enforceable initially, they assume the character of a con-
tract but their subsequent unenforceability renders them to be treated as ‘void contracts’ [Section
2(j)]. According to this section, ‘A contract, which ceases to be enforceable by law, becomes void
when it ceases to be enforceable’. For instance, suppose a contract between a foreign national and
an Indian citizen is enforceable in the ordinary course. But the same contract would cease to be
enforceable in the event of an outbreak of war between India and the country, the foreign national
belongs to, and be treated as void. Therefore, a contract may become void for one reason or the
other. But it cannot be void ab initio; it is only an agreement that can be void ab initio.

Void Agreement Versus Illegal Agreement

A viod agreement and an illegal agreement have several things in common in terms of legal effects.
For instance, both are unenforceable and, in general, incapable of specific performance. However,
Self-Learning
60 Material the two differ in a number of ways. A void agreement is different from an illegal one inasmuch
as the former is simply unenforceable but may not necessarily be forbidden by law. For instance,
marrying a minor girl is void but not forbidden by law as the object behind the same is not unlawful. Void Agreements and
An illegal agreement, on the other hand, is one in which the consideration or object is also unlaw- Contingent Contracts
ful. Accordingly, an illegal agreement is not only void and unenforceable but also unlawful (under
the Contract Act) and, therefore, taints and renders all the agreements collateral to it, or springing
Notes
from it, as void and unenforceable. But in case of a merely void agreement, a transaction collateral
or ancillary to the main transaction is not itself void. In short, every illegal agreement is void, but a
void agreement is not necessarily illegal.

Agreements Expressly Declared Void

The following types of agreements are expressly declared void under the Indian Contract Act:
1. Agreements by or with person(s) incapable of contract [Sections 10 & 11]
2. Agreements entered into under a mutual mistake of fact [Section 20]
3. Agreements of which considerations and objects are unlawful in full or in part [Sections
23–24]
4. Agreements without consideration [Section 25]
5. Agreements in restraint of marriage [Section 26]
6. Agreements in restraint of trade [Section 27]
7. Agreements in restraint of legal proceedings [Section 28]
8. Agreements—the meaning of which is uncertain [Section 29]
9. Agreements by way of wager [Section 30]
10. Agreements to do an impossible act [Section 56].
The first five types of agreements have already been discussed in the previous chapters. This
chapter, therefore, is devoted to the discussion of the remaining kinds of void agreements.

Agreements in restraint of marriage

A marriage contract flows from free consent, therefore, restrictions on marriage are regarded as
contra bonos mores, i.e., opposed to public policy.
Section 26 states, ‘Every agreement in restraint of the marriage of any person, other than a mi-
nor, is void.’ An agreement in restraint of marriage is unenforceable on the ground of public policy,
whether it contains an express undertaking that the subject will not marry, or whether on financial
or other grounds it tends to discourage a subject to marry [Re Michelhoms Will Trust 3].

The restraint may be general or partial

If a person, being a major, agrees for good consideration not to marry at all, or not to marry for a
fixed period, or not to marry a particular person or a class of persons, the promise is not binding.
However, a penalty imposed on remarriage does not amount to restraint of marriage. Thus, an
agreement between two co-widows that if one of them remarried, she should forfeit her right to her
share in the deceased husband’s property has been upheld, the court pointing out that no restraint
was imposed upon either of the two widows for remarriage [Rao Rani vs Gulab Rani 4]. Similarly, an
agreement that upon the husband marrying a second woman, if the first elects to divorce him, the
divorce shall be valid and she will not be deprived of her right to maintenance from him.

Agreements in restraint of trade

Certain agreements that seek to impose a restriction on a person’s right to carry on a trade or pro-
fession fall within the restraint of trade doctrine.
In view of their tendency to create monopolies, all restraints of trade are contrary to public policy
and prima facie void, unless they can be regarded as reasonable between the contracting parties,
and as regards the public policy. Freedom of trade and commerce is a fundamental right protected
by the Constitution of India under Article 19(g). Just as the legislature cannot take away individual
freedom of trade, so also the individual cannot barter it away by an agreement. Justice James V.C. in
Leather Cloth Co. vs Lovsont 5 observed, ‘The principle of law is this: Public policy requires that every
man shall be at liberty to work for himself, and shall not be at liberty to deprive himself of the state
of his labour, skill of talent, by any contract that he enters into’.
Section 27 declares in express terms that ‘Every agreement by which any one is restrained from Self-Learning
exercising a lawful profession, trade, or business of any kind is to that extent void’. Some examples Material 61
of agreements in restraint of trade are presented in Box 4.1
Legal and Regulatory
Environment of
Business Box 4.1 Agreements in Restraint of Trade
Notes
Example 1
X, a trader operating in a particular locality, agrees to pay Y, his competitor, in the business, a fixed
amount as compensation so that Y shuts down his business in that locality. The agreement is void.
If X subsequently refuses to pay Y the agreed compensation, the law will not safeguard Y’s interest.
Similarly, if X files a suit seeking closure of Y’s business, the suit will be dismissed no matter whether
the former has already paid the said compensation to the latter.
Example 2
J, the defendant, at the time of taking employment with a company, promised his previous em-
ployer, the plaintiff, that he would not carry on the same business within 800 miles from Chennai
after leaving the company. It was held that the agreement was void [Oakes and Co. vs Jackson6] .

In Section 27, the expression ‘to that extent’ suggests that if in an agreement there are some
covenants which are prohibited whereas others are not, and if the latter can be severed from the
former, then only the former (i.e., covenants that operate as restraint of trade) would be void and
not the whole of the agreement. However, the elimination of objectionable phrases should not alter
the entire scope and intention of the agreement. For example, in Brahmputra Tea Co. Ltd vs Scarth7,
A upon being employed by B, agreed first, not to compete with B (his employer) after leaving the
job and, second, not to injure his employer’s interest during employment. It was held that the first
condition is a restraint of trade but the second is binding.
But where the agreement is not so divisible, it is wholly void [Parasullah Malik vs Chandrakanta
Das8].

Exceptions
Section 27 is general in its terms and declares all agreements in restraint of trade void. But certain
exceptions to this general rule are recognised. These exceptions can broadly be classified in the
following two categories:
1. Statutory exceptions
2. Judicially interpretative exceptions.

Statutory exceptions
These are the ones created by the statutes and include the following:

Sale of goodwill
‘One who sells the goodwill of a business may agree with the buyer to refrain from carrying on a
similar business, 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’ [proviso to Section 27].
Putting the above proviso simply, if the seller of the goodwill of a business promises not to com-
pete with the purchaser of the goodwill, the contract is not void and is enforceable, provided the
restraint appears to be reasonable as to territorial limits and the length of time. In case of dispute,
the court keeping in view the nature of business will decide whether the limits are reasonable.
For instance, A and B are involved in boat manufacturing business at the banks of river Hooghly in
Howrah. Suppose A sells off his business to B for a specified amount and agrees to abstain from
carrying on the same business for a period of three years (i) in Howrah and (ii) in certain other parts
of India. There is a sale of goodwill but with regard to first promise only. The second promise being
unreasonable in terms of territorial limits is void.

Partnership Act
The Partnership Act validates restraint of trade in the following four cases:
Self-Learning 1. A partner shall not carry on any business other than that of the firm while he is a partner
62 Material [Section 11(2)].
 2. A partner may make an agreement with his/her partners that on ceasing to be a partner Void Agreements and
he/she will not carry on any business similar to that of the firm within a specified period or Contingent Contracts
within specified local limits. Such an agreement shall be valid if the restrictions imposed are
reasonable [Section 36(2)].
Notes
3. Partners may, upon or in anticipation of the dissolution of the firm, make an agreement that
some or all of them will not carry on a business similar to that of the firm within a specified
period or within specified local limits. Such an agreement shall be valid provided the restric-
tions imposed are reasonable [Section 54].
4. Any partner may, upon the sale of the goodwill of a firm, make an agreement with the buyer
that he will not carry on any business similar to that of the firm within a specified period or
within specified local limits. Such an agreement shall be valid only if the restrictions imposed
are reasonable [Section 55(3)].
From the above, it is clear that to recognise any agreement in restraint of trade to be valid under
Sections 36(2), 54, or 55(3) of the Partnership Act, the following two conditions must be satisfied:
(i) The agreement specifies the local limits or the period of restraint and
(ii) The restrictions imposed are reasonable.

Judicially interpretative exceptions

These are the exceptions arising from judicial interpretations of Section 27. A brief description of
such exceptions is given ahead.

Trade combinations
Trade combinations are voluntary agreements among traders or manufacturers in the same line of
business to carry on their business in an organised way. Sugar syndicates, Association of Cement
Companies (ACC), General Insurance Corporation of India (GIC), Federation of Indian Chambers of
Commerce and Industry (FICCI) are some of the examples of trade or business associations in India.
Since all these bodies are aimed at regulating their area of business, besides value addition to the
goods they manufacture or the services they provide, and not restraining the same, formation of
such associations are often desirable not only in the interest of trade itself but also in public inter-
est in general. Restrictions imposed on the activities of their group members are, therefore, not to
be considered void on the ground of restraints of trade. For example, In Haribhai vs Sharef Ali9, four
ginning factories entered into an agreement of fixing uniform rate for ginning production and pool-
ing their earnings to be divided among them in certain proportions. It was held that the agreement
among them was valid and enforceable.
The courts, however, would not allow a restraint to be imposed under the guise or pretext of
trade regulations. Thus, an agreement among some persons to carry on business with the members
of their caste only [Vaithelinga vs Saminanda10] and an agreement to confine the business of a sugar
mill within a zone allotted to it [Carew & Co. Ltd. vs North Bengal Sugar Mills 11] were held void and
unenforceable.

Exclusive dealings agreements

An agreement by a manufacturer to sell during a certain period his entire production to a wholesale
merchant or distributor, and the latter in turn agrees to not to deal with the products of any other
manufacturer is valid and not a restraint of trade. Similarly, an agreement among the sellers of a par-
ticular commodity not to sell the commodity for less than a fixed price has been held as enforceable.
To enforce any exclusive dealing agreement, it is, however, necessary that their terms be reasonable,
i.e., they do not unreasonably check competition.
In the light of the above doctrine, the following agreements have been held to be outside the
scope of Section 27 and, therefore, valid and enforceable:
(i) An agreement by a manufacturer of dhotis to supply 1,36,000 pairs of certain description to
the defendant and not to sell goods of that kind to anybody else for a fixed period [Carlies
Nephews & Co. vs Ricknauth Bucktermull 12].
(ii) An agreement by a person to send all the mica (a mineral found as tiny shiny scales in
rocks) produced by him to the plaintiffs, and not to any other firm nor keep any in stock
[Subha Naidu vs Haji Badsha Sahib13].
(iii) An agreement by a person to sell all the salt manufactured by him to a firm for five years
and further agreed not to sell salt to third parties [Mackenzie vs Sriramiah14]. Self-Learning
Material   63
Legal and Regulatory However, the above exception does not apply in the following cases:
Environment of (i) Where a manufacturer or supplier, after meeting all the requirements of a sole buyer, has
Business surplus to sell to others, cannot be restrained from doing so [Har Bilas vs Mahadeo Pandit
15
].
Notes
(ii) Where a seller of combs entered into an agreement with all the manufacturers of combs
in Patna city in which the latter undertook during their life time to sell all their products
to R and to his heirs and not to sell the same to any one else. Holding the agreement
void under Section 27, the court observed, ‘It bound the manufacturers from generation
to generation; it was unrestricted both as to time and place; it was oppressive; it was
intended to create monopolies’ [Shaikh Kalu vs Ram Saran Bhagat16].
Restraints upon employees
An agreement of service by which an employee binds himself/herself during the term of his/her
agreement, not to compete with employer, is not a restraint of trade and therefore valid [Charles-
worth vs Macdonald 17].
However, an agreement to restrain an employee from competing with his/her employer after the
termination of employment would not be allowed by the courts [Brahmputra Tea Co.vs E. Scarth18]. A
contract of employment, as a matter of fact, by its very nature ties the employee to his/her master
only so long as the employment lasts. Public policy requires that neither the worker nor the master
should be deprived of the benefits of the former’s labour, skill, or talent by imposing restrictions
upon his/her future activities. An agreement imposing a restriction on the employee after leaving
an employer will only be reasonable between the parties if there is some proprietary interest of the
employer meriting protection, i.e., trade secrets or business connection. The restriction must not be
wider than reasonably necessary to protect such interests. Such restrictions must be express and
will not be implied by the court [Faccenda Chicken Ltd vs Fowler19].
From the above discussion, it becomes clear that every restraint of trade is prima facie void, but
certain exceptions to this general rule are recognised. Accordingly, each case must be examined
with regard to its special circumstances so as to consider whether the restraint is reasonable and
justified or not. The philosophy to test the justification of every such agreement is that the restraint
is reasonable with respect to both the interests of contracting parties and the interests of the public
at large. The burden of establishing that, as between the parties, the restraint is reasonable lies on
the promisee; the burden of proving that, as far as the public interest is concerned, the restraint is
unreasonable lies on the promisor.

Agreements in restraint of legal proceedings

According to Section 28, every such agreement
1. by which any party thereto is restricted absolutely from enforcing its 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, or
2. which extinguishes the rights of any party thereto, or discharges any party thereto from
any liability, under or in respect of any contract on the expiry of a specified period so as to
restrict any party from enforcing his rights, is void to that extent.
Exceptions
The above provision is, however, subject to the following exceptions:
Referring a dispute to arbitration  This section (i.e., 28) shall not render a contract illegal by
which two or more persons agree that any dispute that 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.
Referring questions that have already arisen to arbitration  Section 28 shall also not render
illegal any contract in writing by which two or more persons agree to refer to arbitration any ques-
tion between them which has already arisen, or affect any provision of any law in force for the time
being as to references to arbitration.

Agreements with uncertain meaning

Self-Learning
Agreements the meaning of which is not certain or capable of being made certain are void [Section
64  Material
29].
 Void Agreements and
Contingent Contracts
Box 4.2 Uncertain Agreements are Void
Notes
Example 1
A agrees to sell to B 100 tons of oil of a specified description, known as an article of commerce. There
is no certainty here to make the agreement void.
Example 2
A, who exclusively deals in coconut oil, agrees to sell to B ‘100 tons of oil.’ The nature of A’s trade
affords an indication of the meaning of the words, and A has entered into a contract for the sale of
100 tons of coconut oil.
Example 3
A agrees to sell B his white horse for ` 500 or ` 1000. There is nothing to show which of the two
amounts was to be given. The agreement is void.
Example 4
A agrees to sell to B all the grain in his granary at Ramnagar. There is no uncertainty here to make
the agreement void.
Example 5
A agrees to sell to B 1000 tons of rice at a price to be fixed by C. As the price is capable of being made
certain, there is no uncertainty here to make the agreement void.

Some illustrations [appended to Section 29], in which agreements have been declared void for
uncertainty are provided in Box 4.2.
It is a necessary requirement that an agreement, in order to be binding, must be sufficiently
definite to enable the court to give it a practical meaning. Its terms must be so definite, or capable
of being made definite without further agreement of the parties, that promises and performances
to be rendered by each party are reasonably certain [Scammell vs Ousten20 ].
However, an agreement cannot be declared void for uncertainty if it is totally silent as to price,
because in such a situation, reasonable price can be determined in accordance with Section 2 of the
Sale of Goods Act and the agreement will be valid.

Agreements by way of wager

The term ‘wager’ literally means ‘a bet’. It implies an arrangement to risk money on the result of an
(uncertain) event. Therefore, wagering agreements are ordinarily betting agreements.
For example, A and B, who are neighbours, bet as to whether a tremor would rock their city on a
particular day or not. A promises to pay B ` 5000 if the city experiences a tremor, and B promises
an equal amount to A, if it does not. This is an arrangement by way of wager.
The Indian Contract Act has, however, nowhere defined a wager or an agreement by way of wager.
Let us now, examine the following two definitions of a wagering contract given by two law experts
to understand the true nature of ‘wager’.
‘A wagering contract may be defined as a promise by A to pay money to B on the happening of
a given uncertain event, in consideration of B paying money to A on the event not happening’.
[Cockburn C.J.]
‘A wagering contract is one by which two persons, professing to hold opposite views touching the is-
sue of a future uncertain event, mutually agree that, depending 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 than the sum or
stake he will win or lose, there 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 under it may either win or
lose, his win or lose being dependent on the issue of the event, and therefore remaining uncertain
until that issue is known. If either of the parties may win but cannot lose, or may lose but cannot Self-Learning
win, it is not a wagering contract.’ [ Hawkins J. ] Material 65
Legal and Regulatory An agreement by way of wager, therefore, implies nothing but a promise to give money or mon-
Environment of ey’s worth upon the determination of an uncertain event. The following are the common examples
Business of agreements by way of wager:
1. Lottery
Notes
2. Gambling
3. Competitions inwhich prizes depend on chance.

Essentials of a wagering agreement

Analysis of the above definitions makes it clear that to make a transaction wager the following
features must be present:
Uncertain event  A wagering transaction in fact is a game of chance. The essence of a wager is the
uncertainty of the event. To constitute a wager, the performance of the bargain must depend on
the ascertainment of an uncertain event.
Mutuality  There must be mutual chances of gain and loss (i.e., each party should stand to win or
lose), according to the result of the uncertain event. If either of the parties may win but cannot lose
or may lose but cannot win, it is not a wagering agreement.
Neither party to have control over the event  In order to effect an agreement by way of wager,
neither party should have control over the happening of the event one way or the other.
No proprietary interest in the event  There being no other real consideration for the making of
such contract, neither party should have any other interest in that contract other than the sum or
stake he will win or lose.

Consequences of wagering agreements

Agreements by way of wager are unenforceable as well as null and void, as they are considered being
opposed to public policy. Section 30 says:
‘Agreements by way of wager are void, and no suit shall be brought for recovering anything al-
leged 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.’
In India, wagering agreements are simply void but not illegal. However, the States of Maharastra
and Gujarat have, also, declared them as illegal. Therefore, particularly in these two states, a wa-
gering agreement being illegal is not only void between the immediate parties but also taints and
renders all the collateral agreements to it void.

Exceptions to wagering agreements

Horse race  A subscription, contribution, or agreement to subscribe or contribute, made or en-
tered into for or towards any prize or sum of money of the value or amount of ` 500 or upwards, to
be rewarded to the winner or winners of any horse race shall not be void. [See proviso to Section 30].
Put simply, contributions, or betting money in horse races, in which there are cash rewards for the
winner or winners are not deemed illegal in the eyes of the law, provided the sum is ` 500 or more.
Prize competitions  Prize competitions, which involve skill and intelligence (i.e., where prizes do
not depend on chance), for example, picture puzzles, literary competitions, and athletic event are
not wagers, provided the amount of prize does not exceed ` 1000. Lord Heward C.J. observed in
Cole vs Odhams Press21, ‘If skill plays a substantial part in the result, and prizes are awarded accord-
ing to the merits of the solution, the competition is not a lottery. Otherwise it is’. An agreement
to subscribe or contribute towards a prize to be awarded to the winner of a lawful game would be
perfectly lawful and enforceable under the law, although depends on the outcome of an uncertain
event. Thus, in an agreement to enter into a wrestling match wherein the winner was to be rewarded
out of the gate money, it was held that the agreement could not be looked upon as one of wagering
in law [Babasaheb vs Rajaram22].
Contracts of insurance  Despite bearing a resemblance to wagering contracts, contracts of insur-
ance cannot be recognised as wagers. The law distinguishes between the two, for the simple reason
that in a contract of insurance the insurer’s object is to preserve himself/herself from financial loss,
Self-Learning called insurable interest, and not to arrange that he/she should gain, or someone else should lose,
66  Material if an uncertain event turns out in a particular way. Contracts of insurance have in fact become a
necessity with the development of trade and are recognised as contracts that the law would enforce. Void Agreements and
An insurance contract could sometimes turn out to be a wager if the party insuring has no insurable Contingent Contracts
interest.
Notes
Agreements to do impossible acts
An agreement to do an act impossible in itself is void [Section 56].
For example, A agrees with B to double treasure by magic. The agreement is void [Illustration (a)
to Section 56].
The law disregards all the agreements to do impossible acts, mainly because of the following two
reasons:
1. First, the persons who purport to agree to do such obviously impossible acts are deemed
to be either non-serious as to performing such acts or unable to understand what they are
doing.
2. Second, a promise to do an act impossible in itself cannot be of any value to the other party
and, therefore, such agreements lack consideration.

restitution of Benefits received Under a Void Agreement

The term ‘restitution’ legally implies giving back or restoration of the money or benefit received
from the plaintiff under the agreement. Section 65, which provides for restitution, says thus:
‘When an agreement is discovered to be void, or when a contract becomes void, any person who
has received any advantage under such an agreement or contract is bound to restore it, or to make
compensation for it, to the person from whom he received it.’
This provision is based on the simple logic that when a contract is no more enforceable, the party
who has received any benefit under such a contract from the other party must return it or make
compensation for the same to the other party. Box 4.3 presents some examples of restitution of
benefit in the event of non-performance of a contract.

Box 4.3 Illustrations of Restitution [Appended to Section 65]

Example 1
A pays B ` 1000 in consideration of B promising to marry C, A’s daughter. C dies by the time of execu-
tion of the promise. The agreement is void, but B must return A the sum of ` 1000.

Example 2
A make a contract with B to deliver him 250 bags of rice before the first of May. A delivers only 130
bags by the specified date, and none after. B retains these 130 bags after the first of May. He is bound
to pay A for the bags that he has kept.

It is important to note that the restitution of benefit received is not allowed in case of expressly de-
clared void agreements with the exception where the minor has entered into an agreement by misrep-
resenting his/her age or otherwise. The doctrine of restitution is applicable to only those agreements
discovered to be void (later on) in addition to contracts, which subsequently become unenforceable
for one reason or the other provided the said reason(s) was/were beyond the control of the promisor.
For example, A agrees to deliver to B after one month 100 quintals of wheat at the rate of ` 500
per quintal and receives ` 10,000 as advance. However, soon after the agreement, the government
by passing a special Act prohibit private sale of wheat. The contract becomes void, but A must return
the advance money received from B.
Acontingent contract implies a contract, the performance of which depends on the happening
or non-happening of an uncertain event, incidental to such contract. Section 31 defines a contingent
contract as follows: Self-Learning
Material 67
Legal and Regulatory Contingent Contracts: Introduction
Environment of
Business 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.
Notes For example, A contracts to pay to B ` 10,000 if B’s house gets burnt down, or X contracts to pay
Y ` 5000 if his scooter is destroyed.
The nature of both the above-mentioned contracts is contingent. Contracts of insurance, indem-
nity, and guarantee are common instances of contingent contracts.

Essentials of a Contingent Contract

A contingent contract has some essential elements such as it is subject to the occurrence or non-oc-
currence of an uncertain event, the event is incidental to the contract, and the contingency should
not be merely a will of the promisor. Let us examine these key elements of a contingent contract.
1. A contingent contract is subject to happening or non-happening of an uncertain event, col-
lateral to it. In other words, performance of such a contract becomes due only upon occur-
rence or non-occurrence of some future uncertain event.
2. The contingent event is of uncertain nature. A contract that is subject to a certain or an
absolute type of condition cannot be regarded as a contingent contract. For example, a
contract in which A agrees to sell 10 bags of cement to B and B agrees to pay the price at
delivery of goods or afterwards is not a contingent contract because these conditions are of
a certain nature. The delivery would take place and the price will become payable. Similarly,
a contract in which A promises to pay B a fixed sum of money on the death of C is not a
contingent contract for the certainty of event. The person in question will definitely expire
one day and an obligation to perform the contract (i.e., to pay the money to B) will arise on
part of A eventually. But where A agrees to deliver to B a certain quantity of cement should
the government lift the ban on free trading of cement is a contingent contract, for the event,
i.e, lifting of the ban in this case, may or may not occur.
3. The uncertain event on which the performance of a contingent contract depends is collateral
or incidental to the contract, i.e., it does not form part of the consideration of the contract
and is independent of it. For example where A, a contractor, agrees to construct a shop for
B and the latter agrees to pay the former ` 10,000 upon the completion of construction, the
contract is merely a conditional one and not contingent because the event (A’s completing
the construction) on which B’s obligation to pay arises is a part of the reciprocal promises
which constitute the contract and not a collateral event. If, however, in the above case, B
promises to pay A the said amount, provided the latter could complete the construction
within a week, the deal in question turns out to be a contingent contract because now the
event, namely, completion of construction work within a week, is a collateral event, upon the
happening of which the contract would be enforced. Thus, to constitute a contingent con-
tract, it is essential that the future uncertain event be collateral to the bargain in question.
4. The contingency should depend on the will of the promisor or the promisee; it (contingency)
should not be the mere will of the promisor. For instance, where A agrees to construct a
swimming pool for B and B agrees to pay A ` 20,000 upon completion of construction work,
provided his architect approves the construction, is a contingent contract. But in the above
case, if B simply promises to pay to A the stated sum if he so chooses, it cannot be a contin-
gent contract.

Enforcement of Contingent Contract

The rules regarding enforcement of contingent contracts, as contained in sections 32 to 36 of the
Act, are summarised as under.
1. Contingent contracts about doing or not doing anything if an uncertain future event hap-
pens, cannot be enforced by law unless and until that event has happened.
If the event becomes impossible, such contracts become void [Section 32]. Box 4.4 explains
the point with some examples.
2. Contingent contracts to do or not to do anything if an uncertain future event does not hap-
Self-Learning pen, can be enforced when the happening of that event becomes impossible, and not before
68  Material [Section 33]. For example, A agrees to pay B a sum of money if a certain ship does not return
 Void Agreements and
Contingent Contracts
Box 4.4 Illustrations
Notes
Example 1
A makes a contract with B to buy B’s house if A survives C. This contract cannot be enforced by law
unless and until C dies during A’s lifetime.
Example 2
A makes a contract with B to sell a horse to B at a specified price, if C, to whom the horse has been
offered, refuses to buy it. The contract between A and B cannot be enforced by law unless and until
C refuses to buy the horse.
Example 3
A contracts to pay B a sum of money when B marries C. C dies without being married to B. The
contract is contingent at the time of inception but has become void subsequently. [Appended to
Section 32]

to a particular port. The ship, however, sinks. The contract can be enforced after the ship
sinks, as after the tragedy the ship’s return will not be possible.
3. If the future event in which a contract is contingent is the way in which a 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 futher contingencies [Section 34]. For example, A agrees to give B
a sum of money if B marries C. However, C marries D. The marriage of B to C must now be
considered impossible although it is possible that D may die one day and that C may after-
wards marry B [Illustration appended to Section 34].
4. 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
occurred, or if, before the time fixed, such event becomes impossible [Section 35]. For exam-
ple, A promises to pay B a fixed sum of money if a certain ship returns within the year. The
contract may be enforced if the ship returns within the year and becomes void if the ship is
destroyed during the year [Illustration (a) appended to Section 35].
5. Contingent contracts to do or not to do anything, if a specified uncertain event does not hap-
pen 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. For example, A promises to pay B a fixed sum of money if a certain
ship does not return within the year. The contract may be enforced if the ship does not return
within a year, or is destroyed within the year [Illustration (b) appended to Section 35].
6. 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 agreement when it is
made [Section 36]. For example, A agrees to pay B ` 1000 if two straight lines should enclose
a space. The agreement is void due to sheer impossibility of the agreement [Illustration (a)
appended to Section 36].
or
7. A agrees to pay B ` 1000 if B will marry A’s daughter C. C was dead at the time of agreement.
The agreement is void [Illustration (b) appended to Section 36].

Contingent Contract Versus Wagering Contract

Although the occurrence of a specified uncertain event is essential to both contingent and wagering
contracts, there are some fundamental points of difference between them. Following are the points
that distinguish a contingent contract from a wagering contract:
1. A contingent contract is a valid contract, whereas a wagering agreement is void.
2. A contingent contract may not consist of reciprocal promises, whereas an agreement by way Self-Learning
of wager is composed of reciprocal promises. Material 69
Legal and Regulatory 3. In a contingent contract, the future uncertain event is merely collateral, whereas in a wager-
Environment of ing agreement, the future uncertain event is the sole determining factor.
Business 4. The parties to a contingent contract have real interest in the occurrence or non-occurrence
of the contingency, whereas it is not so in a wagering agreement. In a wager, the parties have
Notes
no other interest in the occurrence or non-occurrence of event except for winning or losing
the bet amount.

E xercises
I. Objective-type Questions
1. An agreement that provides for release or forfeiture of rights if no suit is brought
within the time stipulated in the agreement is
(a) Valid (b) Void
(c) Void and illegal (d) Enforceable
2. When a transaction is simply void but not illegal, the collateral transaction would
be
(a) Void (b) Illegal
(c) Void and illegal (d) Valid
3. An illegal agreement taints and renders all the incidental transactions
(a) Void (b) Illegal
(c) Void ab initio (d) Enforceable
4. The exceptions arising under judicial interpretation of Section 27 do not include
(a) Trade combinations
(b) Exclusive dealing agreements
(c) Sale of goodwill
(d) Service agreements
5. Which of the following is one of the exceptions to wagering agreements?
(a) Lottery (b) Crossword puzzle
(c) Athletic competitions (d) Competitive event where prize
depends upon chance
6. Which of the following statements are true?
1. A void agreement is a nullity and cannot be ratified even at the pleasure of
the aggrieved party
2. An agreement which ceases to be enforceable by law, becomes void when
it cases to be enforceable
3. A contract which ceases to be enforceable by law, becomes void when it
cases to be enforceable
4. A contract cannot be void ab initio
Answer Codes:
(a) Statements (1), (2) and (3) are true
(b) Statements (1), (3) and (4) are true
(c) Statements (2), (3) and (4) are true
(d) All the four statements true
7. A transaction collateral to the main transaction is not void in case of:
(a) Void agreement (b) Illegal agreement
(c) Void contract (d) Voidable contract
8. The promise will not be in binding in which of the following cases?
(a) If a person, being a major, agrees for good consideration not to marry at
all
(b) If he agrees not to marry for a fixed period
(c) If he agrees not to marry a particular person or a class of persons
(d) In all the above cases

Self-Learning
70  Material
 9. Which of the following statements is true in relation to ‘agreements in restraint Void Agreements and
of trade’? Contingent Contracts
(a) All restraints of trade are contrary to public policy and prima facie void
(b) All restraints of trade are void and prima facie contrary to public policy
(c) All restraints of trade are contrary to public policy and prima facie void, Notes
unless they can be regarded as reasonable between the contracting parties,
and as regards the public policy
(d) All restraints of trade are void and prima facie contrary to public policy,
unless they can be regarded as reasonable between the contracting parties,
and as regards the public policy.

10. Which among the following is a statutory exception to the general rule - all agree-
ments to the restraint of trade are void?
(a) Sale of goodwill
(b) Exclusive dealing agreements
(c) Restraint upon employees
(d) Trade combinations
II. Review Questions
1. Discuss in brief the law relating to agreements, expressly declared void under
the Indian Contract Act.
2. ‘An agreement in restraint of trade is void’. Elaborate mentioning exceptions to
it, if any.
3. ‘Contingent contracts are a class of conditional contracts and the condition is of
uncertain nature.’ Comment.
4. What are the essential features of contingent contracts? State the rules regarding
enforcement of such contracts.

10. (a) 9. (c) 8. (d) 7. (a) 6. (b)

5. (c) 4. (c) 3. (b) 2. (d) 1. (b)
Answers to Objective-type Questions

Self-Learning
Material   71
 Chapter
4 In Review
Learning Objectives l The Contract Act has declared some agreements as expressly void. They include
agreements by or with parties incompetent to contract; persons incapable of con-
Void agreement versus void contract tracting; agreements of which considerations and objects are unlawful; agreements
Void agreement versus illegal agreement without consideration; agreements in restraint of marriage; agreements in restraint
of trade; agreements in restraint of legal proceedings; agreements with an element
Agreements expressly declared void of uncertainty; agreements by way of wager; and agreements to perform an impos-
Restitution of benefits received under void sible act.
agreements l Damages cannot be claimed by a party injured by attempting to comply with a void

contract. When a contract is exposed to be void, any person who has received any
Essentials of a contingent contract
benefit under such contract is bound to restore it, or to make compensation for it, to
Enforcement of contingent contracts the person from whom he received it.
Contingent contracts distinguished from wa- l A ‘contingent contract’ is one to do or not to do something, if some event, collateral

gering contracts to such contract, does or does not happen. Contingent contracts to do or not to do
anything if an uncertain future event happens cannot be enforced by law unless that
event has happened. If the event becomes impossible, such contracts become void.
Key Terms l 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
Void contract: A contract not enforceable and not before.
by law l Although the occurrence of a specified uncertain event is essential to both contin-

Restitution: Giving back or restoration of gent and wagering contracts, there are some fundamental points of difference be-
the money or benefit received from the tween the two. The former is valid, but a wagering contract is void, and even illegal in
plaintiff under the agreement the states of Gujarat and Maharashtra. Contingent contracts do not contain recipro-
Contingent contract: A contract to do or not cal promises like wagering contracts. Parties to a contingent contract have real inter-
to do something, if some event collateral to est in the occurrence or non-occurrence of the contingency, whereas in a wagering
the contract, does or does not happen agreement there is no other interest in the incident except winning or losing the bet
amount.

72  Legal and Regulatory Environment of Business

 Discharge and

Discharge and
5
Breach of Contracts

Breach of Contracts Notes

© iStock
Learning Objectives
1. Discharge of a contract 5. Specific performance
2. Breach of contract and remedies 6. Injunction
3. Rescission 7. Quantum meruit
4. Damages

Performance of Contract Defined

T he term ‘performance of contract’ means that both the promisor and the promisee have ful-
filled their respective obligations, which the contract placed upon them. For instance, A visits a
stationery shop to buy a calculator. The shopkeeper delivers the calculator and A pays the price. The
contract is said to have been discharged by mutual performance.
According to Section 37, ‘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’.
Promises bind the representatives of the promisor in case of the death of the latter before per-
formance, unless a contrary intention appears in the contract.
Thus, it is the primary duty of each contracting party to either perform or offer to perform their
respective promises. For performance to be effective, the courts expect it to be exact and complete,
i.e., the same must match the contractual obligations. However, where under the provisions of the
Contract Act or any other law, the performance can be dispensed with or excused, a party is absolved
from such a responsibility.

Types of Performance
Performance, as an action of the performing, may be actual or attempted.

Actual performance
When a promisor to a contract has fulfilled his obligation in accordance with the terms of the con-
tract, the promise is said to have been actually performed. Actual performance gives a discharge
to the contract and the liability of the promisor ceases to exist. For example, A agrees to deliver 10
bags of cement at B’s factory and B promises to pay the price on delivery. A delivers the cement on
the due date and B makes the payment. This is actual performance.
Actual performance can further be subdivided into substantial performance and partial
performance.
Self-Learning
Material 73
Legal and Regulatory Substantial performance 
Environment of
This is where the work agreed upon is almost finished. The court then may order that the money must
Business
be paid, but deducts the amount needed to correct minor existing defect. Substantial performance
Notes is applicable only if the contract is not an entire contract and is severable. The rationale behind
creating the doctrine of substantial performance is to avoid the possibility of one party evading
his liabilities by claiming that the contract has not been completely performed. However, what is
deemed to be substantial performance is a question of fact to be decided in each case. It will largely
depend on what remains undone and its value in comparison to the contract as a whole.

Partial performance 
This is where one of the parties has performed the contract, but not completely, and the other side
has shown willingness to accept the part performed. Partial performance may occur where there is
shortfall on delivery of goods or where a service is not fully carried out.
There is a thin line of difference between substantial and partial performance. The two following
points would help in distinguishing the two types of performance.
Partial performance must be accepted by the other party  In other words, the party who is at
the receiving end of the partial performance has a genuine choice whether to accept or reject. Sub-
stantial performance, on the other hand, is legally enforceable against the other party.
Payment is made on a different basis from that for substantial performance  It is made on
quantum meruit, which literally means as much as is deserved. So, for example, if half of the work has
been completed, half of the negotiated money would be payable. In case of substantial performance,
the party that has performed can recover the amount appropriate to what has been done under the
contract, provided that the contract is not an entire contract, i.e., severable with ease . The price is,
thus, often payable in such circumstances, and the sum deducted represents the cost of repairing
defective workmanship.

Attempted performance
When the performance has become due, it is sometimes sufficient if the promisor offers to perform
his obligation under the contract. This offer is known as attempted performance or more commonly
as tender. Thus, tender is an offer of performance, which, of course, complies with the terms of the
contract. If goods are tendered by the seller but refused by the buyer, the seller is discharged from
further liability, given that the goods are in accordance with the contract as to quantity and quality,
and he may sue the buyer for breach of contract if he so desires. The rationale being that when a
person offers to perform, he is ready, willing, and capable to perform. Accordingly, a tender of per-
formance may operate as a substitute for actual performance and can effect a complete discharge.
In this regard, Section 38 says:
‘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. For example, A contracts to deliver to B 100 tons of basmati rice at his
warehouse on 6 March 2004. A takes the goods to B’s place on the due date during business hours,
but B, without assigning any good reason, refuses to take the delivery. Here, A has performed what
he was required to perform under the contract. It is a case of attemped performance and A is not
responsible for non-performance of B nor does he thereby lose his rights under the contract.’

Essentials of Valid Tender

In order to be a valid tender or offer of performance, it must fulfil the following conditions:
1. It must be unconditional [Section 38(1)]. In order to be legally enforceable, a tender should
not only be in accordance with the contractual terms, the promisor should also not at-
tach any condition to it, because it is not reasonable to compel the other party to accept a
changed or otherwise modified performance, whatsoever.
2. It must be made at a proper time and place [Section 38(2)]. If a person’s obligation is to
deliver goods or render services, they must be tendered at a reasonable hour, for example,
Self-Learning not in the middle of the night. If such a tender is refused, it will not release the tendering
74  Material party from further obligation.
 3. It must be made under such circumstances that the person to whom it is made may have Discharge and
a reasonable opportunity of ascertaining that the person by whom it is made is able and Breach of Contracts
willing, and then do what he is bound by his promise to do [Section 38(2)]. For instance, if
a debtor sends money by post and it is lost, he will have to pay again, unless the mode of
Notes
delivery was requested by the creditor and the debtor took reasonable care.
4. If the offer is to deliver a particular thing to the promisee, the promisee must have a reason-
able opportunity of seeing that the thing offered is the same that the promisor is bound by
his promise to deliver [Section 38(3)]. For example, if a seller tenders too few goods, too
many goods, or the right amount of goods mixed with other goods, the buyer may reject all
of them because the performance is not exact. The buyer can also reject the tender where
the goods are not packed in accordance with the contract.
As regards payment of money, it must comply with the following rules:
(i) It must be in accordance with the rules relating to ‘legal tender’. For instance, a tender
of notes of any bank other than the Reserve Bank of India is not legal tender, even
though the creditor may waive his objection to the tender, if he wishes. If a debtor offers
100 US Dollars towards the payment of ` 3000, it will not be a legal tender although it
is worth much more than collector’s amount.
(ii) There must be no request for change. In other words, exactly the right amount of
cash must be tendered. For example, if someone offers a ` 1000 note for the set-
tlement of ` 600 debt, the same will not release the debtor from his obligation to pay,
since it is not reasonable to compel the creditor to provide change.
(iii) Tender by cheque or any other negotiable instrument such as a debit card or credit card
is not a good tender, unless the creditor does not object. It should be noted that if a
proper tender of money is refused, the debt is not discharged, but if the money is paid
into court, the debtor has a good defence to an action by his creditor, and the debt does
not bear interest.
5. An offer to one of the several joint promises has the same legal consequences as an offer
to all of them. For instance, A contracts to deliver at B’s warehouse, which is jointly owned
by B, C, and D on March 1, 100 bales of cotton of a particular quality. In order to make an
offer of performance with the effect stated in this section, A must bring the cotton to B’s
warehouse, on the appointed day, under such circumstances that B or even C or D on B’s
behalf may have a reasonable opportunity of satisfying himself that the commodity offered
(brought in this case) is cotton of the quality contracted for, and that there are 100 bales.
Despite the problems that can sometimes occur in performance, most contracts are nevertheless
satisfactorily discharged in this way.

By Whom can Contract be Performed?

The following entities are perceived to be competent to perform a contract.
Promisor  If it appears from the nature of any case that it was the intention of the contracting
parties that any promise contained in the contract should be performed by the promisor himself,
such a promise must be performed by the promisor himself [Section 40].
Agent  Where personal consideration is not the subject matter of the contract, the promisor or his
representatives may employ a competent person to perform it [Section 40]. For example, A prom-
ises to pay B a sum of money. A may perform this promise, either by personally paying the money to
B or by causing it to be paid to B by someone else; if A dies before the time appointed for payment,
his representatives must perform the promise, or they may employ some able person to do so.
Or,
A promises to paint a picture for B. He must perform this promise personally. In other words, he
cannot have the picture painted by any agent or representative.
Legal representative  Promises bind the representatives of the promisors. This will hold good
even in case of death of the promisors before performance, unless an exemption to that effect is
stated in the contract itself [Section 37]. However, in contracts of personal nature or where per-
sonal consideration is the subject matter of the contract, such promises come to an end should the Self-Learning
promisor die, and therefore, such contracts cannot be performed by the representatives. This has Material   75
been illustrated in Box 5.1.
Legal and Regulatory Third person  When a promisee accepts performance of a promise from a third person, he cannot
Environment of afterwards enforce it against the promisor [Section 41].
Business
Joint promisors  When two or more persons have made a joint promise, then, unless a contrary
Notes intention appears by the contract, all such persons must perform the promise during their lifetime.
In case of death of any of them, his representative jointly with the survivor or survivors must per-
form the promise, and, after the death of the last survivor, the representatives of all the promisors,
must fulfil the promise jointly [Section 42].
Simply put, it means that if two or more persons jointly make a promise, then unless stated oth-
erwise in the contract, the promise should be jointly fulfilled by all the promisors, and in the event
of the death of any promisor/s, the representatives of the deceased promisor would be liable to
perform the promise, jointly with the surviving promisors. After the death of the last survivor, the
promise would be fulfilled by the representatives of the promisors jointly.

Who can Demand Performance?

Ordinarily, it is only the promisee who can demand performance of the promise under a contract.
This is simply because a stranger to the contract cannot sue, and the person who can demand per-
formance is the party to whom the promise is made. In other words, a third party cannot demand
performance of the contract even if it was made for his benefit due to privity of contract. For exam-
ple, A promises B to carve the statute of C, father of B. The person who can demand performance is
B and not C. However, depending on the circumstances, persons other than the promisee can also
demand performance. In accordance with Section 37, in the event of the death of the promisee, his
legal representative can demand performance unless a contrary intention appears in the contract.
However, this is not possible if the contract is of personal nature. Moreover, in case of a joint prom-
ise, the promisee may, in the absence of express agreement to the contrary, compel any one or more
of the joint promisors to perform the entire promise [Section 43].

Time and Place for Performance

The time and place of performance are the matters to be determined by agreement between the
parties to the contact. Certain general rules have been laid down regarding the same by the Contract
Act under Sections 46–50. They are summarised as follows.
Where no time is specified  A contract is not bad for want of certainty if time for performance is
not stated. Where the time for performance is not specified in the contract, the promise must be
performed within a reasonable time. The question ‘What is a reasonable time’ is a question of fact
in each particular case. Reasonable time is a relative term that is considered on a case-to-case basis
[explanation added to Section 46].
Where time is specified  When a contract specifies the time and place for its performance, the
parties must perform accordingly. But, when the contract is to be performed on a certain day, and
the promisor has undertaken to perform without a request from the promisee, he may perform
it at any time during the usual business hours on that day at the specified place. For example, A
promises to deliver goods at B’s warehouse on the January 1. On that day A brings the goods to B’s
warehouse, but after the usual hours for closing, and they are not received. It is deemed that A has
not performed his promise [Section 47].
On application by promisee for performance  When a promise is to be 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. The question ‘What is a proper time and place’ is, in each particular case, a question of
fact [Section 48].
Without application by the promisee  When a promise is to be performed without a request by
the promisee, and no place is fixed for its performance, the promisor must request the promisee to
fix a reasonable place for the performance and perform the promise at such place. For example, A
undertakes to deliver a thousand sacks of jute to B on a specific date. A must apply to B to appoint
Self-Learning a suitable place for the delivery and must deliver it to B there [Section 49].
76  Material
Performance in manner or at time prescribed or sanctioned by promisee Sometimes the prom- Discharge and
isee himself prescribes or states the manner and the time of performance. If it is so, the promisor Breach of Contracts
must perform accordingly. Box 5.2 presents some examples to help understand the point better
[Section 50]. Notes

Performance of Reciprocal Promises

The legal rules governing reciprocal promises are contained in Sections 51–54 of the Contract Act.
They can be summarised as follows.
Promisor is not bound to perform unless promisee is ready and willing A promisor is not bound
to perform, unless the promisee reciprocates and is ready and willing to perform his part of the con-
tract. When a contract consists of reciprocal promises to be simultaneously performed, no promi-
sor need to perform his promise unless the promisee is ready and willing to perform his reciprocal
promise [Section 51] Refer to Box 5.1 for examples explaining Section 51.

Box 5.1 Promisor Not Bound to Perform Unless Promisee is

Ready to Perform

Example 1
A and B entered into a contract that A shall deliver goods to B and B will pay for the good to A on
the delivery of the goods . A need not deliver the goods, unless B expresses readiness and willing to
pay for the goods on delivery. B need not pay for the goods, unless A is ready and willing to deliver
them on payment.
Example 2
A and B entered into a contract that A shall deliver goods to B at a price to be paid in installments,
the first installment to be paid on delivery. A need not deliver, unless B is ready and willing to pay
the first installment on delivery. Likewise, B need not pay the first installment, unless A is ready and
willing to deliver the goods on payment of the first installment.

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; where the
order is not expressly fixed by the contract, they shall be performed in that order which the nature
of the transaction requires [Section 52]. The following examples in Box 5.2 drive home the point.

Box 5.2 Order of Performance of a Contract

Example 1
A and B contract that A shall build a house for B at a fixed price. A’s promise to build the house must
be performed before B’s promise to pay for it.
Example 2
A and B contract that A shall make over his stock-in-trade to B at a fixed price, and B promises to
give security for the payment of the money. A’s promise need not be performed until the security
is given, for the nature of the transaction requires that A should have the security before he delivers
his stock.

Liability of party preventing event on which the contract is to take effect When a contract
contains reciprocal promises, and one party to the contract prevents the other from performing his Self-Learning
Material 77
Legal and Regulatory promise, the contract becomes voidable at the option of the party so prevented, and it is entitled
Environment of to compensation from the other party for any loss which it may sustain in consequence of the non-
Business performance of the contract [Section 53]. For instance, A and B contract that B shall execute certain
work for A for ` 1000. B is ready and willing to execute the work accordingly, but A prevents him
Notes
from doing so. The contract is voidable at the option of B, and if he elects to rescind it, he is entitled
to recover compensation from A for any loss which he has incurred due to the non-performance of
the contract.
Effect of default as to that promise which should be first performed When a contract consists
of reciprocal promises, such that one of them cannot be performed, or that its performance cannot
be claimed till the other has been performed, and the promisor of the promise 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 it may sustain by the non-performance of the
contract [Section 54].
In other words, in a contract involving reciprocal promises, wherein the performance of one
depend on the other and cannot precede the other, then the promisor of the first promise cannot
claim the performance of the reciprocal promise without fulfilling his obligation and is bound to
compensate the other party for any loss it may incur on account of non-performance of the contract.
Some examples to this effect are provided in Box 5.3.

Box 5.3 Defaulting Promisor Must Compensate the Other

Party

Example 1
A hires B’s ship to dispatch a cargo from Kolkata to Mauritius. The cargo is to be provided by A, while
B is to receive a certain freight for its conveyance. A does not provide any cargo for the ship. A cannot
claim the performance of B’s promise and must make compensation to B for the loss which B sustains
by the non-performance of the contract on the part of A.
Example 2
A promises B to sell him 100 bales of merchandise to be delivered next day, and B promises A to pay
for them within a month. A does not deliver the bales as per the promise. B’s reciprocal promise to
pay need not be performed, and A must make compensation.

Discharge of Contract
Discharge of a contract implies termination of contractual obligations. This is because when the
parties originally entered into the contract, the rights and duties in terms of contractual obligations
were set up. Consequently when those rights and duties are put out then the contract is said to have
been discharged. Once a contract stands discharged, parties to it are no more liable even though
the obligations under the contract remain incomplete.
A contract is deemed to be discharged, that is, concluded, and no longer binding, in the following
circumstances.
1. Performance 5. Operation of law
2. Agreement 6. Accord and satisfaction
3. Lapse of time 7. Breach
4. Impossibility of performance
We shall examine each of them as follows.

Discharge by performance
Where both the parties have either carried out or tendered (attempted) to carry out their obli-
gations under the contract, it is referred to as discharge of the contract by performance. Because
performance by one party constitutes the occurrence of a constructive condition, the other party’s
duty to perform is also triggered, and the person who has performed has the right to receive the
Self-Learning
other party’s performance. The overwhelming majority of contracts are discharged in this way. We
78 Material
have already learnt about it earlier in the chapter.
Discharge by substituted agreement Discharge and
Breach of Contracts
A contract emanates from an agreement between the parties. It thus follows that, the contract must
also be discharged by agreement. Therefore, what is required, inevitably, is mutuality. Discharge by
substituted agreement arises when a contract is abandoned, or the terms within it are altered, and Notes
both the parties are in conformity over it. For instance, A and B enter into some agreement, and A
wants to change his mind and not to carry out his terms of the contract. If he does this unilaterally,
then he will be in breach of contract to B. However, if he approaches B and states that he would like
to be released from his liabilities under the contract, then the latter might agree. In that case, the
contract is said to be discharged by (bilateral) agreement. In effect B has promised not to sue A if
he does not perform his part of the contract and the consideration for his promise is A’s promise
not to sue B. Discharge by agreement may arise in the following ways.
Novation  The term novation implies the substitution of a new contract for the original one.
This arrangement may be either between the same parties or between different parties. For a
novation to be valid and effective, the consent of all the parties, including the new one(s), if any, is
essential. Moreover, the subsequent or second agreement must be one capable of enforcement in
law, the consideration for which is the exchange of promises not to enforce the original contract.
Rescission  This refers to cancellation of all or some of the material terms of the contract. If the
contracting parties mutually decide to do so, the respective contractual obligations of the parties
stand terminated.
Alteration  This refers to a change in one or more of the terms of a contract with the consent of
all the contracting parties. Alteration results in a new contract but parties to it remain the same.
Here the assumption is that both the parties are to gain a fresh but different benefit from the new
agreement.
Remission  This means the acceptance (by the promisee) of a lesser sum than what was contracted
for, or a lesser fulfilment of the promise made. As per Section 63, ‘every promisee may (a) remit or
dispense with it, wholly or in part, or (b) extend the time of performance, or (c) accept any other
satisfaction instead of performance’.
Waiver  The term waiver implies abandonment or relinquishment of a right. Where a party deliber-
ately abandons its rights under the contract, the other party is released of its obligations, otherwise
binding upon it.

Discharge by lapse of time

A contract stands discharged if not enforced within a specified time called the ‘period of limita-
tion’. The Limitation Act, 1963, prescribes the period of limitation for various contracts. For instance,
period of limitation for exercising right to recover an immovable property is 12 years, and right to
recover a debt is 3 years. Contractual rights become time barred after the expiry of this limitation
period. Accordingly, if a debt is not recovered within three years of its payment becoming due, the
debt ceases to be payable and is discharged by lapse of time.

Discharge by impossibility of performance

Sometimes after a contract has been established, something might occur, though not at the fault of
either party, which can render the contract impossible to perform, or illegal, or radically different
from that originally undertaken.
However, if whatever happens to prevent the contract from being performed
1. has not been caused by either party,
2. could not have been foreseen, and
3. its effect is to destroy the basis of the contract,
then the courts will, generalty , state that the contract has become impossible to perform. If
that happens then the contract is discharged and neither party will have any liability under
it. Section 56 of the Contract Act clearly provides that an agreement to do an act impossible
in itself is void
The performance of a contractual obligation may become subsequently impossible1 on a number Self-Learning
of grounds. They include the following. Material   79
Legal and Regulatory Objective impossibility of performance  A contract may be discharged if, after its formation,
Environment of performance becomes objectively impossible , as in the following circumstances:
Business (a) Destruction of the subject matter of the contract;
(b) Death or permanent incapacity of the parties (insanity, etc.) where the contract is personal
Notes
in nature;
(c) Outbreak of war, war restrictions (avoidance of trading with alien enemy, and so on);
(d) Imposition of government restriction or change in law that renders performance illegal;
(e) Non-existence or non-occurrence of a particular state of things.
Commercial impracticability  A contract is discharged when performance may be excused if it
becomes much more difficult or expensive than contemplated when the contract was formed.
Frustration of purpose  A contract will be discharged if supervening circumstances make it im-
possible to attain the purpose the parties had in mind.
Temporary impossibility  An event that makes it temporarily impossible to perform will suspend
performance until the impossibility ceases. This too might lead to discharge of a contract on ground
of impossibility.

Discharge by operation of law

A contract stands discharged by operation of law in the following circumstances.
Unauthorised material alteration of a written document  A party can treat a contract discharged
(i.e., from his side) if the other party alters a term (such as quantity or price) of the contract without
seeking the consent of the former.
Statutes of limitations  A contract stands discharged if not enforced within a specified period called
the ‘period of limitation’. The Limitation Act, 1963, prescribes the period of limitation for various
contracts. For instance, period of limitation for exercising right to recover an immovable property is
12 years and right to recover a debt is 3 years. Contractual rights become time barred after the expiry
of this limitation period. Accordingly, if a debt is not recovered within three years of its payment
becoming due, the debt ceases to be payable and is discharged by lapse of time.
Insolvency  A discharge in bankruptcy will ordinarily bar enforcement of most of a debtor’s con-
tracts.
Merger  A contract also stands discharged through a merger that occurs when an inferior right
accruing to party in a contract amalgamates into the superior right ensuing to the same party. For
instance, A hires a factory premises from B for some manufacturing activity for a year, but 3 months
ahead of the expiry of lease purchases that very premises. Now since A has become the owner of
the building, his rights associated with the lease (inferior rights) subsequently merge into the rights
of ownership (superior rights). The previous rental contract ceases to exist.

Discharge by accord and satisfaction

To discharge a contract by accord and satisfaction, the parties must agree to accept performance
that is different from the performance originally promised. It may be studied under the following
sub-heads.
Accord  An accord is an executory contract to perform an act that will satisfy an existing duty. An
accord suspends, but does not discharge, the original contract.
Satisfaction  Satisfaction is the performance of the accord, which discharges the original contrac-
tual obligation.
If the obligor refuses to perform  The obligee can sue on the original obligation or seek a decree
for specific performance on the accord.

Discharge by breach
Breach occurs where a party to a contract fails to perform its contractual obligations, or the perform-
ance is defective. A breach of contract does not per se bring a contract to an end. The breach may
Self-Learning give to the aggrieved party the right to terminate the contract, but it is for the non-breaching side
80  Material to decide whether or not to exercise that option. The aggrieved party has a right of election; that
is to say, it can choose either to affirm the contract or to terminate it. However, once that decision Discharge and
has been taken, it is, in principle, irrevocable. Breach of Contracts
A Breach may be anticipatory or actual.

Anticipatory breach Notes

Also known as ‘breach by repudiation’, anticipatory breach occurs when one party states, before
the arrival of the date fixed for performance, without justification that it cannot or will not carry
out the material part of the contractual obligations on the agreed date or that it intends to perform
in a way that is inconsistent with the terms of the contract. This may also occur where one party
by some action makes performance impossible. That is, anticipatory breach implies an action that
shows a party’s intention to fail to perform or fulfill its contractual obligations to another party. For
instance, A, after agreeing to sell his car to B on a fixed date, sells it to C. This is anticipatory breach.
Effect of anticipatory breach  Where there is an anticipatory breach, the non-breaching party
may either (i) rescind the contract or (ii) treat the contract in force and wait for the time of perfor-
mance. In the first case, it can immediately sue for damages, i.e., it is not required to wait for the
time for performance to expire. For example, D agreed to employ P as a courier for three months
commencing on June 1. Before the said date D told P that his services would not be required. This
was to be an anticipatory breach of contract and it entitled P to sue D for damages immediately
[Hochster vs De La Tour 2]. If the non-breaching party elects to treat the contract operative, it waits
until the time of performance and then holds the other party liable for the non-performance. Thus,
by doing so the non-breaching party is giving an opportunity to the breaching party to still perform,
if it can, in order to get a valid discharge.

Actual breach
Actual breach refers to the failure to perform contractual obligations when performance is due.
Failure to perform obligations is the most common form of breach, wherein a seller fails to deliver
the goods by the appointed time, or where, although delivered, the goods are not up to the mark in
respect of quality or quantity specified in the contract.
Effect of actual breach  Breach is described as a method of discharge, although it may not auto-
matically discharge the contract. Breach of contract leads to two main remedies, namely, breach of
condition and breach of warranty.
Breach of a condition  This is a major term, known as material breach, which entitles the injured
party to damages and gives it an option to treat the contract as subsisting or discharged.
Breach of a warranty  This is a minor term, known as non-material breach, which entitles the non-
breaching party to damages. It does not have the right to repudiate the contract, although a non-
material breach can give it the right to defer performance until the breach is made good. However,
once the breach is remedied, the non-breaching party must go ahead and render its performance,
minus any damages caused by the breach.
Thus, it is clear from the above that not every breach entitles the injured party to treat the con-
tract as discharged. It must be shown that the breach has affected a vital part of the contract, and
that it is a breach of condition rather than breach of warranty.

Remedies for Breach of Contract

A remedy is a relief provided to an aggrieved party should the other side commit a breach. It is the
means, employed to enforce a right, or redress an injury. Once a party fails to perform or performs
inadequately, the other party—the non-breaching party—can choose one or more of several rem-
edies. The most common remedies available to an aggrieved party are recsission of contract, suit for
damages, suit for specific performance, suit for injunction, and suit for quantum meruit. All these
will be examined in turn.

Rescission of Contract
Rescission is the revocation or cancellation of a contract. Section 39 of the Contract Act provides
that when a party to a contract has refused to perform, or disabled itself from performing in its en-
tirety, the promisee may put an end to the contract. In such a case, the other (aggrieved) party can
Self-Learning
refuse further performance and is absolved of all of its obligations under the contract.
Material   81
Legal and Regulatory For example, A promises to supply a PC for B’s office on a certain date on cash-on-delivery (COD)
Environment of basis. However, A fails to deliver the computer on the agreed date. B is absolved of the liability of
Business paying the price and entitled to rescind the contract.
Rescission is done to bring the parties, as far as possible, back to the position in which they were
Notes
before they entered into the contract. This is known as status quo ante. It is an equitable remedy and
is discretionary. The court may decline to rescind a contract if one party has affirmed the contract
by its action [Long vs Lloyd3], or a third party has acquired some rights, or there has been substantial
performance in implementing the contract.

Suit for Damages

A breach of contract also entitles the non-breaching, or injured, party to sue for monetary damages
besides rescinding the contract. Damages are designed to compensate the aggrieved party for the
loss sustained in the bargain. Often, courts rule that aggrieved parties are to be placed in the posi-
tion they would have occupied had the contract been performed fully. Section 73 of the Contract
Act, which deals with compensation for loss or damage caused by breach of contract, states that
when a contract has been broken, the aggrieved party is entitled to receive, from the breaching
party such damages which
1. arose naturally in the usual course of things from such breach. This relates to ordinary dam-
ages, and
2. the parties knew, when they made the contract, to be likely to result from the breach of it.
This relates to special damages.
Types of damages
Depending on the nature of the awards in compensating the injured or aggrieved party, damages
have been classified as follows:
1. Compensatory damages
2. Nominal damages
3. Consequential damages
4. Punitive damages
5. Incidental damages
6. Liquidated or agreed damages and penalty.
All these damages shall be examined in turn.
Compensatory damages  Damages making up the non-breaching party for the loss in the bargain
are known as compensatory damages. These are also called ordinary damages. Since these damages
compensate the aggrieved party for the injuries actually sustained and proved to have arisen directly
from the loss in the bargain due to the breach, the measure of ordinary damages is the difference
between the contract price and the market price on the date of the breach. Accordingly, they simply
replace the loss caused by the wrong or injury. The aim of awarding compensatory damages is, thus,
to protect the claimant’s ‘expectation of interest’ or his ‘performance interest’.
Nominal damages  Nominal damages are awarded in cases in which the aggrieved party has suf-
fered no loss as a result of the other’s breach. For example, when a seller fails to deliver the goods,
but the buyer is able to purchase from elsewhere at no extra cost. An award of a small sum such as
` 100 is granted to the non-breaching party to reflect the view that any loss or damage is purely
technical.
Consequential damages  Consequential damages are also called special damages. These are
awarded as monetary compensation for loss suffered as a consequence of the other party’s
breach. Consequential damage occurs because of some special or unusual circumstances of the par-
ticular contractual relationship of the parties. However, an aggrieved party cannot recover special
damages for loss that he could have avoided by taking reasonable steps. This is sometimes expressed
as the duty to mitigate (or minimise) these damages. For an injured party to obtain consequential
damages, it must show that it has suffered loss as a result of the breach. It is up to the party in breach
to argue that the injured party failed to mitigate its loss.
Punitive damages  Also known as exemplary or vindictive damages, punitive damages are
available in a breach of contract rarely. These are imposed not with an idea to compensate
Self-Learning
the injured or aggrieved party but to punish the wrongdoer so as to deter such conduct in
82  Material future. They reflect the court’s strong disapproval of a defendant’s predominantly reprehensible
behaviour. However, the mere fact that the defendant has broken the contract with the claimant Discharge and
in order to pursue a more profitable relationship with another party does not suffice to entitle the Breach of Contracts
claimant to punitive damages. Much more is required before a conclusion is drawn that a defen-
dant has behaved in an outrageous manner. Oppressive, arbitrary, or unconstitutional action by
Notes
the servants of the insurance and healthcare undertakings are usually the most frequent targets to
recover punitive damages, followed by employers and bankers who are often subjected to punitive
damages. In case of wrongful dishonour of a cheque (due to the negligence or mistake on part of
the banker), the governing rule is—smaller the amount of the cheque, larger will be the amount of
damages awarded, and vice versa.
Incidental damages  Incidental damages compensate for reasonable costs that the injured party
incurs after the breach in an effort to avoid further loss. For example, if an employer breaches an
employment contract with one of his employees, the latter could recover as incidental damages
those reasonable expenses he would incur in attempting to procure substitute employment, such
as long-distance telephone calls or the cost of printing new resumes, etc.
Liquidated or agreed damages and penalty  It is common for the contracting parties to ex-
pressly state in the contract that a certain sum of money will be paid to the injured party
or that goods will be forfeited (the latter being known as retention clause) should a breach
of contract occur. Clauses covering these areas are known as liquidated or agreed dam-
ages clauses. These are self-help remedies and generally appear in commercial contracts,
most commonly so, in relation to late rather than defective performance, especially in the fields
of construction and engineering, and supply or sale of goods. Such clauses do not usually appear in
contracts of employment.
On the other hand, a clause will be construed as a penalty clause, if the sum specified is
extravagant and disproportionate to the damage likely to occur. Penalty clauses are generally not
enforceable whereas liquidated damages clauses are.

Suit for Specific Performance

Specific performance is a decree issued by the court, which orders the defendant (party accused
of breaching a contract) to perform its obligations under the contract. Where damages represent
inadequate or unjust remedy, for example, where the subject matter of the contract is unique or
where there are no standards to ascertain the quantum of loss, the non-breaching party may ap-
proach the court for the grant of an order for specific performance of the contract. The courts have
broad discretion to award specific performance and in exercising this discretion take into account
factors such as
1. whether the person seeking performance is prepared to perform his/her side of the
contract [Chappell vs Times Newspapers Ltd 4].
2. whether the person against whom the order is sought would suffer hardship in performing
it [Patel vs Ali 5].
3. The difference between the benefits that the court order would give to one party and the
cost of performance to the other [Tito vs Waddell 6]
However, an order of specific performance would not be granted in the following circumstances:
1. Monetary compensation is an adequate remedy.
2. It will be inequitable to either party. Thus, it is not available to an infant in respect of a con-
tract not enforceable against him/her.
3. The performance consists of a personal service such as employment contracts because such
an order would restrict an individual’s freedom [Chappell vs Times Newspapers Ltd7].
4. The contracts require constant supervision, for example, building contracts.
5. The defendant cannot perform exactly in accordance with the original contractual obligation.
That is, specific performance is impossible.
6. Specific performance would cause severe hardship to the defendant.
7. Contract made for no conideration.
On the basis of above-mentioned constraints, it can be argued that specific performance is a
substitutionary and not a specific remedy.

Self-Learning
Material   83
Legal and Regulatory Suit for Injunction
Environment of
An injunction is a court order directing a person to do or refrain from doing some specified act,
Business
which, obviously, has been the subject matter of a contract. Like specific performance, an injunction
Notes is an equitable remedy and, therefore, only granted at the discretion of the court. It is awarded in
circumstances in which damages would not be an adequate remedy to compensate the claimant.
The main use of injunction in the contractual situation has been as an indirect means of enforc-
ing a contract involving personal services. In exercising its discretion (of injunction), the court will
use the balance of convenience test—weighing the benefit to the injured party and the detriment
to the other party. For example, a factory begins to allow noxious fumes to escape from a chimney,
affecting the health of neighbouring residents. Damages here would be inadequate, as the residents
would want to stop the fumes being emitted. This can only be remedied by an injunction order. An
injunction will not be granted if its effect would be to compel a party to do something, which he
could not have been ordered to do by a decree of specific performance [Lumley vs Wagner8].
An injunction order may be granted for an indefinite period or temporarily (an interlocutory
injunction) until a case goes to trial.

Suit for Quantum Meruit

Quantum meruit is a Latin term meaning, ‘as much as is merited’ or ‘as much as is earned’. In the
context of contract law, it means something along the lines of ‘reasonable value of services ren-
dered’.
The normal rule of law is that unless a party has performed its promise in its entirety, it cannot
claim performance from the other party. Contrary to it, in certain cases, when a person has done
some work under a contract, and the other party repudiates the contract or some such event occurs
that renders the rest of the performance unworkable, then the court may allow remuneration to the
party, which has performed partly. Thus, quantum meruit is imposed to avoid the unjust enrichment
of one party at the expense of another. The action of quantum meruit is allowed in Indian courts
under Section 70 of the Contract Act.
For example, A, a contractor, is contracted to work on a school. He does some work but quits
(breach of contract) midway. The contractor is entitled to be paid for the services he has already
rendered for the school on the basis of quantum meruit. However, the school would also be entitled
to damages arising out of the need to look for a new contractor.

Quasi Contract: Restitution and Other Remedies

Quasi-contractual obligations are the obligations that the common law implies in circum-
stances distinct from obligations under a contract. It is an area of law in its own right. Remedies
against Quasi-contractual obligations are sometimes available either as an alternative to a
remedy for breach of contract or where there is no remedy for breach of contract, for example,
a claim for quantum meruit (a reasonable remuneration for work done, or for goods supplied under
a contract which is later discovered to be void). Chapter V of the Indian Contract Act deals with the
quasi-contractual relationships under Sections 68–72. These can be summarised as under.
Claim for necessaries supplied to person incapable of contracting, or on his account  If a per-
son incapable of entering into a contract, or anyone 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 [Section 68].
Reimbursement of person paying money due by another, in payment of which he is inter-
ested  A person who is interested in the payment of money that another is bound by law to pay,
and who therefore pays it, is entitled to be reimbursed by the other [Section 69]. For example, B
holds land in West Bengal, on a lease granted by A, the zamindar. The revenue payable by A to the
government being in arrears, his land is advertised for sale by the government. Under the revenue
law, the consequence of such a sale will be the annulment of B’s lease. B, to prevent the sale and the
consequent annulment of his own lease, pays to the government the sum due from A. A is bound to
make good to B the amount so paid.
Restitution  Where a person lawfully does anything for another person, or delivers anything to
Self-Learning him, not intending to do so gratuitously, and such other person enjoys the benefit thereof, the lat-
84  Material ter is bound to make compensation to the former in respect of, or to restore, the thing so done or
delivered [Section 70]. For example, A, a tradesman, leaves goods at B’s house by mistake. B treats Discharge and
the goods as his own. He is bound to pay A for them. A is not entitled to compensation from B, if Breach of Contracts
the circumstances show that he intended to deliver the said goods gratuitously.
Responsibility of finder of lost goods  A person who finds goods belonging to another and takes Notes
them into his custody is subject to the same responsibility as a bailee [Section 71].
Liability of person to whom money is paid, or thing delivered, by mistake or under coercion  A
person to whom money has been paid or anything delivered by mistake or under coercion must
repay for or return it [Section 72].

E xercises
I. Objective-type Questions
1. A contract stands discharged by
(a) Performance (b) Substituted agreement
(c) Impossibility of performance (d) All of the above
2. A substituted agreement embraces
(a) Novation and rescission only (b) Alteration and remission only
(c) Waiver alone (d) All of the above
3. Discharge of a contract due to material alteration falls under
(a) Novation (b) Operation of law
(c) Substituted agreement (d) Remission
4. Objective impossibility renders a contract terminated in which of the following
situations?
(a) Death or incapacity of one of the parties
(b) Specific subject matter of the contract is destroyed
(c) Change in the law that renders performance illegal
(d) All the above
5. Who among the following can demand performance?
(a) Promisee (b) Legal representative
(c) Joint promisee (d) All of the above
6. The right not to perform a contractual obligation is known as
(a) Injunction (b) Rescission
(c) Specific performance (d) Quantum meruit
7. The amount of compensation payable in case of breach and stated in the
contract is a case of
(a) Liquidated damages (b) Penalty
(c) Special damages (d) Punitive damages
8. Which of the following is irrelevant in case of a contract of personal nature?
(a) Damages (b) Rescission
(c) Injunction (d) Specific performance
9. Where a party is restrained from breach of a negative term of a contract, this
refers to
(a) Rescission (b) Injunction
(c) Quantum meruit (d) Ordinary damages
10. Specific performance is not granted when
(a) Monetary compensation is an adequate remedy
(b) It will be inequitable to either party
(c) The court cannot supervise its execution
(d) In all the above cases

Self-Learning
Material   85
Legal and Regulatory II. Review Questions
Environment of
1. What do you mean by performance of a contract? Discuss in detail.
Business
2. Define ‘Tender’. Outline the essentials of a valid tender.
Notes 3. What are the different modes of discharging a contract? Discuss in brief.
4. State the rules regarding discharge of contract by
(a) Substituted agreement (b) Operation of law
(c) Impossibility of performance
5. What is breach of contract? What remedies are available to the non-breaching
party in the event of breach of contract?
6. Distinguish between the following:
(a) Penalty and liquidated damages
(b) Rescission and Injunction
7. Write short notes on the following:
(a) Quantum meruit
(b) Specific performance
8. In what circumstances will a court grant or order
(a) An injunction to restrain a breach of contract
(b) Specific performance of a contract?

10. (d) 9. (b) 8. (d) 7. (a) 6. (b)

5. (d) 4. (d) 3. (b) 2. (d) 1. (d)
Answers to Objective-type Questions

Self-Learning
86  Material
 Chapter
5 In Review
Learning Objectives l Discharge refers to the termination of a party’s obligations arising under a contract.
A contract is deemed to be discharged in the following circumstances:
Discharge of a contract 1. Performance
Breach of contract and remedies 2. Mutual agreement (i.e., by way of novation, rescission, alteration, remission,
and waiver)
Rescission 3. Lapse of time
Damages 4. Operation of law (i.e., due to material alteration, statutes of limitations, insol-
vency, and merger)
Specific performance
5. Impossibility of performance
Injunction 6. Accord and satisfaction
Quantum meruit 7. Breach (actual or anticipatory).
l The most natural way of discharging the contract is to perform it.

l Typically, the remedy for a breach of contract is monetary damages. Where

Key Terms the failure to perform cannot be adequately redressed by money, the other
common remedies available to an aggrieved party are rescission, specific
Performance of contract: Both the performance, injunction, and quantum meruit.
parties have carried out their respective l Rescission is resorted to bring the parties, as far as possible, back to the po-
contractual obligations sition in which they were before they entered into a contract. However, the
Discharge of a contract: Termination of court may decline to rescind a contract if one party has affirmed the contract
contractual obligations by performance or by its action, or a third party has acquired some rights, or there has been
otherwise substantial performance in implementing the contract.
Novation: Substitution of a new contract for l Specific performance is a remedy which requires the defendant to perform

the original one his contractual obligations. Where damages represent inadequate or unjust
Rescission: Cancellation of all of some of remedy, the non-breaching party may approach the court for the grant of a
the material terms of the contract decree for specific performance of the contract.
l An injunction is a court order directing a person to do or refrain from doing
Alteration: Change in one or more of the
some specified act, and it is awarded in circumstances in which damages
terms of the contract with the consent of all
would not be an adequate remedy to compensate the claimant.
the contracting parties
l In quantum meruit, the injured party, instead of claiming damages, may claim pay-
Remission: Acceptance of a lesser sum ment for what has been done under the contract on proportional basis.
than what was contracted for, or a lesser
fulfillment of the promise made
Waiver: Abandonment or relinquishment of
a right under a contract
Anticipatory breach: An action that
demonstrates a party’s intention to
repudiate (break) a contract.
Actual breach: Failure to perform
contractual obligations when performance
is due
Quasi contract: An obligation that the law
creates in the absence of an agreement
between the parties

Discharge and Breach of Contracts  87

Legal and Regulatory

Special Contracts
6
Environment of
Business

Notes

©: iStock
Learning Objectives
1. Contract of indemnity: meaning; 7. Pledge: definition; who can pledge
definition; scope 8. Pledge differentiated from bailment;
2. Contract of guarantee: meaning; pledge and hypothecation
definition 9. Agency: general rules; essentials
3. Contract of guarantee and contract of 10. Test of determining existence of
indemnity distinguished agency relationship
4. Discharge of surety 11. Agency: modes of creation; scope and
5. Bailment: definition; essentials; kinds extent of authority
6. Finder of lost goods: rights and duties 12. Termination of agency; irrevocable
of finder of lost goods agency

Contracts of Indemnity and Guarantee: Introduction

W e often come across the terms ‘guarantee’ and ‘indemnity’ in hire-purchase and loan agreements,
and many other commercial transactions in our life. While seeking a bank loan, a person is
often asked to provide a guarantee. Sometimes with a view to provide protection against some loss
or damage, the term ‘indemnity’ is also supplemented in the document. If someone tends to think
that it probably has something to do with the guarantee, he/she is wrong. A contract of indemnity
is fundamentally different from a contract of guarantee. Both are special types of contracts. Chapter
VIII of the Indian Contract Act deals exclusively and extensively with these kinds of contracts under
Sections 124 to 147.

Contract of Indemnity
A contract of indemnity is a type of contingent contract. The term ‘indemnity’ indicates protection
against some loss or damage. When a person undertakes to make good the loss or to compensate
the party which has suffered some loss, a contract of indemnity results in between the two. Section
124 defines the term ‘contract of indemnity’ as follows:
‘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’. The
person who promises to save the other from a loss is called the indemnifier and the person to whom
this promise is made, or is going to be protected from the loss, is known as indemnified or indemnity
holder. For example, A contracts to indemnify B against the consequences of any proceedings that
C may take against B in respect of a sum of ` 200. This is a contract of indemnity, wherein A is the
Self-Learning ‘indemnifier’ and B the indemnified. This example is an illustration appended to Section 124.
88 Material
Essentials of a valid contract of indemnity Special Contracts
Apart from the regular features of a valid contract, such as offer, acceptance, and free consent, a
contract of indemnity has some additional essential elements that are discussed as follows:
1. Under a contract of indemnity, the indemnifier promises to make good the loss or to com- Notes
pensate the party (indemnified) who has suffered some loss due to the conduct of the
promisor or any other person acting on its behalf, or specified by it. In its wider sense, a
contract of indemnity also includes a promise of indemnity against loss arising from any
cause whatsoever, for example, fire, accident, or natural calamity.
2. A contract of indemnity is primarily a contingent contract. The liability of the indemnifier
arises only at the occurrence of the contingency, i.e., when the indemnity-holder suffers a
loss.
3. The liability of an indemnifier commences as soon as the liability of the indemnity holder to
pay becomes clear and certain, although he has himself not paid anything [Osman Jamal &
Sons Ltd vs Gopal Purshottam1].

Rights of indemnity holder

The indemnity holder, acting within the scope of his authority, is entitled to recover from the in-
demnifier the following amounts:
1. All damages which he/she 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/she may be compelled to pay in any such suit if, in bringing or defending
it, he/she did not contravene the orders of the promisor and acted as it would have been
prudent for him/her to act in the absence of any contract of indemnity, or if the promisor
authorised him/her to bring or defend the suit.
3. All sums which he/she may have paid under the terms of any compromise of any such suit,
if the compromise was not contrary to the orders of the promisor and was one that was
prudent for the promisee to make in the absence of any contract of indemnity, or if the
promisor authorised him/her to compromise the suit.
In a nutshell, the indemnity holder is entitled to all damages plus all costs of the suit and prom-
ised money provided he/she has acted intra-vires (within powers). Besides, if he (indemnity holder)
has incurred a liability and that liability is absolute, he has the right to require the indemnifier to
put him/her in a position to meet the claim [Section 125].

Contract of Guarantee
The term guarantee implies a formal promise or assurance made by one person to another person to
be responsible, if a third person fails to perform a certain duty, for example, repay a debt. Therefore,
a ‘contract of guarantee’ takes shape when a person comes forward and undertakes to discharge
the debt or obligation of a third person in case of his/her default. Section 126 of the Indian Contract
Act defines a contract of guarantee as follows:
‘A contract of guarantee is a contract to perform the promise, or discharge the liability, of a third
person in case of his default.’
Thus, a contract of guarantee is entered into with an objective to enable a person to get a loan,
or goods on credit, and even an employment.
The person who gives the guarantee is called the surety2, 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 [Section 126]. For instance, A applies
for shares in a public limited company and B assures the company that if A does not pay the calls,
B will. This is a contract of guarantee. The primary liability to pay the calls made by the company is
that of A, but if he fails to pay, B will become liable to pay. In this example, B is the surety, A is the
principal debtor, and the company is the creditor.
Thus, a contract of guarantee is a collateral engagement in which the surety undertakes
to be liable to the creditor for the debt of another (i.e., the principal debtor) in case of his
default. There must be a conditional promise to pay if the principal debtor fails to pay. A
liability that is incurred independently of a ‘default’, is not within the definition of guarantee Self-Learning
[Punjab National Bank vs Sri Vikram Cotton Mills3]. Material 89
Legal and Regulatory Consideration for guarantee
Environment of
Like every other contract, a contract of guarantee must have all the essential elements of a
Business
valid contract, such as, competence of parties, free consent, legality of object, and considera-
Notes tion. There is, however, a special feature with regard to consideration in contract of guarantee. There
need not be any direct consideration between the surety and the creditor. Consideration received
by the principal debtor is sufficient for the surety. Section 127 expressly provides to this effect, say-
ing, ‘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. Box 6.1 presents some examples in this regard.

Box 6.1 Consideration for Guarantee

Example 1
B requests A to sell and deliver to him goods on credit. A agrees to do so, provided C will guarantee
the payment of the price of the goods. C promises to guarantee the payment in consideration of A’s
promise to deliver the goods. This is a sufficient consideration for C’s promise.
Example 2
A sells and delivers goods to B. Subsequently, C requests A to forbear to sue B for the debt for a year
and promises that, if A does so, he (C) will pay for them in default of payment by B. A agrees to forbear
as requested. This is a sufficient consideration for C’s promise.

Incapacity of the principal debtor

It is true that the parties to a contract of guarantee should be competent to contract. However, the
incapacity of the principal debtor does not impair the validity of a contract of guarantee. A principal
debtor may be a minor; in such a situation, the surety would be regarded as the principal debtor and
he/she will personally become liable to pay. In that case, the contract between the creditor and the
surety is treated as a primary and independent one, and not collateral. Therefore, the requirement
is that the creditor and the surety must be competent to contract.

Contract of Indemnity and Contract of Guarantee

Distinguished

The distinction between an indemnity and guarantee can be explained with the help of an
example. Suppose A and B go to an electronic items shop, and B tells the seller, ‘Supply the TV
set required by A, and should he fail to pay you the price, I will’. This is a contract of guarantee. The
primary liability to pay is that of A, but if he fails to do so, B would be required to pay. On the other
hand, if B asks the showroom owner, ‘Let him have the TV set and I will see that you are paid’, then
the contract is one of indemnity and not of guarantee. The main points of difference between a
contract of indemnity and a contract of guarantee are summarised in Table 6.1 as follows.

Table 6.1 Difference between Contract of Guarantee and Contract of Indemnity

S. Points of Contract of indemnity Contract of guarantee

no. difference
1. Parties A contract of indemnity requires the A contract of guarantee is a
concurrence of only two parties, viz., tripartite agreement, which
the indemnifier and the indemnity contemplates three persons:
holder or the indemnified. the principal debtor, the
creditor, and the surety.
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90 Material
 Special Contracts
2. Object The object of a contract of indemnity The object of a contract of
is to make good the loss or to guarantee is to enable a
compensate the party that has person to obtain a loan, or
suffered some loss. goods on credit, or even Notes
employment.
3. Nature of The contract of indemnity is for the The contract of guarantee is
contract re-imbursement of the loss. The for the security of the creditor.
indemnifier promises to save the The surety undertakes to
indemnity holder from a contingent discharge the liability of the
risk, i.e., when he suffers some loss. principal debtor, which is not
contingent but is subsisting. In a contract of guarantee,
there is an existing debt or
duty, the performance of which
is guaranteed by the surety.
4. Nature of The promisor (i.e., the indemnifier) The promisor (i.e., the surety)
liability undertakes an independent liability. undertakes to be liable when
In other words, the liability of the the principal debtor fails to
indemnifier is primary. pay, i.e., the liability of the
surety is collateral.
5. Indepen- Indemnifier acts independently The surety gives guarantee
dence of without any request of the debtor only at the request of the
the promisor or the third party. principal debtor.
6. Right to sue The indemnifier cannot sue third If the principal debtor fails to
third parties parties in his own name unless pay, the surety, after he has
there be an assignment in discharged the debt, can
indemnifier’s favour. He may sue proceed against the principal
in the name of the indemnified. debtor in his own right.

Extent of Surety’s Liability

The liability of the surety is co-extensive with that of the principal debtor unless it is otherwise
provided by the contract [Section 128].
The above provision implies that the surety is liable to the same extent to which the princi-
pal debtor is liable. However, if at the time of giving the guarantee, the surety has undertaken
to be liable for a fixed sum, the surety shall be liable to the extent of the specified sum only.
For instance, A guarantees to B the payment of a bill of exchange by C, the acceptor. C dishon-
ours the bill. A is liable not only for the amount of the bill, but also for any interest and charges that
may have become due on it.
However, if A gives the guarantee for the principal amount of the bill, and if B makes a default,
A shall be liable only for the principal amount, as the bill bears.

Kinds of Guarantee
The contracts of guarantee may be classified into two types, namely, specific guarantee and continu-
ing guarantee.

Specific guarantee
When a guarantee is given only for a single debt or a specific transaction only, it is called specific
guarantee. The responsibility of the surety ceases as soon as the guaranteed debt is paid or the
promise is duly performed. In other words, specific guarantee will not extend to other contracts, if
any, between the creditor and the principal debtor. For example, A, a money lender, agrees to give a
loan of ` 10,000 to B, under the contract that if B does not repay the loan, his friend C would repay
the same. This is a contract of specific guarantee and C’s liability would come to an end as soon as
B repays the debt that he had guaranteed. Self-Learning
Material 91
Legal and Regulatory Continuing guarantee
Environment of
Business
A guarantee that extends to a series of transactions is called a continuing guarantee [Section 129].
Under this kind of guarantee, the surety undertakes responsibility for a series of separable and
Notes distinct transactions over a period of time. For instance, a fidelity guarantee, in which the insurer
provides cover for a business against theft by an employee, is a continuing guarantee, as it remains
in force for a period of time.

Revocation of continuing guarantee

A continuing guarantee may be revoked in respect of future transaction in any of the following ways.
By notice of revocation  The surety, as to future transactions, may at any time revoke a continuing
guarantee by serving a notice to the creditor [Section 130].
For instance, A guarantees to B, to the extent of ` 10,000, that C shall pay all the bills that B shall
draw upon him (C). B draws upon C, who accepts the bill. Later on, A serves a notice of revocation.
C dishonours the bill on maturity. A is liable upon his guarantee.
By death of surety  The death of the surety, in the absence of any contract to the contrary, oper-
ates as a revocation of a continuing guarantee, as regards future transactions [Section 131].
The termination of a continuing guarantee by death of the surety, however, becomes effec-
tive only for the future transactions.
In the same manner as the surety is discharged  A continuing guarantee is also annulled
(i.e., no longer legally valid) under all the circumstances under which a surety is discharged from
the liability. In other words, a continuing guarantee stands as along as the surety is not discharged
and the same rules that apply for the discharge of a surety are applicable to a continuing guarantee,
such as
1. Novation [Section 62]
2. Variance in terms of contract [Section 133]
3. Release or discharge of principal debtor [Section 134]
4. Arrangement with the principal debtor [Section 135]
5. Creditor’s act or omission impairing surety’s eventual remedy [Section 139]
6. Loss of security [Section 141]
We shall study these points in detail later in this chapter under the heading ‘Discharge of
Surety’.

Rights of Surety
The rights of a surety can be studied under the following three heads:
1. Rights against the principal debtor
2. Rights against the creditor
· 3. Rights against the co-sureties.

Rights against the principal debtor

The surety has the following two rights against the principal debtor.
Right of subrogation  After discharging the debt, the surety steps into the shoes of the
creditor, i.e., subrogated to all the rights of the creditor against the principal debtor. Section 140
provides, ‘Where a guaranteed debt has become due, or default of the principal debtor to perform
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’.
Right of indemnity  A surety is entitled to be indemnified by the principal debtor for whatever
sum he has rightfully paid under the guarantee. Section 145 provides that ‘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’.

Rights against the creditor

Self-Learning The surety enjoys the following two rights against the creditor.
92  Material
Right to security A surety is entitled to the benefit of every security which the creditor has Special Contracts
against the principal debtor at the time when the contract of surety is entered into, even if the
surety is unaware of the existence of the security, 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 [Section 141]. Examples in Box 6.2 help understand the law in this regard. Notes

Box 6.2 A Surety’s Right to Securities

Example 1
C advances to B, his tenant, ` 2000 on the guarantee of A. C also has a further security for ` 2000 by
way of a mortgage of B’s furniture. C cancels the mortgage. B becomes insolvent and C sues A on his
guarantee. A is discharged from the liability to the amount of the value of the furniture.
Example 2
C, a creditor, whose advance to B is secured by a decree, also receives a guarantee for that advance
from A. C afterwards takes B’s goods in execution of the decree, and then, without the knowledge
of A, withdraws the execution. A is discharged [Appended to Section 141].

Right of set-off When the creditor calls upon the surety to pay the guaranteed amount, the
surety is entitled to plead any set-off which the principal debtor may have against the creditor. He
can claim such a right not only against the creditor but also against third parties who have derived
their title from the creditor.
Rights against the co-sureties Where more than one person has guaranteed a single debt, they
are called co-sureties. In such cases, the liability of co-sureties becomes joint and several. They are
liable to contribute, as agreed, towards the payment of guaranteed debt. But in the absence of any
agreement, if one of the sureties has paid the entire debt to the creditor, he has a right to have
contribution from the co-sureties who are equally bound to pay. The rules relating to contribution
can be studied under Sections 146 and 147.
Where sureties become liable to contribute equally Where two or more persons are co-sureties
for a contract of guarantee, they in the absence of any contract to the contrary become liable, as
between themselves, to pay an equal share of the whole debt, or of that part of it which remains
unpaid by the principal debtor [Section 146]. The examples in Box 6.3 derive home the point.

Box 6.3 Co-sureties Liable to Pay Equally

Example 1
A, B, and C are sureties to D for a sum of ` 3000 lent to E. E defaults in payment. A, B, and C are liable,
as between themselves, to pay ` 1000 each.
Example 2
A, B, and C are sureties to D for a sum of ` 1000 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 defaults in payment. Between the sureties, A and B are liable to pay ` 250
each, and C is liable for ` 500.

Where sureties become liable to contribute subject to the maximum amounts guaranteed by
each one Co-sureties who are bound in different sums are liable to pay equally as far as the limits
of their respective obligations permit [Section 147]. The three instances in Box 6.4 help explain the
point better. Self-Learning
Material 93
Legal and Regulatory
Environment of
Business Box 6.4 Co-sureties Liable to Contribute Maximum Sums
Guaranteed
Notes
Example 1
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, B in that of ` 20,000, C in that of ` 40,000, conditioned for D’s duly
accounting to E. D defaults in payment to the extent of ` 30,000. A, B, and C, are liable to pay
` 10,000 each.
Example 2
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 , B in that of ` 20,000, C in that of ` 40,000, conditioned for D’s duly account-
ing to E. D defaults to the extent of ` 40,000. A is liable to pay ` 10,000, and B and C ` 15,000 each.

Discharge of Surety
A surety’s liability comes to an end under any of the following circumstances:
1. By notice of revocation
2. By death of surety
3. By novation
4. By variance in terms of contract
5. By release or discharge of principal debtor
6. By arrangement between the principal debtor and the creditor
7. By impairing surety’s remedy
8. By loss of security
9. By invalidation of the contract.

Notice of revocation
Ordinarily a guarantee cannot be revoked if the liability has already been accrued. But Section
130 provides for revocation of continuing guarantee. For example, if A has stood surety for a
` 5,00,000 home loan of B from a bank and the money has been disbursed, then A cannot revoke
the guarantee, as the liability has accrued. Accordingly, where a guarantee is a continuing one and
extends to a series of transactions, the surety as to future transactions may revoke it, by giving
notice to the creditor. However, the surety shall remain liable for the acts already acted upon, i.e.,
prior to the notice of revocation.

Death of surety
In case of a continuing guarantee, the death of the surety, in the absence of any contract to the con-
trary, discharges him from liability as regards future transactions (i.e., transactions after his death).
In other words, the surety’s survivors or legal representatives would not be liable unless expressly
mentioned in the contract [Section 131].

Novation
Novation, i.e., entering into a fresh contract, either between the same parties or between other
parties, constitutes another mode of discharging a surety from the liability. If the parties to a con-
tract (of guarantee) agree to substitute it with a new contract, the original contract need not be
performed and so the surety stands discharged with regard to the old contract. For the surety, too,
a fresh contract would have to be drafted [Section 62].

Variance in terms of contract

Any variance or alteration in the terms of the contract made between the principal debtor and the
Self-Learning creditor, without the surety’s consent, discharges the surety as to the transactions taking place
94 Material subsequent to the variance [Section 133].
 Box 6.5 provides a couple of examples in this regard. Special Contracts

Box 6.5 Altering Contract Terms Discharge Surety Notes

[Section 133]

Example 1
A becomes surety to C for payment of rent by B under a lease. Afterwards B and C contract to hike
the rent, without informing A. A would hence be discharged from his liability as a surety for the rent
accruing subsequent to the variance in terms of the contract without his consent.
Example 2
C contracts to lend B ` 5000 on March 1. A guarantees repayment. C pays ` 5000 to B on January 1, A
is discharged from his liability, as the contract has been varied for early release of loan by the creditor
[illustration (e) appended to Section 133].

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 [Section 134]. Box 6.6 presents some examples to
explain the point.

Box 6.6 Creditor’s Omission May Discharge Surety

[Appended to Section 134]

Example 1
A gives a guarantee to C for goods to be supplied by C to B. C supplies the goods to B but afterwards
B is 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
contracts with C, and A is discharged from his surety.
Example 2
A contracts with B to grow a crop of indigo on A’s land and deliver it to B at a fixed rate. C guarantees
A’s performance of this contract. B, however, diverts stream of water, which is necessary for the ir-
rigation of A’s land, and thereby prevents him from raising the indigo. C is no longer liable on his
guarantee [Appended to Section 134].

Arrangement between principal debtor and creditor

Where the creditor, without the consent of the surety, arrives at a settlement with the principal
debtor, or promises to give him more time, or promises not to sue him by a contract between the
creditor and the principal debtor, the surety is absolved from the liability, unless the surety assents
to such contract [Section 135].
Where, however, 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]. For in-
stance, C, the holder of an overdue bill of exchange drawn by A as surety for B, and accepted by B,
contracts with M to give time to B. A is not discharged.

Impairing surety’s remedy

If the creditor commits any act, which is inconsistent with the rights of the surety, or fails to perform
any act that his duty to the surety requires him to do, such that the eventual remedy of the surety
Self-Learning
himself against the principal debtor is impaired; the surety is discharged [Section 139]. Box 6.7 pro-
Material 95
vides illustrations in this regard.
Legal and Regulatory
Environment of
Business Box 6.7 Surety Discharged if creditor Impairs Remedy for
Him
Notes
Example 1
B contracts to build a ship for C for a given sum to be paid in installments 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 the last two installments to B. A is discharged by the prepayment.
Example 2
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. Owing to his (C’s) misconduct and wilful negligence, only a small price is realised. A is
discharged from liability on the note [Appended to Section 139].

Loss of security
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. It is immaterial whether the surety was
or is aware of such security or not [Section 141]. For instance, C advances to B his tenant, ` 2000
on the guarantee of A. C has also a further security for ` 2000 by a mortgage of B’s furniture. C,
however 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.

Invalidation of contract
A surety is also discharged upon invalidation of the contract (i.e., between the creditor and the surety).
A contract of guarantee is invalid in the following circumstances.
Guarantee obtained by misrepresentation Any guarantee that has been obtained by means of
misrepresentation made by the creditor, or with his knowledge or assent, concerning a material part
of the transaction is invalid [Section 142].
Guarantee obtained by concealment Any guarantee that the creditor has obtained by means of
keeping silence as to the material circumstances is invalid [Section 143].
Default on part of co-surety Where a person gives a guarantee upon a contract that the 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 [Section 44].

Contracts of Bailment and Pledge: Introduction

Like contacts of indemnity and guarantee, contracts of bailment and pledge are specific types of
contracts, as the Contract Act has laid down special rules for such types of contracts. Sections
148–181, contained in Chapter IX of the Indian Contract Act of 1872, govern these types of contracts.
This chapter describes the meaning and kinds of bailment, duties, and rights of bailee as well as
of bailor, finder of lost goods—his rights and duties, termination of bailment, pledge, difference
between pledge and bailment, rights and duties of pawnor and pawnee, and pledge by persons,
other than owners.

Bailment
A bailment is a situation wherein the owner of goods entrusts their possession into the care of
another person for some purpose briefly. Section 148 defines bailment thus:
‘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’.
Self-Learning
96 Material
 The person delivering the goods is called the bailor. The person to whom they are delivered is Special Contracts
called the bailee. For instance, A delivers his car to B for repair. Here a relationship of bailment is
created between A and B, where A is the bailor and B is the bailee. Some common examples of bail-
ment that we frequently enter into our day-to-day lives are provided in Box 6.8.
Notes

Box 6.8 Common Examples of Contracts of Bailment

1. Giving watch, TV or a radio set, computers, etc. for repair or servicing.

2. Leaving car or scooter for service/repairs or at a parking lot.
3. Delivering cloth to tailor for stitching a suit.
4. Hiring car, AC, tent, etc.
5. Delivering goods to transporter for despatching and delivering them to the consignee.
6. Leaving diamonds with goldsmith for being studded in gold jewellery.
7. Handing over valuables or pets to the safe custody of a friend or neighbour while leaving sta-
tion.
8. Leaving luggage at cloakrooms.
9. Depositing ‘documents of title’ with the banker as a security (mortage) against a loan.

Essentials of bailment
Bailment, as we have learnt, is a special contract in which the possession of goods changes in order
to achieve a specific purpose. It essentially involves change in possession and not change in owner-
ship. Delivery of goods or return of goods by the bailee also constitutes an essential feature of a
bailment. Following are the key elements that make up a valid bailment.

Contract
Bailment is based on a contract between two persons, namely, the bailor and the bailee. The con-
tract, may, however, be implied in some cases such as finder of lost goods and seizing of someone’s
goods by the State in the exercise of its powers under various Acts.

Subject matter
Goods form the subject matter of the bailment. As per section 2(7) of the Sale of Goods Act, ‘goods’
means every kind of movable property other than money and actionable claim. Thus, depositing
money in a bank account does not constitute bailment. Similarly, a contract of bailment cannot be
entered into with regard to immovable property.

Delivery of goods
Delivery of goods is the essence of bailment. The term bailment though literally means to hando-
ver, it technically signifies change of possession in law. In bailment, therefore, possession of goods
must change. Placing of ornaments or other valuables in a bank locker on this account does not
create a bailment, as ornaments are never delivered to the banker. It is further necessary that the
goods change hands temporarily, voluntarily, and in accordance with the contract. For example, if
somebody obtains the possession of someone’s goods under undue influence, threat, or fraud, it
does not amount to bailment of goods for the lack of agreement and voluntary transfer. Similarly,
a servant or a guest having access to or use of goods is not a bailee.

Delivery may be actual or constructive

Delivery of goods may be actual or constructive. Actual delivery implies physical transfer of
goods from one person to another. For instance, when a student borrows a book from a library,
there is actual delivery. When possession of goods changes by doing anything, which has the
effect of putting the goods in the possession of the bailee, or of any person, authorised to hold
them on behalf of the bailor, or the owner, it amounts to constructive delivery. For example, Self-Learning
Material 97
Legal and Regulatory where the key of a warehouse is handed over to another person, it amounts to delivery of goods
Environment of in the store. Similarly, transfer of railway receipt being document of title to goods, effects a
Business constructive delivery of the goods. Here it is important to note that the constructive delivery
is as good and effective for all practical purposes as actual delivery.
Notes
No change in ownership
Ownership is not transferred. Bailment signifies change of possession of goods from one per-
son to another. But there is no change in the ownership. The bailor continues to be the owner
of the goods.

Purpose
The bailor delivers his goods to the bailee for some definite purpose. The purpose for which the
goods are delivered is usually in the contemplation of both the parties.

Return of goods
Every bailment pre-supposes a condition that the goods bailed would be returned to the bailor,
or otherwise be disposed of according to the directions of the bailor, on the accomplishment of
the purpose, or after the expiry of period of bailment. On this account, it is important to note
that in order to discharge his duty, a bailee is supposed to return the goods bailed out, and not
any other goods although of an equal or even higher value.

Kinds of bailment
Bailment may broadly be classified into the following two categories:
1. Gratuitous bailment and
2. Non-gratuitous bailment.

Gratuitous bailment
A bailment with no consideration is called a gratuitous bailment. In this kind of bailment, neither
the bailor nor the bailee is entitled to any remuneration or reward. Such a bailment may be for
the exclusive benefit of either party, i.e., the bailor or the bailee, discussed as follows.
Bailment for the exclusive benefit of the bailor  In this case, the bailor delivers the goods for
his exclusive benefits and the bailee does not derive any benefit out of it. For example, A leaves his
pets with B, his neighbour, to be looked after during A’s physical absence. In this case, A alone is
being benefited by the bailment. Or, if you park your car in your neighbour’s premises to be taken
care in your absence, you as a bailor derive the exclusive benefit from the bailment.
Bailment for the exclusive benefit of the bailee  This is the case in which a bailor delivers
the goods to the bailee for the exclusive benefits of the bailee and does not gain anything from
the contract himself. For example, you lend your book to a friend of yours for a week without any
charge or favour. In this case, the recipient of the book as the bailee is the sole beneficiary of this
transaction of bailment.

Non-gratuitous bailment
Contrary to gratuitous bailment, a non-gratuitous bailment or bailment for reward is one that
involves some consideration passing between the bailor and the bailee. Obviously in this case,
the delivery of goods takes place for the mutual benefit of both the parties. For example, A hires
B’s car. Here B is the bailor and receives the hire charges, and A is the bailee and enjoys the use
of the car. Similarly, when you give your PC or laptop for repair to some techie, both you and the
computer techie are going to be benefited by this contract— while you get your computer repaired,
he gets his fees or charges.

Duties and rights of the bailor

Duties of the bailor
The bailor owes the following duties to bailee in respect of the goods bailed out by him.
Self-Learning
98  Material
Duty to disclose faults  According to Section 150, the bailor is bound to disclose to the bailee Special Contracts
faults in the goods bailed, of which he is aware, and which materially interfere with the use of
them, or could expose the bailee to extraordinary risks. If he does not make such a disclosure,
he is responsible for the damage arising to the bailee directly from such faults. If the goods are
Notes
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.
Duty to repay bailee’s expenses  A bailor is duty bound to repay to the bailee expenses incurred
by him for work done on the goods received under conditions of bailment, and for which he is not
receiving any remuneration or deriving any benefit. In this regard, Section 158 states, ‘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’.
Duty to indemnify the bailee  The bailor is bound to make good the loss suffered by the bailee
that is in excess of the benefit actually derived, where he had delivered the goods gratuitously and
compelled the bailee to return them before the expiry of the period of bailment [Section 159].
Duty to compensate bailee for breach of warranty  Every contract of bailment warrants the
bailee about the bailor’s title being defect free. Thus, if bailee subsequently suffers any loss by the
reason of the bailor’s title being defective, it is the duty of the bailor to compensate the bailee for
breach of warranty [Section 164].
Duty to claim back the goods  The bailor is bound to accept the goods upon being returned by
the bailee in accordance with the terms of bailment. If he refuses or fails to accept back the goods,
if offered at a proper time and at a proper place, without any reasonable ground, he shall be respon-
sible for any loss or damage to the goods and not the bailee. Moreover, the bailee, in such a case,
can also claim from the bailor all necessary and incidental expenses that he might have incurred to
keep and protect the goods.

Rights of the bailor

A bailor has the following rights.
Right to enforce bailee’s performance  Since the bailor delivers goods to the bailee for some
specific purpose, the former, especially in case of non-gratuitous bailment, has an elemental right
to achieve that purpose or obtain the benefit (i.e., performance) through the latter. For example, if
X delivers a suit length to Y, his tailor, to stitch a suit for him, X (bailor) will see that the tailor does
the needful in the desired manner.
Right to claim damages  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 151]. This gives bailor
a right to claim for damages against the loss, if any, caused to the goods bailed due to the bailee’s
negligence or misconduct.
Right to claim compensation against unauthorised use of goods  If the bailee makes any use of
the goods bailed, which is not according to the conditions of the bailment, the bailor has a right to
claim compensation from the bailee in respect of any damage arising to the goods from or during
such use of them [Sections 154–56]. For example, A lets B use his car but with a condition that only
B shall drive. B allows C, a member of his family, to drive the car. C rides with care, but the car meets
with some accident. B is liable to make compensation to A for the damage done to the car.
Right to terminate the contract  Bailor has a right to terminate the contract if the bailee does
any act with regard to the goods bailed, inconsistent with the conditions of the bailment [Section
153]. For example, A lets his horse to B, on hire, for his own riding. B drives the horse in his carriage.
A can terminate the contract immediately.
Right to demand return of goods along with accretion to, if any  The bailor enjoys the exclusive
right to have the goods bailed delivered back to him in safe and sound condition after the time of
bailment has expired or the purpose behind the bailment has been achieved. Moreover, in the ab-
sence of any contrary term in the contract, the bailor is also entitled to any accretion to the goods
bailed if it occurred while the goods were in the study of bailee. For example, A leaves his hen in the
Self-Learning
custody of B to be taken care of for a week. The hen has laid eggs and thereby hatched the chicks. Material   99
A is entitled not only to the hen but also to the chicks.
Legal and Regulatory Duties and rights of bailee
Environment of
The rights and duties of bailee are discussed as under.
Business
Duties of the bailee
Notes
The bailor and the bailee are reciprocally related to one another. Hence rights of the bailor are
the duties of the bailee and vice versa. Accordingly, the bailee owes the following duties in
respect of goods bailed to him.
Duty to take reasonable care of the goods whilst they are in his possession  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, under similar circumstances, would take of his own goods of the same bulk, quality, and
value [Section 151]. The degree of care required from the bailee is the same whether the bailment
is for reward, or gratuitous.
Duty not to make any unauthorised use of the goods bailed  The bailee is under an obligation
not to resort to unauthorised use of the goods bailed to him. In this regard, an unauthorised use refers
to any act in relation to goods bailed, inconsistent with the condition of bailment. As per Section 153,
a contract of bailment is voidable at the option of the bailor, if the bailee does any act with regard to
goods bailed, inconsistent with the conditions of the bailment. Section 154 further provides that if
the bailee makes any unauthorised use of the goods bailed, he is liable to make compensation to
the bailor for any damage arising to the goods from or during such use of them.
Duty not to set up jus tertii  The bailee should not set up jus tertii, i.e., adverse title (his own title
or the title of a third party) to the bailed goods, as the same will be inconsistent with the conditions
of bailment. Even if a third person claims a better title to the goods other than that of the bailor, the
bailee is duty bound to return the goods to the bailor only.
Duty not to mix the goods bailed with his own goods  A bailee is duty bound not to mix the bailed
goods with his own goods, without the consent of the bailor. In other words, he must keep the goods
bailed to him separate from his own goods. If the bailee, with the consent of the bailor, mixes the
goods of the bailor with his own, the bailor and the bailee shall have an interest, in proportion to their
respective shares, in the mixture thus produced.
Duty to return the goods in accordance with the contract  It is the duty of the bailee to return, or
deliver the goods bailed, according to the bailor’s directions, without any demand, as soon as the
time for which they were bailed has expired, or the purpose for which they were bailed has been
accomplished [Section 160].
If by the default of the bailee, the goods are not returned, delivered or tendered at the proper
time, he will be liable to the bailor for any loss, destruction, or deterioration of the goods from that
time.
Duty to return any accretion to the goods  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 [Section 163]. For example, A leaves a pregnant cow in the
custody of B to be taken care of. The cow gives birth to a calf. B is bound to deliver the calf as well
the cow to A.

Rights of the bailee

Because of the reciprocity of relationships, most of the duties of the bailor are the rights of the
bailee. Accordingly, a bailee enjoys the following rights.
Right to enforce bailor’s duties  The bailee has a right
1. to claim damages from the bailor if he has suffered some loss due to non- disclosure of de-
fects in the goods on the bailor’s part. If the goods were bailed for hire, the bailee would be
entitled to recover damages from the bailor even if the latter was not aware of the existence
of such faults in the goods bailed [Section 150].
2. to claim from the bailor all necessary expenses incurred by him for the purpose of the bail-
ment if the bailment was non-gratuitous [Section 158].
3. to be indemnified against any loss or damage sustained by him by reason of defective title
of the bailor [Section 164].
Self-Learning Similarly, in case of bailment for reward, the bailee will be entitled to recover from the bailor, all
100  Material extraordinary expenses, borne by the bailor for the purpose of bailment.
Right of lien Special Contracts
Where the bailee has, in accordance with the purpose of the bailment, rendered any service involv-
ing 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 Notes
has rendered in respect of them [Section 170]. Examples to this effect are presented in Box 6.9.

Box 6.9 Right of Lien; When Bailee Can Retain Goods

Example 1
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 is paid for the services he has rendered.
Example 2
A gives a piece of 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 to A for the price. B is entitled to retain the coat until
he is paid the stitching charges [Appended to Section 170].

Bankers, factors (merchants buying and selling on commission basis), wharfi ngers (ship
loaders), attorneys of a High Court, and policy-brokers may, in the absence of a contract to the
contrary, retain as a security for 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, unless
there is an express contract to the effect [Section 171].
Right to sell the goods If the bailor fails to take delivery of the goods and to pay the bailee’s
charges, the bailee has a right to sell the goods after giving a notice to the bailor of his intention.
After the sale, the bailee must account to the bailor for the proceeds of sale less the costs of sale
and the amount owed to the bailee in respect of the goods [Section 169].
Right to return the goods to any of the joint-bailors 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 [Section 165].
Right to deliver goods to the 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 of the goods in respect of such delivery [Section 166].
From the foregone discussion it is clear that the duties of the bailor are the rights of bailee,
and the rights of bailor are the duties of bailee. This is simply because bailor and bailee sit in
reciprocal relationship to each other.

Termination of Bailment
The following circumstances render a contract of bailment terminated.
Unauthorised use of goods bailed A bailor may terminate the bailment where the bailee does
any act with regard to goods bailed, inconsistent with the conditions of bailment [Section 153].
Simply put, it means that a bailor can terminate a bailment before its term runs out, in case he finds
the bailee’s conduct, with respect to the bailed goods, contrary to the agreed terms. In such a case,
a bailment can be terminated even before the expiry of the term of the bailment.
Expiry of term of bailment A contract of bailment automatically comes to an end upon the expiry
of the period for which the goods were bailed.
A gratuitous bailment may, however, be terminated at any time, even before the agreed time,
except where the termination before the fixed period causes loss to the bailee exceeding the
benefit actually derived by him from the bailment. In that case the bailor must compensate him
[Section 159]. Self-Learning
Material 101
Legal and Regulatory Accomplishment of purpose  If the goods were bailed for a specific object, the bailment comes
Environment of to an end upon achievement of the said object or purpose.
Business
Death of either party  A gratuitous bailment terminates by the death of either the bailor or the
Notes bailee.
Destruction of subject matter  A contract of bailment also comes to an end if the goods that are
the subject matter of the bailment get destroyed or otherwise become incapable of being used for
bailment any more.

Finder of Lost Goods

A person who finds an article belonging to another is called the finder of lost goods. In the eyes of
the law, the position of a finder of lost goods is exactly that of a bailee. Section 71 says, ‘A person
who finds goods belonging to another, and takes them into his custody, is subject to the same re-
sponsibility as a bailee’. It should be noted that the finder of goods occupies the position of bailee
only against the true owner, since he keeps the goods found in trust only for the real owner. As
against everyone else, the property as regards the goods found vests in the finder on his taking
possession of it.

Duties and rights of finder of lost goods

A finder of goods has the following duties:
1. To exercise reasonable care in preserving the goods found
2. To find the actual owner and restore the goods to him
3. Not to make any personal use of the goods found
4. Not to mix the goods found with his own goods
5. Not to set up any adverse title to the goods found
The law confers the following rights on a finder of goods.
Retain the goods  A finder of goods can retain them against the owner until he (the finder) re-
ceives compensation for expenses and trouble voluntarily incurred by him in finding out the true
owner, and in preserving the goods he has found. He, however, has no right to sue the owner for
such compensation [Section 168].
Sue the owner for reward  Where the owner has offered a specific reward for the return of the
goods lost, he (finder) may sue the owner for such reward and may retain the goods until he receives
it [Section 168].
Sell the found articles  When an article found is commonly the subject of sale and the owner can-
not 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, amounts to two-
thirds of its value [Section 169].

Pledge
A pledge or pawn is a kind of bailment. It is the bailment of a movable thing as security for the
repayment of a debt or performance of a promise. The bailor in this case is called the Pawnor
or Pledgor, whereas the bailee is called the Pawnee or Pledgee [Section 172].
In order to enforce a contract of pledge, the property pledged should be actually or construc-
tively delivered to the pawnee. Ownership of the pledged goods does not pass to the pledgee.
A pawnee has only a special property in the pledge, the general property remains in the pawnor
and wholly reverts to him on discharge of the debt [Lallan Prasad vs Rahmat Ali4]. Any kinds of
movable goods or property, valuables, documents, or securities may be pledged. The government
securities should, however, be pledged by endorsement and delivery.

Pledge and bailment compared

Self-Learning The contracts of pledge and bailment are similar in two of the following respects
102  Material 1. In both the cases, there is a delivery of movable goods or property;
 2. The goods are delivered back to the bailor or pawnor after accomplishment of purpose or Special Contracts
expiry of stipulated time.
The two, however, differ in a number of ways such as the following.
Purpose  Pledge has a specific purpose, i.e., repayment of a debt or performance of a promise, Notes
whereas bailment has a general purpose.
Use of goods  The pawnee has no right to make any use of the goods pledged. On the other hand,
in bailment the bailee uses the goods if the terms of bailment so provide.

Rights and Duties of the Pawnee

Pledge being a species of bailment, the rights and duties of the pawnor and pawnee are almost
similar to those of the bailor and bailee.

Rights of pawnee
The Law confers the following rights to the pawnee.
Right of retaining goods  The pawnee has a right to retain the goods pledged for
1. payment of the debt
2. performance of the promise, and
3. all expenses incurred by him in respect of the possession or for the preservation of the goods
pledged [Section 173].
However, 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.
Still, such a contract, in the absence of anything to the contrary, shall be presumed in regard to
subsequent advances made by the pawnee (i.e., without fresh security) [Section 174].
Right as to extraordinary expenses  The pawnee is entitled to receive from the pawnor extraor-
dinary expenses incurred by him for the preservation of the goods pledged [Section 175].
Right to sue when pawnor makes default  Should the pawnor default in payment of the debt, or
performance of the promise, at the stipulated time, the pawnee may bring a suit against the pawnor
upon the debt or promise while retaining the goods pledged as collateral security [Section 176].
Right to sale  Upon pawnor’s default as regards payment of debt or performance of the promise,
the pawnee may sell the goods 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 [Section 176].
Right to have good title to the goods  Where the pawnor’s title with regard to the goods pledged
by him is defective, the pawnee acquires a good title to the goods, provided he acted in good faith
and without notice of the pawnor’s defect in title [Section 178A].

Duties of pawnee
A pawnee has the following duties:
1. Duty to take reasonable care of the goods pledged
2. Duty not to make personal use of the goods pledged
3. Duty not to mix goods pledged with his own goods
4. Duty to return the goods pledged after the debt has been paid or the promise has been
performed
5. Duty not to commit any act that is inconsistent with the terms of pledge
6. Duty to deliver accretion, if any, to the goods pledged.

Rights and Duties of the Pawnor

Rights of pawnor
Foremost of all his rights, the pawnor has a right to get back the goods pledged plus increase
thereon, if any, by him, after paying off the amount of debt in full and other charges (if appli- Self-Learning
cable), or performing the promise. Material  103
Legal and Regulatory Moreover, if a time is stipulated for the payment of the debt, or the performance of the prom-
Environment of ise, for which the pledge is made, and the pawnor defaults on that count, i.e, repaying the debt
Business or performing the promise, he may redeem the goods pledged at any subsequent time before the
actual sale of them. However, he must, in that case, pay, in addition, any expenses that have arisen
Notes
from his default [Section 177].

Duties of pawnor
The pawnor has the following duties.
Duty to repay the debt or perform the promise  The pawnee is bound to comply with the terms
of pledge. Accordingly, he must repay the debt in full along with interest and other charges, if any,
or perform the promise at the stipulated date or time.
Duty to disclose defects in the goods pledged  The pawnor should disclose to the pawnee defects
in the goods pledged, if any, of which he is aware, failing which he will be liable for any loss to the
pawnee due to such defect.
Duty to meet extraordinary expenses  If the pawnee has incurred any extraordinary expenses
for preserving the goods pledged, it is the duty of the pawnor to compensate him for the same.

Pledge by non-owners
Generally, only the owner or co-owner of the goods can pledge them. But to facilitate mercan-
tile transactions, the law, under certain circumstances, permits a pledge by a person who is not
the owner but is in the possession of the goods. Accordingly, the following non-owners too can
make a valid pledge of the goods.
1. A mercantile agent
2. Person in possession under voidable contract
3. Seller or buyer in possession after sale
4. Person having limited interest.
Mercantile agent  Where a mercantile agent is, with the consent of the owner, in possession
of goods or the document 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, at the
time of pledge, no notice of the fact that the agent has no authority to pledge [Section 178].
Person in possession under voidable contract  A person who is in possession of goods under a
voidable contract can make a valid pledge provided the pawnee has acted in good faith and without
any knowledge of the defect in pawnor’s title [Section 178 A].
Seller or buyer in possession  A seller left in possession of goods sold or documents of title
thereof is no more the owner. But the pledge made by him will be valid provided the pawnee
acted in good faith and had no knowledge of the defect in the pawnor’s title. On the same foot-
ing, a buyer, who with the consent of the seller, obtains possession of goods before sale can make
a valid contract [Refer Section 30 of Sale of Goods Act].
Person having limited interest  Where a person who pledges goods in which he has only a
limited interest, for example, he is a mortgagee or has a lien over these goods, the pledge will
be valid to the extent of that interest [See Section 179].

Contracts of Agency: Introduction

Contact of agency is another class of special contracts contained under Sections 182 to 238 of the
Indian Contact Act, 1872. If a person asks another person to purchase or sell certain goods, or pro-
vide a particular service on his/her behalf, and the latter promises to do the needful, a contract of
agency comes into being. Agency is basically a relationship that arises when one person, called the
principal, authorises another, called the agent, to act on his/her behalf, and the other person agrees
to do so. The law of agency is based on the principle ‘what a person does by another, he/she does
by himself/herself’. Thus, the most important effect of establishing an agency relationship is that
Self-Learning it enables the agent to make a contract between his/her principal and a third party.
104  Material
Agency Defined Special Contracts

The Act attempts to define agency in terms of agent and principal relationship. According to
Section 182 of the Contract Act, ‘an agent is a person employed to do any act for another person,
or to represent another in his dealings with third persons. The person for whom such an act is done Notes
or who is so represented is called the principal’.
As the definition indicates, an agent acts as a connecting link between the principal and the
third parties. After enforcing the contract on behalf of the principal (i.e., the promisor) with a
third party (i.e., the promisee), he/she ceases to be a party to the contract, and the contract
comes into existence only between the principal and the third party. In this way, the role of an
agent is essentially to bring the principal into contractual relations with a third party.

General rules governing an agency

Following are the two important general rules regarding agency:
1. Whatever a man sui juris (i.e., a person competent to contract) may lawfully do by himself,
he may do the same through an agent. This means that any person possessing the capacity
to contract may act through a representative, i.e., an agent. However, the process cannot
be adopted in the transactions or acts requiring personal skills and abilities. For example,
a person cannot enter into a contract of marriage through an agent. Similarly, no one can
make a painting or carve a statue through an agent.
· 2. Maxim qui facit per alium facit per se, i.e., he who acts through an agent is himself/herself act-
ing. In other words, for legal purposes, the acts of an agent are the acts of his principal. In this
regard, Section 226 says, ‘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’. For example, A buys goods from B knowing that he is an agent for their sale but not
knowing who is the principal. B’s principal is the person entitled to claim from A the price
of the goods, and A cannot, in a suit by the principal, set off against that claim a debt due to
himself from B [illustration (a) appended to Section 226].

Essentials of agency
An agency has three distinct characteristics which are as follows.

Intention and power to act on behalf of the principal

The mere fact that a person says he/she is an agent does not make them one if they intend to
act on their own behalf and not on behalf of their supposed principal. Therefore, to become an
agent of another, a person must be intended and adequately authorised to represent another
so that he/she can render the person so represented answerable to a third person. Thus, a person
who agrees in friendship to ferry another’s car from one place to another can be regarded as the
owner’s agent, such that his negligent driving may make the owner liable in tort; but a person who
borrows another’s car for his own purposes would not be so regarded.

Capacity of the parties

The first rule makes it clear that since an agent brings about a contractual relationship between
his/her principal (i.e., the promisor) and a third party (i.e., the promisee), it is essential that
both the principal and the third party should be competent to contract. As per Section 183,
‘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’.
However, the second rule of agency shows that the agent need not have the capacity to
contract, since his/her act is deemed to be the act of the principal. According to Section 184,
‘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’.
Thus, a person may contract through a minor agent, but the minor will not be responsible to his
principal [Foreman vs Great Western Rly. Co.5]. Let us consider an illustration for a clear understand-
ing of this provision. Where A appoints B, a minor as his agent, the contract would be good so far Self-Learning
Material  105
Legal and Regulatory as the third parties are concerned. According to the law governing an agency, A will be responsible
Environment of to the third parties for the acts of B. But B himself will not be answerable to his principal (A) as he
Business has no contractual capacity.
Notes Consideration not necessary
Unlike other forms of contract, a valid agency can be created without consideration. The prin-
cipal may agree to pay consideration to the agent in the form of commission or salary, but it is
not a deciding factor for the validity of their agency relationship. Section 105 clearly provides,
‘No consideration is necessary to create an agency’. A contract of agency, therefore, constitutes
an exception to the general rule contained in Section 25 that no contract will be valid unless it is
supported by consideration.

Factors determining existence of agency relationship

The use of the words ‘agency agreement’ and ‘agent’ by the parties in a contract does not neces-
sarily establish a relationship of agency in the legal sense. The true test of determining whether
a relationship is that of principal and agent is if the agent can make the principal answerable to a
third person. In other words, an agency exists whenever a person has the authority to represent the
other and create a contractual relationship between the latter (principal) and the third parties. An
agency relationship does not exist if a person is only acting at the advice or direction of the other
but not on his/her behalf. Thus, a ‘procurement agent’ has been held ‘to be not an agent’ [State of
Madras vs Jaya Lakshmi Rice Mills 6], as he/she is only a person directed to do an act on commission
and not to represent anyone. Similarly, a person is not an agent merely because he/she gives advice
to others in matters of business [Mahesh Chandra Basu vs Ratha Kishore Bhattacharjee7]. The agent’s
representative capacity along with a derivative authority to effect legal relationship between the
principal and third persons is the distinctive feature of a contract of agency.

Creation of agency
The law recognises various modes to create a contract of agency, namely,
1. Agency by express agreement
2. Agency by implied agreement
3. Agency by ratification
4. Agency by operation of law.

Agency by express agreement

A contract of agency may be made through an express agreement between a principal and his/her
alleged agent. The said agreement may be oral or in writing. The agency so created is called ‘ex-
press agency’. As per Section 187, the authority of an agent is said to be express when it is given by
words, spoken or written. The usual form of a written contract of agency is the ‘Power of Attorney’,
which gives the agent the authority to act on behalf of the principal in accordance with the terms
and conditions therein. An oral appointment is also valid even though the contract that the agent
is authorised to make has to be in writing [Heard vs Pilley 8]. For example, A of Delhi appoints B of
Mumbai by a deed (power of attorney) to sell the goods supplied from his Delhi office in Bombay
and adjoining areas on commission basis. In this way, an agency relationship has been created be-
tween A and B through an express agreement.

Agency by implied agreement

A contract of agency may be implied from the circumstances of the case, things spoken or
written, or the ordinary course of dealing [Section 187]. For example, a solicitor or a counsel
engaged to conduct litigation may have the implied authority to compromise the suit. Simi-
larly, it has been held that a husband who lives with his wife impliedly authorises her to pledge
his credit for necessary household expenses. An implied agency also results in the circumstances
described in Box 6.10.
An implied agency may take the following three distinct forms:
1. Agency by estoppel
Self-Learning 2. Agency by holding out
106  Material 3. Agency by Necessity.
 Special Contracts

Box 6.10 Driving for Friend is an Implied Contract of Agency

Notes
X has a car but he does not know how to drive. He usually takes the services of Y, his neighbour, in
this regard, whenever he goes outside. Y while driving the car meets with an accident and injures Z,
a passerby. X will be liable to Z for damages, since Y is the implied agent of X.

Agency by estoppel Estoppel arises when someone is stopped or precluded from denying the
truth of anything that he/she has represented by his/her words or conduct as a fact, although such
a state of thing did not exist at all. Section 237, which deals with agency by estoppel, states, ‘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’.
A practical situation will help understand the point better. A tells B in presence and within hear-
ing distance of P that he is P’s agent. P does not contradict the statement. Later on B enters into a
contract with A, honestly presuming that A is P’s agent. P will be bound by this contract for there is
an agency by estoppel between him and A. In a suit between P and B, P will be prevented or stopped
from denying his agent’s authority and getting himself relieved from his obligations to B by proving
that no such relationship existed in fact.
Agency by holding out The doctrine of ‘holding out’ is also based on the principle of estoppel.
Here, the alleged principal by his/her words or conduct wilfully leads another person to believe
that the alleged agent is representing him/her. If someone enters into a contract with the person
so representing on that belief, then the person so represented (i.e., the alleged principal) is stopped
from denying the truth of such statements subsequently. In this way, agency, by holding out is a
type of agency by estoppel, where the agency by estoppel is created by the actions of the agent, the
agency by holding out comes into existence by the actions of the principal. For example, P allows
his servant to purchase certain goods from B’s shop on credit and later on he pays for the goods. It
is repeated many times. Later on, when the servant was not in P’s employment, he purchased goods
on P’s credit from the same shop and disappeared. B can recover the price from P on the basis of
the doctrine of holding out.
Agency by necessity Sometimes, owing to the exigencies of circumstances, a person may be
compelled to act as an agent to the other without requiring or seeking the consent of the latter.
Such an agency is called the agency by necessity. For example, a shipmaster can borrow money at a
port where the shipping company has no agent, to get the ship repaired or fuelled so as to complete
the voyage. In this case, the shipmaster becomes an agent by necessity.
In Sims & Co. vs Midland Rly. Co.9, quantity of butter was consigned with the defendant railway
company. The goods being perishable was becoming useless owing to delay in transit and was, there-
fore, disposed of by the station master for the best price available as it was not possible to obtain
instructions from the principal; the sale was held binding on the owner. The company’s action was
justified on the ground of unforeseen emergency, arisen in the course of transit.

Agency by ratification
Where a person without being authorised, purports to act as agent, or a duly authorised agent
acts beyond his/her authority, the principal may elect to ratify or disown such acts. If he chooses to
ratify the agent’s transactions supposedly based on his behalf, an agency by ratification arises. The
effect of ratification is that it renders the ratifier (i.e., the principal) bound to the contract as if he
had expressly authorised the person to transact the business on his behalf.
An agency by ratification is also known as ex post facto agency, i.e., agency arising after the
event. Section 196, which recognises the creation of agency by ratification, provides thus:
‘Where acts are done by one person on behalf of another, but without his knowledge or author-
ity, he may elect to ratify or to disown such acts. If he ratifies them, the same effects will follow as Self-Learning
Material 107
if they had been performed by his authority.’
Legal and Regulatory Rules governing agency by ratification  Although the law provides for an agent, exceeding his
Environment of brief at times, and has given the principal the power to ratify or disclaim such acts, it has also spelt
Business out the circumstances and rules under which such an act can or cannot be considered as agency by
ratification. The following are the rules governing the agency by ratification:
Notes
1. An act will be regarded as a ratification only if the principal had a free choice whether to do
it or not.
2. The agent must purport (intend to seem) to act as an agent [Section 196]. A principal can
only ratify acts that the agent purported to do on his behalf. This rule follows that if the
agent purports to act on his own behalf, the principal cannot ratify.
3. The person ratifying must have contractual capacity [Section 196]. This implies that the
principal must be competent to contract not only at the time when the agent exceeded his
authority but also when he ratified such act of the agent.
4. Ratification may be express or it may be implied in the conduct of the person on whose
behalf the acts are done [Section 196]. For instance, without A’s authority, his brother B
lends his house to C. Later on C pays the rent for the house and A accepts the same. By this
conduct B shall be deemed to have ratified the act of A.
5. The principal must exist when the act is done [Section 196]. Hence, a company cannot ratify
pre-incorporation agreements.
6. The principal at the time of ratification must have the full knowledge of the material facts
[Section 198].
7. The principal must ratify the whole of the transaction [Section 199]. This implies that he
cannot ratify at his will a part of the transaction and repudiate the rest. For example, A,
without B’s authority, lends B’s money to C on the term that C will repay the same in four
equal yearly installments along with an interest at the rate of 12 per cent to be calculated
on yearly reducing balance. Afterwards B accepts the first installment, and it amounts to the
ratification of the whole transaction.
8. The act must be ratified in time. A contract cannot be ratified after the time fixed for its
performance. If no such time is fixed, it must be ratified within a reasonable period of time,
from the principal’s acquiring notice of the unauthorised act.
9. Ratification cannot be made so as to subject a third party to damage [Section 196], or termi-
nate any right or interest of a third person [Section 200]. For example, A, not being author-
ised thereto by B, demands, on behalf of B, the delivery of a chattel, which is the property of
B, from C who is in the possession of it. This demand cannot be ratified by B so as to make
C liable for his refusal to deliver [Illustration (a) appended to Section 200].
10. The ratification should relate back to the actual date of the formation of the contract be-
tween the agent and the third party. In other words, it should have retrospective effect and
not prospective. For example, if A without being authorised thereto lends B’s money to C
and afterwards B ratifies the transaction. The contract will be deemed to have been ratified
by B on the date on which A lent B’s money to C.
11. Although ratification is not confined to lawful acts, an act, which is simply void in law, cannot
be validated by ratification. In other words, only lawful acts can be ratified [Section 196].
Effect of ratification  The effect of ratification is to put the principal, agent, and the third
party into the position that they would have been if the agent’s acts had been authorised from
the beginning. Ratification, in fact, relates back to the time of the unauthorised act and not to the
date when the principal ratified the said act. The doctrine of relating back is based on the assump-
tion that the unauthorised act is not a nullity; if it were, ratification itself would be ineffective either
because a nullity cannot be ratified or, the principal himself could not have validly done the act in
question, when it took place.

Agency by operation of laws

An agency, under certain circumstances, also comes into existence by operation of law. Such
an agency comes into existence neither by an express agreement nor by estoppel and ratifica-
tion, but by the provisions of the law of land. Partnership firm is an universal example of this
type of agency. When a partnership is formed, every partner, by operation of law, automatically
becomes the agent of other partners and the firm. Similarly, the promoters become agents of
Self-Learning the company they promote, MPs and MLAs become agents of their respective constituencies,
108  Material ministers become agents of governments, and so on.
Scope and Extent of Agent’s Authority Special Contracts

All that a person can do as an agent, on behalf of his principal, depends on the terms expressed
in his appointment, or is implied by the circumstances of the particular case. People dealing
with an agent are entitled to presume that he has the authority to do all such acts as are neces- Notes
sary or incidental to such business. The scope and extent of an agent’s authority is determined
by the following two principles:
(i) Agent’s authority in normal circumstances [Section 188]
(ii) Agent’s authority in an emergency [Section 189].

Agent’s authority in normal circumstances

An agent, having an authority to do an act, has the authority to do every lawful thing, which is
necessary in order to do such an act.
An agent having an authority to carry on a business has the authority to do every lawful
thing necessary for the purpose, or to do what is generally done in the course of conducting
such business [Section 188].
However, the custom or usage must not be unreasonable or unlawful. Whether a custom or usage
is unreasonable or unlawful is a question of law. Any custom that changes the very nature of the
agency, as for example, which converts the agent into principal, is unreasonable [Dr Avtar Singh10].
For example, B, who is based in London, employs A to recover a debt in Mumbai due to him. A
may adopt any legal process necessary for the purpose and may give a valid discharge for the same.

Agent’s authority in an emergency

In an emergency, an agent has the authority to do all such acts for the purpose of protecting his/
her principal from incurring loss as would be done by a person of ordinary prudence, in his/her own
case, under similar circumstances [Section 189]. For example, A consigns provisions to B at Kolkata,
with directions to send them immediately to C at Cuttack. B may sell the provisions at Kolkata, if
they will not bear the journey to Cuttack without perishing. Similarly, an agent for the purpose of
sale may buy goods if it were necessary.

Delegation of Authority by an Agent

Incidentally, the agent himself is a delegate of his/her principal. He/she, therefore, cannot further
delegate except with the permission of the principal. Section 190 provides that ‘an agent cannot
lawfully employ another to perform an act which he has expressly or impliedly undertaken to per-
form 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’.
The above provision is based on the Latin Maxim, ‘delegates non protest delegare’ that is, a delegate
cannot further delegate. In plain words, one cannot depute another to perform what he has himself
undertaken to perform. An agent occupies a fiduciary position, which means the principal has got the
full confidence in his integrity and competence. Accordingly, he is not supposed to delegate further
or involve someone else (i.e., appoint a sub-agent) while acting on behalf of his principal without
obtaining his permission. This general rule is, however, subject to the following exceptions:
1. Where the principal knows that the agent intends to appoint a sub-agent but does not object
to it.
2. Where by the ordinary custom of trade, a sub-agent may be employed.
3. Where the duties of the agent do not involve any skill or exercise of discretion, e.g., clerical
or routine task.
4. Where the very nature of agency requires delegation. For instance, a managing director may
appoint someone as his personal secretary.
5. When an emergency makes it necessary to appoint some sub-agent(s).

Sub-agent
Where an agent having authority to delegate further appoints another person to act in the Self-Learning
matter of the agency, the person so appointed is called a ‘sub-agent’, provided he/she acts un- Material  109
Legal and Regulatory der the control and supervision of the former (i.e., original agent). As per Section 191, ‘a sub-agent
Environment of is a person employed by, and acting under the control of, the original agent in the business of the
Business agency’. Thus, in a way, the sub-agent is the agent of the original agent.
Notes Impact of the appointment of a sub-agent  The impact or legal effect related to sub-agents de-
pends on whether their appointment is proper or improper. Sections 192 and 193 of the Contract Act
have defined the legal course in both the circumstances, which have been discussed subsequently.
In case of proper appointment  In such a case, as per Section 192, the following consequences
arise:
1. So far as regards third persons, the principal is bound to and responsible for the acts of
the sub-agent, as if he were an agent originally appointed by the principal.
2. The agent is responsible to the principal for the acts of the sub-agent. For example, a
commission agent for the sale of goods who appoints a sub-agent for selling the goods
of his principal shall be liable to the principal for any misappropriation of sale proceeds
by the sub-agent during the course of such sub-agency. There is no privity of contract
between the principal and the sub-agent and, therefore, the principal cannot sue the
sub-agent for negligence. In Calico Printers’ Association vs Barclay’s Bank11, a sub-agent
failed to insure the principal’s goods, which were destroyed in fire. But the principal could
not recover against the sub-agent.
3. The sub-agent is responsible for his acts to the [original] agent, but not to the principal, ex-
cept in case of fraud or wilful misconduct. Thus, this provision gives the principal, in case of
fraud or wilful wrong, the right of recourse to the sub-agent. But in such a case the principal
has the choice to sue either the agent or the sub-agent [Nensukhdas vs Birdichand 12]. This is
so because the provision does not in any way exclude the principal’s normal right of recourse
to his agent [Section 192].
In case of improper appointment  In terms of Section 193, improper appointment of a sub-agent
results in the following consequences:
1. The principal is not responsible for the acts of the person so employed (i.e., sub-agent).
2. The agent is liable for the acts of the sub-agent both to the principal and to third party. In
other words, the agent is the principal of the sub-agent, both to the principal and the third
party.
3. The sub-agent is not at all responsible to the principal.

Substituted agent
A substituted agent is defined by Section 194 thus: ‘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’.
The analysis of this section shows that substituted agents are different from sub-agents. A sub-
agent cannot replace a substituted agent. A substituted agent, in fact, is the agent of the principal.
The reason behind the same is quite obvious. The moment the substituted agent is appointed,
privity of contract is established between him and the principal, and the original agent ceases to
remain in the picture.
In selecting a ‘substituted agent’ for his principal, the agent ought to exercise as much care as
a man of ordinary prudence would exercise in his own case. Examples to this effect are presented
in Box 6.11.

Rights of Agent
The agent enjoys the following rights against the principal:
1. Right to remuneration
2. Right of retainer
3. Right of lien
4. Right to be indemnified against consequences of lawful acts
5. Right to be indemnified against consequences of acts done in good faith
Self-Learning 6. Right to compensation.
110  Material
 Special Contracts

Box 6.11 Who is a Substituted Agent

Notes
Example 1
A directs B, his solicitor, to sell his estate by auction and to employ an auctioneer for the purpose.
B names C, an auctioneer, to conduct the sale. C is not a sub-agent, but is A’s substituted agent for
the conduct of the sale.
Example 2
A authorises B, a merchant in Kolkata, to recover the money due to him from C & Co. B instructs
D, a solicitor, to take legal proceedings against C & Co. for the recovery of the money. D is not a
sub-agent, but a substituted agent of A [Appended to Section 194].

Right to remuneration
An agent is a person employed or engaged to perform for another. Therefore, as a general rule,
he/she is entitled to receive remuneration for the performance of any act in the business of the
agency. An agent’s right to remuneration is subject to the following four rules:
1. Unless the services rendered by the agent are gratuitous or voluntary, the agent is entitled
to receive agreed remuneration (usually in the form of commission).
2. Where no specific remuneration was fixed, then the agent is entitled to be paid a reasonable
remuneration, i.e., what is usual and customary in the business in which he/she has been
employed.
3. 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 [Section 219]. In simple words, an agent becomes
entitled to receive remuneration as soon as he/she has performed what he/she had prom-
ised to perform. For example, the owner of a house employed an agent to find a tenant. The
agent found a tenant who later bought the house. His/her claim for commission on the sale
failed, since he/she was only employed to let the house [Toulmin vs Millar13].
∑ An agent who is guilty of misconduct in the business of the agency is not entitled to any remu-
neration in respect of that part of the business that he/she has not conducted appropriately
[Section 220]. For instance, A employs B to recover ` 1,00,000 from C and to lay it out on good
security. B recovers the entire amount and invests ` 90,000 on good security, but invests
` 10,000 on a security, which he ought to have known to be bad. As a result, A loses
` 2000. B is entitled to remuneration for recovering ` 1,00,000 and for investing ` 90,000
securely. But he is not entitled to any remuneration for investing ` 10,000, and he must
make good the ` 2000 to B.

Right of retainer
An agent may retain out of any sum received on account of the principal in the business of the
agency the following:
1. all moneys due to him/her in respect of advances made,
2. expenses properly incurred by him/her in conducting such business, and
3. such remuneration as may be payable to him/her for acting as an agent [Section 217].

Right of lien
An agent is (unless otherwise agreed) entitled to a lien on all property (including papers) of the
principal, which has come into his/her possession in the course of the agency [Section 221].

Right to be indemnified against consequences of lawful acts

The employer of an agent is bound to indemnify him/her against the consequences of all lawful acts
done by such agent in the exercise of the authority conferred upon him/her [Section 222]. Some Self-Learning
case studies in Box 6.12 drive home the point. Material 111
Legal and Regulatory
Environment of
Business Box 6.12 Agent’s Right to be Indemnified Against Fallout of
Lawful Acts
Notes
Example 1
B, at Singapore, under instructions from A of Delhi, contracts with C to deliver certain goods to C. A
does not send the goods to B for breach of contract. C files a suit in the court. B informs A of the suit,
and A authorises him to defend the suit. B defends the suit and is compelled to pay damages, costs,
and incurs expenses. A is liable to B for such damages, costs, and expenses.
Example 2
B, a broker at Kolkata, by the orders of A, a merchant, contracts with C for the purchase of 10 casks of
oil for A. Afterwards A refuses to receive the oil, and C sues B. B informs A, who in turn repudiates the
contract altogether. B defends but becomes unsuccessful and has to pay damages and costs and
incurs expenses. A is liable to B for such damages, costs, and expenses [Appended to Section 222].

Right to be indemnified against consequences of acts done in good faith

An agent’s right to be indemnified also extends for the consequences of the acts done in good faith
even though they turn out to be injurious to the rights of third persons [Section 223]. Examples
explaining the point are presented in Box 6.13.

Box 6.13 Agent Has Right to Be Indemnified for Acts Done

in Good Faith

Example 1
A, a decree-holder and entitled to execution of B’s goods, requires the officer of the court to seize
certain goods, presenting them to be the goods of B. The officer seizes the goods, and is sued by C,
the true owner of the goods. A is liable to indemnify the officer for the sum, which he is compelled
to pay to C, as a consequence of obeying A’s directions.
Example 2
B, at the request of A, sells goods in the possession of A, but which A had no right to dispose of. B
does not know this, and hands over the proceeds of the sale to A. Afterwards C, the true owner of
the goods, sues B and recovers the value of the goods and costs. A is liable to indemnify B for what
he has been compelled to pay to C, and for B’s own expenses [Appended to Section 223].

Right to compensation
An agent is also entitled to compensation in respect of injury or loss suffered by him/her due
to the principal’s neglect or want of skill [Section 225]. For example, A employs B as a bricklayer in
building a house and puts up the scaffolding himself. The scaffolding is put up unskillfully and B is
hurt. A must make compensation to B.

Duties of an Agent
Having known the rights of the agents, we should know their corresponding duties. An agent owes
the following obligations or duties to the principal:
1. Duty to act within the scope of the authority
2. Duty to follow instructions or customs
3. Duty to act with due care and skill
Self-Learning
112 Material 4. Duty to render accounts
 5. Duty to communicate Special Contracts
6. Duty to remit sums
7. Fiduciary duty.
Notes
Duty to act within the scope of the authority
The first and foremost duty of every agent is to act within the scope of the authority conferred
upon him/her. He/she will be liable for breach of contract, if he/she acts in a way not authorised
by the terms of his/her appointment. An agent who acts gratuitously or under a unilateral contract
is not bound to do anything but may be liable if he/she begins to perform and then leaves the task
unfinished.

Duty to follow instructions or customs

An agent is bound to carry out strictly the instructions of the principal. In the absence of ex-
press instructions, he/she must follow the prevailing custom in the same kind of business at
the place where the agent conducts the business. When an agent acts otherwise, he/she would
be liable to make good any loss if sustained, and if any profit accrues, he/she must account for
it [Section 211]. The following two examples in Box 6.14 are cases in point.

Box 6.14 Agent is Duty Bound to Follow Instructions or

Custom

Example 1
X instructs his agent Y, employed for the trans-shipment of X’s goods, to get the goods insured, but
Y fails to do so and later the goods are destroyed on the way. Y is liable to compensate X [Pannalal
Jankidas vs Mohanlal 14].
Example 2
A, an auctioneer, contrary to the usual custom of the business, accepts a bill of exchange from B in
payment of the price of goods sold. The bill when presented is dishonoured. A must make good the
loss to his principal [Ferrer vs Robbins15].

Duty to act with due care and skill

The criteria of care and skill expected from an agent are laid down in Section 212.
According to it, 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 is aware of
his/her lack of skill. The agent is always bound to act with reasonable diligence and use his/her
skill and make compensation to the principal in respect of the direct consequences of his/her
own neglect, lack of skill, or misconduct but not in respect of loss or damage that are indirectly
or remotely caused by such neglect, lack of skill, or misconduct.
Thus, an agent must conduct the business of the agency with reasonable skill and diligence.
When the nature of his/her profession requires special skill, the agent must exercise the skill as
required of the members of the profession. Hence, the degree of care and skill expected of an
agent depends on the circumstances and facts of each particular case. Box 6.15 presents some
examples on this count.

Duty to render accounts

An agent is bound to render proper accounts to his/her principal on demand [Section 213].

Duty to communicate
In case of difficulty, an agent must use reasonable diligence in communicating with his principal and
to obtain instructions from him [Section 214]. Self-Learning
Material 113
Legal and Regulatory
Environment of
Business Box 6.15 Agent Must Exercise Reasonable Care and Skill
Notes
Example 1
A, a merchant in Kolkata, has an agent B, in London, to whom a sum of money is paid on A’s account,
with orders to remit. B retains the money for considerable time. A, in consequence of not receiving the
money, becomes insolvent. B is liable for the money and interest from the day on which it ought to
have been paid, according to the usual rate, and for any further direct loss, such as loss due to variation
of rate of exchange, but not further.
Example 2
A, an agent for the sale of goods, having authority to sell on credit, sells to B on credit, without making
the proper and usual enquiries as to the solvency of B. B at the time of such sale is insolvent. A must make
compensation to his principal in respect of any loss sustained as a result [Appended to Section 212].

Duty to remit sums

The agent is bound to pay to the principal all sums received on the latter’s account [Section 218].

Fiduciary duty
Since a principal places confidence in an agent, the latter owes a fiduciary duty to the former in
some respects. Its most important consequences are the following:
1. An agent must not allow his/her interest to conflict with his/her duty. In other words, he/
she must not put himself/herself in a position where his/her interest and duty conflict. He/
she must not, for instance, sell his/her own goods to the principal when he/she is employed,
since his/her interest as a seller would be to get the highest possible price, whereas his/her
duty as an agent is to buy at the lowest possible price [Section 215].
2. He/she must not make any secret profits in the business of the agency, i.e., he/she must
not obtain any advantage over and above the agreed remuneration, which he/she would not
have been able to make, but for his/her position as an agent.
3. An agent must perform the acts personally that he/she has expressly or impliedly under-
taken to perform personally [Section 190]. That is, an agent must not further delegate the
work that has been delegated to him/her by the principal.
4. He/she must not disclose confidential information to anyone, entrusted to him/her by the
principal.
5. Lastly, when an agency is terminated due to the death of the principal or if the principal
becomes unsound, the agent is bound to take, on behalf of the representatives of the prin-
cipal, all reasonable steps for the protection and reservation of the interests entrusted to
him/her.

Rights and duties of principal towards agent

Because of the element of reciprocal relationship between an agent and the principal, all the duties
of the agent become the rights of the principal and all the rights of the agent become the duties of
the principal.

Principal’s Liability for Agent’s Acts

When an agent makes a contract on behalf of his/her principal with a third party, the transaction gives
rise to legal effect between the principal and third party, i.e., the principal is liable to third parties for
the acts of the agent. However, the effect of a contract made by an agent varies according to the
circumstances under which the agent contracted. Accordingly, the extent of the principal’s li-
ability to third parties for the acts of the agent may be discussed under the following heads:
Self-Learning
114 Material 1. When agent acts within the scope of his authority
 2. When agent exceeds his authority Special Contracts
3. Principal is bound by notice given to agent
4. Liability of principal under doctrine of estoppel
5. Liability for agent’s torts or other wrongs Notes
6. Liability of unnamed principal
7. Liability of undisclosed principal

When agent acts within the scope of his authority

The principal is bound by all acts of the agent done within the scope of his/her actual or
orostensible (apparent) authority. Such acts of the 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 [Section 226].

When agent exceeds his authority

When an agent exceeds his/her authority, actual or apparent, and the excess work can be
separated from the authorised work, the principal is bound to the extent of authorised work [Sec-
tion 227]. But where the excess cannot be separated from the authorised work, the principal is not
bound by the transaction, i.e., he/she may repudiate the whole of the transaction [Section 228]. The
examples in Box 6.16 drive home the point.

Box 6.16 Principal’s Liability Where Agent Exceeds

Authority

Example 1
A, an owner of a ship and cargo, authorises B to procure insurance for ` 4000 on the ship. B procures
a policy for the said amount on the ship, and another for the like sum on the cargo. A is bound to pay
the premium for the policy on the ship but not the premium of the policy on the cargo.
Example 2
A authorises B to buy 500 sheep for him. B buys 500 sheep and 200 lambs for a sum of ` 6000 . A may
repudiate the whole transaction [Appended to Sections 227 & 228].

Principal bound by notice given to agent

The principal is bound by any notice given to, or information obtained by the agent, provided it
be given or obtained in the course of the business transacted by him/her for the principal [Section
229]. Any information, which is material for the business of the agency if brought to the notice of
the agent, is deemed to have been brought to the notice of the principal. But, if the agent in the
course of his/her employment does not acquire the notice or information, he/she (agent) cannot
be imputed to the principal [Section 229]. The examples in Box 6.17 explain the point.

Box 6.17 Principal Bound by Notice Served on Agent

Example 1
A is employed by B to buy from C certain goods, of which C is the apparent owner. In the course of
the treaty for the sale, A learns that the goods actually belonged to D, but B is ignorant of that fact. B
is not entitled to set-off a debt owing to him from C against the price of the goods.
Example 2
A is employed by B to buy goods from C, of which C is the apparent owner. A, before his employment
with B, was a servant of C and had then learnt that the goods really belonged to D, but B is ignorant
of that fact. Despite the knowledge of his agent, B may set off against the price of the goods a debt Self-Learning
owing to him from C [Appended to Section 229]. Material 115
Legal and Regulatory Liability for agent’s torts or other wrongs
Environment of
Where an agent commits a tort or other wrongful act (for example, misrepresentation or fraud)
Business
during his/her agency, the principal is liable. The principal is liable even if the tort or wrongful
Notes act is committed exclusively for the benefit of the agent and against the interest of the principal
[Section 230]. Examples to this effect are presented in Box 6.18

Box 6.18 Principal Liable for Agent’s Torts

Example 1
An agent, employed to collect evidence for his principal in a pending law suit, offered to bribe a
witness. It was held that the act was within the course of the employment of the agent and that the
principal was bound by it [Chicago City Rly. Co. vs McMohan16] [Appended to Section 230].

Liability of principal under doctrine of estoppel

When an agent has, without authority, done acts or incurred obligations to third persons on
behalf of his/her principal, the principal is bound by such acts or obligations, if he/she 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 [Section 237]. In this case, the principal incurs his/her
liability to third persons by estoppel.

Liability of unnamed principal

If the agent while contracting with third parties discloses the existence of the principal but
does not disclose the name of the principal, the principal is bound by the contract. If however,
the agent refuses to disclose the identity of his principal upon being asked by third parties, the
agent becomes personally liable on the contract.

Liability of undisclosed principal

When an agent who has the authority to contract on behalf of another enters into a contract
in his/her own name (i.e., he/she discloses neither the name of the principal nor his/her exist-
ence), the principal is called ‘undisclosed principal’. In such a case the agent becomes personally
liable to third party. However, if the third party discovers that there is a principal, then as per Section
233, the third party has the option to sue the agent or the principal or both. For example, A enters
into a contract with B to sell him 100 bales of cotton and afterwards discovers that B was acting as
an agent for C. A may sue either B or C or both, for the price of the cotton.

Termination of Agency
Agency, as a contract, gets terminated by any event that terminates a contract, such as by
performance, revocation, or destruction of subject matter, and also in certain special ways.
Accordingly, the various modes of terminating an agency can broadly be classified into the
following two categories:
1. By act of the party, and
2. By operation of law.

Termination by act of the parties

The termination of agency may be caused by an act of the principal or the agent, or by an
agreement between the two. A brief description of putting an end to agency relationship by
act of the parties is given below.

Revocation of authority by the principal

Self-Learning
116 Material The rules governing revocation of authority by the principal may be summarised as under.
When can the principal revoke the agent’s authority The principal can revoke the authority Special Contracts
given to his agent at any time before the authority has been exercised so as to bind the principal
provided the agency is not irrevocable [Section 203].
Revocation cannot be exercised in respect of partly exercised authority The principal can- Notes
not revoke the authority given to his agent after the authority has been partly exercised, as regards
such acts and obligations that arise from acts already done in the agency. In other words, where the
agent has partly exercised his authority, the principal may revoke agency for future acts only [Sec-
tion 204]. Examples to this effect are presented in Box 6.19.

Box 6.19 Revocation of Authority for Future Acts of Agent

Example 1
A authorises B to buy 1000 bales of cotton on account of A and to pay for it out of A’s money, which
remains in B’s hands. B buys 1000 bales of cotton in his own name, so as to make himself person-
ally liable for the price. A cannot revoke B’s authority so far as payment for the cotton is concerned.
Example 2
A authorises B to buy 1000 bales of cotton on account of A, and to pay for it out of A’s money remain-
ing in B’s hands. B buys 1000 bales of cotton in A’s name, so as not to render himself personally liable
for the price. A can revoke B’s authority to pay for the cotton [Appended to Section 204].

Compensation for revocation Where there is an express or implied contract that the agency
should be continued for any period of time, the principal must make compensation to the agent for
any previous revocation of the agency without sufficient cause [Section 205].
Notice of revocation Reasonable notice must be given of revocation or renunciation, otherwise,
the damage thereby resulting to the agent must be made good to by the principal [Section 206].
Revocation may be expressed or implied Revocation may be expressed or may be implied in
the conduct of the principal or agent, respectively [Section 207]. For example, A empowers B to let
A’s house. Afterwards A lets it himself. This is an implied revocation of B’s authority.

Renunciation of authority by the agent

An agency also comes to an end if the agent himself/herself renounces his/her authority to
contract on behalf of the principal. Section 206 says that reasonable notice must be given of
renunciation, otherwise, the damage thereby resulting to the principal must be made good by
the agent. Like, revocation, renunciation may also be expressed or implied in the conduct of
that agent. For example, A employs B to sell his car within a week. B fails to sell the car within the
stipulated time. There is an implied renunciation of authority on part of B.
By Mutual Agreement An agency, like any other agreement, can be terminated, at any time by
mutual agreement between the principal and the agent.

Termination of agency by operation of law

The relationship of principal and agent comes to an end automatically under any of the follow-
ing circumstances.

Completion of business
An agency automatically comes to an end when its business is completed [Section 201]. For
example, A employs B to sell his goods. The authority of B to sell goods ceases to be exercisable as
soon as the sale is complete.

Self-Learning
Material 117
Legal and Regulatory Death or insanity of the principal or agent
Environment of
An agency is terminated automatically in the event of the death of the principal or the agent,
Business
or if either becomes insane [Section 201]. The principal’s insanity puts an end to the agency even
Notes though the agent has no notice of it [Yonge vs Toynbee 17].

Insolvency of the principal

The principal’s insolvency does terminate the agent’s authority. Besides, the insolvency of the
agent also terminates his authority if it makes him unfit to perform his duties [Section 201].

Expiry of time
Where the agent is appointed for a fixed term, the agency comes to an end by the expiration
of the stipulated time (unless the term of agency has been extended), whether the purpose of
the agency has been accomplished or not [Lalljee vs Dadabhai 18].

Destruction of the subject matter

Destruction of the subject matter of the agency automatically puts an end to it. For example, A
employs someone to let his house. The house collapses in an earthquake, the agency ceases to exist.

Dissolution of company
Where the principal or the agent is an incorporated body (i.e, company), the agency comes to
an end on dissolution of the company.

Upon principal or agent becoming an alien enemy

Where the principal and agent are the citizens of two different countries, their agency relation-
ship comes to an end in the event of an outbreak of war between the two nations. The reason
behind the same is simple. As a consequence of war, the principal and the agent become alien
enemies to each other and the existing contract of the agency becomes unlawful.

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 ap-
pointed by him [Section 210].

Termination of agency: When does it take effect?

The termination of agency as regards the agent and as regards the third parties takes effect at
different points of time. Section 208 is very clear in this regard. It states as follows:
1. The termination of the authority of an agent takes effect when the agent is apprised or
informed about it. Thus, where the principal revokes agent’s authority, the revocation
will take effect when the agent comes to know that the principal has revoked his authority.
2. As regards third parties, the termination takes effect when it comes to their knowledge. So,
where an agent whose authority has been revoked to his knowledge makes a contract with
a third party who deals with him bona fide, the contract will be binding on the principal as
against the third party. Hence, third parties may deal with the agent, as such, till they come
to know of the termination of the agent’s authority. Examples in Box 6.20 will help under-
stand the point better.

Irrevocable Agency
When the principal cannot revoke the authority given to an agent, the agency is termed as an
‘irrevocable’ one. An agency is irrevocable in the following cases in the sense that any attempt to
revoke it is not merely a breach of contract but also ineffective. The agent’s authority continues
despite the attempt to revoke it.

Where agency is coupled with interest

Self-Learning When the agent has substantial interest in the property, which forms the subject matter of
118  Material the agency, the agency is said to be coupled with interest. An agency coupled with interest
 Special Contracts

Box 6.20 Termination of Agency with Respect to Agent,

Third Parties
Notes
Example 1
A directs B to sell goods for him and agrees to give B 5 per cent commission on the price fetched by
the goods. Afterwards A revokes B’s authority by a letter. B, after the letter is sent, but before he re-
ceives it, sells the goods for ` 100. The sale is binding on A, and B is entitled to ` 5 as his commission.
Example 2
A, at Chennai, by letter, directs B to sell for him some cotton lying in a warehouse in Mumbai, and
afterwards, by letter revokes his authority to sell, and directs B to send the cotton to Madras. B after
receiving the second letter enters into a contract with C, who knows of the first letter, but not of the
second for the sale to him of the cotton. C pays B the money, with which B absconds. C’s payment
is good as against A.

is irrevocable. Even the death or insanity of the principal does not terminate such an agency
[Section 202]. The following examples in Box 6.21 drive home the point.

Box 6.21 When Agency Cannot be Revoked Due to Death or

Insanity of Principal

Example 1
A gives authority to B to sell A’s land and to pay himself out of the proceeds the debts due to him
from A. A cannot revoke this authority nor can it be terminated by his insanity or death.
Example 2
A consigns 1000 bales of cotton to B, who has made advances to him on such cotton, and desires B to
sell the cotton and repay himself out of the price the amount of his own advances. A cannot revoke
this authority nor it is terminated by his insanity or death [Appended to Section 202].

Where authority has been partly exercised

The principal cannot revoke the authority given to his/her agent after the authority has been partly
exercised, so far as such acts and obligations arise from acts already done in the agency [Section
204].
Moreover, an agency also becomes irrevocable where the agent has incurred a personal liability.

E XERCISES
I. Objective-type Questions
1. A continuing guarantee may be revoked
(a) By a notice of revocation by the surety
(b) By death of the surety
(c) In the same manner in which the surety is discharged
(d) By any of the above-mentioned ways
2. A contract of guarantee is invalid
(a) When the guarantee has been obtained by misrepresentation
(b) When guarantee has been obtained by concealment of material facts
(c) When co-surety (if any) fails to join the surety
(d) In all the above cases Self-Learning
Material 119
Legal and Regulatory 3. The indemnity holder is entitled to
Environment of (a) All damages that he may be compelled to pay in any suit in respect of any
Business matter to which the promise to indemnity applies
Notes (b) All costs that he may be compelled to bear in bringing or defending any
such suit
(c) All sums that he may have paid under the terms of any compromise of such
suit
(d) All of the above
4. Who among the following can make a valid pledge?
(a) The owner or his authorized agent
(b) A mercantile agent who with the consent of the owner is in possession of
goods or documents of title to goods
(c) A person having limited interest
(d) All of the above
5. Which of the following transactions does not fall in the ambit of bailment?
(a) Delivering goods for carriage
(b) Delivering goods for repair with or without remuneration
(c) Placing of ornaments in a bank locker
(d) Delivering goods to a creditor to serve as security of loan
6. The pawnee can retain the goods pledged for
(a) Payment of the debt or performance of the promise
(b) Interest on the debt
(c) All necessary expenses incurred by him in respect of the possession or for
preservation of the pledged goods
(d) All of the above
7. The relationship of principal and agent may be created by
(a) Express or implied offer (b) Ratification
(c) Operation (d) Any of the above
8. Implied agency includes
(a) Agency by estoppel (b) Agency by holding out
(c) Agency by necessity (d) All of the above
9. The crucial test of agency is that
(a) A person possessing capacity to contract may lawfully do by himself or he
may get it done by another
(b) He who acts through an agent is himself acting
(c) Acts of the agent bind the principal
(d) The principal is not responsible if the agent exceeds his authority
10. Agency is irrevocable
(a) Where the agent has an interest in the property that forms the subject
matter of the agency
(b) Where the agent has partly exercised his authority
(c) Where the agent has incurred a personal liability
(d) In all the above cases
II. Review Questions
1. What is a ‘contract of indemnity’? Bring out difference between a contract of
indemnity and a contract of guarantee.
2. State the rights of surety against
(i) The principal debtor
(ii) The creditor, and
(iii) Co-sureties
3. ‘Between co-sureties there is equality of burden and the benefits.’ Elaborate.
Self-Learning
120  Material
 4. Write short notes on the following: Special Contracts
(i) Rights of an indemnity holder
(ii) Commencement of ‘indemnifier’s liability
(iii) Invalidation of contract of guarantee Notes
5. What are the essentials of a contract of bailment? Distinguish between bailment
and pledge.
6. Examine the duties and rights of a pawnee and pawnor.
7. Distinguish between particular lien and general lien. Who are entitled to general
lien?
8. Discuss the rights and duties of a finder of lost goods.
9. What are the different kinds of bailment? When a contract of bailment comes to
an end?
10. What do you mean by agency by ratification? Discuss the essentials of a valid
ratification.
11. ‘A principal is empowered to revoke the authority of the agent, but he cannot do
so in certain circumstances’. Explain and illustrate the truth of the statement.
12. Discuss in detail the extent of principal’s liability to third parties for the acts of
the agent.
13. Write short notes on the following:
(a) Irrevocable agency
(b) Sub-agent and substituted agent
(c) Test of agency
(d) Agency by necessity
(e) Agency coupled with interest

10. (d) 9. (c) 8. (d) 7. (d) 6 (d)

5 (c) 4. (d) 3. (d) 2. (d) 1. (d)
Answers to Objective-type Questions

Self-Learning
Material  121
 Chapter
6 In Review
Learning Objectives l A contract of indemnity is one whereby a person promises to save the other from
loss caused to him by the conduct of the promisor himself or of any third person.
Contract of indemnity: meaning; definition; l A contract of ‘guarantee’, is a contract, whether oral or written, to perform the prom-
scope
ise or discharge the liability of a third person in case of his default. A contract of
Contract of guarantee: meaning; definition guarantee involves three parties, viz., a person who gives the guarantee is called the
Contract of guarantee and contract of indem- ‘surety’, the person in respect of whose default the guarantee is given is called the
nity distinguished ‘principal debtor’, and the person to whom the guarantee is given is called the ‘credi-
Discharge of surety tor’.
Bailment: definition; essentials; kinds l The discharge or release of the principal debtor is sufficient enough to give a valid

Finder of lost goods: rights and duties of find- discharge to the surety. Besides the surety is discharged from liability by (i) notice
er of lost goods of revocation, (ii) death of surety, (iii) novation, (iv) alteration in terms of contract,
Pledge: definition; who can pledge (v) arrangement between the principal debtor and the creditor, (vi) impairing sure-
Pledge differentiated from bailment; pledge ty’s remedy, (vii) loss of security, and (viii) invalidation of the contract. The first two
and hypothecation modes of discharge apply exclusively to continuing guarantee, whereas the remain-
Agency: general rules; essentials ing ones are applicable in respect of both specific and continuing guarantees.
Test of determining existence of agency rela- l Bailment is an act of delivering goods for a specified purpose on faith. The goods

tionship are to be returned after the purpose is over. Bailment can be only of ‘goods’ which
means every kind of movable property other than money and actionable claim.
Agency: modes of creation; scope and extent
Thus, keeping money in bank account is not bailment.
of authority
l A pledge, is a bailment of goods wherein the goods are delivered as a security for
Termination of agency; irrevocable agency payment of a debt or performance of a promise. Pledge can be made only of mov-
able properties. In order to make the pledge legally valid, it is essential that the pled-
gor has the legal right or title to retain the goods.
Key Terms l The relationship between an agent and his/her principal is called ‘Agency’. The es-

sence of a contract of agency is the agent’s representative capacity coupled with a

Indemnity: Protection against some loss
power to effect legal relations between the principal and the third parties.
or damage
l The law recognises the following modes to form an agency:
Guarantee: A formal promise or ∑ By agreement  When agency is formed through express consent (oral or writ-
assurance made by one person to ten) or implied conduct.
another to be responsible, if a third ∑ By ratification  In this case, the principal either by act or by agreement ap-
person fails to perform a certain duty or proves the conduct of an agent who acted outside the given scope of authority
repay a debt or the conduct of a person who in fact is not an agent.
Bailment: The temporary placement ∑ By estoppel  When the principal reasons a third person to believe that another
of control over, or possession, not the person is his agent.
ownership, of ‘personal (but movable) ∑ By operation of law  This arises in emergency situations, for instance, when the
property’ by one party, bailor, into the agent or someone is unable to contact the principal.
hands of another party, the bailee, for l An agency can be terminated by the principal revoking his authority, by the agent re-

the agreed upon purpose nouncing the business of the agency, by the business of the agency being completed,
Gratuitous bailment: A bailment by lapse of time, by the death or insanity of the principal or agent, or by the principal
without any consideration being adjudicated an insolvent for the relief of insolvent debtors.
Finder of lost goods: A person who finds
an article belonging to another
Pledge: A kind of bailment of a moving
thing as security for the repayment of a
debt or performance of a promise
Agent: A person employed to do any
act for another person, or to represent Estoppel: A legal principle that bars previous conduct, allegation, or
another in his dealings with third a party from denying or alleging a denial
persons certain fact owing to that party’s

122  Legal and Regulatory Environment of Business

 Contract of

Contract of
7
Sale of Goods

Sale of Goods Notes

© iStock
Learning Objectives
1. Contract of sale: definition, essentials 6. Warranty
2. Sale distinguished from agreement to 7. Doctrine of caveat emptor
sell 8. Delivery of goods; modes of delivery;
3. Goods: meaning; classification actual, symbolic, and constructive
4. Price: meaning, modes of fixation delivery
5. Conditions 9. Rights of an unpaid seller

The sale of Goods Act: An Over view

T he most common business deal is about sale of goods. The law relating to sale of goods is contained in
the Sale of Goods Act, 19301. It came into force on 1 July 1930 and extends to the whole of India
except the State of Jammu and Kashmir2. This Act contains all the rules and regulations relating to
various types of contracts for the sale of goods. The Act, however, deals with the sale of only mov-
able goods. Contracts dealing with immovable properties are regulated by a separate Act known as
the Transfer of Property Act, 1882.

Contract of sale Defined

A contract of sale of goods is a contract, whereby, the seller transfers or agrees to transfer the prop-
erty in goods to the buyer for a price’. That is under a contract of sale, a seller (or vendor) in the
capacity of the owner, or part-owner of the goods, transfers or agrees to transfer the ownership in
goods to the buyer (or purchaser) for an agreed upon value in money (or money equivalent), called
the price, paid or the promise to pay same. Accordingly, there can be a contract of sale between one
part-owner and another [Section 4 (1)].
A contract of sale may be absolute or conditional depending upon the desire of the contracting
parties [Section 4(2)].

Making contract of sale

A contract of sale is made by an offer to buy or sell goods for a price and the acceptance of such an
offer. The contract may provide for the immediate delivery of the goods or immediate payment of
the price or both, or for the delivery or payment by installments, or that the delivery or payment or
both shall be postponed [Section 5(1)].
Subject to the provisions of any law for the time being in force, a contract of sale may be made
in writing, or by word of mouth, or partly in writing and partly by word of mouth, or may be implied
from the conduct of the parties [Section 5(2)]. Self-Learning
Material 123
Legal and Regulatory Essentials of contract of sale
Environment of
A close examination of Sections 4 and 5 shows that the following six features are the essential ele-
Business
ments of any contract of sale of goods:
Notes 1. Two parties 2. Goods
3. Transfer of ownership 4. Price
5. All essentials of a valid contract of sale
6. Includes both a ‘sale’ and ‘an agreement to sell’

Two parties
A contract of sale of goods is bilateral in nature wherein property in the goods has to pass from one
party to another. One cannot buy one’s own goods. For example, A is the owner of a grocery shop.
If he supplies the goods (from the stock meant for sale) to his family, it does not amount to a sale
and there is no contract of sale. This is so because the seller and the buyer must be two different
parties, as one person cannot be both a seller as well as a buyer. However, there may be a contract
of sale between one part-owner and another part-owner [Section 4 (1)]. Suppose A and B jointly
own a television set, A may transfer his ownership in the television set to B, thereby making B the
sole owner of the goods. In the same way, a partner may buy goods from the firm in which he is a
partner and vice-versa.

Goods
The subject matter of a contract of sale must be goods. According to Section 2(7) of the Sale of
Goods Act, the term ‘goods’ has been defined thus: ‘Goods’ means every kind of movable property
other than actionable claims3 and money, and includes stock and shares, growing crops, grass, and
things attached to or forming part of the land which are agreed to be severed before sale or under
the contract of sale. It means that every kind of movable property except actionable claims and
money is regarded as ‘goods’. Contracts relating to services are not considered as contract of sale.

Transfer of ownership
Transfer of property in goods is also integral to a contract of sale. The term ‘property in goods’
means the ownership of the goods. In every contract of sale, it is the ownership of the goods that
is transferred from the seller to the buyer, or there should be an agreement by the seller to trans-
fer the ownership to the buyer on a future date. According to Section 2 (11), property means the
general property in goods and not merely a special property. Thus, it is the general property, which
is transferred under a contract of sale as distinguished from special property, which is transferred
in case of pledge of goods, i.e., possession of goods is transferred to the pledgee or pawnee while
the ownership rights remain with the pledger. Thus, in a contract of sale there must be an absolute
transfer of the ownership. It must be noted that the physical delivery of goods is not essential for
transferring the ownership.

Price
The buyer must pay some price for the goods. Section 2 (10) of the Sale of Goods Act defines the
term ‘price’ as ‘the money consideration for a sale of goods’. Accordingly, consideration in a con-
tract of sale has necessarily to be in money. Where goods are offered as consideration for goods, it
will not amount to sale, but it will be called barter or exchange, which was prevalent in ancient times.
Similarly, if a person offers the goods to somebody else without consideration, it amounts to a gift or
charity and not sale. In explicit terms, goods must be sold for a definite amount of money, called the
price. However, the consideration can be partly in money and partly in valued up4 goods [Aldridge vs
Johnson5]. Furthermore, payment is not necessary at the time of making the contract of sale.

Essentials of a valid contract

A contract of sale is a special type of contract, therefore, to be valid, it must have all the essential
elements of a valid contract, viz., free consent, consideration, competency of contracting parties,
lawful object, legal formalities to be completed, etc. If any of the essential elements of a valid con-
tract is missing, then the contract of sale will not be valid. For instance, if A agreed to sell his car to
B because B forced him to do so by means of undue influence, this contract of sale is not valid, since
Self-Learning there is no free consent on the part of the transferor.
124  Material
Contract to include both a ‘sale’ and ‘an agreement to sell’ Contract of
Sale of Goods
The ‘contract of sale’ is a generic term and includes both sale and an agreement to sell [Section
4 (1)]. According to Section 4 (3), ‘Where under a contract of sale the property in the goods is
transferred from the seller to the buyer, the contract is called a sale, but where the transfer of the Notes
property in the 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’. The sale is an executed or absolute contract,
whereas ‘an agreement to sell’ is an executory contract and implies a conditional sale.

Formalities to be fulfilled
The Act does not prescribe any particular form of a valid contract of sale. According to Section 5
(1), a contract of sale can be made merely by an offer, to buy or sell goods for a price, followed by
acceptance of such an offer. Interestingly, neither the payment of price nor the delivery of goods
is essential at the time of making the contract of sale unless otherwise agreed. That is, the contract
may provide for the immediate delivery of the goods or immediate payment of the price or both,
or for the delivery or payment by installments, or delivery or payment or both can be postponed
subject to convenience of the parties.
Section 5 (2) further provides that subject to the provisions of the law for time being in force, a
contract of sale may be made either orally or in writing, or partly orally and partly in writing, or may
even be implied from the conduct of the parties.

Sale and agreement to sell distinguished

As pointed out earlier in this chapter, a contract of sale includes both sale and an agreement to sell.
These two, however, are legally different in terms of their subject matter. And the fact whether the
transaction is a sale or an agreement to sell determines the rights and obligations of the parties to
a contract of sale. The distinction between the two is, therefore, of principal significance.
There are eight main points of distinction between a sale and an agreement to sell, which are
listed as follows:
1. Transfer of ownership 2. Nature of contract
3. Nature of rights of buyer 4. Consequence of breach by buyer
5. Risk of Loss 6. Insolvency of the seller
7. Insolvency of the buyer 8. Consequences in case of resale

Transfer of ownership
Transfer of ownership (property in goods) is the most significant point of distinction betwen sale
and agreement to sell. All other points of differentiation arise from this basic difference. In the case
of sale, the title (ownership) in the goods passes to the buyer immediately at the time of making
the contract, but in the case of an agreement to sell, the title passes at a future time subject to the
conditions to be fulfilled thereafter. Therefore, in a sale the buyer becomes the proprietor of the
goods no sooner as the contract is made, whereas in an agreement to sell, the seller continues to
be the proprietor of the goods agreed to be sold until it becomes a sale.

Nature of contract
A sale is an executed contract because through this all the formalities of the contract are said to
have been completed, and the ownership of the goods is said to have passed to the buyer. An agree-
ment to sell, on the other hand, is an executory contract, as all the formalities of the contract are
not completed but something vital remains to be done, i.e., ownership will pass on some future date.
An agreement to sell becomes a sale on the expiry of the stipulated time or on the fulfilment of the
conditions subject to which the property in goods is to be transferred.

Nature of rights of buyer

A sale creates jus in rem, i.e., gives the right to the buyers to claim the goods as against anybody
who disturbs their right to use the goods, including the seller. As against this, an agreement to sell
creates merely jus in personam, i.e., the right to either party (buyer or seller) against each other for
any default in fulfilling its part of agreement. This means that the buyer gets the rights against the
seller and vice-versa. In other words, an agreement to sell is a contract, pure and simple, but a sale Self-Learning
is a contract plus conveyance, or a fulfilled contract. Material  125
Legal and Regulatory Consequence of breach by buyer
Environment of In case of a sale, if the buyer wrongly refuses to accept (goods) and pay the price, the seller may sue
Business
him/her for the price, even though the goods are still in his/her (seller) possession and have never
Notes been delivered to the buyer. But in case of an agreement to sell, if the buyer refuses to accept the
goods or pay for them, the only remedy available to the seller is to sue for damages. He cannot sue
for price, even though the goods are in the possession of buyer.
For example, X sells five quintals of potatoes to Y for `1000. If Y refuses to accept the goods, X
can sue him for the price (` 1000) despite the fact that the goods are still in X’s possession. But if it
were an agreement to sell, X could, legally, only claim damages (compensation, such as expenditure
incurred in delivering the goods, or the loss he suffered by having to sell the goods to someone else
at a cheaper rate) from Y, since the ownership has not yet been transferred to Y.

Risk of loss
In case of sale, if there is any loss or damage to the goods, it falls on the buyer even if the goods
are with the seller. The general rule is that unless otherwise agreed, risk follows ownership, which
implies whosoever is the owner of the goods at the time of loss, will bear the loss. Accordingly,
in an agreement to sell, if the goods are lost or destroyed by accident, the loss falls on the seller
even if the goods are in the possession of the buyer. This is because till delivery, the agreement
to sell becomes a sale, the ownership of the goods remains with the seller.

Insolvency of the seller

In a sale, if the seller becomes insolvent while the goods are with him/her, the buyer is entitled
to recover the goods from the assignee or the official receiver as the property in the goods
has already passed on to the buyer. However, in case of an agreement to sell, if the seller goes
bankrupt, the buyer cannot claim the goods even if he/she has paid the price. The buyer can
only claim ratable dividend for the money paid from the estate of the insolvent seller.

Insolvency of the buyer

In case of a sale, if the buyer is adjudicated insolvent before paying the price, the seller must
deliver the goods to the official receiver or assignee as the ownership has already passed on
to the buyer. The seller (as an unsecured creditor) is entitled only to a ratable dividend for the
unpaid price. But in an agreement to sell, where the ownership in respect of goods continues to
vest in the seller, the seller may refuse to deliver the goods to the official receiver or assignee
unless he has paid the full price of the goods.

Consequences in case of resale

In a sale, the seller, if still in the possession of goods after sale, cannot resell the goods because
the ownership of goods has already passed on to the buyer. If that is done, the original buyer
shall have a double remedy—a suit for damages against the seller and the right to recover the
goods from the subsequent purchaser. However, it is important to note that the right to recover
the goods from the subsequent buyer ceases to exist, if the third person had purchased them in
good faith and without notice of previous sale or any lien in respect of the goods [Section 30]. In
an agreement to sell, the seller (still being the owner) can dispose of the goods as he/she likes, and
the buyer’s (original one) remedy against the seller’s breach of contract is only a suit for damages.
He/she has no right to follow property in the hands of the subsequent buyer. The subsequent buyer
gets a good title to the goods in such a case, regardless of the fact he/she had knowledge of previ-
ous sale. For example, in a sale if A sells his scooter to B for `10,000, but subsequently it is sold to
C for `15,000. B shall have the right to claim damages from A (for wrongful conversion) as well as to
recover the scooter from C, as at the time of resale A was no longer the owner of the said scooter.
In an agreement to sell, if A agrees to sell his scooter to B for `10,000, and he subsequently sells
the same to C for `15,000, B’s remedy is to claim damages from A for breach of contract. B cannot
recover the scooter from C.
Self-Learning
126  Material
Goods: Meaning and Classification Contract of
Sale of Goods
The subject matter of a contract of sale is essentially movable property, i.e., goods. Let us, therefore,
elaborate the meaning of the term ‘goods’ and also understand its various types that form the
subject matter of a contract of sale. Notes
‘Goods’ means every kind of movable property other than actionable claims and money. It in-
cludes stock and shares, growing crops, grass, and things attached to, or forming part of the land,
which are agreed to be severed before sale or under the contract of sale [Section 2 (7)].
According to the above definition, goods includes every kind of transportable property, i.e., the
things, which can be carried from one place to another. But money and actionable claims, although
movable, have been expressly excluded from the scope of goods. Money means legal tender, i.e.,
the currency that cannot legally be refused in payment of a debt. Currency includes coins and bank
notes as a medium of exchange. However, it excludes old coinage (that has gone out of circulation)
and foreign currency, as both these items can be sold or bought as goods. Exchange (i.e., sale and
purchase) of foreign currency is nevertheless governed by the Foreign Exchange Management Act
(FEMA) and thus cannot be included in goods even if it is not includible as money in the legal terms.
But old and ancient coins are regarded as antiques and may be treated as goods. Actionable claims
have also been excluded from goods for they cannot be sold or purchased and like goods they can
only be assigned. A person cannot make use of actionable claims. For instance, a debt due from
one person to another is an actionable claim that can be enforced by means of a legal action and
cannot be the subject matter of a sale. On the other hand, the things attached to a land or which
form part of land itself (e.g., crops, trees, minerals, and metals) can be the subject matter of sale
provided they are agreed to be severed from the land under the contract of sale. It is interesting to
note that in order to be included as goods, the goods-in-question need not necessarily be tangible
or visible. Goodwill, patents, copyrights, trademarks, gas, water, etc., are all goods and can be the
subject matter of a contract of sale.

Classification of goods
The various kinds of goods relevant to the contract of sale may broadly be classified into the follow-
ing three categories:
1. Existing goods,
2. Future goods, and
3. Contingent goods

Existing goods
These are the goods that are physically in existence at the time of entering the contract of sale. As
per Section 6 of the Sale of Goods Act, existing goods are those goods, that are owned and/or pos-
sessed by the seller at the time of the contract of sale. Where seller is the owner, he has the general
property in them. On the other hand, where the seller is merely in the possession of the goods, e.g.,
as an agent, he has a right to sell them (on behalf of his principal), even though the goods are not
owned by him.
The existing goods may be further sub-divided as
1. specific goods,
2. ascertained goods, and
3. unascertained goods.
Specific goods  Goods identified and agreed upon at the time of making the contract of sale are
specific goods [Section 2(14)]. It is important to note that the goods are not considered to be specific
merely because they are identifiable, rather they must be actually identified. For example, if A agrees
to sell his car or watch to B, it shall be a sale of specific goods if A has only one car or only one watch.
Ascertained goods  These are more or less specific goods. These are the goods that have been
ascertained or identified subsequent to the formation of the contract of sale. Ascertainment basi-
cally involves unconditional appropriation of the goods as the subject matter of a particular con-
tract. For example, A, who deals in Enfield Motor Bikes, has 100 bikes in his showroom and agrees
to sell 40 bikes to Delhi Police under an agreement to sell. Suppose the Delhi Police, i.e., the buyer
selects and sets aside 40 bikes (i.e., quantity agreed) out of the mass of 100 for the given contract,
Self-Learning
the contract is for ascertained goods because the quantity contracted has been identified and ap-
Material  127
propriated towards the contract.
Legal and Regulatory Unascertained goods  Contrary to ascertained goods, these are the goods that are not specifically
Environment of identified or ascertained at the time of entering the contract of sale. They are identified or defined
Business only by description. For example, Mohan, a timber merchant, agrees to supply 50 chairs to a school
out of the lot of 200 chairs lying in his godown. It is a sale of unascertained goods because which of
Notes
the chairs shall be delivered to the buyer have not been identified at the time of the contract of sale.
As soon as 50 particular chairs are identified and set aside for the delivery from the mass, they be-
come ascertained or specific goods. Unascertained goods are sometimes termed as ‘generic goods.’

Future goods
As per Section 2 (6), future goods refers to goods that have to be manufactured, produced, or ac-
quired by the seller after making of the contract of sale. Thus, future goods are goods that either
may not exist at the time of the contract or they exist but have to be acquired by the seller at the
time of the contract. For example, A enters into a contract with B to buy all the apples that would be
produced in B’s orchard over the next year. This is a contract for the sale of future goods amounting
to an agreement to sell.
From the above example, it can be realised that there cannot be a sale of future goods because
ownership cannot be transferred before the goods comes into existence. Since future goods are
not in the possession of the seller at the time of contract, they can become the subject matter of
an agreement to sell and not the sale. Section 6 (3), in this regard, specifically says, ‘Where by a
contract of sale the seller purports to effect a present sale of future goods, the contract operates
as an agreement to sell the goods’. Thus, in law, a contract for sale of future goods operates only as
an agreement to sell and not sale.

Contingent goods 
Contingent goods are those whose acquisition by the seller depends on a contingency, which may
or may not happen [Section 6 (2)].
The above definition indicates that contingent goods are a type of future goods with a minor dif-
ference that the future goods are more certain to come into existence, whereas contingent goods
are less certain to come into existence. Hence, a contract of sale of contingent goods also operates
as ‘an agreement to sell’ and not a sale, as regards transfer of ownership from the seller to buyer.
Such a contract is enforceable only at the occurrence of the contingency, otherwise the contract
becomes void.
For example, A agrees to sell to B a vintage car only if C, its present owner, sells it to him. This
is a contract for the sale of contingent goods as the availability of the car to A depends on its sale
by C to A.

Price
‘Price’ means the money consideration for the sale of goods [Section 2 (10)]. Price is a prerequisite
to constitute a valid contract of sale. No sale of goods can take place without a price. Thus, if there is
no worthwhile consideration to support a voluntary surrender of goods by the real owner to another
person, the transaction is not a sale but a gift and is not governed by the Sale of Goods Act. The price
should be paid or promised to be paid in money, unless otherwise agreed. The money here implies
the legal tender, i.e., the coins and bank notes in circulation (currency of the country). Further the
price may also be paid by means of a negotiable instrument, e.g., cheque, bill of exchange, pro-note,
and hundi, for it is not the mode of payment of a price that is prerequisite for a sale of goods, but
the money consideration that constitutes the essence for a valid contract of sale.

Modes of fixing the price

Sections 9 and 10 contain the different modes of fixing the price, which may be discussed under
the following heads.

Price expressly fixed in the contract itself

The price in a contract of sale may be expressly fixed by the parties themselves. The parties are free
to fix any price they negotiate and in such case the adequacy of the price cannot be questioned
Self-Learning [Section 9 (1)].
128  Material
Price fixed in manner provided in the contract Contract of
Sale of Goods
Where the price is not determined in accordance with the foregoing provisions, the buyer shall
pay the seller a reasonable price. What is a reasonable price is a question of fact dependent on the
circumstances of each particular case [Section 9 (2)]. Notes
Price fixed by the valuation of a third party
Where there is an agreement to sell goods on the terms that the price is to be fixed by the valuation of
a third party and such third party cannot or does not make such valuation, the agreement is thereby
avoided.
Section 10 lays down that if the goods or any part thereof have been delivered to and appropri-
ated by the buyer, he shall pay a reasonable price. If, however, such third party is prevented from
making the valuation by the fault of the seller or buyer, the party not in fault may maintain a suit for
damages against the party in default.
What is reasonable price will vary from case to case. The market price may, however, represent
the reasonable price, if possible to obtain.

Conditions and Warranties: Introduction

As a measure of consumer protection, the Sale of Goods Act assumes that every contract of sale of
goods (unless otherwise agreed to between the parties) is subject to certain terms. These terms
may relate to the quality, use, utility, suitability, price (and the mode of its payment), deliv-
ery (including time and place thereof) of the goods. The parties are at liberty to enter into a
contract with any terms or assurances they please. That is, the seller and the buyer may agree
upon various terms relating to the subject matter of the contract. These terms or statements
may form part of the contract, and the buyer buys the goods relying on such assurances. But
many a time there may be a mere expression of opinions by the seller, which is not the part of
the contract. Statements or assurances that form part of the contract of sale have legal effect
on the contract and are termed as stipulation. On the other hand, mere expression of opinion
by the seller commending his goods does not amount to a stipulation and does not give the
buyer the right to act against the seller.

Conditions
The term ‘Condition’ is defined under Section 12 (2) of the Act. According to it, a condition is a
stipulation essential to the main purpose of the contract, breach of which gives rise to a right to
treat the contract as repudiated. Thus, a condition in a contract of sale is that stipulation which
constitutes the hardcore of the contract and is essential to the main purpose of the contract.
The failure to fulfil the condition gives the aggrieved party a right to repudiate the contract.
The concept of condition is better understood by the following examples in Box 7.1.

Box 7.1 Condition in Contract of Sale

Example 1
A consulted B, a motorcar dealer, for buying a car suitable for touring purposes. B suggested that a
Bugatti car would be appropriate. A purchased the same car relying upon his recommendation. The
car turned out to be unfit for the purpose bought for. A, the buyer, wished to repudiate the contract
by rejecting the car and demanded the refund of the price paid.
In this case, it was held that the term that the car should be suitable for touring purposes was a
condition of the contract, and thereby essential to be fulfilled. It was so vital that its non-fulfilment
defeated the very purpose for which A had bought the car. He was, therefore, entitled to reject the
car and have the refund of the price. In this case, the suitability of the car for touring purpose was
held to be a condition of the contract [Baldry vs Marshall 6].
Example 2
X goes to Y, a horse dealer, and tells him that he wants a horse that can run 35 km/hour. Y points to
a particular horse and says that this will suit the purpose. X buys the horse relying on his represen-
tation. Subsequently, X finds that the horse can run only at a speed of 25 km in an hour. There is a Self-Learning
breach of condition. X may reject the horse and get back the price paid by him. Material 129
Legal and Regulatory Kinds of conditions
Environment of
Conditions may be either express or implied.
Business
Express conditions
Notes
A condition that has been expressly provided for or agreed upon by both the parties at the time
of the contract of sale is called an express condition. For example, if a buyer desires to buy a black
horse, the colour of the horse intended to be bought becomes an express condition. The parties are
at liberty to include any number of express conditions by an express stipulation in a contract of sale.

Implied conditions
Conditions are said to be implied when the law incorporates their existence as implicit to a
contract of sale unless otherwise agreed upon between the parties. Thus, unless the contract-
ing parties stipulate to the contrary, every contract of sale of goods is subject to certain implied
conditions. It may be noted that an express condition does not negate an implied condition unless
inconsistent therewith. Moreover, in the event of any inconsistency or conflict between express and
implied conditions, the express terms shall prevail over the implied ones. Sections 14 to 17 relate to
implied conditions which are of the following seven types:
1. Condition as to title
2. Condition as to description
3. Condition as to sample
4. Condition as to sample as well as description
5. Condition as to quality or fitness
6. Condition as to merchantability
7. Condition as to wholesomeness.
Condition as to title  This condition applies when the sale involves transfer of property in goods
and possession thereof. In this regard, Section 14 (a) clearly provides that in a contract of sale, un-
less the circumstances of the contract are such as to show a different intention, there is an implied
condition that the seller in an actual sale has the right to sell the goods, and in an agreement to sell,
he/she will have it (the right to sell) when the property (title or ownership) is to pass.
The aforesaid provision is based on the principle that ordinarily an owner or his/her author-
ised agent has the right to effect a valid sale of goods since ownership, i.e., property in goods
can be conferred (in favour of buyer) only by either of them. The rule Nemo dat quod non-habet,
i.e., ‘one cannot give what one does not have’ strengthens this condition. As a result of this condi-
tion, if the seller’s title turns out to be defective, the buyer is entitled to reject the goods and have
the price back. It should be noted that in such a case the buyer must restore the goods to the true
owner, but he/she can of course recover the price paid by him/her from the seller for a total failure
of consideration.
Condition as to description  At times the goods are sold by description. In such cases, Section 15
provides that ‘where there is a contract for the sale of goods by description, there is an implied con-
dition that the goods shall correspond with the description’. The term ‘correspond with description’
means that the goods supplied by the seller must be the same as described by him. If subsequently,
it is found that the goods supplied do not match the description, the buyer has a right to reject the
goods and claim the refund of the price, if already paid. He/she can also sue the seller for damages.
For example, A purchased a reaper from B, which he had never seen. The seller described it to be only
a year old and had been used to harvest crops on a 50-acres plot of land. On delivery, however, the
buyer found that the machine was extremely old and had been repainted. It was held that the buyer
was entitled to reject the device, as it did not correspond with the description [Varley vs Whipp7].
Condition as to sample  Many a time, the seller shows a sample of the goods to the buyer and
agrees to supply the goods according to the sample. In such a case since the buyer buys the
goods relying upon the quality of the goods from the sample, there is an implied condition that
the goods supplied will be in accordance with the sample in quality.
In case of a contract of sale by sample, there are the following three implied conditions.
Correspondence of bulk with the sample in quality  It means that the goods delivered must be in accor-
dance with the sample in quality. If the goods supplied differ from the sample, i.e., inferior or superior to
Self-Learning the sample shown, it would entitle the buyer to reject the goods and to recover the price if already paid.
130  Material [Section 17(2)(a)]
Reasonable opportunity of comparing the bulk with the sample This implies that the buyer shall get Contract of
a reasonable opportunity of comparing the bulk with the sample shown to him/her. As a matter of Sale of Goods
fact, the opportunity to compare the goods with the sample depends on the nature and quantum of
goods involved [Section 17(2)(b)]. For instance, if in a sale of 500 bags of rice, the buyer is given an
opportunity to examine the contents of 5 bags only, the buyer can terminate the contract. Thus, if Notes
the seller refuses the buyer an opportunity to compare the goods with the sample or does not give
such opportunity to the buyer, the latter is at liberty to reject the goods and terminate the contract.
Merchantability of the goods The third implied condition in relation to sale by sample is that the
goods shall be free from any defect rendering them unmerchantable, which would not be appar-
ent on reasonable examination of the sample. Such defects are termed as ‘latent defects’ and are
discovered when the goods are put to use. But a seller shall not be liable for any apparent or visible
defects, that could have easily been discovered by a prudent buyer [Section 17(2)(c)]. For example,
A sold to B certain quantity of fabric described as ‘mixed worsted coating’ similar to the displayed
sample. The fabric was same as the sample, but subsequently it was discovered that the cloth was
defective and unfit for stitching coats. It was held that although the bulk corresponded with the
sample, i.e., sample also contained the defect, yet the cloth was unmerchantable on account of
latent defect. On this ground the buyer could reject the goods (i.e., cloth), as the same was not fit
for the purpose [Drummond & Sons vs Van Ingen8].
Condition as to sample as well as description If the seller shows sample of the goods to the
buyer and also provides him the description, Section 15 requires that the goods must correspond
with both the sample and the description. If the goods do not correspond either with the sample
or the description, the buyer can terminate the contract. For instance, there was a sale of foreign
refined rapeseed oil having warranty only equal to sample. The oil that was tendered by the seller
was the same as sample. But it was not foreign refined rapeseed oil, but a mixture of rapeseed and
hemp oil. It was held that the seller was liable for it, and the buyer could refuse to accept the oil
[Nichol vs Galts 9].
Condition as to quality or fitness Ordinarily, in a contract of sale, there is no implied condition as
to the quality of fitness for any particular purpose of the goods supplied. The buyer is supposed to
satisfy himself/herself about the quality as well as the suitability of the goods. Thus, subsequently
if the goods delivered turn out to be unfit or unsuitable for the buyer’s purpose, he/she cannot
terminate the contract and return or exchange the goods, or sue the seller for damages.
In order to avail the implied condition that the goods are reasonably suitable or fit for the purpose
for which they are required, the following requirements must be satisfied:
(a) The buyer requires the goods for a particular purpose.
(b) The buyer expressly or impliedly makes known to the seller the intended purpose.
(c) The buyer relies upon the seller’s skill and judgment with respect to the fitness of the goods
for the intended purpose.
(d) The seller’s business is to supply such goods whether or not he/she is the manufacturer or
producer thereof.
The case studies provided in Box 7.2 drive home the point.

Box 7.2 Condition as to Quality or Fitness of Goods

Example 1
In Priest vs Last10, P, a draper, bought a hot water bottle from L, a chemist. The buyer, P, could not be
expected to have special skill or knowledge with regard to hot water bottles, and the chemist, L,
while delivering him the bottle stated that it was meant for hot water. While being used by plaintiff ’s
wife, the bottle burst and injured her. It was found that the bottle was not fit for use as a hot water
bottle. It was held that the seller, L, was responsible for damages since the purpose was clear from
the nature of goods.
Example 2
In Grant vs Australian Mills11, G purchased woollen underpants from M, a retailer, dealing in goods
of that description. G developed some skin disease on wearing the underpants. The court held that
the goods were not fit for their particular use and, hence, G was entitled to avoid the contract and Self-Learning
to recover the price besides claim damages [Appended to Section 16(1)]. Material 131
Legal and Regulatory Condition to Merchantable Quality ‘Where the goods are bought by description from a seller
Environment of who deals in goods of that description (whether he is the manufacture or producer or not), there is
Business an implied condition that the goods shall be of merchantable quality’ [Section 16(2)].
Thus, in order to avail the relief under this condition, the following two requirements must be
Notes
fulfilled:
(i) The goods should be bought by description, and
(ii) The seller should be dealing in goods of that description.
The expression ‘merchantable quality’ means two things. First, where the goods are purchased
for self-use, they should be capable of being used as the goods of that description, and second,
where the goods are purchased for resale, they should be resalable in the market under their de-
scription, i.e., the goods should be such as would be acceptable to a reasonable person.
It is, thus, clear from the above that the cardinal principle with regard to merchantability is that
the goods should be free from any apparent or hidden defects. The goods are not merchantable
if they have defects that render them unfit for ordinary use or are such that a reasonable person
knowing of their condition would not purchase them. For instance, if the cement becomes concrete,
it is no longer merchantable.
But, if the buyer has examined the goods, there shall be no implied condition as regards defects,
which such examination ought to have revealed [Proviso to Section 16 (2)]. Examples in this regard
are presented in Box 7.3.
Condition as to wholesomeness This condition is a part of the condition as to merchantability and
is applicable only in a contract of sale of provisions and food stuffs, i.e., the items, which are sup-
posed to be physically consumed. Such items must not only answer their description but they must
also be wholesome or sound, i.e., they should be fit for human consumption. In simple words, any
provision or food item should not be stale, contaminated or otherwise unfit for human consumption.
The following case study is a case in point. F bought milk from A’s dairy. The milk contained typhoid
germs. F’s wife consumed that milk, became infected and died. A was held liable for damages [Frost
vs Aylesbury Dairy Co. Ltd 12].

Box 7.3 Implied Condition with Respect to Defects

Example 1
A bought black yarn from D and, when delivered, found it damaged by white ants. The condition as
to merchantability was breached.
Example 2
A purchased a bottle of wine from B. While opening its cork in a normal manner, the neck of the bot-
tle broke off and A’s hand was injured in the process. Held, the goods were not of merchantable qual-
ity and A could recover damages from B [Morelli vs Fitch & Gibbons13] [Appended to Section 16(2)].

C bought a bun from M’s bakery and confectionery shop. The bun contained a stone, which broke
C’s tooth. It was held that M was liable for damages for violating the condition of wholesomeness
[Chaproneere vs Mason 14].

Warranties
A warranty is a stipulation collateral to the main purpose of the contract, the breach of which gives
rise to a claim for damages but not to a right to reject the goods and treat the contract as repudiated
[Section 12(3)].
Thus, a warranty is a stipulation, which is not essential to the main purpose of the contract, it
is only of a subsidiary and collateral nature. Its non-fulfilment does not defeat the very purpose
of the buyer. The effect of a breach of a warranty is that the aggrieved party cannot terminate the
Self-Learning contract but can only claim damages. That is, if the seller fails to fulfil a warranty, the buyer is not
132 Material entitled to reject the goods, he/she can only claim damages from the seller for breach of warranty.
 According to Section 12(4), ‘whether a stipulation in a contract of sale is a condition or warranty Contract of
will depend, in each case, on the construction of the contract’. It means that the terms used in the Sale of Goods
contract do not matter much. Sometimes, a stipulation, referred as a warranty in a contract of sale,
may be a condition, if it is of great significance. Box 7.4 presents examples of warranty.
Notes

Box 7.4 What is a Warranty?

Example1
A buyer goes to a car dealer and asks for a good car. While selling the car, the dealer claims that the
mileage of the car is 16 km per litre. But subsequently the buyer discovers that the car gives a mileage
of only 12 km per litre. Here the buyer cannot repudiate the contract but can only claim damages
from the seller because the statement made by the seller amounts to a warranty.
Example 2
H bought two small ships from K relying upon the latter’s statement that the Dead Weight Tonnage
(DWT) of each ship was 460 tons, whereas the actual DWT of each ship was just 360 tons. The buyer
wanted to reject the ships. It was held that the representation made by the seller about the capacity
was not a condition but merely a warranty and, thus, H, could not reject the ships but could only sue
K for damages [Harrison vs Knowles & Foster15].

Kinds of warranties
As in the case of conditions, warranties may also be either express or implied.

Express warranties
A warranty is said to be express when the term of the contract expressly provides for it. At the time
of contract of sale, both the parties may agree upon any number of express warranties.

Implied warranties
An implied warranty is one which the law incorporates into a contract of sale. Even where no express
representations have been made in connection with a contract of sale, the law implies certain rep-
resentations as having been made by the parties while entering into the contract. Unless otherwise
agreed, the Sale of Goods Act incorporates into every contract of sale of goods, the following three
implied warranties.
1. Warranty as to quiet possession
2. Warranty against encumbrances
3. Warranty to disclose the dangerous nature of goods
Warranty as to quiet possession In every contract of sale, unless different intention appears
from the circumstances of the contract, there is an implied warranty that the buyer shall have the
freedom to a possessed property without interference possession of the goods, i.e., he is entitled
to use the goods in the way he likes. This follows that if the right of possession and enjoyment of
the buyer is disturbed by the seller or any other person (having a superior title to the goods), the
buyer shall be in any way entitled to sue the seller for damages. Breach of this warranty is likely to
occur where the seller’s title is defective or he has not been conferred a clear right to effect the
sale [Section 14(b)]. For example, A purchased a secondhand typewriter from B. A thereafter spent
some money on its repair and service and used it for sometime. Unknown to both the parties the
typewriter subsequently turned out to be a stolen one and as such A was compelled to restore it to
the true owner. A was held entitled to recover damages from B amounting to not merely the price
paid but also the cost of repair for the breach of this warranty [Mason vs Burningham 16].
Warranty against encumbrances There is a further warranty that the goods are not subject to
any charge or encumbrance in favour of a third party. If the buyer’s possession is disturbed by the
reason of the existence of encumbrances, he can claim damages from the seller. In every contract of
sale there is an implied warranty that the goods shall be free from any charge in favour of any third Self-Learning
party. However, this assertion shall not be applicable where the buyer has been informed of the Material 133
Legal and Regulatory encumbrances or has notice of the same. Furthermore, it should be noted that the claim for damages
Environment of under this warranty shall be available only when the buyer discharges the amount of encumbrance
Business [Collinge vs Heywood ] [Section 14(c)]. For example, A sold his scooter to B for ` 5000. The scooter
was already hypothecated as security against a loan of ` 3000. B was not aware about this charge
Notes
on the goods. Consequently B had to pay ` 3000 to X in order to enjoy the goods. Now B is entitled
to claim this amount from the seller, A.
Warranty to disclose the dangerous nature of goods  There is third implied warranty applicable
in case of dangerous goods. If the goods sold are inherently dangerous or likely to cause a mishap,
the seller must warn the innocent buyer of the probable danger. If there is breach of this warranty,
the buyer shall be entitled to claim compensation from the seller for any injury suffered by him on
this count. For example, C purchased a tin of disinfectant powder from A. The seller knew that the lid
of the tin was defective and was to be opened with extra care, otherwise it could be dangerous. He
even knew that the buyer was ignorant about it but did not bother to warn him. When C opened the
tin in a normal manner, the powder flew into her eyes causing injury. In this case, A was held liable
for damages to C as he should have warned C, the innocent buyer of the probable danger [Clarke vs
Army and Navy Co-operatives Society Ltd 17].

When condition sinks to level of warranty

In some cases, a condition sinks or descends to the level of a warranty and, thereby, breach of
condition is treated as the breach of a warranty. As a result of it, the buyer loses his right to reject
the goods and treating the contract as repudiated. However, his remedy to claim damages contin-
ues. Section 13 of the Sale of Goods Act deals with the circumstances, wherein, a condition may
be reduced to the status of a warranty. A condition may slip to a warranty under the following two
circumstances.

Voluntary waiver by the buyer

A condition becomes a warranty when the buyer waives the condition on its non-fulfilment or treats
its breach as a breach of warranty. If a buyer elects to waive the breach of condition, he/she remains
liable for the price if not already paid and cannot reject the goods [Section 13(1)]. But in such a case,
however, he/she can sue the seller for damages for breach of warranty. The waiver, by the buyer,
may be express or implied. Once the buyer exercises her/his option, i.e., waives the condition or
elects to treat the breach of condition as a breach of warranty, he/she cannot later compel the seller
for its fulfilment.

Compulsory treatment of breach of condition as breach of warranty

In certain circumstances, the buyer is bound to treat the breach of condition as a breach of
warranty. Section 13(2) provides that where a contract of sale is not divisible and the buyer has
accepted the goods or part thereof, the breach of condition can only be treated as a breach of
warranty. The buyer in such a case cannot reject the goods and treat the contract as repudi-
ated on the ground that certain condition was not fulfilled. He/she can only maintain an action
against the seller for damages. But where the contract is separable, and the buyer has accepted
part of the goods, he/she can still exercise his/her right to reject the remaining goods.

What is acceptance of goods?

It is important to note that mere possession or taking delivery of the goods does not amount to ac-
ceptance. As per Section 42, the buyer is deemed to have accepted the goods in any of the following
circumstances:
(i) When he/she intimates to the seller that he/she has accepted them, or
(ii) When the goods have been delivered to him/her and he/she does any act in relation to them
which is not inconsistent with the ownership, e.g., he/she pledges the same, or
(iii) When after the lapse of reasonable time, he/she retains the goods without intimating to the
seller that he/she has rejected them.

Condition and Warranty Distinguished

As a matter of fact, the difference between the two terms, viz., ‘condition’ and ‘warranty’ is that of
Self-Learning a degree and not that of kind. The distinction between the two stipulations has been summarised
134  Material
in Table 7.1.
 Contract of
Table 7.1 Difference between Condition and Warranty Sale of Goods

S. no. Point of Condition Warranty

Difference Notes
1. Nature It is a stipulation that is essen- It is a stipulation, which is only
tial to the main purpose of the collateral or subsidiary to the
contract. main purpose of the contract.
2. Effect of breach If there is breach of condition, In case of breach of warranty,
the aggrieved party can repudi- since it is affecting only the
ate the contract itself and sue collateral or auxiliary part of
the seller for damage. the contract, the aggrieved
party can claim only damages.
3. Importance It is of vital importance for It is not of vital importance.
completion of the contract. The main contract can be
completed even if the warranty
is not fulfilled.
4. Treatment A breach of condition may be A breach of warranty under no
treated as breach of warranties circumstances can be treated
if the aggrieved party chooses as breach of condition.
to be satisfied only with claim-
ing damages or when the con-
tract is not divisible and the
buyer has accepted the goods
or part thereof.

Doctrine of Caveat Emptor

The term caveat emptor is a Latin expression that means caution buyer, i.e., ‘let the buyer beware’.
This is a cardinal principle of the law relating to sale of goods, which states that it is for the buyer to
satisfy himself/herself about the quality of the goods while entering into a deal with the seller. If the
buyer buys the goods for a particular purpose, he/she must satisfy that they are fit for the purpose.
It is no part of seller’s duty to point out defects of the goods that he/she is offering for sale. Under
the doctrine of caveat emptor, the buyer cannot recover from the seller for defects on the property
that rendered it unfit for ordinary purposes. Thus, the buyer must take care of his/her own interest
while purchasing goods. The same principle is contained in Section 16, which reads as follows.
‘Subject to the provisions of this Act and of any other law for the time being in force, there is no
implied warranty or condition as to the quality or fitness for any particular purpose of goods supplied
under a contract of sale’. Box 7.5 presents some examples with respect to the doctrine of caveat emptor.

Box 7.5 Doctrine of Caveat Emptor

Example 1
A person bought some pigs in an auction. The pigs were sold ‘subject to faults’, i.e., no warranty was
given by the seller in respect of any fault or error of description. The buyer, however, paid the price
for healthy pigs. As they were infected all but one died of swine fever. The infected pigs also spread
disease to other healthy pigs of the buyer. It was held that the seller was not bound to disclose the
fact of ill health of the pigs. It was the buyer’s duty to satisfy himself as regards the health of the pigs
[Ward vs Goddard Hobbs 18].
Example 2
A purchases a trouser for his son from B, a merchant dealing in ready-made garments. But the trouser
does not fit his son exactly. It’s too loose. Here the doctrine of caveat emptor operates, and hence the
buyer will not have a right to return or exchange the goods. Self-Learning
Material 135
Legal and Regulatory Exceptions to the doctrine of caveat emptor
Environment of
The rule of caveat emptor is not applicable in the following six cases:
Business
1. Where the seller makes a misrepresentation and the buyer relies on it, the doctrine of caveat
Notes emptor does not apply and the contract entered between the parties would be a contract
voidable at the option of the buyer.
2. Where the seller actively conceals a defect in the goods which is not visible on reasonable
examination of the same, or where the seller makes a false representation amounting to
fraud, and the buyer, relying upon it, enters into a contract with the seller, the doctrine of
caveat emptor does not apply. The buyer is entitled to terminate such a contract and also
claim damages from the seller for fraud.
3. Where the buyer, relying upon the skill and judgment of the seller, has expressly or impliedly
communicated to him the purpose for which the goods are required, and the goods do not
reasonably fit such purpose [Section 16 (1)].
4. Where goods are bought by description from a seller who deals in goods of that description
(whether or not he is the manufacture or producer), there is an implied condition that the
goods purchased shall be of merchantable quality. If the goods are not found of merchant-
able quality, the seller cannot take the defence of the doctrine of caveat emptor. But the
doctrine applies, if the buyer has examined the goods, as regards defects, in which such
examination ought to have discovered [Section 16 (2)].
5. Where the goods are sold by sample and the bulk of the goods supplied do not correspond
with the sample in quality, the doctrine of caveat emptor would not apply [Section 17].
6. The doctrine of caveat emptor also does not apply in case of sale by sample as well as descrip-
tion, if the bulk of goods supplied do not correspond with the sample as well as with the
description [Section 15].

Deliver y of Goods
Delivery in the Sale of Goods Act is defined as a voluntary transfer of possession from one person
to another [Section 2 (2)]. Thus, to effect a valid delivery, goods from one person to another must
be transferred willingly and not by means of fraud, theft, or force, etc. Mere possession of goods
does not amount to delivery of goods.

Modes of delivery
Delivery of goods sold may be made by doing anything that the parties agree, shall be treated as
delivery or which has the effect of putting the goods in the possession of the buyer or of any person
authorised to hold them on his/her behalf [Section 33].
Accordingly, delivery of goods may be made in any of the following three ways:

Actual delivery
Also known as ‘physical delivery’, ‘actual delivery’ takes place when the goods are physically
handed over by the seller or his/her authorised agent to the buyer or his/her agent authorised to
take possession of the goods. For example, A, the seller of a car, hands the car over to B, the buyer;
it is a case of actual delivery of the goods.

Symbolic delivery
Where the goods are bulky and heavy and it is not possible to physically hand them over to the
buyer, delivery thereof may be made by indicating or giving a symbol. Here the goods itself are not
delivered, but the ‘means of obtaining possession’ of goods are delivered. For example, delivering
the keys of the warehouse where the goods are stored, or the keys of a purchased car to its buyer,
bill of lading which will entitle the holder to receive the goods on arrival of the ship.

Constructive delivery
In this case neither physical nor symbolic delivery is made. In constructive delivery, the person in
possession of the goods acknowledges that he holds the goods on behalf of and at the disposal of
Self-Learning the buyer. Constructive delivery is also called attornment. This type of delivery may be effected in
136  Material the following three ways:
 (i) Where the seller, after having sold the goods, agrees to hold them as bailee for the buyer; Contract of
(ii) Where the buyer, who is already in possession of the goods as bailee of the seller, holds Sale of Goods
them as his own, after the sale; and
(iii) Where a third party, for example, a carrier/transporter, who holds the goods, as bailee for Notes
the seller, agrees and acknowledges holding them for the buyer.

Rules regarding delivery of goods

The following rules apply with respect to delivery of goods.

Effect of delivery
Whether the delivery is actual, symbolic, or constructive, it should have the effect of putting the
goods in the possession of the buyer or his/her authorised agent. Thus, an effective delivery is one
that enables the buyer to exercise his/her contract over the goods [Section 33].

Delivery and payment are concurrent conditions

Unless otherwise agreed, the delivery of goods and payment of price are concurrent conditions,
i.e., the seller should be ready and willing to give possession of the goods to the buyer, who in turn
should be ready and willing to pay the price in exchange for possession of goods simultaneously
[Section 32].

Effect of part-delivery
A delivery of part of the goods in progress of the delivery of the whole has the same effect for the
purpose of passing the property in such goods, as a delivery of the whole. But where part delivery
is made with the intention of severing it from the whole lot, then it does not operate as a delivery
of the whole of the goods [Section 34]. The case illustrations in Box 7.6 would help understand the
point better.

Box 7.6 Effect of Part-delivery

Example 1
A sold certain goods to B lying at a wharf. The seller directed the wharfingers to deliver the goods to
B. B weighed all the goods and took away a part of them. It was held that the delivery amounted to
a delivery of whole of the goods [Hammond vs Anderson19].
Example 2
A sold a stake of hay, grown on his field to B. The buyer was permitted to remove only a part of it
and B acted accordingly. It was held that this did not amount to delivery of the whole, as the inten-
tions of the parties were to separate the part delivered from the rest of hay [Bunnery vs Poyntz20]
[Appended to Section 34].

Buyer to apply for delivery

In the absence of any express term to do so, the seller is not bound to deliver the goods unless the
buyer applies for delivery [Section 35]. Even where the goods to be delivered are to be acquired or
procured by the seller, the duty of the seller ends with intimating the buyer that the goods have
been procured and are ready for delivery. In such cases also, it is the duty of the buyer to demand
delivery, and if he/she fails to do so, he/she can have no cause of action against the seller. The par-
ties to the contract of sale may, however, agree otherwise.

Place of delivery
The place of delivery is usually stated in the contract. Where it is so stated, the goods must be
delivered at the stipulated place during business hours on a working day. But where no place is Self-Learning
mentioned, then in accordance with Section 36 (1) the following rules shall apply: Material 137
Legal and Regulatory 1. In case of actual sale, the goods sold are to be delivered at the place at which they are at the
Environment of time of sale.
Business 2. In case of an agreement to sell, the goods agreed to be sold are to be delivered at the place
decided at the time of the agreement.
Notes
In case, at the time of agreement to sell, the goods are not in existence, they are to be delivered
at the place at which they are manufactured or produced.

Time of delivery
The contract may expressly specify the time for delivery of goods. When it is so specified, the seller
is bound to deliver the goods to the buyer within the specified time. But where no time for send-
ing them is fixed, then the delivery must be made within a reasonable time [Section 36(2)]. What
is ‘reasonable time’ is a question of fact. It varies from case to case depending on the facts and
circumstances of each particular case.

Delivery when goods are in possession of third party

Where the goods at the time of sale are in the possession of a third person, there is no delivery by
the seller unless and until such third person acknowledges to the buyer that he holds the goods on
his behalf. As already commented, such a delivery is termed as ‘constructive delivery’ or ‘attorn-
ment’ and requires the consent of all the three parties, i.e., the seller, the buyer, and the person
having possession of the goods. Thus, in such a case the ‘delivery order’ will not do anything unless
the seller’s agent who is in the possession of goods has consented thereto [Section 36 (3)].
However, where the goods are sold by transfer of documents of title to goods, such as railway
receipts (R/R), bill of lading (B/L), etc., then the buyer is deemed to be in possession of the goods
represented by such document, and the acknowledgement of the third party having the possession
of the goods is not required. Thus, in such a case, the transfer of documents of title itself constitutes
an effective delivery of the subject matter.

Expenses of delivery
Unless otherwise agreed, the expenses of and incidental to putting the goods into a deliverable
state shall be borne by the seller. Similarly, the expenses of and incidental to receiving delivery must
be borne by the buyer [Section 36 (5)].

Delivery of wrong quantity

The seller is bound to deliver the goods according to the contract. The delivery of goods should be
in the quantity contracted for. Any delivery less or more than the contracted quantity is treated as
defective delivery or delivery of wrong quantity. Section 37 recognises three cases of wrong delivery,
viz., short delivery, excess delivery, or mixed delivery. The rules vis-à-vis delivery of wrong quantity
in each of the three types is as follows.
Short delivery  Where the seller delivers to the buyer a quantity of goods less than what he con-
tracted to sell, the buyer may reject them. But if he (buyer) accepts the goods so delivered, he shall pay
for them at the contract rate [Section 37 (1)]. However, by accepting the delivery of lesser quantity, the
buyer is not debarred from suing the seller for damages for short delivery of the goods. For example,
a seller agreed to sell and supply to a buyer 10 bags of basmati rice at an agreed price of ` 1000 per
bag. The seller could, however, deliver only six bags to the buyer. The buyer is entitled to reject the
goods on account of short delivery. But if he accepts these six bags, he will have to pay for them at
the rate of ` 1000 per bag. He may, nevertheless, claim damages from the seller for short delivery
of the goods.
Excess delivery  Where the seller delivers to the buyer a quantity of goods larger than he con-
tracted to sell, the buyer has the option
(i) to accept the contracted quantity and reject the rest, or
(ii) to reject the whole quantity, or
(iii) to accept the whole quantity [Section 37 (2)].
If the buyer accepts the whole of the goods so delivered, he shall become liable to pay for all the
goods at the contract rate. For example, A agrees to sell and delivers to B 50 quintal of wheat at an
agreed rate of ` 5000 per quintal. Instead A delivers 55 quintals. Now it is up to the buyer, B, to
Self-Learning reject the whole lot, or accept only 50 quintals and reject the excess, or accept the whole lot and
138  Material
pay for them at the contract rate.
Mixed delivery  Where the seller delivers to the buyer the goods he contracted to sell, mixed with Contract of
goods of a different description not included in the contract, the buyer may accept the goods, which Sale of Goods
are in accordance with the contract and reject the rest, or may reject the whole lot [Section 37 (3)].
For example, A agrees to sell and deliver 100 bags of ‘Aahar’ flour, each of 5 kg to B at the rate of
Notes
` 65 per bag. But A delivers 90 bags of ‘Aahar’ flour brand and 10 bags of ‘Rose’ brand. In this case,
the buyer B can either reject the whole quantity of flour or may accept 90 bags of ‘Aahar’ brand and
reject 10 bags of ‘Rose’ brand. In case of the latter, he will have to pay only for 90 bags of ‘Aahar’
brand at the rate of ` 65 per bag.
It should be noted that, if the buyer rejects the whole lot on ground of delivery of wrong quantity,
it does not result in cancellation of the contract. The seller still has the right to deliver the goods
contracted for again and the buyer shall be bound to accept the same [Vilas Udyog Ltd vs Prag Va-
naspati21].
Moreover, the above provisions are subject to any usage of trade, special agreement of dealing
between the parties [Section 37 (4)].

Installment deliveries
Unless otherwise agreed, the buyer of goods is not bound to accept delivery thereof by installments
[Section 38 (1)]. It means that if the parties so agree, the delivery of the goods can be made by in-
stallments. In other words, the delivery of goods by installments may be made and demanded only
if the contract of sale provides for the same either expressly or impliedly.
For example, in Richardson vs Dunn22, A, a coal merchant, agreed to sell to B 200 tons of coal. But
A shipped only 152 tons and intimated about the same. But the buyer didn’t reply. It was held, that
the buyer (B) impliedly assented to the delivery of coal in installments.
Sometimes, there may be a contract for delivering the goods by installments and each installment
of goods is to be separately paid for. In such a case, the problem arises when there is a breach either
by the seller or the buyer, i.e.,
∑ The seller makes no delivery or defective delivery in respect of one or more installments or
∑ The buyer neglects or refuses to take delivery of or pay for one or more installments.
In such a situation, the issue is whether the whole contract is to be treated as repudiated or only
one installment is repudiated for which the party may claim damages and the rest of the install-
ments are to be duly delivered and accepted [Section 38 (2)].
In Maple Flock Co Ltd vs Universal Furniture Products (Wembley) Ltd 23, M agreed to supply to U
10 tons of flock in 20 installments. The first 15 installments were delivered as per the terms of the
contract but the 16th installment was defective. However, the subsequent deliveries were again
satisfactory. The buyer wanted to repudiate the whole contract. It was held that the buyer could not
treat the whole contract as repudiated because the circumstances of the case showed that there
was no possibility of the default being repeated.

Delivery to carrier or wharfingers

Section 39 (1) provides that ‘where the seller is authorised or required to send the goods to the
buyer, delivery of the goods to a carrier whether named by the buyer or not, for the purpose of
transmission to the buyer or delivery of the goods to wharfingers for safe custody, is prima facie
deemed to be a delivery of the goods to the buyer’. In such cases the goods are at the risk of the
buyer. But, where it is agreed that the goods are to be delivered at a specified place, for example, at
the buyer’s factory, then the delivery of goods to a carrier is not equivalent to a delivery to the buyer.
In addition to above duty, the seller is required to perform two more duties.
First, the seller must make a reasonable contract with the carrier or wharfinger on behalf of the
buyer, for the safe transmission or custody of the goods. If the seller fails to do so, and the goods
are lost or damaged in course of transit or whilst in the custody of the wharfinger, the buyer may
decline to treat the delivery to the carrier or wharfinger as a delivery to himself or may hold the
seller responsible in damages [Section 32 (2)].
Second, unless otherwise agreed, where goods are sent by the seller to the buyer by sea route,
where it is usual to insure, the seller must give such notice to the buyer in time as may enable him
to insure them during their sea transit. If the seller fails to do so, the goods shall be at his risk during
such sea transit [Section 39 (3)]. For example, in Cooke vs Ludlow24, A, a buyer from Bristol, ordered B,
a London- based seller to supply certain goods by any conveyance from London to Bristol. The seller
Self-Learning
(B) sent the goods to ‘wharf’, for overseas shipment where the buyer (A) was notified by him that Material  139
Legal and Regulatory the goods will be conveyed to Bristol by a ship named ‘Commerce’. However, the ship ‘Commerce’
Environment of was fully laden due to which the goods were sent by another ship. But the buyer was not aware of
Business this fact. The ship carrying the buyer’s cargo sunk into the sea. It was held that the buyer was liable
to pay the price of the goods because the seller had given a reasonable notice to the buyer and the
Notes
change of ship was not known to him (the seller) either.

Deterioration of goods in transit

If the goods are to be delivered at a place other than that where they are when sold at the risk of
the seller, the risk of deterioration of goods in transit will, unless otherwise agreed, be borne by the
buyer [Section 40].

Acceptance of delivery by buyer

As described at the beginning of this chapter, for the performance of a contract of sale, it is
necessary that when the seller delivers the goods according to the contract, the buyer accepts
them and pays the price, if not already paid for. In other words, a contract of sale of goods is
said to be duly performed when the goods are accepted and duly paid for by the buyer. Here, it
is important to note that the mere fact that the buyer has accepted the goods and taken pos-
session thereof does not amount to acceptance of goods. In the eyes of the law, ‘acceptance’
is something more than this. Section 42 provides that a buyer is considered to have accepted
the goods in any of the following circumstances:
1. When he/she intimates to the seller that he/she has accepted the goods.
2. When he/she does any act in relation to the goods which is inconsistent with the owner-
ship of the seller. For example, when the buyer uses, consumes, pledges, resells, etc., in
the capacity of an owner.
Dealing with the document of title, however, does not amount to acceptance [Chao vs British
Traders & Shippers Ltd25]. In Hardy & Co vs Hillens & Fowlers26, A sold a certain quantity of wheat to
B and conveyed the same by ship. On the arrival of the ship, B took the delivery of the wheat and
subsequently sold a part of it, and afterwards found that the wheat was not in accordance with the
contract in terms of quality and, therefore, sought to reject it by giving a notice to the seller. It was
held that the buyer had lost the right of rejection as he had accepted the wheat by a dealing, incon-
sistent with the right of the seller, insofar as he sold out a portion of it, and the notice of rejection
was ineffective.
3. When after the lapse of a reasonable time, he retains the goods without intimating to the
seller that he has rejected them.

Buyer’s right of examining the goods

Before intimating to the seller about his acceptance, the buyer has a right to examine and test the
goods with a view to ascertaining and satisfying himself whether the goods are in accordance with
the contract in terms of quality as well as quantity. In this regard, Section 41 provides as under.
∑ ‘Where goods are delivered to the buyer, which he has not previously examined, he is not
deemed to have accepted them unless and until he has had a reasonable opportunity of
examining them for the purpose of ascertaining whether they are in conformity with the
contract’ [Section 41 (1)].
∑ ‘Unless otherwise agreed, when the seller tenders delivery of goods to the buyer, he is
bound, on request, to afford the buyer a reasonable opportunity of examining the goods for
the purpose of ascertaining whether they are in conformity with the contract’ [Section 41
(2)].

Buyer not bound to return rejected goods

Unless otherwise agreed, where goods are delivered to the buyer and he refuses to accept them,
having the right to do so, he is not bound to return them to the seller. It is sufficient, if he intimates
to the seller that he has refused to accept them [Section 43].

Liability of the buyer for neglecting or refusing to take delivery

When the seller is ready and willing to deliver the goods and requests the buyer to take delivery,
Self-Learning and the buyer does not within a reasonable time after such request take delivery of the goods, he
140  Material is liable to the seller for
 1. any loss occasioned by his neglect or refusal to take delivery and also Contract of
2. a reasonable charge for the care and custody of the goods. Sale of Goods
Furthermore, nothing in this section shall affect the rights of the seller where the neglect or re-
fusal of the buyer to take delivery amounts to a repudiation of the contract [Proviso to Section 44].
Notes
To put in simple words, the seller in such a case may sue for the price for damages.

Who is an Unpaid seller?

An unpaid seller is one who has not received the full price of the goods sold by him. Section 45 of
the Sale of Goods Act defines an unpaid seller as under.
‘The seller of goods is deemed to be an unpaid seller
1. When whole of the price has not been paid or tendered, or
2. When a bill of exchange or other negotiable instrument has been received as conditional
payment and the condition on which it has been received has not been fulfilled by rea-
son of the dishonour of the instrument or otherwise’.
A closer look of this section makes it clear that a seller is considered to be an unpaid seller
when
1. The goods have been sold and the price is overdue.
2. The full price has not been paid or tendered to the seller.
3. A bill of exchange or other negotiable instrument made a conditional payment, and the
instrument has been dishonoured.

Box 7.7 The Unpaid Seller

Example 1
A sold his scooter to B for ` 10,000. B paid ` 7500 and failed to pay the balance. Here A is unpaid seller.
Example 2
A sold certain goods to B for ` 5000. B cleared the payment by cheque. On presentment, the cheque
was dishonoured. A is unpaid seller.
Example 3
A purchased a music system from B’s showroom for ` 20,000. A paid ` 10,000 instantly and agreed
to pay the balance one month later. B is not an unpaid seller during this credit period. But, B shall be-
come an unpaid seller, if A does not discharge his liability on expiry of the credit period of one month.
In the above case, B may become an unpaid seller before the expiry of one month (i.e., credit period)
in case of A’s insolvency [Appended to Section 45].

Rights of an Unpaid seller

The rights of an unpaid seller can be classified under two heads:
1. Rights against the goods
2. Rights against the buyer.

Rights against goods

The Act confers the following four rights to an unpaid seller against the goods:
∑ Right of lien or retention
∑ Right of stoppage of goods in transit
∑ Right of resale
∑ Right to withhold delivery.
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Material 141
Legal and Regulatory Right of lien or retention
Environment of
The term ‘lien’ implies retaining the possession of the goods until the price due in respect of the
Business
same is paid or tendered. As per Section 47, an unpaid seller of goods who is in possession of them
Notes is entitled to retain possession of them until payment or tender of the price under the following
conditions:
∑ Where the goods have been sold without any stipulation as to credit.
∑ Where the goods have been sold on credit, but the term of credit has expired.
∑ Where the buyer becomes insolvent (even though the credit period has not expired).
The term insolvent should not be confused with a person who has been adjudged insolvent under
the Insolvency Law. In Sale of Goods Act, an insolvent person is one who has ceased to pay his debts
in the ordinary course of business or is unable to pay his debts when they become due, whether he
has committed an act of insolvency or not [Section 2(8)].
The seller may exercise his right of lien no matter whether he is in possession of the goods,
merely as an agent or bailee for the buyer.
Lien depends on physical possession. In other words, the unpaid seller’s lien is a possessory lien,
which means the lien can be exercised so long as the seller is in actual possession of the goods.
Transfer of ownership or title is immaterial to put into effect the right of lien. It is not affected even
where the seller has delivered to the buyer documents of title to the goods such as bill of lading,
delivery orders, etc., provided the goods remain in actual possession of the seller. However, if the
buyer subsequently transfers the document of title to a bona fide buyer, the unpaid seller’s right of
lien or stoppage-in-transit is defeated [Section 53].
The real test of exercising the right of lien subsists in the fact whether the property in goods
has passed to the buyer. If the seller still retains the title, then it will be anomalous or incorrect to
state that the seller has a lien against his own goods. Technically, this should be termed as ‘a right
of withholding delivery’ and not ‘a right to retain possession of goods (lien)’.

Box 7.8 Right to Lien: When Can It Be Exercised?

Example 1
A sold certain goods to B for ` 10,000 and allowed him to pay the price within a month. B, the buyer,
becomes insolvent during the period of credit. A being the unpaid seller can retain the possession
of the goods for non-payment of the price by B.
Example 2
A sells his car to B. The price is to be paid within a month of the sale. While the vehicle is still in the
possession of A, he issues the sale letter in favour of B and hands over other documents of title to
him. B, however, does not pay the price within the stipulated period. A being an unpaid seller is
entitled to refuse to deliver the car until the price is paid. Transfer of documents of title to the goods
does not impede the right of lien. The right of lien, as a matter of fact, is linked with the possession
of goods and not with the property therein.

Right of stoppage-in-transit
The right of stoppage of goods in transit implies preventing the goods from being delivered to the
buyer, resuming possession, thereof, while in transit and retaining them until payment or tender of
the price. This right is earned only when the lien is lost. In one sense, the right of stoppage-in-transit
is an extension of right of lien as by exercising this right, the unpaid seller regains possession of
the goods.
When can this right be exercised? According to Section 50, ‘subject to the provisions of this
Act, when the buyer of the goods becomes insolvent, the unpaid seller who has parted with the
possession of the goods has the right of stopping them in transit, that is to say, he may resume pos-
Self-Learning session of the goods as long as they are in the course of transit, and may retain them until payment
142 Material or tender of the price’.
 The analysis of this Section shows that in order to exercise the right of stoppage-in-transit, the Contract of
following conditions must be fulfilled: Sale of Goods
1. The seller is unpaid;
2. The property has passed to the buyer;
Notes
3. The buyer has become insolvent; and
4. The goods are in transit, i.e., neither with the seller nor with the buyer or his agent.
The right of lien can be exercised only for non-payment of price. That is, the right of stoppage-
in-transit shall be available to an unpaid seller until payment or tender of price, i.e., seller will lose
this right, the moment the price is paid or tendered by the buyer.

Lien and stoppage-in-transit distinguished

The rights of lien and stoppage-in-transit are similar in one respect. The seller can exercise both
these rights to retain/regain possession of the goods where property in the goods has already been
passed to the buyer but the seller has not yet received his price in full. Nevertheless, the two differ
in a number of ways. The points of difference between lien and stoppage-in-transit are condensed
in Table 7.2.

Table 7.2 Difference between Lien and Stoppage-in-Transit

S. no. Lien Stoppage-in-transit

1. To exercise the right of lien, goods must The right of stoppage-in-transit can be
be in actual possession of the seller. exercised when the seller has parted with his
goods but the goods are in transit.
2. This right is available when the buyer is This right too is exercised against non-
in default, no matter whether he is inso- payment of the price but only when the
lvent. buyer has become insolvent.
3. Lien comes to an end as soon as the un- The right of stoppage-in-transit, in fact,
paid seller parts with the goods, i.e., the commences when the seller has parted
goods go out of his possession. with his goods, i.e., delivered them to a
carrier and comes to an end no sooner
than they are delivered to the buyer.
4. This right remains in force till the right This right, as a matter of fact, is an extension of
of stoppage-in-transit commences. right of lien and operates only when
lien is no more forceable. It remains in force
till the goods are delivered to the buyer.
5. This is a right to retain possession of the This is a right to regain possession of the
goods and is available even when the goods and is available only when the buyer
buyer is not insolvent. becomes insolvent.

Right of resale
So far, we have discussed two important rights of an unpaid seller against the goods, namely, lien
and stoppage-in-transit. But these rights do not much protect an unpaid seller’s interest. By exer-
cising either of these rights, an unpaid seller can at best retain or regain the possession of goods
already sold by him. Now the question arises that if the buyer continuously remains in default,
should the seller retain the goods (and not resell them) as long as he remains an unpaid one? The
situation becomes more critical when the goods are of a perishable nature. The law, therefore, has
granted another protection to the unpaid seller by giving him a right to resell such goods in certain
circumstances.
As per Section 54, a seller who is in possession of self-sold goods that have not been paid for by
the buyer is entitled to resell them in the following circumstances.
Where the goods are of perishable nature In case goods sold are perishable, the unpaid seller
can resell them after the expiry of reasonable time. He does not need to serve any notice to the
original buyer in such a case. Significantly, perishability of the goods is not restricted only to their
physical deterioration but also implies commercial atrophy of the same. Self-Learning
Material 143
Legal and Regulatory
Environment of Where the seller expressly reserves such right  Where the seller expressly reserves a right of re-
Business sale, in case the buyer defaults in payment, the unpaid seller may resell the goods when the buyer
defaults. In such a case the original contract of sale will of course be rescinded but without prejudice
Notes to any claim which the seller may have for damages.
Where the unpaid seller gives notice to buyer of his intention to resell  Having exercised the
right of lien or stoppage-in-transit, the unpaid seller should give notice to the buyer of his/her inten-
tion to resell. If the buyer does not, within a reasonable time, pay or tender the price, the unpaid
seller may re-sell the goods within a reasonable time. In such a case the unpaid seller will also be
entitled to recover from the original buyer damages for any loss occasioned by his/her breach of
contract. However, the buyer shall not be entitled to any profit, which may occur on the sub-sale.
Contrary to it, if the unpaid seller does not serve a notice to the defaulting buyer of his intention to
re-sell, he/she shall not be entitled to recover such damages, and the buyer shall be entitled to the
profit, if any, on the resale [Section 54(2)].
Furthermore, if the unpaid seller fails to give a reasonable notice to the defaulting buyer, it af-
fects the rights of the unpaid seller only. It does not affect the title of the subsequent buyer. In this
regard, Section 54(3) provides as under.
‘Where an unpaid seller, who has exercised his right of lien or stoppage-in-transit, re-sells the
goods, the buyer acquires a good title thereto as against the original buyer, notwithstanding that
no notice of the resale was given to the original buyer.’

Right to withhold delivery

Where the property in goods has not passed to the buyer, the unpaid seller, in addition to the
remedies discussed hitherto, has a right to withhold delivery, similar to and co-extensive with his
rights of lien and stoppage-in-transit, where the property has passed to the buyer [Section 46(2)].

Rights of unpaid seller against buyer

In addition to the rights against the goods, an unpaid seller has certain remedies against the buyer
personally. These rights are as follows:
1. Suit for Price
2. Suit for damages for non-acceptance
3. Suit for damages for repudiating contract before due date
4. Suit for interest and special damages.

Suit for price

The buyer is legally bound to pay the price for the goods he/she has purchased. Where under a
contract of sale the property in the goods has passed to the buyer and he/she wrongfully neglects
or refuses to pay for the goods as per the terms of the contract, the seller may sue him/her for the
price of the goods [Section 55(1)].
On the other hand, if the property in goods has not passed to the buyer, as a general rule, the
seller can only sue for damages; he cannot file a suit for the price. However, as per Section 55(2),
‘where under a contract of sale the price is payable on a certain day irrespective of delivery and the
buyer wrongfully neglects or refuses to pay such price, the seller may sue him for the price, although
the property in goods has not passed and the goods have not been appropriated to the contract’.
Thus, where the contract (of sale) stipulates payment of the price on a certain day, transfer of owner-
ship and delivery of the goods are immaterial to sue the buyer for recovery of price.

Suit for damages for non-acceptance

‘Where the buyer wrongfully neglects or refuses to accept and pay for the goods, the seller may sue
him for the damages for non-acceptance’ [Section 56].
What should be the amount of damages, however, is to be calculated in accordance with the rules
contained in Sections 73 and 74 of the Indian Contract Act, 1872, which may briefly be summarised
as follows:
1. Where the goods in question have a ready market, the conventional rule is that the seller
may recover from the buyer damages equal to the difference between the contract price
Self-Learning
and the market price on the date of the breach of the contract, if the market price exceeds
144  Material
 the contract price. For example, A agreed to sell 50 kg of almonds to B at the rate of ` 250 Contract of
per kg. The almonds were to be delivered after 15 days and the price was to be paid upon Sale of Goods
delivery. The seller delivered the goods on the due date but the buyer refused to accept and
pay for them. On the date of breach, the market price of almonds was ` 300 per kg. Here A
Notes
is entitled to claim ` 2500 [that being the difference between the market price on date of
breach and the contract price, i.e., (300–250) = 50 ¥ 50 = 2500 as damages from B.
2. Where the goods do not have a ready market, the measure of damages will depend on the
facts of each case. As a general rule, the damages in such a case will be equal to the estimated
loss arising directly and naturally in the ordinary course of events, from the buyer’s breach
of contract. For instance, where the goods have been manufactured on some special order,
and the buyer wrongfully neglects or refuses to accept the delivery and pay for the same,
then the seller will be entitled to full price of the goods as damages, for the simple reason
that such goods may not be saleable or may have no commercial value for other buyers. In
Thompson (WL) Ltd vs Robinson (gunmakers) Ltd 27, R entered into a contract with T Ltd, a car
dealer to purchase a ‘Vanguard’ car. But upon being offered, R refused to accept the delivery.
In a sense, there was no market price of this car on the date of breach of contract due to the
fact that the supply of the car exceeded the demand at that time. It was held that T Ltd were
entitled to damages for the loss of their bargain, i.e., the profit they would have made, as
they sold one car less than they would have sold otherwise.

Suit for damages for repudiating contract before due date

If the buyer repudiates the contract before the due date of delivery of goods, the seller may either
treat the contract as subsisting or wait till the due date of delivery, or he may treat the contract as
rescinded and sue for damages for the breach. In the latter case, amount of damages will be deter-
mined according to the price prevailing on the date of breach and the contract price. But where the
seller treats the contract subsisting (i.e., operative) and waits till the due date of delivery, then the
buyer may demand the goods when the date of delivery arrives and the seller will be bound to deliver
the goods. In such a situation, the unpaid seller can claim damages only if the buyer repudiates the
contract on the due date of delivery of the goods. For example, A agreed to sell to B 100 grams of
gold at the rate of ` 10,000 per 10 grams. The gold was to be delivered after 15 days and the price
was to be paid on delivery. But before the due date of delivery, upon being informed by B that he was
no more interested in the deal and unwilling to accept the delivery of the goods, A sold the gold to
C at the rate of ` 9,400 per 10 gram (i.e., prevailing market rate on the date of breach). A can sue
B for the damages at the rate of ` 600 per 10 grams.
Suit for interest and special damages
Section 61 entitles an unpaid seller to recover interest or special damages in any case where by law,
interest or special damages may be recoverable. This section also acknowledges that in the absence
of a contract to the contrary, the court may award interest at a reasonable rate to the seller on the
amount he is entitled to recover from the buyer. The interest may be calculated from the date of the
tender of the goods or from the date on which the price was payable. It is important to note that the
seller can claim interest only when he is entitled to recover the price. If the unpaid seller has the
only remedy to claim damages, then he will not be entitled to any interest.
Moreover, the court has discretionary powers to award interest by way of damages notwith-
standing there was no contract as to payment of interest [Girja Prasad vs Sardar Labh Singh28].

E xercises
I. Objective-type Questions
1. Which of the following is not a basic requirement to form a valid contract of sale?
(a) Two parties (b) Transfer of property in goods
(c) Consideration in price (d) Delivery of goods
2. Which of the following is not correct in respect of a contract of sale?
(a) There may be immediate delivery of goods
(b) The delivery of goods or payment of price or both may be made at some
Self-Learning
future date
Material  145
Legal and Regulatory (c) There may be immediate delivery of goods but price to be paid at some
Environment of future date
Business (d) Delivery of goods is irrelevant
Notes 3. For a contract of sale to be void on the ground of destruction of subject matter,
which of the following conditions must be satisfied?
(a) It must be a contract of sale for specific goods
(b) The goods must have perished before making the contract
(c) The seller must not be aware about the destruction of goods
(d) All of the above
4. To avail relief under condition as to fitness, the condition(s) to be satisfied is/are
(a) the exact purpose must have disclosed
(b) the seller must be a dealer in such goods
(c) the buyer must have relied upon the seller’s skill or judgment
(d) all of the above
5. The expression ‘Nemo dat quod non-habet’ means
(a) let the buyer beware
(b) only the owner of the goods can transfer a title thereto
(c) one cannot give what one does not have
(d) condition as to little may be negative by express terms
6. The doctrine of caveat emptor does not apply
(a) where the seller makes a false or mis-representation, or fraud
(b) where the seller conceals a defect in the goods, which cannot be found out
on reasonable examination
(c) in case of implied conditions and warranties
(d) in all the above situations
7. Which of the following is not an implied condition in a contract of sale?
(a) Condition as to quality or fitness
(b) Condition as to merchantable quality
(c) Condition as to wholesomeness
(d) Condition as to free from encumbrances
8. To be called an ‘unpaid seller’, the condition(s) to be satisfied is/are
(a) The goods have been sold and the price is due
(b) The buyer has not yet paid or tendered the full price
(c) A bill of exchange or other negotiable instrument, such as cheque, was re-
ceived as payment of the price but the same has dishonoured on presentation
(d) All of the above
9. In which of the following circumstances, an unpaid seller cannot resell the goods?
(a) Where the goods are perishable
(b) Where the seller expressly reserves a right of resale
(c) Where the buyer transfers the document of title of goods to a person who
buys them in good faith and for consideration
(d) Where the unpaid seller has given a notice to the buyer about his intention
to resell and the buyer does not pay or tender the price within a reasonable
time
10. Which of the following rights is/are available to the unpaid seller against the
buyer personally?
(a) Suit for the price (b) Suit for damages
(c) Suit for interest and special damages (d) All of the above
II. Review Questions
1. What is a contract of sale? Distinguish between a sale and an agreement to sell.
2. Define goods. What is the effect of destruction of specific goods on a contract of
sale?
3. Discuss briefly the formalities to be fulfilled to make a contract of sale.
Self-Learning 4. Define and distinguish between ‘condition’ and ‘warranty’.
146  Material 5. State the implied conditions in a contract of sale of goods.
 6. Explain the doctrine of caveat emptor. What are the exceptions to this doctrine? Contract of
Sale of Goods
7. Under what circumstances does a ‘condition’ descend to the level of a ‘war-
ranty’?
8. Describe the provisions of the Sale of Goods Act relating to the implied conditions Notes
in a contract of-
(1) ‘Sale of sample’ and
(2) ‘Sale by sample as well as by description’
9. What do you mean by the term ‘delivery of goods’ in a contract of sale? Explain
in brief the rules relating to the delivery of goods.
10. ‘Delivery does not amount to acceptance of goods’. Comment. Also discuss the
liability of the buyer.
11. Who is an unpaid seller? What are his rights?
12. Explain fully the right of lien. When is this right said to have lost?
13. ‘Right of stoppage-in-transit is an extension of the right of lien.’ Elucidate.

10. (d) 9. (c) 8. (d) 7. (d) 6. (d)

5. (c) 4. (d) 3. (d) 2. (d) 1. (d)
Answers to Objective-type Questions

Self-Learning
Material  147
 Chapter
Legal and Regulatory
Environment of

In Review
Business

7
Notes

Learning Objectives ●● A contract of sale of goods is a contract, whereby, the seller transfers or agrees to
transfer the property in goods to the buyer for a price. There can be a contract of
Contract of sale: definition, essentials sale between one co-owner and another co-owner.
Sale distinguished from agreement to sell ●● A sale consists in the passing of title from the seller to the buyer for a price but in an
agreement to sell, the transfer of property in the goods is to take place at a future
Goods: meaning; classification time or subject to some condition thereafter to be fulfilled.
Price: meaning, modes of fixation ●● The goods, which form the subject matter of a contract of sale, may be either exist-
ing goods, owned or possessed by the seller, or future goods. When a seller, by a
Conditions
contract of sale, purports to effect a sale of future goods or contingent goods, the
Warranty contract operates as an agreement to sell.
Doctrine of caveat emptor ●● Price represents the money consideration for a sale of goods. The price in a contract
of sale may be fixed by the contract, or may be left to be fixed in a manner thereby
Delivery of goods; modes of delivery; actual,
agreed, or may be determined by the course of dealing between the parties. Where
symbolic, and constructive delivery
the price is not determined in accordance with the foregoing provisions, the buyer
Rights of an unpaid seller shall pay the seller a reasonable price. What is a reasonable price is a question of
fact dependent on the circumstances of each particular case.
●● A condition is a stipulation essential to the main purpose of the contract, the breach
Key Terms of which gives rise to a right to treat the contract as repudiated besides seeking for
damages. A warranty, on the other hand, is a stipulation collateral to the main pur-
Contract of sale: A contract whereby a
pose of the contract, the breach of which gives rise to claim for damages but not a
seller transfers or agrees to transfer the
right to reject the goods and treat the contract as repudiated.
property in goods to the buyer for a price
●● Under the doctrine of ‘caveat emptor’, the buyer alone is responsible for checking
Goods: Every kind of movable property the quality and suitability of goods before a purchase is made. This doctrine is sub-
other than actionable claims and money ject to certain exceptions such as where the seller actively conceals latent defects;
Future goods: Goods that are yet to be where the seller misrepresents or commits a fraud; where goods are bought by de-
manufactured, produced, or acquired by scription from a seller who deals in goods of that description and the goods supplied
the seller after making the contract of sale by the seller do not correspond with the description; etc.
Contingent goods: Goods whose acquisition ●● It is the duty of the seller to deliver the goods sold and of the buyer to accept and
by the seller depends on a contingency, pay for them, in accordance with the terms of the contract of sale. Whether the
which may or may not happen delivery is actual, symbolic, or constructive, it should have the effect of putting the
Price: Refers to the money consideration for goods in the possession of the buyer or his/her authorised agent.
the sale of goods ●● The seller of goods is deemed to be an ‘unpaid seller’ when the whole of the price
has not been paid or tendered. The rights of an unpaid seller may be classified as
Condition: A stipulation essential to the
against the goods and against the buyer personally.
main purpose of the contract, the breach
of which gives rise to a right to treat the
contract as repudiated
Warranty: A stipulation collateral to the
main purpose of the contract, the breach of
which gives rise to a claim for damages but
not to a right to reject the goods and treat
the contract as repudiated
Caveat emptor: Let the buyer beware
Delivery: Voluntary transfer of possession
of goods from one person to another
Unpaid seller: One who has not received
the full price of the goods sold by him
Lien: Retention of possession of goods until
the price due in respect of the same is paid
or tendered

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148   Material
Legal and Regulatory Environment of Business
 The Consumer

The Consumer
8
Protection Act, 1986

Protection Act, 1986 Notes

© iStock
Learning Objectives
1. The Act: salient features; aim and 2. Rights of consumer; restrictive trade
objectives practice; unfair trade practice; service;
trader
3. Grievance redressal machinery

The Consumer Protection Act, 1986: An Over view

T he Consumer Protection Act, 19861, is an important milestone in the history of socio-economic

legislations in India. It is one of the most progressive and comprehensive legislation enacted
by Parliament to safeguard the interest of consumers in the country. The Act, which was passed in
December 1986 and came into force in April 1987, attempts to give consumers complete protection
from malpractices of manufacturers, producers, suppliers, wholesalers, retailers, and providers
of various services. The Act is designed to make available inexpensive and speedy justice to the
consumer. The Act extends to the whole of India except the State of Jammu and Kashmir2. The Act
was amended in 1991 and 1993 for addressing certain loopholes. Furthermore, in order to make the
Consumer Protection Act more effective and purposeful, a comprehensive amendment to the Act
was made in December 2002 and brought into force from 15 March 2003. The remedy provided for
consumers under this Act is through a three-tier quasi-judicial mechanism, comprising the District
Forums at the district level, State Commissions at the State level and the National Commission
located in Delhi at the apex level.

Salient Features of the Act

The salient features of the Act are as follows:
1. The Act applies to all goods and services unless specifically exempted by the Central Govern-
ment.
2. It covers all the sectors—private, public, and co-operative.
3. The provisions of the Act are chiefly compensatory in nature .
4. It seeks to confer upon the consumers the following six rights:
(i) Right to safety, (ii) Right to be informed, (iii) Right to choose, (iv) Right to be heard,
(v) Right to seek redressal, and (vi) Right to consumer education.
5. The Act also envisages establishment of Consumer Protection Councils at the central,
state, and district levels, whose main objectives are to promote and protect the rights of
Self-Learning
consumers.
Material 149
Legal and Regulatory 6. To provide a simple, speedy, and inexpensive redressal of consumer grievances, the Act
Environment of envisages three-tier quasi-judicial machinery at the national, state, and district levels. These
Business are—National Consumer Disputes Redressal Commission known as the National Commis-
sion, State Consumer Disputes Redressal Commissions (known as State Commissions) and
Notes
the District Forums.
7. Engagement of an advocate is not mandatory to file a complaint and pursue under the Con-
sumer Protection Act.

Aim and Objectives of the Act

The Consumer Protection Act was enacted primarily to promote and protect the rights of consumers
in a healthy way. Unlike existing regulations which are punitive or preventive in nature, the provi-
sions of this statute are chiefly compensatory in nature. The Act seeks to provide simple, speedy,
and inexpensive redressal to the consumers’ grievances, and relief of a specific nature and award
of compensation wherever appropriate to the consumer.

Major Concepts
Some of the important terms used in the Consumer Protection Act are briefly introduced below.

Appropriate laboratory
An appropriate laboratory means a laboratory or organisation that is
(i) recognised by the Central Government,
(ii) recognised by a State Government, subject to such guidelines as may be prescribed by
the Central Government in this behalf, or
(iii) any such laboratory or organisation established by or under any law for the time-being
in force, which is maintained, financed or aided by the Central Government, or a State
Government, for carrying out analysis or test of any goods with a view to determining
whether such goods suffer from any defect [Section 2(1) (a)].

Complainant
According to the Act, ‘complainant’ means any one of the following.
(i) a consumer;
(ii) any voluntary consumer association registered under Section 25 of the Companies Act,
1956, or under the Societies’ Registration Act, 1860; the Indian Trust Act, 1908; or any
Co-operative Societies Act of any State;
(iii) the Central Government or any State Government;
(iv) one or more consumers, where there are numerous consumers having the same interest;
and
(v) in case of the death of a consumer, his legal heir or representative who or which makes
a complaint [Section 2(1) (b)].

Grounds of complaint
‘Complaint’ means any allegation made in writing by a complainant with a view to obtaining any
relief provided by or under this Act. The grounds of complaint are as follows:
(i) An unfair trade practice or a restrictive trade practice has been adopted by any trader; or
(ii) The goods bought by the consumer or agreed to be bought by him/her suffer from one or
more defects.
(iii) The services hired or availed of, or agreed to be hired or availed of by him suffer from any
deficiency in any respect.
(iv) A trader or service provider has charged for the goods or the service mentioned in the
complaint a price in excess of the price (a) fixed by or under any law; (b) displayed on the
goods or any package containing such goods; (c) displayed on the price list exhibited by
him under any law; or (d) agreed between the partners.
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150  Material
 (v) Goods which will be hazardous to life and safety when used, are being offered for sale to The Consumer
the public (a) in contravention of the provisions of any law requiring the traders to display Protection Act, 1986
information in regard to the contents, manner, and effect of use of such goods; (b) if the
trader could have known with due diligence that the goods are unsafe. Notes
(vi) Services which are hazardous or likely to be hazardous to life and safety of the public
when used are being offered [Section 2(1) (c)].

Consumer
As defined under the Act, ‘consumer’ means any person who:
(i) buys any goods for a consideration which has been paid or promised, or partly paid and
partly promised, or under any system of deferred payment, and includes any (other)
user of such goods other than the person who buys such goods for consideration paid
or promised or partly paid or partly promised, or under any system of deferred payment
when such use is made with the approval of such person, but does not include a person
who obtains such goods for resale or for any commercial purpose, or
(ii) hires or avails of any services for a consideration which has been paid or promised or
partly paid and partly promised, or under any system of deferred payment, and includes
any beneficiary of such services other than the person who hires or avails of the services
for consideration paid or promised, or partly paid and partly promised, or under any sys-
tem of deferred payments, when such services are availed of with the approval of the
first-mentioned person but does not include a person who avails of such services for any
commercial purpose [Section 2(1) (d)].
Here, ‘commercial purpose’ does not include use of goods bought by a consumer and services
availed by him exclusively for the purpose of earning his livelihood by means of self-employment.
The definition of ‘consumer’ given in the Act makes it clear that it includes not only the person
who buys any goods or hires a service for consideration, but also any user of such goods or services,
when such use is made with the approval of the buyer or hirer. This was necessary because the goods
purchased or services hired by a buyer are also likely to be used by his family members, relatives, and
friends. Under the general principles of the law of contract, however, such users of goods or service
(beneficiaries) are not entitled to sue the supplier or trader of such goods on the ground of privity
of contract. But, a person, who buys goods or hires service for any commercial purpose, other than
for earning livelihood through self employment, is not a consumer.

Defect in goods
‘Defect’, according to the Act, means any fault, imperfection or shortcoming in the quality, quantity,
potency, purity, or standard (of goods) which is required to be maintained by or under any law or
under any contract, express or implied, or as is claimed by the trader in any manner [Section 2(1)(f)].

Deficiency in service
Equivalent to defect in case of goods, the term ‘deficiency’ is applicable in case of services. It means
any fault, imperfection, shortcoming, or inadequacy in the quality, nature, and manner of perform-
ance (of a service) which is required to be maintained by or under any law , or has been undertaken
to be performed by a person in pursuance of a contract or otherwise in relation to any service [Sec-
tion 2(1)(g)].

Goods
‘Goods’ means goods as defined in the Sale of Goods Act, 1930. Accordingly, ‘goods’ means every
kind of movable property other than actionable claims and money, and includes stock and shares,
growing crops, grass, and things attached to or forming part of the land which are agreed to be
severed before sale or under the contract of sale [Section 2(1)(i)].

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Material  151
Legal and Regulatory Manufacturer
Environment of
Business ‘Manufacturer’ means a person who
(i) makes or manufactures any goods or parts thereof, or
Notes (ii) does not make or manufacture any goods but assembles parts thereof made or manufac-
tured by others and claims the end product to be goods manufactured by himself, or
(iii) puts or causes to be put his own mark on any goods made or manufactured by any other
manufacturer and claims such goods to be goods made or manufactured by himself [Sec-
tion 2(1)(j)].

Person
‘Person’, according to the Act includes the following:
(i) A firm whether registered or not;
(ii) A Hindu undivided family;
(iii) A co-operative society; and
(iv) Every other association of persons whether registered under the Societies’ Registration
Act, 1860 or not [Section 2(1)(l)].

Restrictive trade practice

It means any trade practice which requires a consumer to buy, hire, or avail of any goods or, as the
case may be, services as a condition precedent for buying, hiring, or availing of other goods or serv-
ices in such a manner as to impose on the consumers unjustified costs or restrictions. It includes
(a) delay beyond the period agreed to by the trader in the supply of goods or in providing the
services, which is likely to result in rise of price.
(b) any trade practice which requires a consimer to buy, hire, or avail any goods or services as
a condition precedent to buying, hiring, or availing of other goods or services (tie-up sales)
[Section 2(1)(n)].

Service
‘Service’ means service of any description which is made available to potential users and includes
the provision of facilities in connection with banking, financing, insurance, transport, processing,
supply of electrical or other energy, boarding or lodging or both, housing, construction, entertain-
ment, amusement, or the purveying of news or other information [Section 2(1) (O)].
Service, however, does not include the rendering of any service free of charge or under a contract
of personal service [Section 2(1)(o)].

Trader
‘Trader’, in relation to any goods, means a person who sells or distributes any goods for sale and
includes the manufacturer thereof, and where such goods are sold or distributed in a packaged form,
includes the packer thereof [Section 2(1)(q)].

Unfair trade practice

It means a trade practice which, for the purpose of promoting the sale, use, or supply of any goods,
or for the provision of any service, adopts any unfair method or unfair or deceptive practice, includ-
ing any of the following practices:
1. The practice of making any statement to the public whether orally or in writing or by visible
representation which
(i) falsely represents that the goods are of a particular standard, quality, quantity, grade,
composition, style or model
(ii) falsely represents that the services are of a particular standard, quality or grade
(iii) falsely represents any re-built, second-hand, renovated, reconditioned, or old goods as new
goods
(iv) represents that the goods or services have sponsorship, approval, performance, charac-
teristics, accessories, uses or benefits which such goods or services do not have
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152  Material
 (v) represents that the seller or the supplier has a sponsorship or approval or affiliation which The Consumer
such seller or supplier does not have Protection Act, 1986
(vi) makes a false or misleading representation concerning the need for, or the usefulness of,
any goods or services
Notes
(vii) gives to the public any warranty or guarantee of the performance, efficacy, or length of
life of a product, or of any goods that is not based on an adequate or proper test thereof
Where a defence is raised to the effect that such warranty or guarantee is based on adequate or
proper test, the burden of proof of such defence shall lie on the person raising such defence
(viii) makes to the public a representation in a form that purports to be (a) a warranty or guarantee
of a product or of any goods or services, or (b) a promise to replace, maintain, or repair an
article or any part thereof or to repeat or continue a service until it has achieved a specified
result, if such purported warranty or guarantee or promise is materially misleading or if there
is no reasonable prospect that such warranty, guarantee, or promise will be carried out
(ix) materially misleads the public concerning the price at which a product or like products or
goods or services, have been or are, ordinarily sold or provided, and, for this purpose, a rep-
resentation as to price shall be deemed to refer to the price at which the product or goods
or services has or have been sold by sellers or provided by suppliers generally in the relevant
market unless it is clearly the price at which the product has been sold or services have been
provided by the person by whom or on whose behalf the representation is made
(x) gives false or misleading facts disparaging the goods, services, or trade of another person
[Section 2(1)(r)].
For the purposes of clause (1), a statement shall be deemed to be a statement made to the public
by, and only by, the person who had caused the statement to be so expressed, made or contained
if the statement is
(a) expressed on an article offered or displayed for sale, or on its wrapper or container, or
(b) expressed on anything attached to, inserted in, or accompanying, an article offered or dis-
played for sale, or on anything on which the article is mounted for display or sale, or
(c) contained in or on anything that is sold, sent, delivered, transmitted, or in any other manner
whatsoever made available to a member of the public.
(d) permits the publication of any advertisement whether in any newspaper or otherwise, for
the sale of supply at a bargain price, of goods or services that are not intended to be offered
for sale or supply at the bargain price, or for a period that is, and in quantities that are, rea-
sonable, having regard to the nature of the market in which the business is carried on, the
nature and size of business, and the nature of the advertisement.
2. For the purposes of clause (2), ‘Bargaining price’ means
(a) a price that is stated in any advertisement to be a bargain price, by reference to an ordinary
price or otherwise, or
(b) a price that a person who reads, hears, or sees the advertisement, would reasonably under-
stand to be a bargain price having regard to the prices at which the product advertised or
like products are ordinarily sold.
3. An unfair practice is one which permits
(i) the offering of gifts, prizes, or other items with the intention of not providing them as of-
fered or creating impression that something is being given or offered free of charge when
it is fully or partly covered by the amount charged in the transaction as a whole
(ii) the conduct of any contest, lottery, games of chance, or skill, for the purpose of promoting,
directly or indirectly, the sale, use or supply of any product or any business interest.
3A. Withholding from the participants of any scheme offering gifts, prizes, or other items free of
charge, on its closure, the information about final result of the scheme. The participants of
the scheme shall be deemed to have been informed of the final results of the scheme where
such results are within a reasonable time published prominently in the same newspapers in
which the scheme was originally advertised.
4. Permits the sale or supply of goods intended to be used, or are of a kind likely to be used,
by consumers, knowing or having reason to believe that the goods do not comply with the
standards prescribed by competent authority relating to performance, composition, con-
tents, design, constructions, finishing, or packaging as are necessary to prevent or reduce
the risk of injury to the person using the goods.
5. Permits the hoarding or destruction of goods, or refuses to sell the goods or to make them
available for sale or to provide any service, if such-hoarding or destruction or refusal raises Self-Learning
or tends to raise or is intended to raise, the cost of those or other similar goods or services. Material  153
Legal and Regulatory 6. Manufacture of spurious goods or offering such goods for sale or adopting deceptive prac-
Environment of tices in the provision of services.
Business

Notes Rights of Consumer

Consumer interest in the market is the focus, or the art of enlightened marketing mix. Business and
consumerism both aim at the protection of consumer interest—business through self-regulation
and consumerism through self-help. Consumerism invokes government assistance when business
misbehaves and fails to fulfil its responsibilities. To facilitate this, the Act under Section 6 provides
the following six rights of consumers:
1. Right to Safety  It is the right of the consumer to be protected against the marketing of goods
and services by unscrupulous sellers, which are potentially hazardous to life and property. The goods
purchased and services availed of should not only meet their immediate needs, but also fulfil long
term interests.
2. Right to be informed  This refers to the entitlement of the consumer to be informed about the
quality, quantity, potency, purity, standard, and price of goods so as to protect the buyer against
unfair trade practices. A consumer should insist on getting all the information about the product or
service before making a choice or a decision. This will enable him/her to act wisely and responsibly,
and also enable him to desist from falling prey to high pressure and misleading selling techniques.
3. Right to choose  It is the right of the consumer to be assured, as far as possible, of access to a
variety of goods and services at competitive price. In case of monopolies, it implies the right to be
assurdof satisfactory quality and service at a fair and reasonable price.
4. Right to be heard  This implies that consumer’s interests will receive due consideration at ap-
propriate fora. It also includes the consumer’s liberty to be represented in various fora constituted
for consumer welfare.
5. Right to seek redressal of grievances  This refers to the privilege of the consumer to seek
compensation against unfair trade practices or unscrupulous exploitation. It also includes the right
to fair settlement of genuine grievances of the consumers. Consumers can also take the help of
consumer organisations in seeking redressal of their grievances.
6. Right to consumer education  This refers to the entitlement of the consumer to acquire the
knowledge and skill to be an informed buyer. Ignorance of consumers, particularly of rural folk, is
the main cause of their exploitation. They should know their rights and must exercise them. Only
then real consumer protection can be achieved.

Three-tier Grievance-redressal Machiner y

In order to provide simple and speedy redressal of consumer grievances, Section 9 of the Consumer
Protection Act envisages a three-tier quasi-judicial machinery at the national, state and district lev-
els. Popularly called as consumer courts, the redressal machinery comprises the following.
1. National Consumer Disputes Redressal Commission or the ‘National Commission’ at the
apex level. It is based in Delhi.
2. Consumer Disputes Redressal Commissions or ‘State Commissions’. These are based in state
capitals.
3. ‘District Forums’, which are established at the district level.
As on June 15, 2013, there are 35 State Commissions, one in each State or Union Territory and 629
district forums. The organisational setup established under the CPA is shown in Figure 8.1.

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154  Material Fig. 8.1  Organisational setup under the CPA
District forum The Consumer
Protection Act, 1986
Establishment
Section 9 (a) of the Act lays down that there shall be established for the purposes of this Act, a Notes
Consumer Disputes Redressal Forum, to be known as the ‘District Forum’, established by the State
Government—three in each district of the state—by notification. The State Government may, if it
deems fit, establish more than one District Forum in a district.

Composition
As envisaged in the law, the District Forum is a three-member bench, headed by a serving or retired
district judge, or a person qualified to be one and two other members—one of whom is a woman—
who are economics, law, commerce, or public affairs experts.
According to Section 10 of the Act, each District Forum shall consist of the following:
(a) a person who is, or has been, or is qualified to be a District Judge, who shall be its President.
(b) two other members, who shall be persons of ability, integrity and standing, and have ad-
equate knowledge or experience of, or have shown capacity in dealing with, problems relat-
ing to economics, law, commerce, accountancy, industry, public affairs or administration, one
of whom shall be a woman.
Every appointment under sub-section (1) shall be made by the State Government on the recom-
mendation of a selection committee consisting of the following:
(i) the President of the State Commission — Chairman
(ii) Secretary, Law Department of the State — Member
(iii) Secretary in-charge of the Department dealing — Member
with consumer affairs in the State

Term of office
Every member of the District Forum shall hold office for a term of five years or up to the age of 65
years, whichever is earlier. He shall not be eligible for re-appointment. However, a member may
resign his/her office in writing under his/her hand addressed to the State Government.

Terms of engagement
The salary or honorarium and other allowances payable to, and the other terms and conditions of
service of the members of the District Forum shall be such as may be prescribed by the State Gov-
ernment. However, the appointment of a member on whole-time basis shall be made by the State
Government on the recommendations of the President of the State Commission taking into consid-
eration such factors as may be prescribed including the work-load of the District Forum.

Jurisdiction
The District Forum is empowered to settle cases, where the value of compensation claimed is up to
` 20 lakh. Also, the district forum can entertain cases where any one of the parties, complainant or
defendant, either resides or is doing business.
The District Forum has the jurisdiction to entertain complaints where the value of the goods or
services and the compensation, if any, claimed does not exceed ` 20 lakh.
A complaint shall be instituted in a District Forum within the local limits of whose jurisdiction
(a) the opposite party or each of the opposite parties, where there are more than one, at the
time of the institution of the complaint, actually and voluntarily resides or carries on busi-
ness, or has a branch office or personally works for gain, or
(b) any of the opposite parties, where there are more than one, at the time of the institution of
the complaint, actually and voluntarily resides, or carries on business or has a branch office,
or personally works for gain. However, in such case either the permission of the District
Forum is given, or the opposite parties who do not reside, or carry on business or have a
branch office, or personally work for gain, as the case may be, acquiesce in such institution,
or
(c) the cause of action, wholly or in part, arises [Section 11].
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Material  155
Legal and Regulatory The State Commission
Environment of
Business
Forming the middle tier of the redressal mechanism are the state commissions, one in each state
capital, to settle issues between ` 20 lakh and ` 1 crore. These commissions also serve as appellate
Notes courts for verdicts of district forums. Each State Commission is headed by a president or chairman,
who is of the rank of a serving or retired High Court judge and two to four members—one of whom
is a woman. The related qualifications for the chairman and other members of the state commission
as also its powers and jurisdiction are discussed in detail in the following paragraphs.

Composition
Each State Commission shall consist of
(a) a person who is or has been a Judge of a High Court, appointed by the State Government,
who shall be its President. However, no appointment under this clause shall be made except
after consultation with the Chief Justice of the High Court
(b) not less than two and not more than such number of members, as may be prescribed, one
of whom shall be a woman, who shall have the following qualifications, namely,
(i) be not less than thirty-five years of age
(ii) possess a bachelor’s degree from a recognised university, and
(iii) be persons of ability, integrity, and standing, and have adequate knowledge and expe-
rience of at least ten years in dealing with problems relating to economics, law, com-
merce, accountancy, industry, public affairs, or administration.
Nonetheless, not more than 50 per cent of the members shall be from amongst persons having
a judicial background.
The expression ‘persons having judicial background’ shall mean persons having knowledge and
experience for at least a period of ten years as a presiding officer at the district level court or any
tribunal at equivalent level.
Further a person shall be disqualified for appointment as a member if he/she
(a) has been convicted and sentenced to imprisonment for an offence, which, in the opinion of
the State Government involves moral turpitude, or
(b) is an undischarged insolvent, or
(c) is of unsound mind and stands so declared by a competent court, or
(d) has been removed or dismissed from the service of the Government or a body corporate
owned or controlled by the Government, or
(e) has, in the opinion of the State Government, such financial or other interest as is likely to
affect prejudicially the discharge by him of his functions as a member, or
(f) has such other disqualification as may be prescribed by the State Government
Every appointment referred above shall be made by the State Government on the recommenda-
tion of a selection committee consisting of the following, namely,
(i) President of the State Commission — Chairman
(ii) Secretary of the Law Department of the State — Member
(iii) Secretary in-charge of the department dealing — Member
with consumer affairs in the State

Salary and honorarium

The salary or honorarium and other allowances payable to, and the other terms and conditions of
service of the members of the State Commission shall be such as may be prescribed by the State
Government [Section 16(2)].

Term of office
Every member of the State Commission shall hold office for a term of five years or up to the age of
67 years, whichever is earlier, and shall not be eligible for re-appointment.
Notwithstanding anything contained in sub-section (3), a person appointed as a President or as
a member before the commencement of the Consumer Protection (Amendment) Act, 1993, shall
Self-Learning continue to hold such office as President or member, as the case may be, till the completion of his
156  Material term [Section 16(3)].
Jurisdiction The Consumer
Protection Act, 1986
The State Commission shall have the jurisdiction
(a) to entertain—
(i) complaints where the value of the goods or services and compensation, if any, claimed exceeds Notes
` 20 lakh but does not exceed ` 1 crore, and
(ii) appeals against the orders of any District Forum within the State, and
(b) to call for the records and pass appropriate orders in any consumer dispute which is pending
before or has been decided by any District Forum within the state where it appears to the
State Commission that such District Forum has exercised a jurisdiction not vested in it by
law, or has failed to exercise a jurisdiction so vested or has acted in exercise on its jurisdic-
tion illegally or with material irregularity [Section 17].

Vacancy in the office of the President

When the office of the President of the District Forum or of the State Commission, as the case may
be, is vacant or when any such President is, by reason of absence or otherwise, unable to perform the
duties of his/her office, the duties of the office shall be performed by such person, who is qualified
to be appointed as the President of the District Forum or, as the case may be, of the State Commis-
sion, as the State Government may appoint for the purpose [Section 18A].

National Commission
At the apex of the redressal mechanism, stands the five-member National Commission headed by
a person no less than the rank of a serving or retired Supreme Court judge. Of the four other mem-
bers, two are supposed to have a judicial background, and one of them has to be a woman.

Composition
The National Commission shall consist of
(a) a person who is or has been a Judge of the Supreme Court, to be appointed by the Central
Government, who shall be its President. However, no appointment under this clause shall be
made except after consultation with the Chief Justice of India
(b) not less than four and not more than such number of members as may be prescribed one of
whom shall be a woman, who shall have the following qualifications, namely,
(i) be not less than thirty-five years of age
(ii) possess a bachelor’s degree from a recognised university, and
(iii) be persons of ability, integrity, and standing and have adequate knowledge and expe-
rience of at least ten years in dealing with problems relating to economics, law, com-
merce, accountancy, industry, public affairs, or administration
However, not more than 50 percent of the members shall be from amongst the persons having
judicial background.
The expression ‘persons having judicial background’ shall mean persons having knowledge and
experience for at least a period of ten years as a presiding officer at the district level court or any
tribunal at equivalent level.
Further a person shall be disqualified for appointment if he/she
(a) has been convicted and sentenced to imprisonment for an offence, which, in the opinion of
the Central Government involves moral turpitude, or
(b) is an undischarged insolvent, or
(c) is of unsound mind and stands so declared by a competent court, or
(d) has been removed or dismissed from the service of the Government or a body corporate
owned or controlled by the Government, or
(e) has in the opinion of the Central Government such financial or other interest as is likely to
affect prejudicially the discharge by him/her of his/her functions as a member, or
(f) has such other disqualification as may be prescribed by the Central Government
Every appointment under this clause shall be made by the Central Government on the recommen-
dation of a selection committee consisting of the following, namely,
(i) a person who is a Judge of the Supreme Court, — Chairman
to be nominated by the Chief Justice of India
(ii) the Secretary in the Department of Legal Affairs — Member Self-Learning
in the Government of India Material  157
Legal and Regulatory (iii) Secretary of the Department dealing with Consumer — Member
Environment of Affairs in the Government of India
Business
The jurisdiction, powers, and authority of the National Commission may be exercised by Benches
Notes thereof.
A Bench may be constituted by the chairperson of the Commission, known as the President, with
one or more members as the President may deem fit [Section 20].

Compensation
The salary or honorarium and other allowances payable to and the other terms and conditions of
service of the members of the National Commission shall be such as may be prescribed by the Central
Government.

Term of office
Every member of the National Commission shall hold office for a term of five years or up to the age
of 70 years, whichever is earlier and shall not be eligible for re-appointment. Notwithstanding, a
person appointed as a President or as a member before the commencement of the Consumer Pro-
tection (Amendment) Act, 1993, shall continue to hold such office as President or member, as the
case may be, till the completion of his/her term.

Jurisdiction
Subject to the other provisions of this Act, the National Commission shall have the jurisdiction
(a) to entertain
(i) complaints where the value of the goods or services and compensation, if any, claimed
exceeds ` one crore, and
(ii) appeals against the orders of any State Commission, and
(b) to call for the records and pass appropriate orders in any consumer dispute which is pending
before or has been decided by any State Commission where it appears to the National Commis-
sion that such State Commission has exercised a jurisdiction not vested in it by law, or has failed
to exercise a jurisdiction so vested, or has acted in the exercise of its jurisdiction illegally or with
material irregularity [Section 21].

Filing of a Complaint and the Procedure of Hearing

A complaint regarding a defect in any goods or deficiency in service, as the case may be, can be
made in writing to the district forum, either by the aggrieved consumer, or a consumer rights or-
ganisation on behalf of the consumers, or a group of aggrieved consumers or the Central or State
Governments. While a district forum can take up cases that involve a compensation up to a value
of ` 20 lakh, the State Commissions are authorised to take up cases, where the value of goods and
services in question is up to ` one crore. For amounts exceeding that value, the matter is decided by
the National Commission. Besides this, the State Commissions and the National Commission also
serve as appellate authorities of the lower tiers respectively.
The respective forums, entitled to deal with the cases shall deal with them in the prescribed
manner explained as follows.

Manner in which a complaint can be made

A complaint in relation to any goods sold or delivered or agreed to be sold or delivered or any service
provided or agreed to be provided, may be filed with a District Forum, by
(a) the consumer to whom such goods are sold or delivered or agreed to be sold or delivered or
such service provided or agreed to be provided
(b) any recognised consumers association, whether the consumer to whom the goods sold or
delivered or service provided or agreed to be provided, is a member of such association or
not, or

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158  Material
 (c) one or more consumers, where there are numerous consumers having the same interest, The Consumer
with the permission of the District Forum, on behalf of, or for the benefit of, all consumers Protection Act, 1986
so interested, or
(d) the Central or the State Government [Section 12].
Notes
Procedure on receipt of complaint
On receiving a complaint with respect to a defect in goods or deficiency in service, the district fo-
rum, first refers the same to the party against whom the complaint has been filed, seeking its reply
within a month of receiving the complaint. A further grace of 15 days is given in certain cases. If
the defendant does not respond to the forum’s notice, it shall proceed to decide the matter on the
basis of the facts in front of it. In cases of defective goods, the forum may also refer the samples to
appropriate laboratory for an objective analysis. If the defendant contests the laboratory analysis, it
should be in writing. The district forum will decide the matter on the basis of the evidence in front
of it after giving reasonable opportunities to both sides to present their points. For such matters,
the district forum is deemed to have the same powers as of a district court deciding civil cases.
In this regard, Section 13 states that the District Forum shall, on receipt of a complaint, if it relates
to any goods
(a) refer a copy of the complaint to the opposite party mentioned in the complaint directing
him to give his version of the case within a period of 30 days or such extended period not
exceeding 15 days as may be granted by the District Forum
(b) where the opposite party on receipt of a complaint referred to him, denies or disputes the
allegations contained in the complaint, or omits or fails to take any action to represent his
case within the time given by the District Forum, the District Forum shall proceed to settle
the consumer dispute in the manner specified in clauses (c) to (g)
(c) where the complaint alleges a defect in the goods that cannot be determined without proper
analysis or test of the goods, the District Forum shall obtain a sample of the goods from the
complainant, seal it and authenticate it in the manner prescribed, and refer it to the appro-
priate laboratory along with a direction that the laboratory makes an analysis with a view to
finding out whether such goods suffer from any defect alleged in the complaint, or suffer
from any other defect, and to report its findings thereon to the District Forum within a period
of forty-five days of the receipt of the reference or within such extended period as may be
granted by the District Forum
(d) before any sample of the goods is referred to any appropriate laboratory under clause (c), the
District Forum may require the complainant to deposit to the credit of the Forum such fees
as may be specified, for payment to the appropriate laboratory for carrying out the necessary
analysis or test in relation to the goods in question
(e) the District Forum shall remit the amount deposited to its credit under clause (d) to the ap-
propriate laboratory to enable it to carry out the analysis or test mentioned in clause (c) and
on receipt of the report from the appropriate laboratory, the District Forum shall forward
a copy of the report along with such remarks as the District Forum may feel appropriate to
the opposite party
(f ) if any of the parties disputes the correctness of the findings of the appropriate laboratory,
or disputes the correctness of the methods of analysis or test adopted by the appropriate
laboratory, the District Forum shall require the opposite party or the complainant to submit
in writing his objections in regard to the report made by the appropriate laboratory
(g) the District Forum shall thereafter give a reasonable opportunity to the complainant as well
as the opposite party of being heard as to the correctness or otherwise of the report made
by the appropriate laboratory and also as to the objection made in relation thereto under
clause (f) and issue an appropriate order under Section 14
(2) The District Forum shall, if the complaint received by it under Section 12 relates to goods
in respect of which the procedure specified in sub-section (1) cannot be followed, or if the
complaint relates to any services
(a) refer a copy of such complaint to the opposite party directing him to give his version
of the case within a period of thirty days or such extended period not exceeding fifteen
days as may be granted by the District Forum
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Material  159
Legal and Regulatory (b) where the opposite party, on receipt of a copy of the complaint, referred to it denies or
Environment of disputes the allegations contained in the complaint, or omits or fails to take any action
Business to represent his case within the time given by the District Forum, the District Forum shall
proceed to settle the consumer dispute
Notes
(i) on the basis of evidence brought to its notice by the complainant and the opposite
party, where the opposite party denies or disputes the allegation contained in the
complaint, or
(ii) on the basis of evidence brought to its notice by the complainant where the op-
posite party omits or fails to take any action to represent his case within the time
given by the Forum
(3) No proceedings complying with the procedure laid down in sub-sections (1) and (2) shall be
called in question in any court on the ground that the principles of natural justice have not
been complied with.
(4) For the purposes of this section, the District Forum shall have the same powers as are vested
in a civil court under the Code of Civil Procedure, 1908 (5 of 1908) while trying a suit in re-
spect of the following matters, namely,
(i) The summoning and enforcing attendance of any defendant or witness and examining
the witness on oath
(ii) The discovery and production of any document or other material object producible as
evidence
(iii) The reception of evidence on affidavits
(iv) The requisitioning of the report of the concerned analysis or test from the appropriate
laboratory or from any other relevant source
(v) issuing of any commission for the examination of any witness, and
(vi) any other matter which may be prescribed
(5) Every proceeding before the District Forum shall be deemed to be a judicial proceeding
within the meaning of Sections 193 and 228 of the Indian Penal Code (45 of 1860), and the
District Forum shall be deemed to be a civil court for the purposes of Section 195 and Chap-
ter XXVI of the Code of Criminal Procedure, 1973 (2 of 1974).
(6) Where the complainant is a consumer referred to in sub-clause (iv) of clause (b) of sub-
section (1) of Section 2, the provisions of Rule 8 of Order I of Schedule I to the Code of Civil
Procedure, 1908 (5 of 1908) shall apply, subject to the modification that every reference
therein to a suit or decree shall be construed as a reference to a complaint or the order of
the District Forum thereon.

Findings of the District Forum/relief provided

If, after the proceeding conducted under Section 13, the District Forum is satisfied that the goods
complained against suffer from any of the defects specified in the complaint or that any of the al-
legations contained in the complaint about the services are proved, it shall issue an order to the
opposite party directing him to do one or more of the following things, namely,
(1) to remove the defect pointed out by the appropriate laboratory from the goods in question
(2) to replace the goods with new goods of similar description which shall be free from any
defect
(3) to return to the complainant the price, or, as the case may be, the charges paid by the com-
plainant
(4) to pay such amount as may be awarded by it as compensation to the consumer for any loss
or injury suffered due to the negligence of the opposite party
(5) to award punitive damages
(6) to remove the defects/deficiencies in the services in question
(7) to discontinue the unfair trade practice or the restrictive trade practice and not to repeat
them
(8) not to offer the hazardous goods for sale
(9) to withdraw the hazardous goods from being offered for sale
(10) to cease the manufacture of hazardous goods and to desist from offering hazardous services
Self-Learning (11) to pay compensation to consumers not identifiable
160  Material
 (12) to issue corrective advertisement The Consumer
(13) to provide for adequate costs to parties [Section 14]. Protection Act, 1986

Appeal
Notes
Any person aggrieved by an order made by the District Forum may prefer an appeal against such
order to the State Commission within a period of thirty days from the date of the order, in such form
and manner as may be prescribed [Section 15].
The State Commission may, however, entertain an appeal after the expiry of the said period of 30
days if it is satisfied that there was sufficient cause for not filing it within that period.

Power and procedure before State Commission

The provisions of Sections 12, 13, and 14 and the rules made thereunder for the disposal of complaint
by the District Forum shall, with such modification as may be necessary, be applicable to the disposal
of disputes by the State Commission [Section 18].

Appeal
Any person aggrieved by an order made by the State Commission in exercise of its powers conferred
by sub-clause (i) of clause (a) of Section 17 may prefer an appeal against such order to the National
Commission within a period of 30 days from the date of the order in such form and manner as may be
prescribed. The National Commission may entertain an appeal after the expiry of the said period of
30 days if it is satisfied that there was sufficient cause for not filing it within that period [Section 19].

Power and procedure before the National Commission

The National Commission shall, in the disposal of any complaints or of any proceedings before it,
have
(a) the powers of a civil court as specified in sub-sections (4), (5), and (6) of section 13
(b) the power to issue an order to the opposite party directing him to do any one or more of
the things referred to in clauses (a) to (i) of sub-section (1) of section 14, and follow such
procedure as may be prescribed by the Central Government [Section 22].

Appeal
Any person, aggrieved by an order made by the National Commission in exercise of its powers,
may prefer an appeal against such order to the Supreme Court within a period of 30 days from the
date of the order. However, the Supreme Court may entertain an appeal after the expiry of the said
period of 30 days if it is satisfied that there was sufficient cause for not filing it within that period
[Section 23].

Finality of order
Every order of a District Forum, State Commission, or the National Commission shall, if no appeal
has been preferred against such order under the provisions of this Act, be final [Section 24].

Limitation period
The District Forum, the State Commission or the National Commission shall not admit a complaint
unless it is filed within two years from the date on which the cause of action has arisen. Notwith-
standing, a complaint may be entertained after the above period, if the complainant satisfies the
District Forum, the State Commission or the National Commission, as the case may be, that there
was sufficient cause for not filing the complaint within such period [Section 24A].
However, no such complaint shall be entertained unless the National Commission, the State
Commission or the District Forum, as the case may be, records its reasons for condoning such delay
[Proviso to Section 24A].

Administrative control
(1) The National Commission shall have administrative control over all the State Commissions in the
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following matters, namely, Material  161
Legal and Regulatory (i) calling for periodical returns regarding the institution, disposal, pendency (i.e., awaiting
Environment of decision or settlement) of cases
Business (ii) issuance of instructions regarding adoption of uniform procedure in the hearing of matters,
Notes prior service of copies of documents produced by one party to the opposite parties, furnish-
ing of English translation of judgments written in any language, speedy grant of copies of
documents
(iii) generally overseeing the functioning of the State Commissions or the District Forums
to ensure that the objects and purposes of the Act are best served without in any way
interfering with their quasi-judicial freedom.
(2) The State Commission shall have administrative controls over all the District Forums within its
jurisdiction in all matters referred above [Section 24B].

Enforcement of orders by the forums

Every order made by the District Forum, the State Commission or the National Commission, may
be enforced by the District Forum, the State Commission or the National Commission as the case
may be, in the same manner as if it were a decree or order made by a court in a suit pending therein
and it shall be lawful for the District Forum, the State Commission, or the National Commission
to send, in the event of its inability to execute it, such order to the court within the local limits of
whose jurisdiction
(a) in the case of an order against a company, the registered office of the company is situated,
or
(b) in the case of an order against any other person, the place where the person concerned
voluntarily resides or carries on business or personally works for gain, is situated, and there-
upon, the court to which the order is so sent, shall execute the order as if it were a decree
or order sent to it for execution [Section 25].

Dismissal of frivolous or vexatious complaints

Where a complaint instituted before the District Forum, the State Commission or, the National Com-
mission, as the case may be, is found to be frivolous or vexatious, it shall, for reasons to be recorded
in writing, dismiss the complaint and make an order that the complainant shall pay to the opposite
party such cost, not exceeding ` 10,000, as may be specified in the order [Section 26].

Penalties
Where a trader, or a person against whom a complaint is made, or the complainant fails or omits to
comply with any order made by the District Forum, the State Commission, or the National Commis-
sion, as the case may be, such a trader, or person, or complainant shall be punishable with a prison
term from one month to three years, or with a fine which shall not be less than ` 2,000, and not more
than ` 10,000 [Section 27].
The District Forum, the State Commission or the National Commission, as the case may be, may,
if it is satisfied that the circumstances of any case so require, impose a sentence of imprisonment
or fine, or both, for a term lesser than minimum term and the amount lesser than the minimum
amount, specified in this section [Proviso to Section 27].

Consumer Protection Councils

Besides the three-tier quasi judicial machinery to settle consumers’ grievances and complaints, the
Act also provides for the setting up of Consumer Protection Councils at the Centre as well as State
level for enforcement of consumer rights.

The Central Consumer Protection Council

Establishment
Self-Learning The Central Government may, by notification, establish with effect from such date as it may specify
162  Material in such notification, a council to be known as the Central Consumer Protection Council (hereinafter
referred to as the Central Council) [Section 4(1)].
Composition The Consumer
Protection Act, 1986
The Central Council shall consist of the following members, namely,
(a) the Minister in charge of consumer affairs in the Central Government, who shall be its Chairman,
and Notes
(b) such number of other official or non-official members representing such interests as may be
prescribed [Section 4(2)].

Meetings of the Central Council

1. The Central Council shall meet as and when necessary, but at least one meeting of the coun-
cil shall be held every year.
2. The Central Council shall meet at such time and place as the Chairman may think fit and shall
observe such procedure in regard to the transaction of its business as may be prescribed
[Section 5].

Objects of the Central Council

The objects of the Central Council shall be to promote and protect the rights of the consumers,
such as
1. The right to be protected against the marketing of goods and services which are hazardous
to life and property;
2. The right to be informed about the quality, quantity, potency, purity, standard, and price of
goods or services, as the case may be, so as to protect a small consumer against unfair trade
practices;
3. The right to be assured, wherever possible, access to a variety of goods and services at com-
petitive prices;
4. The right to be heard and to be assured that consumers’ interests will receive due considera-
tion at appropriate forums;
5. The right to seek redressal against unfair trade practices or restrictive trade practices or
unscrupulous exploitation of consumers; and
6. The right to consumer education [Section 6].

State Consumer Protection Councils

Establishment
The State Government may, by notification, establish with effect from such date as it may specify in
such notification, a council to be known as the Consumer Protection Council (hereinafter referred
to as the State Council) [Section 7(1)].

Composition
The State Council shall consist of the following members, namely
(a) the Minister in-charge of consumer affairs in the State Government who shall be its Chair-
man
(b) such number of other official or non-official members representing such interests as may be
prescribed by the State Government [Section 7(2)].

Meetings
The State Council shall meet as and when necessary but not less than two meetings shall be held every
year. Time and place of meeting shall be such as the Chairman may think fit and shall observe such
procedure in regard to the transaction of its business as may be prescribed by the State Government
[Section 7(3)]

Objects of the State Council

The objects of every State Council shall be to promote and protect within the State the rights of the
consumers laid down in clauses (a) to (f) of Section 6 [Section 8].
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Material  163
Legal and Regulatory Miscellaneous Provisions
Environment of
Business The miscellaneous provisions of the Consumer Protection Act may be summarised as under.
Protection of action taken in good faith
Notes
No suit, prosecution, or other legal proceedings shall lie against the members of the District Forum,
the State Commissions, or the National Commission, or any officer or person acting under the di-
rection of the District Forum, the State Commission or the National Commission for executing any
order made by it or in respect of anything which is in good faith done or intended to be done by such
member, officer or person under this Act or under any rule or order made thereunder [Section 28].

Power to remove difficulties

If any difficulty arises in giving effect to the provisions of this Act, the Central Government may, by
order in the Official Gazette, make such provisions not inconsistent with the provisions of this Act
as appear to it to be necessary or expedient for removing the difficulty. However, no such order shall
be made after the expiry of a period of two years from the commencement of this Act [Section 29].

Power to make rules

The Central Government may, by notification in the Official Gazette, make rules for carrying out the
provisions contained in the following sections of the Act.
Clause (a) of sub-section (1) of Section 2 regarding ‘appropriate laboratory’,
Clause (b) of sub-section (2) of Section 4 regarding ‘number of other official or non-official mem-
bers to be consisted by Central Government and representing interest of consumers’
Sub-section (2) of Section 5 regarding time and place of Central Council meeting and the procedure
to be observed by the Chairman in regard to the transaction of its business as may be prescribed by
the Central Government
Section 19 regarding ‘appeals to National Commission against the order of State Commissions’
Sub-section (2) of Section 20 regarding ‘the salary or honorarium and other allowances payable
to and the other terms and conditions of service of the members of the National Commission’ and
Section 22 regarding ‘power of and procedure applicable to the National Commission’.
Besides, the State Government may, by notification, make rules for carrying out the provisions con-
tained in the following sections of the Act.
Clause (b) of sub-section (2) and sub-section (4) of Section 7, i.e., ‘number of other official or
non-official members representing such interests as may be prescribed by the State Government,
the State Council shall consist’, and ‘the time and place of State Council meeting and the procedure
to be observed by the Chairman in regard to the transaction of its business’ respectively.
Sub-section (3) of Section 10 as regards ‘the salary or honorarium and other allowances payable to,
and the other terms and conditions of service of the members of the District Forum’
Clause (c) of sub-section (1) of Section 13 regarding ‘where the complainant alleges a defect in the
goods which cannot be determined without proper analysis or test of the goods, procedure to be
adopted by the District Forum for redressal of complaint’
Sub-section (3) of Section 14 regarding ‘the procedure relating to the conduct of the meetings of
the District Forum, its sittings and other matters’
Section 15 regarding ‘filing appeal to the State Commission against the order of District Forum’, and
Sub-section (2) of Section 16, i.e., as regards ‘the salary or honorarium and other allowances pay-
able to, and the other terms and conditions of service of, the members of the State Commission
[Section 30].

Laying of rules and regulations before Parliament

Every rule made by the Central Government under this Act shall be laid, as soon as possible after it is
made, before each House of Parliament, while it is in session, for a total period of thirty days which
Self-Learning may be comprised in one session or in two or more successive sessions, and if, before the expiry of
164  Material
the session immediately following the session or the successive sessions aforesaid, both Houses The Consumer
agree in making any modification in the rule or both Houses agree that the rule should not be made, Protection Act, 1986
the rule shall thereafter have effect only in such modified form or be of no effect, as the case may be,
so, however, that any such modification or annulment shall be without prejudice to the validity of Notes
anything previously done under that rule [Section 31].
Moreover, every rule made by a State Government under this Act shall be laid as soon as may be
after it is made, before the State Legislature.

E xercises
I. Objective-type Questions
1. Which of the following services shall not be covered under Consumer Protection
Act?
(a) Professional services rendered by a Chartered Accountant engaged by a
client
(b) Dignostic test administered by a doctor at AIIMS
(c) Legal advice rendered by a practicing Supreme Court advocate
(d) Medical procedures done by doctors at Escorts Heart Institute
2. State which of the following is not a consumer for the purpose of goods?
(a) One who buys any goods for a consideration for private use or consumption
only
(b) One who uses such goods with the approval of the buyer
(c) One who buys goods for commercial purpose
(d) One who buys some equipment for the purpose of self employment
3. Who among the following can file a complaint under the Consumer Protection Act?
(a) a consumer
(b) the Central or the State Government
(c) one or more consumers if there are many consumers having the common
interest
(d) Any of the above
4. The term ‘manufacturer’ means a person who
(a) makes or manufacturers goods or parts thereof
(b) assembles parts made or amnufactured by others and claims the end prod-
uct to be manufactured by himself
(c) puts or causes to put his own mark on any goods made or manufactured by
any other manufacturer and claims such goods to be made or manufactured
by himself
(d) All of the above
5. Which is not one of the salient features of the Consumer Protection Act, 1986?
(a) The Act applies to all goods and services unless specifically exempted by
the Central Government.
(b) It covers only private sector.
(c) The provisions of the Act are chiefly compensatory in nature.
(d) Engagement of advocate is not mandatory to file and pursue a complaint
under the Act.
6. Those complaints can be filed with the State Commission where the value of
goods or services and the compensation claimed is
(a) Up to ` 20 lakhs
(b) More than ` 20 lakhs
(c) More than ` 20 lakhs but less than ` 1 crore
(d) More than ` 1 crore
7. Which of the following right is not provided by the Consumer Protection Act, 1986
to the consumers?
(a) Right to safety (b) Right to be informed
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(c) Right to seek redressal (d) Right to discipline
Material  165
Legal and Regulatory 8. A complainant not satisfied with the order of the District Forum may prefer an
Environment of appeal against the order before the State Commission within how much time from
Business the date of passing the order by the district forum:
(a) 30 days (b) 45 days
Notes
(c) 60 days (d) 90 days
9. Who among the following is not a consumer?
(a) Insurance company (b) Licensee to run a PCO
(c) Lottery ticket holder (d) All of the above
10. The time limit for filing a complaint before the District Forum, the State Com-
mission, or the National Commission, as the case may be, is
(a) One year from the date on which the cause of action arises
(b) Two years from the date on which the cause of action arises
(c) Three years from the date on which the cause of action arises
(d) Five years from the date on which the cause of action arises
II. Review Questions
1. Describe the salient features of the Consumer Protection Act, 1986. Enumerate
also the objectives of the Act.
2. Explain ‘unfair trade practice’ under the Consumer Protection Act.
3. Give the statutory definition of the following terms
(a) Defect (b) Deficiency
(c) Goods (d) Manufacturer
(e) Person (f) Complaint
(g) Complainant
4. Discuss briefly the composition, powers, and functions of the District Forum,
State Commission, and National Commission.
5. What is a Central Consumer Protection Council? Discuss its objects.
6. Give a summarised view of the Consumer Protection Act 1986.

10. (b) 9. (d) 8. (a) 7. (d) 6. (c)

5. (b) 4. (d) 3. (d) 2. (c) 1. (b)
Answers to Objective-type Questions

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166  Material
 Chapter
8 In Review
Learning Objectives ●● The Consumer Protection Act, 1986 is designed to make available cheap and quick
remedy to a small consumer. It applies to all goods and services unless specifically
The Act: salient features; aim and objectives
exempted by the Central Government and covers all the sectors—private, public,
Rights of consumer; restrictive trade practice; and cooperative. The provisions of the Act are rather compensatory than preventive
unfair trade practice; service; trader
or punitive.
Grievance redressal machinery
●● It seeks, inter alia, to promote and protect the rights of consumers such as—(a) right
to safety, (b) right to be informed, (c) right to choose, (d) right to be heard, (e) right
Key Terms to seek redressal, and (f) right to consumer education.
●● For simple, fast and inexpensive settlement of consumers’ disputes and for matters
Complaint: Any allegation made in writing
by a complainant with a view to obtaining connected therewith, the Act envisages three-tier quasi-judicial machinery compris-
relief ing the (I) National Commission, (II) State Commission and (III) District Forums; op-
Defect: Any fault, imperfection or erating at national, state, and district levels respectively. Besides, to provide better
shortcoming in the quantity, quality, protection of the interests of consumers, the Act makes provision for the establish-
potency, purity, or standard (of goods)
ment of consumer councils and other authorities.
which is required to be maintained by
or under any law or under any contract,
express or implied, or as is claimed by the
trader in any manner
Trader: A person who sells or distributes
any goods for sale and includes the
manufacturer thereof

The Consumer Protection Act, 1986  167

Legal and Regulatory

The Negotiable
9
Environment of
Business

Notes
Instruments Act, 1881

© iStock
Learning Objectives
1. Negotiable instruments: meaning, 4. Negotiable instruments: Rules of inter-
definition, characteristics national law
2. Kinds of negotiable instruments: prom- 5. Presentment for acceptance
issory notes, bills of exchange, cheques 6. Dishonour of a negotiable instrument
3. Negotiable instruments: Special rules by non-acceptance, non-payment
of evidence 7. Material alteration

The Negotiable Instruments Act, 1881: An Over view

T he law regulating promissory notes, bills of exchange, and cheques is contained in the Negoti-
able Instruments Act, 18811. Though the Act was enacted with an object to define and amend the
then existing law relating to promissory notes, bills of exchange and cheques, yet other instru-
ments which satisfy the conditions of negotiability by usage or custom of trade, share warrants,
and bearer debentures, also come under its purview. This Act is based on the English Common
Law related to promissory notes, bills of exchange and cheques. Although some provisions of
the Act have become redundant with the passage of time, change in modes of doing business,
and use of modern technology in commerce, yet the basic principles of the Act remain valid,
and the Act—amended from time to time—has stood the test of time. The Act came into force on
1 March 1881. It extends to the whole of India including the State of Jammu and Kashmir.

Negotiable Instrument: Meaning and Definition

A negotiable instrument is essentially an instrument of credit, readily convertible into money and
easily deliverable from one person to another. The word ‘negotiable’ means ‘passable by delivery’,
and ‘instrument’ means ‘a written document which creates a right in favour of some person’. Thus,
the expression ‘negotiable instrument’ implies a written document transferable by delivery from
one person to another. The unique advantage associated with a negotiable instrument is its easy
negotiability. It is transferable with a simple procedure requiring a signature and delivery (in case of
order instruments) or just delivery (in case of bearer instruments). The law endorses such a way of
transfer of a negotiable instrument and protects the interest of the parties involved therein. How-
ever, for an instrument to be valid, it may not necessarily be negotiable. Instruments marked as ‘not
negotiable’ may be legally binding and governed by the provisions of the Act. As per the section,
‘a negotiable instrument’ means a promissory note, bill of exchange, or cheque payable either to
order or to bearer.
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168 Material
Presumptions The Negotiable
Instruments Act, 1881
Sections 118–119 of the Act lay down certain presumptions that generally apply to negotiable instru-
ments. These eight presumptions are said to prevail, unless the contrary is proved.
Consideration It is presumed that every negotiable instrument was made, drawn, accepted, en- Notes
dorsed, negotiated or transferred for negotiation [Section 118 (a)].
Date It is presumed that every negotiable instrument bearing a date was made or drawn on the
due date [Section 118 (b)]. An instrument could also be post-dated and even be issued on a public
holiday. But a post-dated instrument can be sued on only after the passing of the due date.
Time of Acceptance It is presumed that every accepted bill of exchange was accepted within a
reasonable time after its date and before its maturity [Section 118 (c)].
Time of Transfer It is presumed that every transfer of a negotiable instrument was made before
its maturity [Section 118 (d)].
Order of endorsement It is presumed that the endorsements appearing up on a negotiable in-
strument were made in the order in which they appear thereon [Section 118 (e)].
Stamp It is presumed that a negotiable instrument, except a cheque (as no stamp duty is pre-
scribed for cheques under the Indian Stamp Act) was duly stamped. This proves helpful in case the
instrument is destroyed or lost.
Holder-in-due-course It is presumed that the holder of a negotiable instrument is also a holder-
in-due-course unless it is proved that the holder has obtained the instrument from its lawful owner
or from any person in lawful possession thereof, by committing an offence, fraud, or for unlawful
consideration. Thus, a holder-in-due-course is one who has obtained the instrument in good faith
and for value.
Proof of Protest In a suit upon an instrument, which has been dishonoured, the court shall, on
proof of the protest, presume the fact of dishonour unless such fact is disproved. In the event of
dishonour of a negotiable instrument, the holder can file a suit for recovery of the amount contained
in the instrument but before doing so, he/she should obtain a certificate from a notary about the
fact of dishonour. This certificate is called protest. The ‘protest’ must be properly drawn up in con-
formity with the provisions of Section 101 of the Act. The court shall, on proof of protest, presume
that the instrument was presented for payment or acceptance and that it was dishonoured by non-
acceptance or non-payment, as the case may be. Protest acts as a prima facie evidence of dishonour.
All the above presumptions can, however, be refuted by the defendant by means of evidence to
the contrary.

Promissory note
A ‘promissory note’ is an instrument in writing (not being a bank note or currency note) containing
an unconditional undertaking, signed by the maker to pay a certain sum of money only to, or the
order of a certain person, or only to bearer of the instrument [Section 4].
The person making the promise to pay is called the ‘maker’ and the person who is to receive the
money stated in the instrument is called the ‘payee’.

Parties to a promissory note

A promissory note, also called ‘pro-note’, may have the following parties.
Maker A person who issues or executes the note promising to pay the amount stated therein is
called the maker.
Payee This is the person who is to receive the money stated in the pro-note.
Holder This is the person who is entitled in his own name to the possession of a pro-note, and to
receive or recover the amount thereon. He/She may be either the payee or some other person to
whom he may have endorsed the note.
Endorser This is the maker or payee who may endorse an instrument.
Endorsee The endorsee is the transferee or the person in whose favour the pro-note has been
endorsed. Self-Learning
Material 169
Legal and Regulatory Essentials of valid promissory note
Environment of
The definition given in the Act sets out the essentials of a promissory note. It also makes it clear that
Business
although banknotes (i.e., promissory notes issued by a banker payable to bearer on demand) and
Notes currency notes (i.e., promissory notes issued by RBI or the Central Government payable to bearer
on demand) bear almost all the characteristics of a promissory note, yet they should not be treated
as a promissory note. The following are the essential characteristics of a promissory note.
1. It must be in writing.
2. It must contain an express undertaking to pay.
3. The promise or undertaking to pay must be unconditional.
4. The promise must be for paying certain sum of money.
5. It must be signed by the maker.
6. The maker must be a certain person.
7. The payee must be certain.
8. Payment must be in legal tender money of India.
9. It must be properly stamped.
10. It must contain number, place and date of signature.
These features are described below.
It must be in writing A promissory note must be in writing. An oral promise to pay is not enforce-
able. It may be written in ink or with pencil and includes printing or typing also. No particular format
of words is necessary. But, of course, the words used must indicate a clear undertaking to pay. It is
even not necessary that the word ‘promise’ be used as held in Balmukund vs Munnalal.
The specimens of a typical promissory note are given in Box 9.1.

Box 9.1 Specimens of a typical promissory note

Specimen 1
` 5000 /- New Delhi,
2 June 2013
Sixty days after date I promise to pay Mr Y the sum of rupees fifty thousand only, with
interest thereon at 12% per annum, for value received.
To, Revenue Stamp
Mr Y
New Delhi Mr X (Sd/- on stamp)

Specimen 2

` 5000 /- New Delhi,

2 June 2013
On demand I promise to pay Mr Y or order the sum of rupees five thousand only
To,
Mr Y Revenue Stamp
New Delhi Mr X (Sd/- on stamp)

Self-Learning
170 Material
It must contain an express undertaking to pay.  A promissory note must contain an express The Negotiable
undertaking or promise to pay. Though the use of word ‘promise’ or ‘undertaking’ is not necessary, Instruments Act, 1881
there must be a clear and fair intention to show an express undertaking to pay. A promissory note,
which contains ‘I am indebted to X for ` 1000’, is not a promissory note since there is no express
promise to pay. This implies a mere acknowledgement of indebtedness but is not a promissory note Notes
(although it may be valid as an agreement and may be binding upon the parties involved). Let us
consider the following expressions:
(a) ‘I promise to pay X or order ` 50,000.’
(b) ‘Mr B, I.O.U. (I owe you) ` 50,000.’
(c) ‘I am liable to pay X ` 50,000.’
(d) ‘I have borrowed from X ` 50,000 and I shall be accountable to him for the same with inter-
est thereon.’
Of the above, only (a) truly represents a promissory note. The rest are not promissory notes, as
they do not contain an express and clear promise or undertaking to shell out.
The promise or undertaking to pay must be unconditional.  A promissory note, in order to be
valid, should contain an unconditional promise to pay. The promise to pay should not be dependent
upon the happening of some uncertain and contingent event. An uncertain and conditional promise
may render it invalid. It should, however, be noted that if a promise is conditional or contingent on
the happening of an event which is certain to occur, the promise shall not be held conditional within
the meaning of Section 4. Thus, an instrument, which bears such type of undertaking or promise, will
be valid and become negotiable after the happening of such event or fulfilment of such condition.
For instance, let us consider the following examples:
(a) ‘I promise to pay Mr Y ` 5000 when I am able to pay.’
(b) ‘I promise to pay Mr Y ` 5000 on my marriage with Z.’
(c) ‘I promise to pay Mr Y ` 5000 seven days after the death of Z.’
Of the above cited examples (a) and (b) do not represent a valid promissory note as the promise in
both the cases is conditional and uncertain. Example (c), however, truly characterises a promissory
note as the promise is based on a condition or event which is certain to happen. Such a promise is
not considered to be conditional within the meaning of Section 4.
The promise must be for paying certain sum of money. The amount of a promissory must be
definite and certain so as to deliver the validity of the instrument.
It must be signed by the maker.  A pro-note will not be authentic unless the maker or promisor
signs it, even if the promisor writes it in his/her own handwriting. Place and form of signature are,
however, immaterial. If the maker is illiterate, his/her thumb impression is sufficient.
The maker must be a certain person.  The maker, i.e., the person by whom the payment is to be
made must be certain. If a person signs under a fictitious or an assumed name, he/she shall be liable
as a maker, since a maker is presumed certain if his/her for identity depicts from his description. In
case there are two or more makers, they will bind themselves jointly or jointly and severally but not
alternatively as the general rule implies ‘Where liability lies no ambiguity must lie’.
The payee must be a certain person.  Like the maker, the payee of a promissory note must also
be a certain and definite person on the face of the instrument. A promissory note in favour of a ficti-
tious person is illegal and void. Nonetheless, it is immaterial whether the payee is named properly or
misnamed. A payee may even be indicated by his official designation provided he can be identified
by evidence. A promissory note may be made payable to two or more people jointly or alternatively.
But if it is payable to alternative payees, it must be made payable originally to order. A promissory
note made payable to bearer originally is illegal and void as per the RBI Act, 1934. Finally, a prom-
issory note made payable to the maker himself shall not render any validity because of the fact a
promisor cannot be promisee for the same instrument.
The payment must be in legal tender.  The amount payable must be in legal tender of money of
India, i.e., rupees only. If an instrument is payable in foreign currency or in kind (goods, etc.), it shall
not be valid as a promissory note. For example, consider the following expressions of promissory
notes:
(a) ‘I promise to pay B ` 50,000/- on demand.’
(b) ‘I promise to pay B $ 20,000 at New Delhi.’
(c) ‘I promise to pay B ` 50,000 and to deliver him my black horse.’
(d) ‘I promise to pay Peter ` 1,00,000 in cash and ` 5,000 worth of a suit length .’ Self-Learning
Of the above-cited illustrations all, except (a), are invalid promissory notes. Material  171
Legal and Regulatory It must be properly stamped.  A promissory note must be duly stamped as per the requirements
Environment of of the Indian Stamps Act, 1899, and the maker’s signature, or initials, or thumb impression on it
Business must duly cancel it. A pro-note can be stamped either with adhesive stamps or engrossed on a
stamp paper of proper value. An unstamped or improperly or inadequately stamped pro-note is not
Notes
admissible in evidence and suit cannot be maintained upon it. It should, however, be noted that
an unstamped or improperly or insufficiently stamped pro-note is though invalid but it does not
hamper the recovery of loan if proved otherwise.
It must contain the number, date, and place of signature.  A pro-note must contain the number,
name of place and the date on which it was made. Their omission, however, will not cause the in-
strument to be invalid. If it is undated, it shall be deemed to be dated on the date of delivery. Beside
date, it is usual to provide for the place of signature and signature of two witnesses, though the law
does not insist upon them for ensuring the validity of the note.

Bill of exchange
A ‘bill of exchange’ is an instrument in writing, containing an unconditional order, signed by the
maker, directing a certain person to pay a sum of money only to, or to the order of, a certain person,
or to the bearer of the instrument [Section 5].
The bill of exchange is used primarily in international trade, and is a written order by one person
to pay another a specific sum on a specific date, sometime in the future. It is known as ‘draft’ in
the US. If the bill of exchange is drawn on a bank, it is called a bank draft.

Parties to bills of exchange

A bill of exchange may involve the following parties:
Drawer  This is the person who writes and signs the bill.
Drawee  This is the person on whom the bill is drawn.
Acceptor  This is the person who accepts the bill. In practice, the drawee is the acceptor but a
third person may accept a bill on behalf of the drawee.
Payee  This is the person to whom the money stated in the bill is payable. He may be the drawer
or any other person to whom the bill has been endorsed.
Holder  This is the person who is in the possession of the bill, after being drawn. He/She may be
the original payee, endorsee and bearer in case of a bearer bill.
Endorser  The person, either the drawer or holder, who endorses the bill to any one by signing on
the back of it is called an endorser.
Endorsee  He/she is the person in whose favour the bill is endorsed.
‘Drawee in case of need’  This is a person who is introduced at the option of the drawer. Any
endorser may insert the name of such person, and the effect of it is that a resort may be had to him
in case the bill is dishonoured for non-acceptance or non-payment or in any other need.
‘Acceptor for honour’  The person who may voluntarily become a party to a bill as acceptor in the
event of the refusal by original drawee to accept the bill if demanded by the notary. The acceptor
for honour offers to accept the bill supra protest2 with a view to safeguard the honour or prestige
of the original drawer or any other endorser, as the case may be. This happens when the bill gets
dishonoured and a formal certificate of dishonour, known as protest, is issued by the Notary Public
to the holder of a bill in question. Hence the term supra protest.
It is not necessary that all the above-mentioned parties are involved in one bill of exchange. Usu-
ally there are three parties to a bill of exchange — drawer, drawee, and payee. It is also not neces-
sary that three separate persons should answer to the description of drawer, drawee, and payee.
Depending upon the situation one person may fill any two of three positions. Accordingly, drawer
and payee may be the same person. For instance, when the bill is drawn as ‘pay to me or my order’,
drawer and drawee may be the same person. Similarly, when a principal draws a bill on his agent or
upon himself, drawee and payee may be the same person.

Self-Learning
172  Material
 Specimen of a bill of exchange The Negotiable
Instruments Act, 1881
` 1,00,000/- New Delhi,

1st June 2013 Notes
Sixty days after date pay Bhushan or order the sum of rupees one lakh only, for value received.
To,
Ashok Kumar
Jamia Nagar, Revenue Stamp
New Delhi-110025       Accepted Sd/- Ashok kumar Mr Ajay (Sd/- on stamp)

In the above specimen bill of exchange Ajay is the drawer, Ashok Kumar is drawee and Bhushan
is the payee (original).

Essentials of bill of exchange

The definition of a bill of exchange is very close to that of a promissory note. Therefore, a bill of
exchange has more or less the same essential characteristics as a promissory note. The following
are the essential elements of a bill of exchange.
1. It must be in writing.
2. It must contain an express order directing a certain person to pay.
3. The order to pay must be unconditional.
4. There are parties to a bill of exchange, viz., drawer, drawee, and payee.
5. It must be signed by the drawer.
6. The drawer must be a certain person.
7. The drawee must be a certain person.
8. The payee must be a certain person.
9. The sum payable must be certain.
10. The order must be to pay money only.
11. A bill of exchange can be drawn payable to bearer but cannot originally be drawn payable
to bearer on demand.
12. It must be duly stamped according to the Indian Stamps Act.
13. Other formalities, like date, place and the words ‘For value received’, etc., are usually
found in a bill of exchange though they are not necessary a legal requirement.

Forms of bills of exchange

The various bills of exchange can be classified as follows:
1. Inland bill 2. Foreign bill
3. Trade bill 4. Accommodation bill
5. Documentary bill 6. Clean bill
7. Fictitious bill 8. Bill-in-sets
9. Escrow 10. Bank draft
Inland bill  A bill of exchange is an inland bill if it is (i) drawn or made payable in India even though
it has been drawn on a foreign resident, or (ii) drawn in India upon any person who is a resident in
India even though it is made payable in a foreign country. Thus, to be an inland instrument, it must
satisfy either of the two conditions:
∑ The instrument must have been drawn or made payable in India or
∑ The drawee must be in India.
For example, a bill drawn in India and payable in India but drawn upon a person in Canada, i.e.,
resident thereof is an inland bill. Similarly, a bill drawn in India made payable in Canada upon a
person in India is also an inland bill.
Foreign bills  Those bills which are not inland bills are deemed to be foreign bills. Normally, a
foreign bill is drawn in a set of three copies. Self-Learning
Material  173
Legal and Regulatory Trade bill When a bill is drawn, accepted or endorsed for a genuine trade transaction, it is a trade
Environment of bill. A trader usually makes use of a trade bill when he sells goods on credit. A trade bill is invariably
Business
backed by consideration and based on a genuine trade transaction. Box 9.2 gives an illustration of
Notes a genuine trade bill.

Box 9.2 A Typical Trade Bill and the Parties Involved

A sells goods worth ` 40,000 to B on credit and gives him 60 days to pay the price. A owes the same
amount of money to C who supplies goods to A. To conclude the transaction, A may draw a bill on
B directing him to pay the money after 60 days of the date of bill to C. A will sign the bill and present
it to B for acceptance. Acceptance is necessary in order to create right and obligation. If B agrees to
obey the order of A he will accept the bill by writing across its face the word ‘accepted’ and signing
his name underneath and then delivering the bill to the holder. By doing so B, the drawee, now
becomes the acceptor of the bill and shall be liable to its holder, such a bill is termed as a genuine
trade bill.

Accommodation bill An accommodation bill is one, which is made to provide financial help to
some party. It is a bill in which a person lends or gives his name to oblige a friend or some person
to whom he is known or otherwise. An accommodation bill is drawn, accepted, or endorsed without
consideration. The party lending his name to oblige the other party is known as the accommodating
party and the party so obliged is called the accommodated party. It must be noted that the accom-
modating party will no longer be liable on the instrument to the party accommodated for lack of
consideration between them, and the instrument is merely to help. But the accommodating party is
liable to the holder for value. The following example will help understand the point better. A, who
is in need of ` 10,000, approaches his friend B, who instead of lending the money directly suggests
that A should draw a bill in his favour, which he would accept. Accordingly, A draws the bill and B
accepts it. A in turn gets the bill discounted with his banker at the commercial rate of discount. On
due date, A would pay ` 10,000 to B to enable him to meet the bill. The real creditor in this case is
the banker and not B. B is mere surety and A is the real debtor.
Documentary bill When documents of title to the goods or other documents, such as bill of lad-
ing, invoice, railway receipt, insurance policy, etc., are attached to the bill of exchange, it is called
documentary bill. Such documents are delivered to the buyer only on acceptance or payment of the
bill. Such bills are usually used in connection with foreign trade.
Clean bill Contrary to a documentary bill, a clean bill is one, with which no documents related to
the goods represented by the bill are attached. In inland trade, normally clean bills are used.
Fictitious bill When the name of the drawer or the payee or both is fictitious in a bill, the bill is
termed as fictitious bill. Such type of bill is drawn in a fictitious name and is made payable to the
drawer’s order and as such both the drawer and the payee are said to be fictitious persons. A ficti-
tious person is one who is non-existing or a pretended one. As per Section 42, if a fictitious bill is
accepted by a genuine person, it becomes a good bill in the hands of a holder-in-due-course and
acceptor is liable to him if he can show that the signature of the supposed drawer and that of the
first endorser (payee) are in the same handwriting.
Bill-in-sets A bill-in-sets is one, which is drawn in sets of three. A bill is sometimes drawn in more
than one original copy, especially when such copies are required by various parties as in case of a
foreign trade transaction. The three copies (called parts) of a bill-in-set are sent by different mail
routes in order to avoid delay or inconvenience, likely to arise due to loss or miscarriage of the bill
and to ensure safe transmission of at least one part of the bill to the drawee and his acceptance
thereon as early as possible.

Self-Learning
174 Material
 Specimen of a Bill-in-sets The Negotiable
First part Instruments Act, 1881

£ 50,000/- London,
Notes
10th June 2013
Three months after sight of this first bill of exchange (second and third of the same tenor and date
being unpaid) pay to Messers Mumbai Export Company Ltd, Mumbai or order the sum of Sterling
Pounds five thousand only for value received.
To
Messers Hindustan Machinery Revenue Stamp
Company Ltd, Mumbai London Trading Co.Ltd

This bill is drawn by the London Trading Company Ltd. (Drawer or maker), directing Hindustan
Machinery Company Ltd, of Mumbai (drawee or acceptor) to pay five thousand Sterling pounds to
Messer Mumbai Export Company Ltd, Mumbai (payee).
Like wise second and third parts of the bill are drawn. The second part contains a reference to
the first, and the third part contains a reference to the first and second parts.
Escrow  When an instrument is delivered conditionally, or for a special purpose as a collateral se-
curity, or for safe custody only, and not for the purpose of transferring property absolutely therein,
i.e., negotiation, it is termed as escrow. As between the immediate parties, when an instrument is
delivered, conditions agreed upon are fulfilled. Such an instrument does not create any liability to
pay until and unless conditions agreed upon are fulfilled or the purpose for which the said instru-
ment was delivered is satisfied. This, however, in compliance of Section 46, does not affect the
rights of a holder-in-due-course and the defence of conditional delivery cannot be set up against a
holder-in-due-course.
Bank draft  Also known as demand draft, a bank draft is an order to pay money drawn by one office
or branch of a bank upon another office or branch of the same bank or on a different bank instruct-
ing the latter to pay a certain sum of money to a specified person or his order. When the order is
on another branch of the same bank, it is actually a cheque but the same is still termed as a draft.
When a draft is issued on another bank, it has all the features of a bill of exchange except that it
is not stamped and accepted. Even if it is drawn upon another branch of the same bank, it can be
treated as a bill of exchange as it satisfies all the conditions of Section 5.

Cheque
A cheque is a bill of exchange drawn on a specified banker and not expressed to be payable other-
wise than on demand [Section 6]. Simply stated, a cheque is a kind of bill of exchange drawn on a
bank that is always payable on demand. The definition of cheque is modified by an amendment to
the Negotiable Instruments Act in 2002, according to which cheque includes electronic image of a
truncated cheque and a cheque in electronic form. This makes provision for electronic submission
and clearance of the cheque.
A cheque being a kind of a bill of exchange satisfies all the requirements of a bill except that it
does not require any acceptance and bears no stamp.
Thus, a cheque must be signed by the drawer (i.e., the maker). It must contain an unconditional
order to pay a certain amount of money to a specified person named therein or his order, or to the
bearer; must specify the banker upon whom it is drawn, and must be dated.

Parties to a cheque
A cheque generally involves the following parties.
Drawer  The person who makes the cheque
Drawee  The banker of the drawer on whom the cheque is drawn
Payee  The person who is to receive the money stated in the cheque
Holder  A person who is in the possession of a cheque and is entitled to receive or recover the
amount thereon. Self-Learning
Material  175
Legal and Regulatory Endorser  The maker, drawee, payee or endorsee can endorse a cheque by signing on the back of
Environment of it. The endorser of a cheque has the status of a new drawer.
Business
Endorsee  The transferee or the person in whose favour the instrument has been endorsed.
Notes
Essentials of a cheque
If one takes a close look at the definition of a cheque, given in Section 6, one notices that a cheque
has the following 10 essential elements (or characteristics).
It must be in writing  A cheque must be in writing. An oral order to pay does not constitute a
cheque.
It should be drawn on a banker  It is always drawn on a specified banker. A cheque can be drawn
on a bank where the drawer has an account, saving bank, or current.
It contains an unconditional order to pay  A cheque cannot be drawn so as to be payable con-
ditionally. The drawer’s order to the drawee bank must be unconditional and should not make the
cheque payable dependent on a contingency. A conditional cheque shall be invalid.
The cheque must have an order to pay a certain sum  The cheque should contain an order to pay
a certain sum of money only. If a cheque is drawn to do something in addition to, or other than to
pay money, it cannot be a cheque. For example, if a cheque contains ‘Pay ` 5,000 and a TV worth `
10,000 to A’ it is not a cheque.
It must be signed by the drawer and must be dated  A cheque does not have any validity unless
signed by the original drawer. It should be dated as well.
It is payable on demand  A cheque is always payable on demand.
Validity  A cheque is normally valid for six months from the date it bears. Thereafter it is termed
as stale cheque. A post-dated or antedated cheque will not be invalid. In both cases, the validity of
the cheque is presumed to commence from the date mentioned on it.
It may be payable to the drawer himself  Cheques may be payable to the drawer himself/herself.
It may be drawn payable to bearer on demand unlike a bill or a pro-note.
Banker is liable only to the drawer  The banker on whom the cheque is drawn shall be liable only
to the drawer. A holder or bearer has no remedy against the banker if a cheque is dishonoured.
It does not require acceptance and stamp  Unlike a bill of exchange, a cheque does not require
any acceptance of the drawee. It is, however, customary for the banks to mark a cheque as ‘good’
for the purpose of clearance. But this marking does not amount to acceptance. Similarly, no revenue
stamp is required to be affixed on a cheque.

Distinction between a bill of exchange and a cheque

Although by definition, and even otherwise, a cheque is similar to a bill of exchange and
the provisions of the Negotiable Instruments Act applicable to bills of exchange do apply to
cheques too, yet there are certain difference between the two. The major difference between a
Bill of Exchange and a cheque are summarised in Table 9.1.
[Note:  Section 85 discharges a drawee bank, from the liability, making Payment-in-due-course of a
cheque payable to order. Similarly, Section 128 discharges a drawee bank making Payment-in-due-
course of a crossed cheque even if the money does not reach the true owner.]

Crossing of a cheque
A cheque can be either open or crossed. An open cheque is one, which can be paid over the counter of
the bank. A crossed cheque cannot be cashed across the counter but must be collected through a banker.
When two parallel lines are drawn, usually on the left hand top corner of the cheque, it is called crossing.
By doing so, a cheque becomes ‘account payee’. A crossing acts as a direction to the drawee or
paying banker to pay the money to a specified banker as desired by the payee or credit the amount
stated on the cheque in the account of the payee if he has an account with the drawee bank and not
to pay otherwise. The primary objective of crossing is to secure payment to a holder so that it could
be traced to the person collecting the amount of cheque. To restrain negotiability, words such as,
Self-Learning
‘Account payee only’ or ‘Not Negotiable’ can be inserted on the free space between the two parallel
176  Material lines. Crossing, in fact, provides protection and security to the holder or beneficiary.
 The Negotiable
Table 9.1 Difference between a Bill of Exchange and a Cheque Instruments Act, 1881

S. no. Point of difference Bill of exchange Cheque

Notes
1. Drawee A bill can be drawn on any person A cheque is always drawn on a
(i.e., upon an individual as well as banker.
a banker).
2. Payable It may be drawn payable on demand It can only be drawn payable
or on the expiry of a certain period on demand, and within six
or days after sight or date. months of the date mentioned
on the cheque.
3. Grace period A grace of 3 days is allowed in the No grace is given in case of a
case of payment of bill payable cheque for payment for the
after sight or date. sole reason that, a cheque is
payable on demand.
4. Acceptance Acceptance by the drawee is must It does not require any accep-
before payment can be demanded tance and is intended for
in respect of a bill. immediate payment.
5. Payable to A bill cannot be made payable to A cheque can be made payable
bearer bearer on demand. to the bearer on demand.
6. Estoppel of The drawer cannot stop payment Countermanding of payment
payment of a bill. That is, a bill of exchange can revoke a cheque being a
cannot be countermanded. revocable mandate. Banker or
the drawee is empowered to
stop payment of a cheque if all
the required formalities are not
adhered to.
7. Presentment for The drawer of a bill is discharged The drawer of a cheque is dis-
payment (i.e., not liable to pay), if it is not charged only if he suffers any
presented for payment. loss or damage due to delay
in its presentment for payment
and he shall be discharged to
the extent of such damage. He
is not discharged from liability
if the cheque is not presented
for payment.
8. Notice of Notice of dishonour of a bill is If a cheque is dishonoured,
dishonour necessary in order to charge its notice of dishonour need not
drawer. be given to the drawer. Insuffi-
ciency of funds in his (drawer)
account is sufficient and appro-
priate evidence to charge him.
9. Crossing The Act contains no provision A cheque may be crossed, i.e.,
for crossing of a bill. made ‘account payee’.
10. Stamp duty It should be adequately It does not require any stamp
stamped. duty.
11. Noting and A dishonoured bill should be It neither requires ‘noting’ nor
Protesting ‘noted’ (i.e., with the notary) ‘protest’ in the event of
and ‘protested’ for payment. dishonour.
12. Statutory No statutory protection is Privilege of certain statutory
protection to available to the drawee or protection is granted to the
the drawee acceptor of a bill of exchange. drawee bank with regard to
payment of cheques in specific
circumstances. Self-Learning
Material 177
Legal and Regulatory Modes of crossing  There are three types of crossing of a cheque:
Environment of 1. General crossing,
Business 2. Special crossing, and
3. Account payee’s crossing.
Notes
General crossing  According to Section 123, ‘where a cheque bears across its face an addition of
the words “and company” or any abbreviation thereof, between two parallel transverse lines, or of
two parallel transverse lines only, either with or without the words “not negotiable” that addition
shall be deemed to be a crossing and cheque shall be deemed to be crossed generally’.
The above definition illustrates that two transverse parallel lines are a must for a general crossing.
Where a cheque is crossed generally, the banker on whom it is drawn shall not pay it to anyone
other than to a banker [Section 126]. Therefore, the holder may get the cheque collected through his
banker only and not cashed over the counter of a bank. The addition of the words ‘and company’ do
not have any significance but the addition of the words ‘not negotiable’ restrict the negotiability of
the cheque and in case of transfer, the transferee will not get a better title than that of a transferor
(see Fig. 9.1(a)).
Special crossing  When the name of a banker is written across the face of a cheque with or without
the words ‘not negotiable’, it is a special crossing. The transverse parallel lines may or may not be
used in this kind of crossing. Thus, where the cheque is crossed specially, the paying banker will pay
only to the banker whose name appears across the cheque, or to his collecting agent. Thus, in case
of special crossing, the paying banker is to honour the cheque only when it is presented through
bank mentioned in the crossing, or an agent of such bank, i.e., another banker acting as agent
(see Fig. 9.1(b)).
‘Account payee’ crossing  It is the most prevalent one which restricts the negotiability of a
cheque. It may be made both under general crossing as well as special crossing. Such crossing warns
the collecting banker that the proceeds are to be credited only to the account of the payee. If the
collecting banker allows the proceeds of a cheque bearing such a crossing to be credited to any
other account, it would be guilty of negligence and will not be entitled to the protection given to
collecting bankers under Section 131.

Specimen of General Crossing

Not Not
Negotiable Negotiable

‘ A/C Payee’ ‘ & Co.’

Fig. 9.1(a)  Specimen of General Crossing

Specimen of Special Crossing

A/C Payee Not

only Negotiable
Axix Bank
Axix Bank Axix Bank

Fig. 9.1(b)  Specimen of special crossing

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178  Material
‘Payment-in-Due-Course’ The Negotiable
Instruments Act, 1881
A Payment-in-due-course means a payment in accordance with the apparent tenor of the instru-
ment, in good faith and without negligence of any person in possession thereof. A payment-in-due-
Notes
course, as defined in the Negotiable Instruments Act, operates as a valid discharge of a negotiable
instrument against the holder. Therefore, every person who is supposed to make payment under a
negotiable instrument must make the payment thereunder in due course, in order to obtain a valid
discharge against the holder. If he/she fails to do so, he/she will be liable for it.
According to Section 10 of the Act, a payment will be a Payment-in-due-course under the follow-
ing circumstances:
1. It is in accordance with the apparent tenor of the instrument, i.e., according to what appears
on the face of the instrument to be the intention of the parties.
2. It is made in good faith and without negligence, and under circumstances which do not af-
ford a reasonable ground for believing that the person to whom it is made is not entitled to
receive the amount.
3. It is made to the person in possession of the instrument who is entitled to receive the pay-
ment.
4. It is made only in money.
Some examples of payment-in-due-course are presented in Box 9.3.

Box 9.3 Payment-in-due-course

Example 1
A executes a promissory note in favour of B and the amount is payable to B or his order. C, who is the
son of B, approaches A who is not in possession of the pro-note and demands payment. However, A
believing in C makes the payment to C. The above payment is not a payment-in-due-course for the
sole reason that C was not in the possession of the instrument.
Example 2
A presents a bearer cheque to a banker, which bears the account number of the drawer, i.e., account
holder (A) correctly. Also, the amount is properly written on it in figures as well as in words. It bears
the signature of the drawer and date. Since there is sufficient fund in the account of the drawer, the
banker after completing the necessary formalities makes the payment to the holder. Later on it is
discovered that the cheque was a forged one. On this ground it is not a Payment-in-due-course.

In Allahabad Bank Ltd vs Kul Bhushan3 , it was held that if a cheque bears a forged signature of
the drawer, the payment would not be a payment-in-due-course; the banker failed to exercise rea-
sonable care and caution since the drawer had never intended that the payment should be made.

Maturity of negotiable instruments

Maturity of a negotiable instrument refers to the date on which the payment of the instrument is
due. Payment of an instrument can be demanded only when it becomes due. According to Section
22 of the Negotiable Instruments Act, ‘the maturity of a promissory note or bill of exchange is the
date on which it falls due. But, three days of grace shall be allowed in case of all instruments (note
and bill) other than those that are expressed to be payable on demand’. However, Section 21 states
that, ‘A promissory note or bill of exchange payable “at sight” or “on presentment” is payable on
demand’. It is due for payment as soon as it is issued. The question of maturity therefore does not
arise in respect of negotiable instruments. An instrument payable on demand is meant instant Self-Learning
payment and so the question of maturity does not arise. Cheques are always payable on demand, Material 179
Legal and Regulatory therefore maturity is not applicable in respect of a cheque. Similarly, a pro-note or bill of exchange
Environment of payable ‘on demand’ or ‘at sight’ or ‘on presentment’ does not involve maturity. It is only in case
Business of instruments payable in modes other than on demand, i.e., ‘at sight’ or ‘at presentment’, that
maturity has to be considered. If the day of maturity falls on a public holiday, the instrument is pay-
Notes
able on the preceding business day. For example, if a pro-note or bill matures on a Sunday, it will be
deemed due on Saturday and not on Monday.

Days of grace
Every negotiable instrument which is payable otherwise than ‘on demand’ is entitled to three days
of grace. Section 22 provides that ‘every promissory note or bill of exchange expressed to be payable
on a specified day, or at a certain period “after date” or “after sight”, or at a certain period after the
happening of an event which is certain to happen, is at (becomes due for) maturity on the third day
after the date on which it is expressed to be payable’.
For example, if a bill is drawn on 1st January which is expressed to be payable three months after
date shall have April 4 as its maturity date. If the month in which the period would terminate has no
corresponding day, the period is held to terminate on the last day of such a month. For example, a bill
dated 30 January 2008 if made payable one month after date, will have 4 March 2008 as its maturity.
It should be noted that besides cheques, a bill or pro-note payable ‘at sight’ or on ‘presentment’
or ‘on demand’ or where no time for payment is specified are not entitled to days of grace. If an
instrument is payable by installment, three days of grace are to be allowed on each installment [Sec-
tion 7]. Every bill or note, which is entitled to days of grace, must be presented on the last day of
grace, and their payment cannot be demanded before that date. In the event of dishonour of such
instruments, a suit can be filed on the next day after maturity. Ordinarily, an instrument which is
presented for payment earlier than the third day of grace is considered invalid. The holder, however,
becomes entitled to sue before maturity in the event of the insolvency of drawer or drawee.

Negotiable Instruments: Special Rules of Evidence

Under the Act, there are certain special rules of evidence, applicable to all types of negotiable in-
struments. A summary of the same is as follows.

Presumptions
Sections 118 and 119 deal with certain assumptions as to negotiable instruments. These assumptions
basically imply certain facts that are presumed in case of every negotiable instrument.

Estoppel
Estoppel simply implies prevention of claim. Sections 120–122 of the Negotiable Instruments Act
deal with the following three estoppels, which are considered to be there against the parties to the
negotiable instruments. In other words, the Act binds the parties liable upon an instrument by the
following three estoppels.

Estoppel against denying the original validity of the instrument

No maker of a promissory note, and no drawer of a bill of exchange or cheque, and no acceptor
of a bill for the honour of the drawer shall be permitted to deny the validity of the instrument as
originally made or drawn in a suit thereon by a holder-in-due-course [Section 120].

Estoppel against denying the capacity of the payee to endorse the instrument
No maker of a promissory note, and no acceptor of a bill of exchange payable to order shall, in a
suit thereon by a holder-in-due-course, be permitted to deny the payee’s capacity to endorse the
instrument at the date of the note [Section 121].

Estoppel against denying the signature or capacity of prior parties

No endorser of a negotiable instrument shall, in a suit thereon by a subsequent holder, be permit-
ted to deny the signature or capacity to contract of any prior party to the instrument [Section 122].

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180  Material
Negotiable Instruments: Rules of International Law The Negotiable
Instruments Act, 1881
A negotiable instrument may be drawn in one country and be payable in another. That is, drawer
or maker, drawee and payee in relation to a negotiable instrument may not belong to or be located
in one country. In such cases, different laws of the land will govern the liability of the parties. Sec- Notes
tions 134 to 137 deal with the rules of International Law related to foreign instruments, which may
be discussed under the following heads.

Law governing the liability of parties to foreign instruments

The liability of the maker or drawer of a foreign promissory note, bill of exchange, or cheque is gov-
erned in all essential matters by the law of the place where he/she made the instrument. Similarly,
respective liabilities of the acceptor and endorser of a foreign instrument are also regulated by the
law of the place where the instrument is made payable. The above rule is, however, subject to a
contrary contract between the parties. The parties to a foreign negotiable instrument may provide
by an agreement which country’s law shall determine their liability [Section 134].
For example, a bill of exchange was drawn by A in California where the rate of interest is 25 per
cent, and accepted by B, payable in Washington where the rate of interest is 6 per cent. The bill is
endorsed in India, and dishonoured subsequently. An action on the bill is brought against B in India.
He is liable to pay interest at the rate of 6 per cent, only, but if A is charged as drawer, A is liable to
pay interest at the rate of 25 per cent.

Law governing the dishonour of foreign instruments

Section 135 provides that ‘where a promissory note, bill of exchange, or cheque is made payable in
a country different from that in which it is made or endorsed, the law of the country where it is made
payable determines what constitutes dishonour and what notice of dishonour is sufficient’. That is,
dishonour of a foreign negotiable instrument and the notice in connection with the dishonour shall
be governed by the law of the country where the instrument was made payable.
For example, a bill of exchange drawn and endorsed in India but accepted and payable in France
is dishonoured. The endorsee causes it to be protested for such dishonour and gives notice thereof
in accordance with the law of France, though not in accordance with the rules contained in the Ne-
gotiable Instruments Act (of India). The notice is sufficient.

Instruments made out of India but in accordance with Indian law

According to Section 136, ‘where a negotiable instrument is made, drawn, accepted, or endorsed
outside India but in accordance with the law of India (i.e., the Negotiable Instruments Act, 1881),
the fact that the instrument is invalid according to the law of the country where it is made, does not
invalidate any subsequent acceptance or endorsement made thereon within India’. Thus, where the
making or drawing of an instrument is invalidated in a foreign country for want of stamp or similar
other reason, the subsequent acceptance or endorsement, being an independent contract will be
valid provided that it was valid according to the Indian law.
The law of any foreign country regarding promissory notes, bills of exchange, and cheques shall
be presumed to be the same as that of India unless and until the contrary is proved [Section 13].

Presentment of Negotiable Instruments: Introduction

Presentment implies placing or exhibiting a negotiable instrument for acceptance, sight, or payment
to the acceptor, maker, drawee, or any other party liable thereto by or on behalf of the holder
thereof. This entails that presentment is done for any of the following three purposes:
1. Presentment for Acceptance,
2. Presentment for Sight, and
3. Presentment for Payment.

Presentment for Acceptance

Out of three negotiable instruments—bill of exchange, promissory note, and cheque, it is only
the bill of exchange that is required to be presented for acceptance. However, it is not necessary to Self-Learning
Material  181
Legal and Regulatory present every bill for acceptance, before presenting it for payment. A bill ‘payable on demand’, ‘or
Environment of payable on a certain day’, or ‘payable on the expiry of fixed period after date’ (say payable 60 days
Business after due date), or ‘payable on happening of a certain event’ need not be presented for accept-
Notes ance. The holder in the above cases may, if he/she deems fit, present the bill for acceptance but
the bill in question will become due for payment, even otherwise, i.e., without being presented
for acceptance.
Negligence to present the bill in such cases, however, will not affect the liability of the par-
ties liable to the holder, in case the bill is dishonoured by non-payment.
Presentment for acceptance is, nevertheless, essential in the following cases in order to
render the parties liable under the bill:
1.· Where a bill is payable at a specified period after acceptance or after sight. The expression
‘after sight’ in a bill of exchange means after acceptance. Such a bill must be presented
to the drawee for sight or acceptance in order to ensure the responsibility for payment
on maturity of the instrument [Section 61].
2.· Where a bill expressly stipulates that before it is paid it shall be presented for acceptance.
In other cases, presentment is optional and depends on the discretion of the payee. It is,
however, advisable that the bill be presented to the drawer for his/her acceptance in any case
so that the holder obtains an additional security of the acceptor as well as the immediate right
of recourse against the drawer and the endorser, if any, in the event of dishonour of a bill by
non-acceptance, and he/she needs not wait till the maturity date of the bill. Presentment for
acceptance is advantageous from the drawer’s point of view too because if acceptance is refused,
he/she may on receiving early notice of dishonour will be better equipped to get his property out
of the hands of the drawee.

Bill: Mode of Acceptance

The acceptance of a bill is the indication of courtesy extended by the drawee or his/her agent towards
the order of the drawer. A bill is said to have been accepted when its drawee signs across the face of
the bill with or without writing the word ‘accepted’ and delivers it back to the holder or separately
gives him a note of his acceptance. The drawee of a bill incurs no liability on any bill addressed to him
for payment until gives his/her acceptance and thereby becomes the acceptor thereof. A refusal to
accept gives the holder (payee) no right against the drawee. However, the holder in such a situation
can give notice of dishonour and sue the drawer or endorser straight away, i.e., without waiting for
the date of maturity of the bill.

Requisites of valid acceptance

In order to be valid, an acceptance must fulfil the following conditions. It must
1. be in writing,
2. be duly signed by the acceptor,
3. be apparent on the instrument,
4. after signing (the instrument) be delivered back to the holder,
5. be absolute and unconditional, and
6. be made by drawee only.
Must be in writing  The drawee of a bill should give his assent by putting his signature on the bill.
An oral promise will not do. However, writing the word ‘accepted’ is not essential and thus mere
acceptor’s signatures shall be enough to indicate the acceptance.
Duly signed by the acceptor  Signature of the acceptor is necessary not only to constitute a valid
acceptance but also to make the acceptor or drawee liable on the bill. If the acceptor does not sign,
the acceptance will be rendered invalid even though he/she writes the word ‘accepted’ in his own
handwriting.
Apparent on the instrument  Acceptance must be made on the face or back of the instrument
either by writing the word ‘accepted’ followed by acceptor’s signature or by merely signing. Accep-
tance should not be given on its (instrument’s) replica, copy, or any attached slip of paper, called
Self-Learning Allonge.
182  Material
Instrument must be delivered back  The drawee/acceptor after giving their assent to pay the The Negotiable
amount as mentioned in the bill must return the instrument back to the drawer/endorser. Instruments Act, 1881
Absolute and unconditional  The acceptor must agree to pay the amount as mentioned in the
instrument in full without any condition or limitation. In case of conditional acceptance, the holder Notes
may treat the negotiable instrument dishonoured.
Made by drawee only  A bill of exchange is accepted by the drawee only. In case of more than
one drawee, acceptance made by one or more drawees, but not by all, is also a qualified acceptance.
In such a case the holder may treat the bill dishonoured for non-acceptance. However, in case of
partnership, due to agency relationship, acceptance by one partner amounts to acceptance by all
or the firm.

Types of acceptance
An acceptance on the bill may be classified into general acceptance and qualified acceptance.

General or unqualified acceptance

A general acceptance is absolute. An acceptance which gives assent without qualification to the
order of the drawer, is termed as a ‘general acceptance’. In general or unqualified acceptance, the
drawee accepts the order of the drawer to pay the amount as specified in a bill in full, without any
condition or qualification. As a rule, an acceptance has to be general in order to be valid.

Qualified acceptance
A qualified acceptance is one wherein the drawee accepts a bill subject to conditions or qualifications
as to time, place, event, amount, etc. According to Section 86, ‘If the holder of a bill of exchange
acquiesces (agrees) in a qualification acceptance, or one limited to part of the sum mentioned in
bill, or which substitutes a different place or time for payment, or which, where the drawees are
not partners, is not signed by all the drawees, all previous parties whose consent is not obtained
to such acceptance are discharged as against the holder and those claiming under him, unless on
notice given by holder they assent to such acceptance’. The above section makes it clear that the
holder of a bill is not bound to take a qualified acceptance. If, however, he accepts a conditionally
accepted bill, he must be careful to secure the assent (if possible) of all the prior parties, because
they are discharged unless they give their consent to such qualified acceptance. Simply put, if the
holder takes a conditionally accepted bill, no other party prior to him would be liable to pay the bill
in the absence of their consent to the qualified acceptance. Also, a conditional or qualified accept-
ance may render a bill invalid.
Classification of qualified acceptance  An acceptance is deemed to be qualified where
1. it is conditional, declaring the payment to be dependent on the happening of an event
therein stated.
2. it undertakes the payment of part only of the sum ordered to be paid.
3. no place of payment being specified on the order, it undertakes the payment at a specified
place, and not otherwise or elsewhere, or where a place of payment being specified in the
order it undertakes the payment at some other place and not otherwise or elsewhere.
·4. it undertakes the payment at a time other than that at which under the order or would be
legally due.
Thus, a qualified acceptance can be classified as follows:
1. Qualified as to place
2. Qualified as to amount
3. Qualified as to time
4. Made by some of the drawees only, and
5. Made for payment in installments.
Qualified as to place  An acceptance qualified as to place is one by which the drawee undertakes
to pay a bill only at a specified place and not elsewhere. For example, an acceptance reading as
‘Accepted payable at Canara Bank only’, or ‘Accepted payable at Canara bank and not elsewhere’.
It must be noted that the usage of the words ‘only’ or ‘not elsewhere’, is important to render an Self-Learning
Material  183
Legal and Regulatory acceptance qualified otherwise it will be treated as general acceptance. For example, if a bill is ac-
Environment of cepted reading as ‘Accepted payable at Canara bank’, then it will be a general acceptance and not
Business a qualified one for the fact it does not explicitly state that the bill is nowhere payable except at
Canara bank.
Notes
Qualified as to amount  If the drawee while accepting a bill of exchange undertakes the payment
of part only of the sum ordered to be paid, the acceptance is said to be qualified as to amount.
Qualified as to time  An acceptance can be made qualified as to time. If the drawee while ac-
cepting a bill of exchange undertakes to pay the bill at a time different from that mentioned in the
instrument itself, whether sooner or later. For instance, a bill drawn payable 60 days after date and
accepted in words reading as ‘Accepted payable 75 days after date’. Or, ‘Accepted payable 30 days
after date’, the acceptance is qualified as to time.
Made by some of the drawees only  An acceptance made by one or more of the several drawees
but not by all is also a qualified acceptance. As a rule, however, if a bill is drawn on several persons
(not being partners), acceptance must be made by all. If only some of the drawees accept the bill and
even one of them refuses to accept, the holder has a right to treat the bill dishonoured. The case of a
partnership firm is, however, different wherein due to agency relationship, acceptance by any one or
more drawees (partners) is considered acceptance by all and therefore, will be binding on the firm.
Made for payment in instalments  It is the acceptance by which the drawee agrees to discharge
the bill in instalments.
Condition or qualification of acceptance must be stated very clearly. It should appear on the face
of the instrument in clear and unambiguous language. If the drawee wishes to make any qualification
while giving acceptance, he/she must do so on the face of the instrument in such a manner that the
holder of it does not fall short to understand that it was accepted subject to certain qualifications.

Presentment of bill of exchange

The rules for the presentment of a bill of exchange for acceptance are discussed under the follow-
ing heads.

Presentment for acceptance by whom?

A bill of exchange should be presented for acceptance by the person entitled to demand the accept-
ance thereof [Section 61]. Thus, the holder of the bill or his/her duly authorised agent can present
the bill for acceptance. If, however, somebody else on behalf of the holder who is not entitled to
demand acceptance, presents a bill and the bill is accepted by the drawee, such acceptance would
be deemed to have been made for the benefit of the person entitled to the bill and shall be valid.

Presentment for acceptance to whom?

A bill of exchange should be presented for acceptance to the person who can give his acceptance
thereto. In this regard Section 33 reads:
‘No person except the drawee of a bill of exchange, or all or some of several drawees, or a person
named therein as a ‘drawee in case of need’ or an ‘acceptor for honour’, can bind himself by an
acceptance.’
Section 34 however states, ‘where there are several drawees of a bill of exchange who are not
partners, each of them can accept it for another without his authority’. Section 75 conversely pro-
vides that ‘Presentment for acceptance or payment may be made to the duly authorised agent of the
drawee, maker, or acceptor, as the case may be, or where the drawee, maker, or acceptor has died,
to his legal representative, or where he has been declared an insolvent, to his assignee’.
A close examination of the above-mentioned sections suggests that a bill of exchange can be
presented for acceptance to the following persons:
1. Drawee or his/her duly authorised agent
2. If there are many drawees, the bill must be presented to all of them
3. Legal representatives of the drawee, if the drawee is dead
4. Official receiver or assignee of the insolvent drawee
5. ‘Drawee in case of need’, if any, if the original drawee refuses to accept the bill
Self-Learning
6. ‘Acceptor for honour’ may also accept the bill in case the bill is not accepted and is noted
184  Material or protested for non-acceptance. An acceptor for honour is a person who comes forward to
accept the bill dishonoured by non-acceptance.
Time for presentment The Negotiable
Instruments Act, 1881
1. If no time is specified in the bill for presentment, it must be made before maturity or within
a reasonable time after it is drawn.
2. If the bill itself specifies a period for presentment, it must be presented within the stipulated Notes
period.
3. In the case of the bill in which presentment for acceptance is optional, presentment must
be made at any time before payment.
It is important to note that the presentment in all the above cases must be made on a business
day within usual business hours.

Place of presentment
If the place of presentment for acceptance is specified in the instrument, it must be presented at that
place. On the other hand, if no place for presentment is mentioned, the bill should be presented at
the place of business or residence of the drawee.

Effect of non-presentment
In cases where presentment for acceptance is essential, a default of such presentment will discharge
the party liable to the holder [Section 61]. Thus, if the holder fails to present the bill before the
drawee or the party liable to give his acceptance therein, the drawer and all the endorsers prior to
the defaulting holder shall not be liable to such order. In such a case no action is maintainable in
respect of consideration.

Presentment for acceptance: When excused

The bill in question should not be treated as dishonoured by non-acceptance in the following cases:
1. Where the drawee cannot be found even after a reasonable search [Section 61]
2. Where the drawee is a fictitious person or one incapable of contracting [Section 91]
3. Where although presentment has been irregular, acceptance has been refused on some
other ground

Proof of presentment
In case of compulsory presentment, presentment must be proved in order to enable a party to
recover its claim thereon.

Presentment of promissory note made after sight

If a promissory note is made payable after sight, it implies that payment cannot be demanded till
the instrument is exhibited to the maker thereof. In this regard Section 62 states, ‘A promissory
note payable at a certain period after sight must be presented to the maker thereof for sight (if can
after reasonable search be found) by a person entitled to demand payment, within a reasonable time
after it is made and in business hours on a business day. In default of such presentment, no party
thereto is liable therein to the person making such default’. This implies that where a promissory
note is made payable after sight, presentment of it for sight is necessary in order to fix the maturity
of the instrument. If the holder commit default in such presentment, all the antecedent parties are
discharged from their liability to the holder making such default.

Drawee’s time for deliberation

According to Section 63, ‘the holder must, if so required by the drawee of a bill of exchange, allow
the drawee forty-eight hours (exclusive of public holidays) to consider whether he will accept it’.
This suggests that after 48 hours, the drawee should return the bill to the holder or else the holder
thereof can treat the bill dishonoured.
Delay on part of drawee may, however, be excused, if it has been caused by circumstances over
which the holder of the bill had absolutely no control, e.g., declaration of war or a moratorium, illness
of holder, etc.
It is relevant to note that the holder, as soon as the bill is dishonoured for non-acceptance, be-
comes entitled to maintain a legal action against the parties liable to him.

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Material  185
Legal and Regulatory Acceptance for honour
Environment of
Generally, a bill of exchange can be accepted only by the drawee. But Section 108 provides, ‘When a
Business
bill of exchange has been noted or protested for non-acceptance or for better security, any person,
Notes not being a party already liable thereon, may with the consent of the holder by writing on the bill
accept the same for the honour of any party thereto’. This is called the acceptance for honour. The
question of acceptance for honour does not arise in case of promissory notes or cheques. Moreover,
a bill can be accepted for honour only in the following cases:
1. When it has been noted or protested for non-acceptance or
2. For better security otherwise.
Any person who is not otherwise liable on the bill can accept it for honour. Even the drawee,
despite having refused to accept the bill originally, may accept it for the honour of any party thereto.
However, a bill can be accepted for honour only with the consent of the holder. The holder at his
option may take or refuse such acceptance. But, if he chooses to give his consent, he waives his right
of action against the prior parties liable to him on the bill.
There is no prescribed form of acceptance for honour. If the requirements stated above are ful-
filled, the acceptance is valid. An acceptor for honour may give his acceptance by writing across the
bill— ‘Accepted supra protest’ or ‘Accepted S.P’.

Liabilities and rights of acceptor for honour 

An acceptor for honour is liable to pay only when the instrument has been duly presented at matu-
rity to the drawee for payment and the bill been noted or protested for non-payment. Furthermore, if
a bill has been protested for non-payment after having been accepted, any person may intervene and
pay it supra protest on behalf of any party liable thereon. A person accepting for honour is entitled
to recover the amount paid by him to the holder from the person for whose honour he has accepted
the bill notwithstanding that the acceptance had been given without his order or knowledge.

Presentment for sight

Presentment for sight is required only in respect of a promissory note payable after sight, which means
showing or exhibiting the instrument to the maker for his knowledge. According to Section 62, ‘A
promissory note, payable at a certain period after sight must be presented to the maker thereof for
sight (if he can after reasonable search be found) by a person entitled to demand payment, within
a reasonable time after it is made and business hours on a business day. In default of such present-
ment, no party thereto is liable therein to the person making such default’. It is thus clear that the
payment on promissory note which is made payable after sight cannot be demanded till the note
has been exhibited to the maker and if the holder fails to present the note, the effect is the same as
in case of non-presentment of a bill of exchange for acceptance and thereby no party on the note
shall be liable to the holder making such default.
A promissory note made payable at a certain period after sight, must be presented for the ac-
knowledgement of the maker in order to fix the maturity of the instrument. All the subsequent
parties shall be discharged from their liability to the holder, if he commits default in such present-
ment. Significantly, it is not necessary to present every pro-note for sight. No presentment for sight
is needed in respect of the following pro-notes:
·1. Note payable ‘at sight’
·2. Note payable ‘on demand’
·3. Note payable ‘on a fixed day/date’, e.g., 15 July 2008 or last working day of month
·4. Note payable ‘on the expiry of a fixed period’, e.g., 60 days after date.
Conversely, the following types of promissory notes should invariably be presented for sight:
1. Payable at a specified period ‘after sight’ and
2. The one that stipulates that it shall be presented for sight before it is presented for payment.
As started earlier, if the holder fails to present the above promissory notes for sight, no party
shall be liable to him.

Presentment for Payment

Every negotiable instrument must be properly presented for payment. Section 64 says: ‘Promis-
Self-Learning
186  Material sory notes, bills of exchange, and cheques must be presented for payment to the maker, acceptor,
or drawee thereof respectively, by or on behalf of the holder’.
 The fundamental object of presenting an instrument is to give the maker an opportunity to The Negotiable
honour the instrument. No right to sue arises in the absence of such presentment. The Exception Instruments Act, 1881
to Section 64 provides, ‘where a promissory note is payable on demand and is not payable at a
specified place, no presentment is necessary in order to charge the maker thereof’. It is clear now
Notes
that all notes (except those payable on demand and those not payable at a specified place), bills and
cheques must be presented for payment to the maker, acceptor, or drawee thereof, by or on behalf
of the holder during the usual hours of business, and if drawn at bankers, within banking hours [See
Section 65]. Any default in presenting the instrument for payment would discharge the parties other
than the maker, acceptor, or drawee as against the holder of the instrument.

Rules regarding presentment for payment

The rules regarding presentment for payment may be studied under the following heads.
Presentment to whom?  All negotiable instruments, which are subject to presentment for pay-
ment, must be so presented to the maker, acceptor, or drawee thereof, as the case may be or to
his/her duly authorised agent, or where the drawee, maker, or acceptor has died to his/her legal
representative, or where he/she has been declared an insolvent, to his/her assignee [Section 64 read
with Section 75]. If there are more than one makers, drawees, or acceptors (not being partners) and
no place of payment is specified, presentment must be made to all of them.
Presentment by whom?  The person presenting a negotiable instrument for payment must be
capable of giving a valid discharge to the debtor. Hence, either the endorsee or the payee can pres-
ent a negotiable instrument for payment.
Time for presentment  A promissory note or bill of exchange, made payable after a specified
period at a specified date or sight thereof must be presented for payment at maturity [Section 66].
A premature presentment, and even one-day delay would render the presentment ineffectual
and discharge the parties liable on the instrument (except maker or acceptor) as against the holder.
Presentment for payment of promissory note payable by installments  A promissory note pay-
able by installments must be presented for payment on the third day after the date fixed for payment
of each installment. Non-payment on such presentment has the same effect as non-payment of a
note at maturity [Section 67]. It means in such a case, three days of grace for such installment after
the date when it falls due (for payment) are allowed.
Presentment of cheque to charge drawer  A cheque , in order to charge the drawer, must be pre-
sented at the bank upon which it is drawn before the relation between the drawer and his banker has
been altered to the prejudice of the drawer [Section 72 read with Section 84]. Simply put, it implies
that a cheque may be presented for payment at the bank on which it is drawn without delay, and
before the relations between the drawer and banker undergo a change against the drawer.
Presentment of instrument payable at demand  Subject to the provisions of Section 31, a ne-
gotiable instrument payable on demand must be presented for payment within a reasonable time
after it is received by the holder [Section 74]. Accordingly, every bill, promissory note, and cheque
needs to be presented within a reasonable time after being received by the holder in order to make
drawer of the instrument liable thereto.
Presentment of cheque to charge any other person  A cheque , in order to charge any other per-
son except the drawer, must be presented within a reasonable time after delivery thereof by such
person [Section 73]. Any other person here predominantly refers to the endorsers. In order to hold
the endorser liable, it is necessary that the cheque be presented for payment within a reasonable
time after delivery of the cheque. If an endorsee keeps a cheque for an unreasonable length of time
before he endorses it, he will be held liable for the subsequent dishonour of the cheque provided
that the holder (endorsee) presents the cheque for payment to the drawee bank within a reasonable
time after tracking it.
Hours for presentment  Presentment for payment must be made during the usual hours of busi-
ness, and if at banker, within banking hours.
However, delay in presentment [for acceptance or payment] is excused if the delay is caused by
circumstances beyond the control of the holder, and not imputable to his default, misconduct, or
negligence. When the cause of the delay ceases to operate, presentment must be made within a Self-Learning
Material  187
reasonable time [Section 75A].
Legal and Regulatory Place of presentment for payment  Sections 68 to 71 of the Act lay down the provisions as regards
Environment of the proper place at which presentment for payment must be made. A brief account of the same is
Business given below.
Notes Where instrument is made payable at a specified place and not elsewhere  A promissory note, bill of
exchange, or cheque made, drawn, or accepted payable at a specified place and not elsewhere must,
in order to charge any party thereto, be presented for payment at that place [Section 68]. Thus, if in
such cases the instrument is not presented at that place, no party thereto will be liable thereon to
the holder of the instrument.
Where no exclusive place of payment has been specified  A promissory note or bill of exchange, wherein
no place of payment has been indicated, must be presented for payment at the place of business (if
any), or at the usual residence of the maker, drawee, or acceptor thereof, as the case may be [Sec-
tion 70].
Where maker, drawee, or acceptor has no known place of business or fixed residence  If the maker,
drawee, or acceptor of a negotiable instrument has no known place of business or fixed residence
and no place is specified in the instrument for presentment for acceptance or payment, such pre-
sentment may be made to him in person wherever he can be found [Section 71].
Payee must be able to find the addressee by the exercise of reasonable diligence.

Presentment of cheque
Subject to the provision of Section 84, in order to charge the drawer of a cheque, it must be no-
ticed that a crossed or account payee cheque can be presented to any bank in which the holder
operates his/her account. It is the uncrossed or bearer cheque which must be presented at the
bank upon which it has been drawn for cash payment. Moreover, a cheque must be presented
at the bank upon which it is drawn before the relation between the drawer and his banker has
been altered to the prejudice of the drawer [Section 72].
To sum up, the holder should exercise reasonable diligence to find the maker or acceptor or
drawee, as the case may be, whether or not his place of business or residence has been speci-
fied or even there is no known place of business or fixed residence. Section 64 also states that
where authorised by agreement or usage, presentment through the post office by means of a
registered letter is sufficient. In the event of failure or undue delay or default in making the
instrument available for payment (in compliance with the above mentioned rules), the parties
there to (except the maker, drawee, or acceptor thereof) are not liable thereupon to the holder.

Effect of non-presentment for payment

Non-presentment of bills of exchange and cheques for payment discharges the drawer and
endorsers thereof. But in case of a promissory note, non-presentment for payment discharges
only the endorsers, if any, not the other parties, if presentment is necessary thereof [Sections
68-69 read with section 64]. This is due to the fact that their liability is conditional, and if the
condition is not fulfilled, the liability stands discharged.

Presentment for payment: When excused?

After maturity no presentment for payment is necessary against any party if, after maturity, with
knowledge that the instrument has not been presented, it makes a part payment on account of the
amount due on the instrument, or promises to pay the amount due thereon, whole or in part, or
otherwise waives its right to take advantage of any default in presentment for payment [Clause (c)
to Section 76]. Proof of such a payment or promise to pay is, of course, necessary.
Moreover, presentment of a bill or cheque for payment is excused:
Where drawer does not suffer damage  Presentment for payment is excused against the drawer,
if he/she could not suffer damage for want of such presentment [Clause (d) to Section 76]. When
the drawer has no funds, belonging to him/her in the hands of the drawee or when drawee is a
fictitious person or incompetent to contract or where drawer and drawee is the same person, the
holder can make the drawer liable without presentation. In such cases, neither notice of dishonour
Self-Learning nor presentment for payment shall be required within a reasonable time.
188  Material
Delay in making presentation  Delay in making presentation for payment is excused, when delay The Negotiable
is caused by circumstances beyond the control of the holder and not due to any lapse or negligence Instruments Act, 1881
on the latter’s part. For example, if due to declaration of war between country of the holder and that
of the drawee, the holder could not present the bill at maturity, delay in presentment is excusable.
Notes
But when the impossibility of presentment ceases to operate, the instrument must be presented
with reasonable diligence and within a reasonable tme.

Dishonour of Negotiable Instruments

Dishonour in relation to a negotiable instrument means loss of honour or respect for the instrument in
question on the part of the maker, drawee, or acceptor, as the case may be, which eventually re-
sults in non-realisation of payment due on the instrument. Any type of negotiable instruments,
i.e., bill of exchange, promissory note, or cheque may be dishonoured by non-payment by the
drawee/acceptor thereof. But a bill may also be dishonoured by non-acceptance because bill of
exchange is the only negotiable instrument that requires its presentment for acceptance and
non-acceptance thereof can amount to dishonour. A cheque being drawn on specified bank
and not expressed to be payable otherwise than on demand is never presented to the drawee
bank for acceptance and same is the case of a promissory note. However, as discussed earlier,
a pro-note made payable at a certain period after sight is required to be presented for sight,
but it is never subject to presentment for acceptance.

Dishonour by Non-acceptance
A bill is said to be dishonoured by non-acceptance in the following circumstances:
1. When the drawee or one of the several drawees, not being partners, commit default in
acceptance upon being duly required to accept the bill. In this regard, Section 63 ex-
pressly provides that the holder must, if so required by the drawee of a bill of exchange
presented to for acceptance, allow the drawee 48 hours (exclusive of public holidays)
to consider whether he will accept it.
2. Where presentment is required and the bill remains unpresented.
3. Where the drawee is incompetent to enter into a valid contract.
4. Where the bill is given a qualified acceptance.
5. If the drawee is a fictitious person.
6. If the drawee cannot be found even after reasonable search [Section 61].
7. Where the drawee has either become insolvent or is dead and the holder does not present
the bill to the assignee or legal representative of the insolvent or deceased drawee.
It is relevant to note that where a drawee-in-case-of-need is named in a bill of exchange or
in any endorsement thereon, the bill is not dishonoured until it has been dishonoured by such
drawee [Section 115].

Dishonour by Non-payment
A promissory note, bill of exchange, or cheque is said to be dishonoured by non-payment when the
maker of the note, acceptor of the bill, or drawee of the cheque commit default in payment upon being
duly required to pay the same. Also, the holder of a bill or pro-note may treat it as dishonoured, without
placing for payment when presentment for payment is excused expressly by the maker of the pro-
note, or acceptor of the bill and the note or bill when overdue remains unpaid [Section 92 read
with Section 76].
If a bill is dishonoured either by non-acceptance or by non-payment, the drawer and all the
endorsers of the bill are liable to the holder, provided notice of such dishonour is given to them.
The drawee, on the other hand, shall be liable to the holder only in the event of dishonour by
non-payment.

Dishonour of Cheque for Insufficiency of Funds in the

Account
Self-Learning
A cheque drawn by a person on an account maintained by him with a bank for payment of any
Material  189
amount of money to another person can be returned unpaid for lack of enough funds in the
Legal and Regulatory said account. This is called dishonour of cheques for insufficiency of funds (in the drawer’s ac-
Environment of count). In such cases, the drawer is also criminally liable for this offence and may be punished with
Business imprisonment for a term, which may extend to one year, or with fine that may extend to twice the
amount of the cheque, or with both [Section 138].
Notes

Notice of Dishonour
Notice of dishonour refers to formal communication, oral or written, of the fact of dishonour.
When a negotiable instrument is dishonoured either by non-acceptance or non-payment, the holder
should give notice of the dishonour to all the parties, he seeks to hold liable. A notice of dishonour
has its own significance. If it is not given to the drawer and endorsers, it will discharge them all
from liability not only on the bill or pro-note but also with regard to the original consideration. Such
notice also enables a person (drawer) so notified to protect himself/herself as against the drawee or
acceptor who has illegitimately dishonoured the instrument issued by him/her.

Rules regarding notice of dishonour

The rules regarding notice of dishonour can be discussed under the following heads.

Notice of dishonour in case of non-acceptance

If the drawee refuses to accept the bill duly presented to him/her for acceptance, the bill stands dis-
honoured, and the notice of dishonour must be given in accordance with the Act. However, it must be
remembered that in the event of dishonour by non-acceptance, the rights of a person, who becomes
a holder-in-due-course subsequent to the omission to give notice, are not perjured by the omission.

Notice of dishonour in case of non-payment

Where an instrument has been dishonoured due to non-payment, and proper notice of dishonour
has been served, notice of a subsequent dishonour on account of non-payment is no more required
unless the instrument in the meantime has been accepted. Conversely, where a bill has been duly
accepted by its drawer but the holder fails to get the payment, notice of dishonour by non-payment
must be given to the drawee.

Notice by whom?
According to Section 93, notice of dishonour must be given by the holder or by some party liable on
the instrument. ‘A notice given by a stranger stands invalid and inoperative. Moreover, any party
receiving notice of dishonour must, in order to render any prior party liable to him, give notice of
dishonour to such party within a reasonable time unless such party otherwise receives due notice
from the holder or some other party liable to the instrument dishonoured’ [Section 95]. It means,
where the holder has given a notice of dishonour to any party liable on the instrument and that
party, in turn, has given notice of dishonour to all prior parties, the holder can treat that notice as
one given by him.

Notice to whom?
Notice of dishonour must be given to all the parties (other than the maker of the dishonoured prom-
issory note or the drawer or acceptor of the dishonoured cheque or bill) or their duly authorised
agents who are sought to be made liable. Where there are two or more persons, jointly liable as
drawers or endorsers, notice to any one of them is enough if the holder seeks to make them jointly
liable on the instrument. If the holder seeks to make all the drawers and endorsers individually li-
able, he should give the notice of dishonour separately to all of them [Section 93]. In case the party
entitled to notice has expired, the notice of dishonour may be given to his/her legal representative,
or where, he/she has been declared an insolvent, notice may be given to his/her official assignee
or receiver [Section 94]. But if the party to whom notice of dishonour is dispatched is dead and the
party dispatching the notice is ignorant of the fact, a fresh notice must be given to his legal repre-
sentative [Section 97].
It is important to note that the notice of dishonour is not necessary to the maker of a pro-note,
or acceptor of a bill or drawer of a cheque because of the underlying fact that they are primarily
Self-Learning liable on the instrument. As principal debtors, this is their duty to pay the instrument on due date.
190  Material
Form and mode of giving notice The Negotiable
Instruments Act, 1881
There is no prescribed mode or format for giving a notice of dishonour. It may be given in any form
satisfying the requirements of law. According to Section 94, the notice of dishonour may be oral or
written; may, if written, be sent by post; it may be in any form; but it must inform the party to whom it Notes
is given, either in express terms or reasonable intendment that the instrument has been dishonoured,
and in what way, and that he/she will be held liable thereon, and it must be given within a reasonable
time after dishonour, at the place of business or (in case such party has no place of business) at the
residence of the party for whom it is intended. Thus, a notice of dishonour may be oral or in writing,
but it must be an actual formal notice and the language used must indicate that the instrument has
been dishonoured due to non-acceptance or non-payment, as the case may be, and that the recipi-
ent of the notice will be held liable.

Reasonable time of giving notice

The determination of ‘reasonable time’ for giving notice of dishonour depends on the nature of
the instrument. While calculating reasonable time, public holidays must be excluded [Section 105].
Furthermore, Section 106 lays down the following rules for determining reasonable time for giv-
ing a notice of dishonour:
(i) If the holder and the party to whom notice of dishonour is to be given carry on business
or live (as the case may be) at different places, it is deemed to be reasonable time if the
notice is dispatched by the next post or on the next day, after the day of dishonour.
(ii) If the said parties carry on business or live in the same place, such notice is considered,
given within a reasonable time, if it is dispatched to reach its destination on the day, after
the day of dishonour.

Reasonable time for transmitting such notice

A party receiving notice of dishonour, who seeks to enforce its rights against a prior party, is said to
have transmitted the notice within a reasonable time if it transmits the notice within the same time
after its receipt as it would have had to give notice if it had been the holder [Section 107].

Cases in which notice of dishonour is excused

As per Section 98, notice of dishonour is excused in the following cases:
(i) When it is dispensed by the party entitled thereto.
(ii) When the drawer has countermanded payment, i.e., issued stop payment instructions to
the drawee, no notice of dishonour is necessary to charge him/her.
(iii) When the party charged could not suffer damage for want of notice.
(iv) When the party entitled to notice cannot be found after due search.
(v) When the party bound to give notice is unable to give it for any other reason but without
any fault of its own.
(vi) When the acceptor is also a drawer (i.e., when drawer and acceptor are the same person)
no notice of dishonour is necessary to charge the drawer, for instance, when a firm draws
a bill on its branch.
(vii) When the party entitled to notice, knowing the fact of dishonour, promises uncondition-
ally to pay the amount due on the instrument.

Dishonoured Instrument: Noting and Protest

Noting
The term ‘noting’ refers to the recording of the fact of dishonour of a negotiable instrument by the
notary public4. When a promissory note or bill of exchange is dishonoured by non-acceptance
or non-payment, the holder may cause such dishonour to be noted by a public notary upon the
instrument, or upon a piece of paper attached thereto, or partly upon each [Section 99].
Noting serves as the authentic and legal proof of presentment and acceptance. Section 99 in
this regard further provides that noting must be made within a reasonable time after dishonour,
and must specify the date of dishonour, the reason why the holder treats it as dishonoured,
and the notary charges. Self-Learning
Material  191
Legal and Regulatory Protest
Environment of
The term ‘protest’, that follows noting, implies the formal certificate of dishonour of the instrument
Business
by the notary public. According to Section 100, where a promissory note or bill of exchange has been
Notes dishonoured by non-acceptance or non-payment, the holder may, within a reasonable time, reason
such dishonour to be noted and certified by a notary public, such certificate is called a protest.
Noting does not afford any evidence of presentment for dishonour unless it is followed by protest
notwithstanding that the former contains the full name of the notary public.

Contents of protest
According to Section 101, a protest under Section 100 must contain
(i) The instrument itself or a literal transcript (i.e., a copy) of the instrument and of every-
thing written or printed there upon.
(ii) The name of the person for whom and against whom the instrument has been protested.
(iii) Fact of the presentment of the instrument and its subsequent dishonour and the reason
given by the drawee or acceptor for non-acceptance, or non-payment, or refusal to give
better security5.
(iv) The place and time dishonour, when note or bill has been dishonoured, and the place and
time of refusal, when better security has been refused.
(v) The signature of the notary public making the protest.
(vi) The name of the person by whom and of the person for whom, in case of an acceptance
for honour or payment for honour, and the manner in which such acceptance or payment
was offered and affected.

Material Alteration
The term ‘material alteration’ indicates alteration or change in any material part of the instrument.
It may be defined as any change, which alters the very nature of the instrument. Thus, it is the al-
teration, which changes and destroys the legal identity of the original instrument and causes it to
speak a different language in legal effect from that which it originally included. A material alteration
makes the instrument void, i.e., inoperative and affects the rights and obligations of the parties to
the instrument. It, however, does not affect one who becomes a party to an instrument subsequent
to its material alteration, if any.

Material alteration—what constitutes

Every alteration or change on a negotiable instrument cannot be established as material alteration
and would not necessarily vitiate the instrument or affect the rights and obligations of the parties
thereto. The Negotiable Instruments Act is silent on the subject as to what constitutes a material
alteration. Courts of Law in India in this regard have followed the English Common Law, which held
that anything, which has the effect of altering the legal relations between the parties, the character
of the instrument, or the sum payable, amounts to a material alteration. Accordingly, an alteration
can be termed as material alteration if it is such that it alters or attempts to alter the character of
the instrument and affects or attempts to affect the contract, which the instrument contains. It
may arise not only by means of altering, changing, or erasing a certain thing already written on the
instrument but also by a new insertion.

Instances of material alteration

The following are considered as material alterations:
(i) Alteration of the date of the instrument6
(ii) Alteration of the amount payable7
(iii) Alteration in time of payment
(iv) Alteration of the place of payment8
(v) Alteration of rate of interest or any change of party thereto, if any 9
(vi) Tearing of the material part of the instrument
(vii) Where a bill is accepted generally, the insertion of a place of payment
(viii) Addition of a new party to the instrument
Self-Learning (ix) Addition of words to a bill of exchange endorsed in blank so as to convert the same into
192  Material special endorsement.
 The above list of material alterations is not conclusive or exhaustive. There may be other altera- The Negotiable
tion or changes that may be regarded as material alterations depending on the facts and nature of Instruments Act, 1881
each particular case.

Instances that are not material alteration or immaterial alteration Notes

The following are, however, not taken as material alterations.
(i) Alteration made for the purpose of correcting a clerical error or mistake such as correct-
ing the date in an instrument as 1992 instead of 1929
(ii) Filling up an inchoate (incomplete)instrument [Section 20]
(iii) Converting a blank endorsement into a full one [Section 49]
(iv) Converting a bearer cheque into an order cheque or even account payee
(v) Alteration made before the issuance of the instrument
(vi) Any alteration to carry out the common intention of the parties [Section 87]
(vii) An alteration effected with the consent of the parties liable on the instrument
(viii) Crossing of an uncrossed cheque
(ix) The addition of the words ‘on demand’ to a promissory note wherein no time of payment
is expressed [Gardener vs Walsh10]
(x) Making qualified acceptance [Section 86].
Besides the above, an alteration that is the result of an accident, e.g., instrument torn by a child
or mutilated by washing, document burnt in part accidently without any mala fide intention on part
of the holder is also considered as an immaterial alteration [HSBC vs Lo Lee Shi 11].
In the above cases, the document in terms of its value remains valid and enforceable and the
parties thereto cannot be discharged from their liabilities on such grounds.

Effect of material alteration

According to Section 87, ‘any material alteration of a negotiable instrument renders the same void
as against anyone who is a party thereto at the time of making such alteration and does not consent
thereto, unless it was made in order to carry out the common intention of the original parties’.
Thus, the main effect of a material alteration is that it makes the instrument void, i.e., it discharges the
instrument itself as against any person who was a party to such instrument at the time of material altera-
tion and did not give his approval to it. All the prior parties to a negotiable instrument, which was altered
subsequently without their consent thereto, shall not be liable even to holder-in-due-course, having
no notice or knowledge of the alteration. It makes no discrimination whether the alteration was for
the benefit or detrimental to any party to the instrument [Rampadarth vs Hari Narain12]. Moreover, it
is also immaterial whether the holder himself altered the instrument or any stranger altered it while
the instrument was in the custody of the holder because a party, who is in custody of an instrument,
is bound to preserve it in its original state [Davidson vs Cooper 13].
It is, however, worth noting that a materially altered instrument is not absolutely void, i.e., not
unenforceable against all the parties thereto. It is void only against those who did not give their
approval to the alteration, and can be enforced against those who consented to the alteration
or effected the alteration. Such an instrument is also operative against those who become
parties to the instrument subsequent to the alteration. There is, however, an exception to this
rule. An acceptor or endorser of a negotiable instrument is bound by his acceptance or endorse-
ment notwithstanding any previous alterations of the instrument [Section 88]. On the other
hand, Section 89 provides protection to a party who pays a materially altered bill of exchange
or promissory note or cheque provided that the alteration does not appear on the face of the
instrument in-question and pays so in good faith and without negligence on its part. Such a
party shall stand discharged if it makes payment to a person in the possession of the instru-
ment under the circumstances, which do not afford a reasonable ground for believing that it is
disentitled to such payment. Besides, the payer under the above circumstances is also entitled
to debit the party on whose account the payment was made with the amount paid. For instance,
A drew a cheque for ` 500 in favour of B, who altered the figure 500 into 5000 without taking the
consent of the maker. The instrument appeared to be drawn for ` 5000 on the face of it. The drawee
Self-Learning
banker paid ` 5000 to B on the presentment of cheque for payment. The banker did so according
Material  193
Legal and Regulatory to the apparent tenor of the instrument and in good faith. In this case, since the banker acted bona
Environment of fide and without negligence, it is entitled to debit with ` 5000.
Business

Notes E xercises
I. Objective-type Questions
1. Which one of the following is not a presumption about negotiable instruments?
(a) Consideration
(b) Date
(c) Absolute and good title to the transferee
(d) Stamp
2. Which one of the following is a negotiable instrument by custom and usage among
the businessmen?
(a) Deposit receipt (b) Dividend warrant
(c) Share certificate (d) Demand draft
3. When a negotiable instrument is delivered conditionally or for a special purpose
as a collateral security or for safe custody only, it is called
(a) Accommodation bill (b) Genuine trade bill
(c) Escrow (d) Documentary bill
4. Presentment for sight is necessary in case of
(a) All promissory notes
(b) Promissory note being made payable at a certain period after sight
(c) All promissory notes and bills of exchange
(d) Bill of exchange being payable after sight
5. Presentment for acceptance is excused and consequently bill in question may be
treated as dishonoured by non-acceptance in which of the following cases?
(a) Where the drawee is a fictitious person, or is a person incapable of
contracting
(b) When the drawee could not be found even after a reasonable search by the
holder
(c) Where although presentment has been irregular, acceptance has been re-
fused on some other ground.
(d) In all the above cases
6. How much time a holder must, if so required by the drawee of a bill of exchange
presented to him for acceptance, allow the drawee to consider whether he will
accept it?
(a) 48 hours (inclusive of public holidays)
(b) 48 hours (exclusive of public holidays)
(c) 24 hours (inclusive of public holidays)
(d) 24 hours (exclusive of public holidays)
7. In which of the following cases presentation of a negotiable instrument for pay-
ment is necessary on the part of the holder?
(a) Where the maker, drawee, or acceptor, i.e., the payer does something
intentionally which prevents the presentment of instrument
(b) When the payer closes the place of business during business hours on a
working day (if the instrument is payable at his place of business)
(c) When the payer cannot be found even after reasonable search (if the instru-
ment is not payable at any specified place)
(d) In all the above cases
8. Which among the following is not an instance of material alteration?
(a) Addition of a new party to the instrument
(b) Addition of words to a bill, which was endorsed in blank so as to convert
the same into special endorsement
(c) Affixing stamps on a bill of exchange besides signature and cancellation by
Self-Learning two parallel lines
194  Material (d) Addition of a new party to the instrument
 9. Notice of dishonour must be given The Negotiable
(a) To the drawer and drawee only Instruments Act, 1881
(b) To the drawer, acceptor, and endorser(s) only
(c) To all the parties liable on the instrument or to their duly authorized agent
(d) To all the parties who are secondarily liable on the instrument or to their Notes
duly authorized agent
10. Notice of dishonour is excused
(a) When the party charged could not suffer damage for want of notice
(b) When the party entitled to notice cannot be found after reasonable search
(c) When the drawer has countermanded payment
(d) In all the above cases
II. Review Questions
1. Describe the basic features of negotiable instruments. Also explain the presump-
tions, legally permitted in respect of a negotiable instrument.
2. ‘A cheque is a bill of exchange’. Comment. Also distinguish between a bill of
exchange and a cheque.
3. Explain ‘payment-in-due-course’. Discuss ‘maturity’ of negotiable instruments
and payment of interest thereon.
4. Summarise ‘special rules of evidence’ governing negotiable instruments.
5. Explain ‘presentment for payment’. What are the rules to be followed in order
to constitute a valid presentment of negotiable instruments for payment?
6. When is the presentment for acceptance excused and the bill treated as dishon-
oured?
7. When does presentment for payment become unnecessary? Elaborate.
8. What is meant by dishonour of a negotiable instrument? In what different ways
may an instrument be dishonoured? State the instruments, which can be dishon-
oured by non-acceptance, and those by non-payment.
9. ‘Material alteration renders the instrument void’. Elaborate. Give instances of
material alterations. What alterations are permissible under the Negotiable In-
struments Act?
10. Discuss ‘noting’ and ‘protest’. Are ‘noting’ and ‘protest’ obligatory under the
Negotiable Instruments Act? Explain ‘protest for better security’.

10. (d) 9. (d) 8. (c) 7. (d) 6. (b)

5. (d) 4. (b) 3. (c) 2. (d) 1. (c)
Answers to Objective-type Questions

Self-Learning
Material  195
 Chapter
Legal and Regulatory
Environment of

In Review
Business

9
Notes

Learning Objectives ●● A negotiable instrument is a written document, which requires a party to pay a cer-
tain sum of money on specified terms. The most remarkable feature of a negotiable
Negotiable instruments: meaning, definition, instrument is that it is freely passable from one person to another, wherein the trans-
characteristics feree can get a better title than that of the transferor. Three classes of negotiable
Kinds of negotiable instruments: promissory instruments are: promissory note, bill of exchange, and cheques, payable either to
notes, bills of exchange, cheques order or to bearer.
●● It is only the bill of exchange, which is required to be presented for acceptance, al-
Negotiable instruments: Special rules of beit, it is not necessary to present every bill for acceptance, before presenting it for
evidence payment. Presentment for acceptance is essential in the following cases:
Negotiable instruments: Rules of interna- 1. Where a bill is payable at a specified period after acceptance or after sight. The
tional law expression ‘after sight’ in a bill of exchange means after acceptance.
2. Where a bill expressly stipulates that before it is paid it shall be presented for ac-
Presentment for acceptance
ceptance.
Dishonour of a negotiable instrument by ●● A promissory note, bill of exchange, or cheque is said to be dishonoured by non-
non-acceptance, non-payment payment when the maker of the note, acceptor of the bill, or drawee of the cheque
Material alteration defaults in payment upon being duly required to pay the same.
●● If a bill is dishonoured either by non-acceptance or by non-payment, the drawee and
all the endorsers of the bill are liable to the holder, provided a notice of such dishon-
Key Terms our is given to them. The drawee, on the other hand, shall be liable only in the event
of dishonour by non-payment. The drawer of a cheque is also criminally liable if his
Negotiable instrument: An instrument banker returns his cheque for insufficiency of funds in his account.
of credit, readily convertible into money ●● Material alteration is the alteration, which alters or destroys the legal identity of the
and easily deliverable from one person to original instrument. A material alteration makes the instrument inoperative.
another
Promissory note: An instrument in writing
(not being a bank note or a currency note)
containing an unconditional undertaking
signed by the maker to pay a certain sum
of money only to, or the order of a certain
person, or only to bearer of the instrument
Bill of exchange: An instrument in writing,
containing an unconditional order, signed
by the maker, directing a certain person to
pay a sum of money only to, or to the order
of, a certain person, or to the bearer of the
instrument
Payment-in-due-course: A payment in
accordance with the apparent tenor of
the instrument, in good faith and without
negligence of any person in possession
thereof
Presentment: Placing or exhibiting a
negotiable instrument for acceptance, sight,
or payment
Dishonour of negotiable instruments:
Loss of honour or respect for a negotiable
instrument at the end of maker, drawee,
or acceptor which eventually results in
non-realization of the payment due on the
instrument
Material alteration: Any change that alters
the very nature of the instrument

Self-Learning
196
196   Material
Legal and Regulatory Environment of Business
 Limited Liability

Limited Liability
10
Partnership

Partnership Notes

©: iStock
Learning Objectives
1. What is a Limited Liability Partnership? 3. Structure of an LLP
2. Rationale Behind Introduction of LLP 4. Procedure of Formation of LLPin India
in India

Limited Liability Partnership: An Introduction

L imited Liability Partnership (LLP), a concept that is relatively new to India, is an alternative
corporate business form in which depending upon the agreement some or all the partners shall
have limited liability. In LLP, one partner is not accountable for the acts (negligence or misconduct)
of other partners. This unique characteristic of LLP sets it fundamentally apart from and advanta-
geous to a conventional (limited liability) partnership. Since LLP contains elements of both “a cor-
porate structure” and “a partnership firm structure”, it is called a hybrid between a company and a
partnership which offers the dual benefits of limited liability of a company and the flexibility of a
partnership.

Genesis and Foundation of LLP in India

The LLP structure exists in the countries like the UK, the US, various Gulf countries, Australia and
Singapore. On the advice of experts who have studied LLP legislations in various countries, the In-
dian LLP Act, 2008, is broadly based on the UK LLP Act, 2000, and the Singapore LLP Act, 2005;
which allow creation of LLP in a body corporate form, i.e., as a separate legal entity, separate from
its partners/members.
The desirability of LLP form in India was expressed in the context of small enterprises by Bhat
Committee (1972), Naik Committee (1992), Expert committee on Development of Small Sector En-
terprises headed by Sh. Abid Hussain in 1997 and the study group on “Development of Small Sec-
tor Enterprises” (SSEs) headed by Dr. S. P. Gupta in 2001. The committees set up by the Ministry of
Corporate Affairs, namely, Committee on Regulation of Private Companies and Partnerships headed
by Sh. Naresh Chandra (2003), Committee on New Company Law (Dr. J.J. Irani Committee) (2005)
also recommended for legislation on LLPs.
The Limited Liability Partnership (LLP) Bill was passed by the Rajya Sabha on 24 October, 2008.
The Bill was passed by Lok Sabha on 12 December, 2008. The President gave assent to this Bill on 7
January, 2009, and thereby the Act (Limited Liability Partnership Act, 2008) came into effect from
1 April, 2009.

Self-Learning
Material 197
Legal and Regulatory What is Limited Liability Partnership?
Environment of
Business LLP is a new business vehicle that enables professional expertise and entrepreneurial initiative to
combine and operate in flexible, innovative, and efficient manner. It is a hybrid between company
Notes and conventional partnership offering fundamentally:
(a) the privilege of limited liability accorded to the partners of the LLP; and
(b) the flexibility of internal control and management of firm’s affairs through “LLP Agreement”,
or in the absence of the Agreement, default provisions (Schedule I) covering the mutual
rights and duties of LLP and its partners.

Salient features of llp

1. Distinct Business Model  LLP is a form of business model which is organized and it operates
on the basis of an agreement. It provides flexibility without imposing detailed legal and procedural
requirements, enables professional or technical expertise and initiative to combine with financial
risk taking capacity in an innovative and efficient manner. Every limited liability partnership shall
use the words “Limited Liability Partnership” or its acronym “LLP” as the last words of its name.
2. Separate Legal Entity and Perpetual Succession  LLP shall be a body corporate and a legal
entity separate from its partners. It will have perpetual succession.  The LLP is a separate legal en-
tity, and is liable to the full extent of its assets but liability of the partners is limited to their agreed
contribution in the LLP. The LLP can continue its existence irrespective of the changes in partners.
3. Ability to Sue in its Own Name  As a juristic legal person, an LLP can sue in its own name and
can be sued by others. Partners are not liable to be sued for dues against the LLP. The LLP, however,
is not relieved of the liability for its other obligations as a separate entity.
4. Liability of Partners  Limited Liability of Partners is the essential hallmark of an LLP which sets
it fundamentally apart from a conventional partnership. Liability of one or more partners, depending
upon the agreement, is limited to their agreed contribution in the LLP. Further, no partner would
be liable on account of the independent or unauthorized actions of other partners; thus allowing
individual partners to be shielded from joint liability created by another partner’s wrongful business
decisions or misconduct.
5. Control and Influence  LLP is capable of entering into contracts and holding property in its own
name. Though Registrar of Companies (ROC) shall register an LLP and monitor its affairs, unlike
corporate shareholders, its partners have the right to manage the business directly and indepen-
dently. In contrast, corporate shareholders have to elect a board of directors under the provisions of
corporate laws in force who in turn hire corporate officers who then have, as corporate individuals,
the legal responsibility to manage the corporation in the corporation’s best interest.
6. Mutual Rights and Duties of Partners  The mutual rights and duties of partners inter se and
those of the LLP and its partners shall be governed by the agreement between the partners or
between the LLP and the partners. This agreement would be known as “LLP Agreement”. In the
absence of the latter as to any matter, the mutual rights and liabilities of the partners shall be as
provided for under Schedule I to the Act. Therefore, in case any LLP proposes to exclude provisions
or requirements of Schedule I to the Act, it would have to enter into an LLP Agreement, specifically
excluding applicability of any or all paragraphs of Schedule I.
7. Maintenance of Accounts and Filing of Annual Return Must  An LLP shall be under obligation
to maintain annual accounts reflecting true and fair view of its state of affairs. Every LLP would be
required to file annual return in “Form 11” with the ROC within 60 days of closure of the financial
year. The annual return will be available for public inspection on payment of prescribed fee to the
Registrar (ROC). Since tax matters of all entities in India are addressed in the Income Tax Act, 1961,
the taxation issues of an LLP shall be dealt with in accordance with the provisions in that Act.
8. Mode of Winding Up  An LLP may be wound up either voluntarily or by the Tribunal to be es-
tablished under The Companies Act, 2013.

Rationale Behind Introduction of Llp in India

Self-Learning LLP provides access to limited liability status which in turn encourages entrepreneurship and pro-
198  Material motes business growth. It closes the gap in current framework by:
 l Offering an alternative business vehicle to complement the traditional choices of business Limited Liability
vehicles; and Partnership
l Providing flexibility and freedom to select the best business model that suits the needs and

requirements of businesses on the basis of commercial criteria.

Notes
Moreover, LLP is more affordable vis-à-vis companies and offers more protection vis-à-vis sole
proprietorship and conventional partnership.
For the above reasons, LLP is fast catching up as a strategic choice of business structure for many
small businesses in India.

Structure of an LLP
An LLP can be formed with a minimum of two partners who may be individuals or body corporate
through their nominees. Besides, any conventional partnership firm consisting of two or more
partners engaged in a profit-making venture may become an LLP. In any case, there must be at least
two “designated members” at all times, otherwise the members’ limited liability may be at risk.
There is no specific requirement to have any non-designated members and there is no specified
limit of maximum number of partners in LLP. An LLP may be established such that all members are
considered to be designated members. Designated members have the same rights and duties as any
other member, but there are additional responsibilities such as signing accounts on behalf of the
LLP, delivering accounts and annual returns to the Registrar of Companies, notifying the Registrar
of changes to the LLP’s members or registered office and acting on behalf of the LLP in the event of
winding up, much in the way such duties and responsibilities fall on company directors.
In general terms, an LLP can be governed by the Partnership Agreement. Although there is no
requirement to file any such governing document with Registrar of Companies; it is highly recom-
mended that a formal agreement is established to ensure the business of the LLP has a proper
framework for the resolution of disputes between members or for the provision of suitable exit
strategies. The formal partnership agreement may also determine revenue split between members
and varying responsibilities if appropriate.
The LLP must also have an official registered office. Unlike limited companies, there are no direc-
tors or company secretary, and of course, no shareholders. Every LLP shall have either the words
“Limited Liability Partnership” or the acronym “LLP” as the last words of its name.

Procedure of Formation of Limited Liability

Partnership in India
Incorporation is a simple process, tailored to provide an easy route to completion of the necessary
formalities. Like formation of a joint stock company, LLP incorporations are now available online,
i.e., electronically whereby the whole process can be completed within hours. The following steps
are required to be undertaken for forming an LLP electronically in India:

Step I: Deciding the partners and designated partners

An LLP can be incorporated with a minimum of at least two partners who may be individuals or body
corporate through their nominees. Of the total number of partners, at least two shall be designated
partners, of which at least one must be “Resident in India”. However, there is no specific require-
ment to have any non-designated partner and there is no maximum to the number of members
allowed. An LLP may be established such that all members are considered to be designated partners.
A person ‘Resident in India’ means a person who has stayed in India for a period of not less than
one hundred and eighty two days during the financial year immediately preceding the year in which
the formation of LLP is sought.
“Designated partner” means a partner who is designated as such in the incorporation documents
or who becomes a designated partner by and in accordance with the LLP Agreement.

Step II: Obtaining DPIN and digital signature

Designated Partner Identification Number (DPIN)  Every designated partner must obtain a
DPIN from the Central Government [Section 7 (6)]. DPIN in this behalf is an eight digit numeric Self-Learning
number allotted by the Central Government in order to identify a particular partner and can be Material  199
Legal and Regulatory obtained by making an online application in e-Form 7 to the Central Government and submitting
Environment of the physical application along with necessary identity and address proof of the person applying
Business with prescribed fees.
Notes Digital Signature Certificate  The Information Technology Act, 2000, provides for use of digital
signatures on the documents submitted in electronic form in order to ensure the security and au-
thenticity of the documents filed electronically. As all the documents and forms required for incor-
porating an LLP in India to be filed electronically and under the signatures of Designated Partners,
thus at least one Designated Partner has to obtain the digital signature certificates from government
recognized Digital Signature Authority (DSA). The signatures shall also be required for signing and
filing of all relevant forms and documents.

Step III: Choosing a Name for the LLP

The next step is to decide the name for the proposed LLP. The choice of name for an LLP follows the
same rules as with limited companies. Anyone intending to incorporate an LLP has to evaluate the
proposed name under the prescribed parameters and make an application in “Form 1” (Application
for reservation or change of name) for reservation of the desired name. The name of the LLP (to be
incorporated) shall not be similar or identical with a company or LLP already registered in India and
should not contain words prohibited under the Emblems and Names (Prevention of improper use)
Act, 1950, or the ones which are undesirable in the opinion of the Central Government.

Step IV: Drafting of LLP agreement

The next step is drafting of LLP Agreement governing the mutual rights and duties among the
partners and among the LLP and its partners. As with any business partnership, it is vital that the
partners draw up a suitable written agreement to determine issues such as control, division of
revenue, and exit strategies.
The agreement inter alia should contain the following details:
(i) Name of the proposed LLP
(ii) Names of the Partners and the Designated Partners
(iii) Form of contribution by each partner
(iv) Profit sharing ratio
(v) Rights and duties of partners
(vi) Proposed business
(vii) Rules for governing the LLP
In case, no agreement is entered into, the rights and duties as prescribed under Schedule I to the
LLP Act, 2008, shall be applicable to the proposed LLP. It is not necessary to have the LLP Agreement
signed at the time of incorporation, as the details of the same needs to be filled in e-form 3 within
30 days of incorporation but in order to avoid any dispute between the partners as to the terms
and conditions of the agreement after the formation of LLP, it is always beneficial to have the LLP
Agreement drafted and executed before the incorporation of the LLP.
In case the agreement is executed outside India, then it must be notarized and consularized.

Step V: Filing of incorporation documents and payment of registration fees

After drafting of LLP agreement, the next step is the filing of incorporation documents, consent
of partners and their declaration electronically through prescribed e-forms with the Registrar of
Companies for incorporation of the LLP and payment of prescribed fees based on the total mon-
etary value of contribution of partners in the proposed LLP. A brief account of the relevant e-forms
is given below:
Form 2: Incorporation Document  This is an informative document setting down the details of
LLP, its partners including designated partners along with their share of contribution and consent for
forming partnership to carry on a lawful business with profit motive along with declaration stating
that all the requirements of Limited Liability Partnership Act, 2008, regarding incorporation of LLP
in India have been duly complied with.
Form 3: Details of LLP Agreement  This form provides for the necessary information in respect
Self-Learning to the LLP agreement entered between the partners.
200  Material
Form 4: Consent of Partners  In this form, the consent of each partner to become a partner of an Limited Liability
LLP along with their address and identity proof to be filed with the Registrar of Companies. Partnership
Forms 3 and 4 are required to be filed within 30 days of the incorporation.
Moreover, just like in case of formation of a joint stock company, the partners are required to
Notes
subscribe their names along with signatures to the Subscription Sheet, which shall be witnessed
by any chartered Accountant/Company Secretary/Advocate in practice.
In case the subscription sheet is executed outside India, then it must be notarized and consular-
ized.

Step VI: Certificate of incorporation

After the ROC is satisfied that all the formalities with respect to the incorporation have been com-
plied, he will issue a Certificate of Incorporation as to formation of the Limited Liability Partner-
ship within maximum of 14 days from the date of filing of documents which shall be the conclusive
evidence of formation of the LLP.
Source: adapted from www.mca.gov.in

LLP Versus Sole Proprietorship

An LLP is fundamentally a different personality from a sole proprietorship. The difference between
the two can be discussed along the following points.

Legal identity
Sole proprietorship in India is not an incorporated entity and therefore has no separate legal identity.
In the eyes of the law and the public, the sole proprietor as the owner and his sole proprietorship
business are one and the same. As a result, sole proprietor has absolute control over the business
and its operations but he is personally responsible for all the debts and legal actions against the
business. An LLP, on the other hand, has its own legal identity, separate from its members (partners)
who own the entity and manage its affairs. This essentially implies that:
(a) The entity (LLP) can incur and receive obligations and hold property in its own name, enter
into contracts with its members, directors, employees, and with third parties.
(b) The entity can sue and be sued in its own name.
(c) The entity continues unchanged even if the identity of its participants changes.
(d) The entity can enter into legal relationships with its members or directors.
The above privileges are not available with the sole proprietorship.

Extent of liability
Since a sole proprietorship does not have a separate legal entity, the owner has unlimited liability.
That is, creditors may sue you for debts incurred and can also obtain a decree to claim against his
personal assets. Contrarily, since LLPs in India are setup as limited liability legal entities, their busi-
ness obligations remain within the entity itself and thus shield their members or partners via the
provision of limited liability. Essentially it means that the partners’ exposure is limited to the amount
they have invested in the entity and their personal assets are protected.

Perpetuity and succession

As a sole proprietor, owner and his business are inseparable. The business has no perpetuity and
comes to a standstill with the demise of its owner. LLPs, on the other hand, have a continued ex-
istence irrespective of the status of its partners. Partners’ resignation or death does not normally
affect the existence of the LLP.

Ease of expansion
Central to the growth and expansion of any business is the capital. As a sole proprietor, it’s quite
difficult to raise funds externally through loans or investment in the business. Capital is limited to
the owner’s personal finances and the profits generated by the business. This makes business expan-
sion difficult. While, generally, LLPs also face the difficulty of raising external capital, which is often
Self-Learning
limited to its partners’ contributions, they can still take advantage of the ability to raise capital base Material  201
by means of adding more partners.
Legal and Regulatory Taxation
Environment of
Sole proprietorships in India are not taxed at the business level but at the personal income level of
Business
the owners concerned. For sole proprietors, all business profits are considered as personal income
Notes of the owner and therefore taxed as part of the personal income as per the personal income tax
slabs in force. Whereas, LLPs, in India, are treated as legal entities and therefore LLPs’ profits are
taxable as corporate profits.

Transfer of Ownership
Unlike, a sole proprietorship, an LLP cannot be sold as whole. Instead, each partner will have to
individually transfer his interest in the firm.

Ongoing Maintenance
Sole proprietorships are the easiest and least expensive form of business to set up and maintain in
India as there are no ongoing filing requirements or the annual renewal of the sole proprietorship.
Ongoing maintenance of an LLP is little more complex than a sole proprietorship albeit less complex
than a private limited company. In terms of annual compliance requirements, a LLP must submit an
annual declaration of solvency or insolvency to authorities. There are no other documents to be filed.

Dissolution
Dissolving or terminating a sole proprietorship is easier than terminating an LLP. For an LLP, the pro-
cedure calls for issuing a notice of termination followed by a notice of cessation to the registration
authorities (ROC). The termination process in case of LLP can take anywhere within 3 to12 months,
depending on the complexities involved.

LLP Versus Conventional Partnership

1. Conventional or traditional or say ordinary partnership is governed by the Partnership Act,
1932, while a limited liability partnership is exclusively governed by the Limited Liability
Partnership Act, 2008.
2. Under ordinary partnership firm, 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. That is, liability of a
partner is unlimited. Under LLP structure, on the other hand, liability of a partner is limited
to his agreed contribution.
3. Unlike conventional partnership, in LLP no partner is liable for the independent acts of
other partners. This unique characteristic of LLP shields individual partners from joint li-
ability created by another partner’s wrongful acts or misconduct. Mutual rights and duties
of the partners within an LLP are governed by an agreement (LLP Agreement) between the
partners or between the partners and the LLP as the case may be and in the absence of LLP
Agreement by Schedule I whereas under ordinary partnership mutual rights and duties of
partners are subject to agreement between the firm and the partners.
4. There shall not be any upper limit on number of partners in an LLP unlike an ordinary part-
nership firm where the maximum number of partners cannot exceed 20.

LLP Versus Joint Stock Company

A basic difference between an LLP and a joint stock company lies in that the affairs of a company are
regulated by the statute (i.e. Companies Act, 2013) whereas for an LLP it would be by a contractual
agreement between the partners. The management-ownership divide inherent in a company is not
there in a limited liability partnership.  LLP will have more flexibility as compared to a company and
subject to lesser compliance requirements as compared to latter. Moreover, incorporating an LLP is
cost effective compared to a joint stock company, as the minimum statutory fee for incorporation of
a company is Rs.6000, whereas that of LLP is Rs. 800. Also, a joint stock company is required to be
incorporated with minimum paid up capital of Rs.1 lakh, whereas there is no such minimum speci-
fied limit in case of LLP. Also, unlike companies, compliances such as holding of statutory meetings,
Self-Learning quarterly board meetings, and similar compliances are not required for LLPs.
202  Material
 E xercises Limited Liability
Partnership

I. Objective-type Questions
1. Which of the following statements are true in relation to an LLP? Notes
(i) Depending upon the agreement some or all partners have limited liability.
(ii) There is no limit to the maximum number of partners.
(iii) One partner is accountable for the acts of other partners.
(iv) It is called a hybrid between a company and a partnership
Answer Codes:
(a) Statements (i), (ii) and (iii) are true
(b) Statements (ii), (iii) and (iv) are true
(c) Statements (i) (ii) and (iv) are true
(d) Statements (i) , (iii) and (iv) are true
2. Limited Liability Partnership Act, 2008, came into effect on:
(a) 24 October, 2008 (b) 12 December, 2008
(c) 7 January, 2009 (d) 1 April, 2009
3. The additional responsibilities of designated members include:
(a) Signing accounts on behalf of the LLP
(b) Delivering accounts and annual returns to the Registrar of Companies (ROC)
(c) Notifying the ROC of changes to the LLP’s members or registered office, if
any and acting on behalf of the LLP in the event of winding up.
(d) All of the above
4. The foremost step to form an LLP electronically is:
(a) Obtaining DPIN and Digital Signature
(b) Choosing a Name for the LLP
(c) Drafting of LLP Agreement
(d) Filing of Incorporation Documents and Payment of Registration Fees
5. Which is not true in respect of an LLP?
(a) There must be at least two “Designated Members” at all times
(b) Designated members do not have the same rights and duties as any other
member
(c) There is no specific requirement to have any non-designated members
(d) An LLP may be established such that all members are considered to be
designated members
6. Which one of the following is an unincorporated organisation?
(a) General/Unlimited Partnership Firm
(b) Limited Liability Partnership Fir.
(c) Private Ltd. Company
(d) Public Ltd. Company
7. One of the major distinctions between a conventional (unlimited) partnership
and LLP is:
(a) In an LLP all the partners may not actively engage themselves in the func-
tion of the firm.
(b) An LLP is a distinct business model.
(c) In an LLP, one partner is not accountable for the acts (negligence or mis-
conduct) of other partners.
(d) An LLP offers the flexibility of internal control and management of firm’s
affairs through an ‘Agreement’.
8. The mutual rights and duties of partners of an LLP shall be governed by
(a) The LLP Act, 2008
(b) The ‘LLP Agreement’.
(c) The Companies Act, 2013
(d) The “LLP Agreement” and in the absence of the latter as to any matter, the
as per the Schedule I to the LLP Act
9. A Limited Liability Partnership may be wound up Self-Learning
(a) Voluntarily Material  203
Legal and Regulatory (b) By the Tribunal to be established under The Companies Act, 2013
Environment of (c) By the Registrar (ROC) if the firm fails to file annual return in the prescribed
Business form with the ROC within 60 days of closer of the financial year
(d) Either voluntarily or By the Tribunal to be established under The Companies
Notes Act, 2013
10. Besides any conventional partnership firm consisting of two or more partners
engaged in a profit-making venture to become an LLP at its option; an LLP, in
particular, can be formed with
(a) A minimum of two partners who must be individuals
(b) A minimum of two partners who must be resident individuals (ROI)
(c) A minimum of two partners who must be resident individuals (ROI) or body
corporate through their nominees.
(d) A minimum of two partners who may be individuals or body corporate
through their nominees.
II. Review Questions
1. What is Limited Liability Partnership? Discuss its structure.
2. Discuss the characteristic features of a limited liability partnership firm.
3. Discuss the essence of an LLP. Distinguish between an LLP and conventional part-
nership.
4. Comment on the following:
(a) Rationale behind introduction of LLP in India
(b) DPIN (c) LLP Versus Joint Stock Company
(d) LLP Agreement (e) Designated Partner

10. (d) 9. (d) 8. (d) 7. (c) 6. (a)

5. (b) 4. (a) 3. (d) 2. (d) 1. (c)
Answers to Multiple Choice Questions

Self-Learning
204  Material
 Chapter
10 In Review
Learning Objectives l The LLP is a body corporate and a legal entity separate from its members. It is con-
sidered to be a unique corporate business vehicle as it provides benefit of limited
What is a Limited Liability Partnership? liability while allowing its members the flexibility of organizing its affairs internally.
Rationale Behind Introduction of Llp in India Minimum of two partners are required to form of an LLP but there is no any limit
Structure of an LLP to the maximum number of partners. However, an entity set up for charitable or
Procedure of Formation of LLP in India other such purposes shall not be able to set up an LLP since the essential require-
ment for setting an LLP is “carrying on a lawful business with a view to profit”. The
LLP Act, 2008, also allows foreign nationals including foreign companies and LLPs to
Key Terms incorporate an LLP in India provided at least one designated partner of the “to-be-
Limited liability partnership: A partnership incorporated LLP” is resident of India. An LLP can be incorporated electronically in
in which some or all partners (depending on India with ease. LLPs shall be registered with the Registrar of Companies (ROC) after
the agreement) have limited liabilities following the provisions specified in the LLP Act.
LLP Agreement: Agreement or any
supplement thereof determining the
mutual rights, duties and obligations of
the partners in relation to each other and
Limited Liability Partnership(LLP)
Designated Partner Identification Number
(DPIN): An eight digit numeric number
allotted by the Central Government in order
to identify a particular partner in respect of
an LLP

Limited Liability Partnership  205

Legal and Regulatory

The Depositories
11
Environment of
Business

Notes
Act, 1996

© iStock
Learning Objectives
1. Major concepts 4. Power of the Company Law Board to
2. Important provisions call for information and enquiry
3. Rights and obligations of depositories, 5. Penalty for offences by companies
participants, issuers, and beneficial
owners

The Depositories Act, 1996: An Over view

T he Depositories Act, 1996, is an important legislation to provide for the regulation of deposito-
ries, which facilitates the holding of securities in dematerialised (electronic) form. It was enacted
by the Parliament in 1996 and extends to the whole of India. This legislation seeks to promote ef-
ficiency in settlement systems and curb the menace of fake, forged, and stolen securities. In the
depository system, the transfer of ownership of securities is done through simple account transfers.
The investor who is known as beneficial owner (BO) has to open a demat account through any DP
for dematerialisation of his holdings and transferring securities. This seems more or less similar to
holding funds in bank accounts. This method does away with all the risks and hassles normally as-
sociated with paperwork. The cost of transacting in a depository environment is considerably lower
as compared to transacting in certificates.

Major Concepts
Some of the important terms used in the Depositories Act are briefly introduced below.
Beneficial Owner refers to an investor whose name is recorded as such with a depository.
Board means the Securities and Exchange Board of India established under Section 3 of the SEBI
Act, 1992.
Bye-laws mean bye-laws made by a depository under Section 26.
Depository means a company formed and registered under the Companies Act, 1956, and which has
been granted a certificate of registration under Section 12(1A) of the SEBI Act, 1992.
Depository Participant (DP) refers to an agent of the depository who offers depository services to
investors. Accordint to SEBI guidelines, financial institutions, banks, stockbrokers, etc., are eligible
to act as DPs.
Issuer refers to any person making an issue of securities.
Record includes the records maintained in the form of books or stored in a computer or in such other
form as may be determined by regulations.
Self-Learning Registered Owner refers to a depository whose name is entered as such in the register of
206 Material the issuer.
Regulations mean the regulations made by the Board. The Depositories
Security means such security as may be specified by the Board. Act, 1996
Service means any service connected with recording of allotment of securities or transfer of owner-
ship of securities in the record of a depository.
Notes
Important Provisions
Important provisions of the Act have been briefly explained below.

Setting Up of Depository
The Depositories Act paved the way for the establishment of NSDL (National Securities Depository
Limited), the first depository in India. NSE joined hands with the leading financial institutions to
establish NSDL. It is a public ltd. company formed under the Companies Act, 1956. The legislative
framework governing the operations of NSDL has a three-tier structure:
Depositories Act, 1996 provides guidelines for the setting up and the working of depositories
in India.
SEBI (Depositories and Participants) Regulations, 1996 notified under the Depositories Act,
1996 provides the regulatory framework for depositories.
Byelaws and Business rules of NSDL governs the functioning and operational procedures of
NSDL and its business partners.
CDSL (Central Depository Securities Limited), the second depository in the country, was pro-
moted by BSE jointly with leading banks such as, SBI, Bank of India, Bank of Baroda, HDFC Bank,
Standard Chartered Bank, Union Bank of India, and Centurion Banks. It started its operations in 1999.

Certificate of commencement of business by depositories

(1) No depository shall act as a depository unless it obtains a certificate of commencement of
business from the Board.
(2) A certificate granted under sub-section (1) shall be in such form as may be specified by the
regulations.
(3) The Board shall not grant a certificate under sub-section (1) unless it is satisfied that the
depository has adequate systems and safeguards to prevent manipulation of records and
transactions provided that no certificate shall be refused under this section unless the de-
pository concerned has been given a reasonable opportunity of being heard [Section 3].

Role and Functions of Depositories, Participants,

Issuers, and Beneficial Owners
Agreement between depository and participant
(1) A depository shall enter into an agreement with one or more participants as its agent(s).
(2) Every agreement under sub-section (1) shall be in such form as specified by the bye-laws
[Section 4].

Services of depository
Any person, through a participant, may enter into an agreement, in such form as specified by the
bye-laws, with any depository for availing its services [Section 5].

Surrender of certificate of security

(1) Any person who has entered into an agreement under Section 5 shall surrender the certifi-
cate of security, for which he seeks to avail the services of a depository, to the issuer in such
manner as may be specified by the regulations.
(2) The issuer, on receipt of the certificate of security under sub-section (1), shall cancel the
certificate of security and substitute in its records the name of the depository as a registered
owner in respect of that security and inform the depository accordingly.
(3) A depository shall, on receipt of information under sub-section (2), enter the name of the
person referred to in sub-section (1) in its records, as the beneficial owner [Section 6].
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Material 207
Legal and Regulatory Registration of transfer of securities with depository
Environment of
(1) Every depository shall, on receipt of intimation from a participant, register the transfer of
Business
security in the name of the transferee.
Notes (2) If a beneficial owner or a transferee of any security seeks to have custody of such security
the depository shall inform the issuer accordingly [Section 7].

Options to receive security certificate or hold securities with depository

(1) Every person subscribing to securities offered by an issuer shall have the option either to
receive the security certificates or hold securities with a depository.
(2) Where a person opts to hold a security with a depository, the issuer shall intimate to such a
depository the details of allotment of the security, and, on receipt of such information, the
depository shall enter in its records the name of the allottee as the beneficial owner of that
security [Section 8].

Securities in depositories to be in fungible form

(1) All securities held by a depository shall be dematerialised and shall be in a fungible form i.e.,
returnable or negotiable in paper form.
(2) Nothing contained in Sections 153, 153A, 153B, 187B, 187C, and 372 of the Companies Act,
1956, shall apply to a depository in respect of securities held by it on behalf of the beneficial
owners [Section 9].

Rights of depositories and beneficial owner

(1) Notwithstanding anything contained in any other law for the time being in force, a deposi-
tory shall be deemed to be the registered owner for the purposes of effecting transfer of
ownership of security on behalf of a beneficial owner.
(2) Save as otherwise provided in sub-section (1), the depository as a registered owner shall not
have any voting rights or any other rights in respect of securities held by it.
(3) The beneficial owner shall be entitled to all the rights and benefits and be subjected to all
the liabilities in respect of his /her securities held by a depository [Section 10].

Register of beneficial owner

Every depository shall maintain a register and an index of beneficial owners in the manner provided
in Section 150, Section 151 and Section 152 of the Companies Act, 1956 [Section 11].

Pledge or hypothecation of securities held in a depository

(1) Subject to such regulations and bye-laws, as may be made in this behalf, a beneficial owner
may, with the previous approval of the depository, create a pledge or hypothecation in re-
spect of a security owned by him/her through a depository.
(2) Every beneficial owner shall give intimation of any such pledge or hypothecation to the
depository and such a depository shall thereupon make entries in its records accordingly.
(3) Any entry in the records of a depository under sub-section (2) shall be evidence of a pledge
or hypothecation [Section 12].

Furnishing of information and records by depository and issuer

(1) Every depository shall furnish to the issuer information about the transfer of securities in
the name of beneficial owners at such intervals and in such a manner as may be specified by
the bye-laws.
(2) Every issuer shall make available to the depository copies of the relevant records in respect
of securities held by such a depository [Section 13].

Option to opt out in respect of any security

(1) If a beneficial owner seeks to opt out of a depository in respect of any security he/she shall
Self-Learning inform the depository accordingly.
208  Material
 (2) The depository shall, on receipt of intimation under sub-section (1), make appropriate en- The Depositories
tries in its records and shall inform the issuer. Act, 1996
(3) Every issuer shall, within 30 days of the receipt of intimation from the depository and on fulfil-
ment of such conditions and on payment of such fees as may be specified by the regulations,
Notes
issue the certificate of securities to the Beneficial Owner or the transferee, as the case may be
[Section 14].

The Bankers’ Books Evidence Act to apply to depositories

The Banker’s Books Evidence Act, 1891, shall apply in relation to a depository as if it were a bank as
defined in Section 2 of that Act [Section 15].

Depositories to indemnify loss in certain cases

(1) Without prejudice to the provisions of any other law for the time being in force, any loss
caused to the Beneficial Owner due to the negligence of the depository or the participant,
the depository shall indemnify such a Beneficial Owner.
(2) Where the loss due to the negligence of the participant under sub-section (1) is indemnified
by the depository, the depository shall have the right to recover the same from the partici-
pant [Section 16].

Rights and obligations of depositories

(1) Subject to the provisions of this Act, the rights and obligations of the depositories, partici-
pants, and the issuers whose securities are dealt with by a depository shall be specified by
the regulations.
(2) The eligibility criteria for admission of securities into the depository shall be specified by the
regulations [Section 17].

Enquir y and Inspection

Power of the Board to call for information and enquiry
(i) The Board, on being satisfied that it is necessary in the public interest or in the interest of
investors to do so, may, by order in writing
(a) call upon any issuer, depository, participant, or beneficial owner to furnish in writing
such information relating to the securities held in a depository, as it may require; or
(b) authorise any person to make an enquiry or inspection in relation to the affairs of the
issuer, beneficial owner, depository, or participant, who shall submit a report of such
enquiry or inspection to it within such period as may be specified in the order.
(ii) Every director, manager, partner, secretary, officer or employee of the depository, or issuer
or the participant or beneficial owner shall, on demand, produce before the person making
the enquiry or inspection, all information or such records and other documents in his/her
custody having a bearing on the subject matter of such enquiry or inspection [Section 18].

Power of Board to give directions in certain cases

Save as provided in this Act, if after making, or causing to be made, an enquiry or inspection, the
Board is satisfied that it is necessary
(i) in the interest of investors, or orderly development of securities market; or
(ii) to prevent the affairs of any depository or participant being conducted in the manner detri-
mental to the interests of investors or securities market, it may issue such directions:
(a) to any depository or participant or any person associated with the securities market; or
(b) to any issuer, as may be appropriate in the interest of investors or the securities market
[Section 19].

Penalties
Offences
Whoever contravenes or attempts to contravene or abets the contravention of the provisions of this Self-Learning
Act or any regulations or bye-laws made thereunder shall be punishable with imprisonment for a Material  209
term which may extend to five years, or with fine, or with both [Section 20].
Legal and Regulatory Offences by companies
Environment of
(1) Where an offence under this Act has been committed by a company, every person who at the
Business
time the offence was committed was in charge of, and was responsible to, the company for
Notes the conduct of the business of the company, as well as the company, shall be deemed to be
guilty of the offence and shall be liable to be proceeded against and punished accordingly:
However, any such person liable to any punishment provided in this Act, if he proves that
the offence was committed without his knowledge or that he had exercised all due diligence
to prevent the commission of such an offence.
(2) Where an offence under this Act has been committed by a company and it is proved that
the offence has been committed with the consent or connivance of, or is attributable to
any neglect on the part of, any director, manager, secretary or other officer of the company,
such a director, manager, secretary or other officer shall also be deemed to be guilty of the
offence and shall be liable to be proceeded against and punished accordingly [Section 21].
Explanation:  For the purposes of this section,
(a) Company means any body or corporate and includes a firm or other association of individu-
als; and
(b) Director, in relation to a firm, means a partner in the firm.

Miscellaneous
Cognizance of offences by courts
(1) No court shall take cognizance of any offence punishable under this Act or any regulations
or bye-laws made there under, save on a complaint made by the Board.
(2) No court inferior to that of a Metropolitan Magistrate or a Judicial Magistrate of the First
Class shall try any offence punishable under this Act [Section 22].

Appeals
(1) Any person aggrieved by an order of the Board made under this Act, or the regulations made
there under, may prefer an appeal to the Central Government within such time as may be
prescribed.
(2) No appeal shall be admitted if it is preferred after the expiry of the period prescribed there-
fore.
However, an appeal may be admitted after the expiry of the period prescribed if the appel-
lant satisfies the Central Government that he had sufficient cause for not preferring the
appeal within the prescribed period.
(3) Every appeal made under this Section shall be made in such form and shall be accompanied
by a copy of the order appealed against and by such fees as may be prescribed.
(4) The procedure for disposing of an appeal shall be such as may be prescribed.
However, before disposing of an appeal, the appellant shall be given a reasonable opportu-
nity to be heard [Section 23].

Power of Central Government to make rules

(i) The Central Government may, by notification in the Official Gazette, make rules for carrying
out the provisions of this Act.
(ii) In particular, and without prejudice to the generality of the foregoing power, such rules may
provide for all or any of the following matters, namely:
(a) the time within which an appeal may be preferred under sub-section (1) of Section 23;
(b) the form in which an appeal may be preferred, under sub-section (3) of Section 23 and
the fees payable in respect of such appeal;
(c) the procedure for disposing of an appeal under sub-section (4) of Section 23 [Section
24].

Power of Board to make regulations

(i) Without prejudice to the provisions contained in Section 30 of the Securities and Exchange
Self-Learning
Board of India Act, 1992 (15 of 1992), the Board may, by notification in the Official Gazette,
210  Material
 make regulations consistent with the provisions of this Act and the rules made thereunder The Depositories
to carry out the purposes of this Act. Act, 1996
(ii) In particular, and without prejudice to the generality of the foregoing power, such regula-
tions may provide for:
Notes
(a) the form in which record is to be maintained under clause (i) of sub-section (1) of Section
2;
(b) the form in which the certificate of commencement of business shall be issued under
sub-section (2) of Section 3;
(c) the manner in which the certificate of security shall be surrendered under sub-section
(1) of Section 6;
(d) the manner of creating a pledge or hypothecation in respect of security owned by a
beneficial owner under sub-section (1) of Section 12;
(e) the conditions and the fees payable with respect to the issue of certificate of securities
under sub-section (3) of Section 14;
(f) the rights and obligations of the depositories, participants and the issuers under sub-
section (1) of Section 17;
(g) the eligibility criteria for admission of securities in the depository under sub-section (2)
of Section 17 [Section 25].

Power of depositories to make bye-laws

(i) A depository shall, with the previous approval of the Board, make bye-laws consistent with
the provisions of this Act and the regulations.
(ii) In particular, and without prejudice to the generality of the foregoing power, such bye-laws
shall provide for:
(a) the eligibility criteria for admission and removal of securities in the depository;
(b) the conditions subject to which the securities shall be dealt with;
(c) the eligibility criteria for admission of any person as a participant;
(d) the manner and procedure for dematerialization of securities;
(e) the procedure for transactions within the depository;
(f) the manner in which securities shall be dealt with or withdrawn from a depository;
(g) the procedure for ensuring safeguards to protect the interests of participants and ben-
eficial owners;
(h) the conditions of admission into and withdrawal from a participant by a beneficial owner;
(i) the procedure for conveying information to the participants and beneficial owners on
dividend declaration, shareholder meetings and other matters of interest to the beneficial
owners;
(j) the manner of distribution of dividends, interest and monetary benefits received from
the company among beneficial owners;
(k) the manner of creating pledge or hypothecation in respect of securities held with a deposi-
tory;
(l) oversea rights and obligations among the depository, issuer, participants and beneficial
owners;
(m) the manner and the periodicity of furnishing information to the Board, issuer, and other
persons;
(n) the procedure for resolving disputes involving depository, issuer, company, or a benefi-
cial owner;
(o) the procedure for proceeding against the participant committing breach of the regula-
tions and provisions for suspension and expulsion of participants from the depository
and cancellation of agreements entered with the depository;
(p) the internal control standards including the procedure for auditing, reviewing and moni-
toring.
(iii) Where the Board considers it expedient so to do, it may, by order in writing, direct a deposi-
tory to make any bye-laws or to amend or revoke any bye-laws already made within such
period as it may specify in this behalf.
(iv) If the depository fails or neglects to comply with such an order within the specified period,
the Board may make the bye-laws or amend or revoke the bye-laws made either in the form Self-Learning
specified in the order or with such modifications thereof, as the Board thinks fit [Section 26]. Material  211
Legal and Regulatory Removal of difficulties
Environment of
(1) If any difficulty arises in giving effect to the provisions of this Act, the Central Government
Business
may, by order published in the Official Gazette, make such provisions not inconsistent with
Notes the provisions of this Act as appear to it to be necessary or expedient for removing the dif-
ficulty:
However, no order shall be made under this Section after the expiry of a period of two years
from the commencement of this Act.
(2) Every order made under this Section shall be laid, as soon as possible after it is made, before
each House of Parliament [Section 29].

Internal and Concurrent Audit of Depository Participants

While the Depositories Act, 1996 and SEBI (Depositories and Participants) Regulations, 1996, pro-
vide regulatory framework for functioning of depositories in India. NSDL and CSDL, the two deposi-
tory service providers in the Indian capital markets with almost 100 lakh demat accounts between
them have authorized Practising Company Secretaries to undertake internal and concurrent audit
of the operations of the Depository Participants (DPs). The purpose of this audit is to assure the
management and depositories that the business operations of the participant are conducted in the
manner that all the foreseeable risks are addressed to with appropriate internal control mechanism.
The audit focuses on account opening procedures and would entail following all the known know-
you-client (KYC) norms and cross checking with the Tax Information Network's permanent account
number (PAN) database. Besides, it will also include issuance of delivery instruction slip booklets,
date and time of stamping of instruction slips, blocking of used/reported lost/stolen instruction
slips and so on.
The concurrent audit is to be done by chartered accountants or company secretaries holding a
certificate of practice. An auditor is supposed to conduct the audit within the same day or latest by
the next working day. In case the audit cannot be completed due to a large volume of applications,
the auditor should ensure that it is completed within a week. The concurrent audit will be effective
from August 1, '06 and the report is to be submitted on a quarterly basis. The Institute of Company
Secretaries of India had brought out a Handbook on Internal Audit of Depository participants.

E xercises
I. Objective-type Questions
1. Beneficial owner means
(a) a person whose name is recorded as such with a depository
(b) any person making an issue of securities
(c) a person registered as such under sub-section 1A of Section 12 of the SEBI
Act
(d) a company formed and registered under the Companies Act, 2013 and which
has been granted a certificate of registration under the SEBI Act
2. Rules made by the Central Government for carrying out the provisions of the
Depositories Act may provide for
(a) the time within which an appeal may be preferred under sub-section (1) of
Section 23
(b) the form in which an appeal may be preferred, under sub-section (3) of
Section 23 and the fees payable in respect of such an appeal
(c) the procedure for disposing of an appeal under sub-section (4) of Section
23
(d) for all or any of the above matters
3. Regulations made by the Board may provide for
(a) the form in which record is to be maintained
(b) the rights and obligations of the depositories, participants, and the issuers
(c) the manner in which the certificate of security shall be surrendered
(d) all of the above
Self-Learning
212  Material
 4. Bye-laws made by the depositories shall provide for The Depositories
(a) the eligibility criteria for admission and removal of securities in the deposi- Act, 1996
tory
(b) the eligibility criteria for admission of any person as a participant
(c) the manner and procedure for dematerialization of securities Notes
(d) all of the above
5. Who is a registered owner?
(a) a depository whose name is entered as such in the register of the issuer
(b) any person making an issue of the securities
(c) a person whose name is recorded as such with a depository
(d) all of the above
6. is the first and largest depository in India.
(a) CSDL (b) IDBI
(c) NSDL (d) UTI
7. The conversion of paper-form of securities into electronic form is known as
form.
(a) Rematerialised (b) Dematerialised
(c) Both A and B (d) None of the Above
8. A bundle of securities, packaged for the purpose of maximizing returns or mini-
mizing risks is called .
(a) Portfolio (b) Portfolio Revision
(c) Portfolio Evaluation (d) Portfolio Selection
9. An important regulation which seeks to facilitate the holding of securities in
demat form and promote the efficiency in settlement systems is known as:
(a) The Securities Contracts (Regulation) Act, 2013
(b) The Depositories Act, 1996
(c) The IT Act, 2000
(d) The Competition Act, 2002
10. Arrange the following in the order in which they were established
(i) CDSL (ii) Depository Act
(iii) NSDL (iv) SEBI
Answer Codes:
(a) (i), (ii), (iii), (iv) (b) (iv), (ii), (ii), (iii)
(c) (iv), (i), (ii), (iii) (d) (iv), (ii), (iii), (i)
II. Review Questions
1. Define the following terms under the Depositories Act, 1996:
(a) Beneficial owner (b) Board (c) Participant
(d) Issuer (e) Depository (f) Registered owner
2. Under what circumstances can the Board issue directions to any depository, par-
ticipant, issuer?
3. Explain the power of the Central Government to make rules for carrying out the
provisions of the Depositories Act. Outline the matters that these rules may pro-
vide for, in particular.
4. Comment on the ‘power of the Board to make regulations’.
5. ‘The bye-laws made by the depositories shall provide for certain matters’. Enu-
merate these matters.

10. (d) 9. (b) 8. (a) 7. (b) 6. (c)

5. (a) 4. (d) 3. (d) 2. (d) I. (a)
Answers to Objective-type Questions

Self-Learning
Material  213
 Chapter
11 In Review
Learning Objectives ●● The introduction of depository system has brought a revolutionary change in the way
the capital market operates. The Depositories Act, 1996 in this behalf is an important
Major concepts legislation. Towards the capital market reforms, the Act provides for the regulation
Important provisions of the depositories in securities. It paved the way for the establishment of two de-
positories—NSDL and CDSL, respectively, with the objective of enhancing efficiency
Rights and obligations of depositories, in settlement systems and also to reduce the peril of fake, forged, and stolen securi-
participants, issuers, and beneficial owners ties. In the depository system, securities are held in depository accounts (in dema-
Power of the Company Law Board to call for terialised form), more or less similar to holding funds in bank accounts. The transfer
information and enquiry of ownership of securities is done through simple account transfers. This process
provides convenient, dependable, and secure depository services at affordable cost
Penalty for offences by companies
to all market participants. Though the depository system has effectively eliminated
paper-based certificates which were prone to be fake, forged, and counterfeit result-
ing in bad deliveries, yet a lot needs to be done to make the markets efficient and
Key Terms investor friendly.
Beneficial owner: An investor whose name
is recorded with a depository
Depository: An organisation which holds
securities (like shares, debentures, bonds,
government securities, mutual fund units
etc.) of investors in electronic form at their
request through a registered Depository
Participant
Depository participant: An agent of the
depository who offers depository services
to investors
Issuer: Any person making an issue of
securities
Registered owner: A depository whose
name is entered in the register of the issuer

214  Legal and Regulatory Environment of Business

 Nature and Kinds of

Nature and Kinds of

12
Companies, Company …

Companies, Company Notes

Formation and
Prospectus

© iStock
Learning Objectives
1. Company: meaning and defining char- 3. Lifting the corporate veil
acteristics 4. Formation of company
2. Kinds of companies 5. Prospectus

The Companies Act, 2013: An Over view

T he laws governing companies in India have been compiled and contained in the Companies Act,
2013, which through its various provisions seeks to protect the interest of various stakeholders
dealing with the company. The new Act consists of 470 sections spread over 29 chapters and seven
schedules appended to it. Thus, as many as 188 sections of the preceding legislation (Companies
Act, 1956) have been scrapped in the new Act so as to make it a more compact and effective legisla-
tion. The new company law adopts forward looking approach, which empowers Central Government
to frame rules governing companies and makes contravention of any of the rules punishable with
fine. This is a landmark legislation that will have a wide ranging impact on corporate India as it inter
alia introduces higher standards of corporate governance and makes spending on corporate social
responsibility (CSR) mandatory; promotes gender equality on corporate boards; allows for class
action suits; and looks forward to overhaul the way companies function and are regulated in the
country. The main amendments brought about by the new legislation (Companies Act, 2013), in a
nut shell, are given in the box below.

The Companies Act, 2013: Major provisions at a glance

● Provision for a uniform financial year i.e. from 1st April to 31st March for all the companies
subject to certain exceptions [Section 2(41)].
● Provision made for ‘One Person Company’ (OPC), which means a private limited company
having only one person as a member – a new vehicle for individuals for carrying on business
with limited liability [Section 2(62)].
● Maximum number of members in a ‘private limited company’ increased from 50 to 200 to
expand the scope of operations of private limited companies [Section 2(68)].
● The concept of ‘small company’ has been introduced for the first time by the new Act, which
means a private company, the paid up share capital of which does not exceeds fifty lakh
rupees or such higher amount as may be prescribed, which shall not be more than five crore
rupees; or turnover of which as per its last profit and loss account does not exceeds two
crore rupees or such higher amount as may be prescribed, which shall not be more than
twenty crore rupees [Section 2(85)]. Self-Learning
Material 215
Legal and Regulatory
Environment of
●● The organization of ‘object clause’ of the memorandum into three distinct sub-clauses i.e.,
Business the main, ancillary and other objects has been done away with. Now the memorandum
should contain only the object(s) for which the company is proposed to be incorporated
Notes and any matter considered necessary for furtherance thereof [Section 4(c)].
●● Tribunal has been empowered to direct removal of a company’s name from the register of
companies, if the company got incorporated by furnishing false or incorrect information
or by suppressing material facts [Section 7].
●● No company (even a private company) having a share capital can commence any business or
exercise any borrowing powers immediately after being incorporated i.e. without fulfilling
certain formalities [Section 11].
●● Private limited companies, now can issue equity shares with differential voting rights with-
out complying with the requirement of Rule 4 of Companies (Share Capital and Debenture
Rules, 2014), which otherwise requires a track record of distributable profit for last three
years, authority in AOA, ordinary resolutions, etc. [Sections 43 & 47].
●● The scope of ‘officer who is in default’ widened and shall now include specified external
agencies and individuals [Section 60].
●● Buy-back of shares by the companies has been liberalized by relaxing certain conditions.
Companies now can buy-back their shares and other securities even if they have defaulted
in repayment of deposits or interest payable thereon, redemption of debentures, or pay-
ment of dividends provided the default is remedied and a period of three years has lapsed
after such default ceases to subsist [Section 70 Proviso].
●● The time limit of 18 months for holding first AGM by a company (other than ‘OPC’) from
the date of its incorporation has been curtailed to 9 months. The first AGM, however, as
provided earlier, shall be held within 9 months from the date of the closure of its first finan-
cial year. Every subsequent AGM must be held within six months from the date of closing
of the relevant financial year [Section 96(1) Proviso].
●● Every listed company or one having 1000 or more shareholders will have to mandatorily
provide an e-voting facility to its members to vote at general meetings after 31 December
2014. However, all listed companies shall have to provide the e-voting facility to its mem-
bers for all resolutions in general meetings with immediate effect [Section 108 read with
Companies (M & A) Rules, 2014].
●● Some specified business by any company other than ‘OPC’ or a private limited company can
be transacted only by means of postal ballot, which means voting (for passing resolutions)
by post or any electronic mode [Section 110].
●● A company will be under legal obligation to transfer the unpaid or unclaimed dividend
to a special account opened in any scheduled bank called the ‘Unpaid Dividend Account’
[Section 124].
●● ‘Consolidated Financial Statements’ shall be mandatory if a company has one or more
subsidiaries, which shall include its balance sheet, profit and loss account and cash flow
statement. Earlier (under the Companies Act, 1956) these documents were required to be
filed separately [Section 129].
●● Provision made for constitution of the National Financial Reporting Authority (NFRA) by
the Central Government to provide for matters related to accounting and auditing stand-
ards under the Act. NFRA shall be a quasi-judicial body, empowered to exercise disciplinary
control over the chartered accountants [Section 132].
●● Provisions requiring certain companies to set up Corporate Social Responsibility (CSR)
committees to formulate policies for the social and economic welfare of the neglected or
deprived class of the society, introduced and thereby mandated CSR spending [Section
135].
●● Internal audit by CAs/CWAs/such other professionals as may be decided by the Board shall
be mandatory for prescribed classes of companies [Section 138].
●● Maximum tenure of ‘Auditors’ and ‘Independent Directors’ specified [Sections 139(2) &
149(11)].
●● Compliance with the auditing standards by the company auditor shall be mandatory
[Section 143(9)].
Self-Learning ●● Every listed public company and other prescribed classes of companies shall have at least
216  Material one-third of the total number of directors as ‘Independent Directors’ [Section 149].
 Nature and Kinds of
●● Every company shall have at least one ‘Resident Director’ who has stayed in India for not Companies, Company …
less than 182 days in the previous calendar year [Section 149].
●● One ‘woman director’ shall be mandatory for prescribed classes of companies [Section
149]. Notes
●● Every listed company shall have one director elected by ‘small shareholders’. In this behalf
‘small shareholders’ means a shareholder holding shares of nominal value of not more than
twenty thousand rupees or such other sum as may be prescribed [Section 151].
●● Board of Directors of private limited companies having up to 50 members, now can exer-
cise certain powers (borrowing money, investing, selling or leasing undertakings of the
company) without obtaining the consent of members by way of a special resolution [Sec-
tion 180].
●● The limit of raising political contribution by a company has been raised to 7.5% from the
existing 5% of the average net profit of the company during the three immediately preced-
ing financial years [Section 182].
●● A new provision prohibiting insider trading in securities by a director or key managerial
personnel (KMP) with criminal implications for non-compliance introduced. [Section 195]
●● Secretarial audit (a compliance audit by an independent company secretary) has been
made mandatory for every listed company and other specified companies effective from
the financial year 2013-14 onwards. Certain ‘Secretarial Standards’ issued by the Institute
of Company Secretaries of India (ICSI) shall be mandatory [Section 204].
●● Provision made for investigation into the affairs of companies by Serious Fraud Investiga-
tion Office (SFIO) [Section 211].
●● Existing restrictions on the merger of an Indian company with a foreign company in spe-
cific jurisdictions removed; facilitating cross-border corporate flexibility [Section 234].
●● Provision made to obtain the status of a ‘dormant company’ which means company that
doesn’t trade and has no accounting transactions [Section 455].
●● National Company Law Tribunal (NCLT) and National Company Law Appellate Tribunal
(NCLAT) shall now be a reality to deal with any oppression or mismanagement in a com-
pany as the existing Company Law Board has been abolished [Chapter XXVII].
Note: All the above provisions/amendments have become applicable from the commencement
of the new Act i.e. 1st April 2014 unless otherwise specified.

Company: Concept and Origin

The term ‘company’ is derived from the Latin words ‘com’, meaning with or together and ‘pains’,
meaning bread. Originally, it referred to a group of persons who would take their meals together. In
common parlance, however, a company refers to an assemblage of people who have come together
for some specific purpose; economic, or otherwise; and who have incorporated themselves into a
distinct legal entity in the form of a corporation for that purpose. Companies are a useful device to
do business, especially when the business has grown bigger than can be effectively managed by a
few people, and also requires added financial support.

Company: Definition and characteristics

The Companies Act does not define a company in terms of its characteristic features. Section 2(20)
merely reads, ‘a company means a company formed and registered under this Act or under any pre-
vious company law’. Thus, the above section does not identify any describing feature of a company.
However, to understand the nature of a company, the following definitions may prove of some help.
A company is an association of many persons who contribute money or monies worth to a common
stock and employ in some trade or business and who share the profit and loss arising therefrom. The
common stock so contributed is denoted in money and is the capital of the company. The persons
who contribute to it or whom it pertains to are members. The proportion of capital to which each
member is entitled is his share. The shares are always transferable albeit the right to transfer is
often more or less restricted. Lord Justice Lindley
A corporation is an artificial being, invisible, intangible, and existing only in contemplation of the
Self-Learning
law. Being a mere creation of law, it possesses only the properties, which the Charter of its creation Material  217
confers upon it, either expressly or as incidental to its very existence. Chief Justice Marshall
Legal and Regulatory A company is an artificial person created by law, having a separate entity, with a perpetual succes-
Environment of sion and common seal. Prof. Haney
Business
The above definitions bring out the following distinct features of a company, which together
Notes make it a unique association and explicate its nature.
1. Independent legal entity
2. Limited liability
3. Everlasting existence
4. Separate property
5. Flexibility of investment
6. Common seal
7. Capacity to sue and being sued
8. Separation of ownership and management
9. Proportionate representation
10. Right to own property

(H3)Independent Legal Entity

After being incorporated under the Act, a company becomes an independent legal entity, with an
existence separate from its members. It has its own identity (name) and seal, its assets and liabilities
are separate and distinct from those of its members. It is capable of owning a property, incurring
debt, having a bank account, employing people, entering into contracts, and suing and being sued
separately.
Limited liability  Limited liability is a concept whereby a person’s financial liability is limited to a
fixed sum, most commonly the value of a person’s investment in a company or partnership with lim-
ited liability. A shareholder in a limited company is not personally liable for any of the debts of the
company other than for the value of his investment in that company. In other words, a shareholder
is liable to pay only the unpaid money due on the shares held by him when called upon to pay and
nothing more, even if liabilities of the company far exceed its assets. By contrast, sole proprietors
and partners in general partnerships are each liable for all the debts of the business due to unlimited
liability.
Although a shareholder’s liability for the company’s actions is limited, the shareholder may still
be liable for its own acts. For example, the directors of small companies (who are frequently also
shareholders) are often required to give personal guarantees of the company’s debts to those lend-
ing to the company. They will then be liable for those debts in the event that the company cannot
pay, although the other shareholders will not be so liable. This is known as co-signing.
Everlasting existence  A company does not die or cease to exist unless it is deliberately wound
up or the task for which it was formed has been completed. Membership of a company may keep on
changing from time to time but that does not affect the life of the company. Death or insolvency of
members does not have an effect on the subsistence of a company.
Separate property  Since a company is a distinct legal entity, the company’s property is its own.
A shareholder cannot claim to be the owner of the company’s property during the existence of the
company. The Supreme Court of India has held that a shareholder is not the part-owner of the com-
pany or its property; he is only given certain rights by law, for example, to vote or attend meetings,
or to receive dividends.
Flexibility of investment  Shares in a company are freely transferable. When a shareholder trans-
fers his shares to another person, the transferee steps into the shoes of the transferor and acquires
all the rights of the transferor in respect of those shares. However, private companies can restrict
the right of their members to transfer shares.
Common seal  A company, though a juristic person, does not have a physical presence. Therefore,
it acts through its managerial personnel—Board of directors—for carrying out its activities and
entering into various contracts. Such contracts must bear the seal of the company. The common
seal is used by a company as the symbol of its incorporation and acts as the official signature of
the company. The name of the company must be engraved on the common seal. Any document not
bearing the common seal may not be accepted as authentic and, hence, the same may not have any
Self-Learning legal effect.
218  Material
Capacity to sue and being sued  A company can sue or be sued in its own name as distinct from Nature and Kinds of
its members. Similarly, a company has every right to enter into contractual obligations with other Companies, Company …
parties. However, the Supreme Court of India has held in the case of State Trading Corporation of
India vs. CTO3 that a company cannot have the status of a citizen under the Constitution of India.
Notes
Separation of ownership and management  A company is administered and managed by the
Board of directors. The shareholders are simply the holders of the shares in the company and need
not necessarily be the managers of the company.
Proportionate representation  Proportional representation implies ‘one share - one vote’, i.e., if
a person has 10 shares, he will have 10 votes in the company. This is in direct contrast to the voting
principle of a co-operative society where the ‘one member - one vote’ principle applies, i.e., irrespec-
tive of the number of shares held; one member can have only one vote.
Right to own property  Company is a distinct legal entity and can own, transfer, and manage a
property in its own way. The company’s property is its personal. A member cannot claim to be the
owner of the company’s property not only during the existence of the company, but in the event of
its being wound-up too.

Company Distinguished From Ordinar y Partnership Firm

A company differs from an ordinary partnership firm in several material respects, discussed as
follows:
1. An ordinary or conventional partnership firm is governed by the Indian Partnership Act, 1932,
whereas a company is governed by the Companies Act, 2013.
2. A partnership is sum total of persons who have come together to share the profits of the
business carried on by all or any of them acting for all. It is not a distinct legal entity. Registra-
tion is not obligatory in case of partnership; it comes into being on the basis of agreement,
oral or written. Conversely, a company represents a group of persons who have associated
together for the attainment of a specific goal, business, or otherwise. It enjoys a separate
legal existence independent of its members after being registered (compulsorily) under the
law.
3. Liability of the partners of a firm is unlimited. Whereas, the liability of shareholders of a
limited company is limited to the extent of unpaid shares or the unpaid amount guaranteed
by them.
4. Property of the firm belongs to the partners and they are collectively entitled to it. But in
case of a company, the property belongs to the company and not to its members or share-
holders.
5. A partner cannot transfer his interest in the partnership firm without the consent of all
other partners. Whereas in case of a company, shares may be transferred freely without the
permission of other members, unless contrary provisions exist in the articles, that usually
happens in case of a private company.
6. In an ordinary partnership, the number of members must not exceed 10 in case of a banking
business and 20 in other businesses. A public company may have as many members as it
desires subject to a minimum of seven members. A private company cannot have more than
200 members.
7. There must be at least two members to form a partnership firm. The minimum number of
members necessary for a public limited company is seven and for a private limited company
is two.
8. In case of a partnership, consent of all the partners is required for any decision. In case of a
company, decision of the majority members or shareholders prevails.
9. On the death of any partner, the partnership is dissolved unless there is a provision to the
contrary. Conversely, on the death of a shareholder the company’s existence does not get
terminated.

Limited Liability Partnership Firm vs. Joint Stock Company

A joint stock company also differs from a limited liability partnership (LLP) firm in that the affairs
of a company are regulated by the statute (i.e. Companies Act, 2013) whereas for an LLP it would be Self-Learning
Material  219
Legal and Regulatory by a contract among the partners. The management-ownership divide inherent in a company is not
Environment of there in an LLP. An LLP will have more flexibility as compared to a company and will be subjected to
Business lesser compliance requirements as compared to latter. Moreover, incorporating an LLP firm is cost
effective compared to a joint stock company, as the minimum statutory fee for incorporation of a
Notes
company is Rs.6000 whereas that of an LLP is Rs. 800. Also, a joint stock company is required to
be incorporated with a minimum paid up capital of Rs.5 lakh (for a public limited company) and Rs.
1 lakh, (for a private limited company) whereas there is no such minimum specified limit in case of
an LLP. Also, unlike companies, compliances such as holding of statutory meetings, quarterly board
meetings and similar compliances are not required for LLPs.

Kinds of Companies
Companies may be classified into the following categories:
1. Private and public companies
2. Limited and unlimited companies
3. One person company
4. Small company
5. Charitable companies
6. Parent and subsidiary companies
7. Government company
8. Foreign company
9. Dormant company

Private and Public Companies

On the basis of their defining characteristics, companies may be classified as private company and
public company, as discussed below.

Private Company
‘Private company’ means a company having a minimum paid-up share capital of one lakh rupees or
such higher paid-up share capital as may be prescribed, and which by its articles,
(i) restricts the right to transfer its shares;
(ii) except in case of ‘One Person Company’, limits the number of its members to two hundred;
and
(iii) prohibits any invitation to the public to subscribe for any securities of the company.
However, for the purpose of clause (ii), where two or more persons hold one or more shares in
a company jointly, they shall, be treated as a single member. Moreover, persons who are in the em-
ployment of the company; and persons who, had been formerly in the employment of the company,
were members of the company while in that employment and have continued after the employment
ceased, shall not be included in the number of members [Section 2(68)].
If a private company contravenes any of the aforesaid provisions, it ceases to be a private com-
pany and thereby loses all the exemptions and privileges, which it otherwise is entitled to.

Public Company
‘Public company’ means a company which,
(a) is not a private company;
(b) has a minimum paid-up capital of five lakh rupees or such higher paid-up capital as may be
prescribed;
However, a private company, which is a subsidiary of a public company, shall be deemed to be a
public company [Section 2(71)].

Privileges and Exemptions of a Private Limited Company

A private limited company as against a public limited one enjoys the following privileges and ex-
emptions:
1. Minimum number of members in respect of a private limited company is two as against
seven in case of a public limited company [Section 2(68) & (71)].
Self-Learning 2. Minimum number of directors is only two in respect of a private limited company whereas
220  Material three in case of a public one [Section 149].
 3. Private limited Companies, now can issue equity shares with differential voting rights with- Nature and Kinds of
out fulfilling the requirement of a track record of distributable profits for last three years, Companies, Company …
provisions in the articles, ordinary resolutions, etc. [Rule 4 of Companies (Share Capital and
Debenture) Rules, 2014].
Notes
4. Ordinary resolution instead of a special one is enough for a private limited company for
offering shares to its employees under the ESOP scheme at the time of allotment of shares
[Section 62(1) (b)].
5. Private limited companies (covered in the exemption limit) can accept deposit from their
members without complying with a strict procedure, including issue of circular, creating
deposit insurance, etc [Section 73(2)].
6. A private limited company is exempt from summiting the candidature of a person to appoint
him as the director in general meeting [Section 160].
7. Single motion in general meeting to appoint two or more person as directors is allowed for
private limited companies [Section 162].
8. Board of directors of private limited companies having up to 50 members, can exercise cer-
tain powers (borrowing money, investing, selling or leasing undertakings of the company)
without obtaining the consent of members by way of a special resolution [Section 180].
9. A private limited company (fulfilling the exemption criteria) can advance loan to its director
and any person in whom directors are interested [Section 185].
10. Private limited companies can enter into a contract with related parties in which directors
are interested [Section 188].
11. No need to take the approval of the Central Government and shareholders for appointing
and fixing terms and conditions and remuneration of the managing director (MD), whole-
time director or manager by private limited companies [Section 196(4) & (5)].

Conversion of a Private Limited Company into a Public Limited Company and Vice-Versa
A private limited company can be converted into a public limited one and vice-versa through altera-
tion of articles of the company in question provided such alteration is approved by the Tribunal. In
this behalf, the Companies Act, 2013 provides as under:
Subject to the provisions of this Act and the conditions contained in its memorandum, if any,
a company may, by a special resolution, alter its articles including alterations having the effect of
conversion of: -
(a) a private company into a public company; or
(b) a public company into a private company:
However, when a company being a private company alters its articles in such a manner that they
no longer include the restrictions and limitations which are required to be included in the articles
of a private company under this Act, the company shall, as from the date of such alteration, cease
to be a private company:
Any alteration having the effect of conversion of a public company into a private company shall
not take effect except with the approval of the Tribunal which shall make such an order as it may
deem fit [Section 14(1)].
Every alteration of the articles under this section and a copy of the order of the Tribunal approv-
ing the alteration as per sub-section (1) shall be filed with the Registrar, together with a printed copy
of the altered articles, within a period of fifteen days in such manner as may be prescribed, who shall
register the same [Section 14(2)].

Limited and Unlimited Companies

A company may be limited or unlimited.

Limited company
A limited company is one wherein the liability of its members is limited and may further be sub-
classified as below.
A company limited by shares  This is the most common form of a company used for business
ventures. Specifically, a limited company is a ‘company in which the liability of each shareholder or
member is limited to the amount individually invested’. Shareholders have no financial liability in
case of fully paid-up shares. Self-Learning
Material  221
Legal and Regulatory A company limited by guarantee  Commonly used where companies are formed for non-com-
Environment of mercial purposes, such as clubs or charities. The members guarantee the payment of certain (usu-
Business ally nominal) amounts if the company goes into insolvent liquidation, but otherwise they have no
economic rights in relation to the company. This type of company is common in England.
Notes
A company limited by guarantee with a share capital  A company limited by guarantee with a
share capital, a hybrid entity, usually used where the company is formed for non-commercial pur-
poses, but the activities of the company are partly funded by investors who expect a return.

Unlimited company
The liability of members of an unlimited company is unrestricted. Therefore, their liability is similar
to that of the partners of a conventional partnership firm. However, Companies Act, 2013does not
permit the formation of an unlimited company.

Companies with Charitable Objects

Section 8 of the Act (akin to Section 25 of the erstwhile Companies Act, 1956) provides for the for-
mation of companies with charitable objects.
The Central Government may grant a license to a person or an association of persons proposed
to be registered under this Act as a ‘limited company’ if the following conditions are fulfilled:
(a) The company is formed for the promotion of commerce, art, science, sports, education,
research, social welfare, religion, charity, protection of the environment or any other such
object;
(b) It intends to apply its profits, if any, or other income in promoting its above objects; and
(c) It intends to prohibit the payment of any dividend to its members.
The applicants bear the responsibility to prove to the satisfaction of the Central Government that
the proposed company is to be formed for the charitable objects, as discussed above.
Such companies shall be entitled to remove the word(s) ‘Limited’ or ‘Private Limited’ against their
names and shall enjoy all the privileges and be subjected to all the obligations of limited companies.
A firm may be a member of the company registered under this Section [Section 8(1)].
However, a company registered under the above-mentioned Section shall not alter the provi-
sions of its memorandum or articles except with the previous approval of the Central Government.
Moreover, such company may convert itself into a company of any other kind only after complying
with such conditions as may be prescribed [Section 8(4)].
Any other kind of limited company may be granted license by the Central Government to be
registered under Section 8(1) if it fulfills the conditions laid down under clauses (a), (b), and (c), as
mentioned above [Section 8(5)].
The Central Government may revoke the license granted to a company under Section [8(1)], if
the company contravenes any of the requirements or conditions of the Section or its affairs are
conducted fraudulently or in a manner prejudicial to public interest. However, the company in
question will be given a reasonable opportunity of being heard before passing of such order of
revocation [Section 8(6)].

Small Company
The concept of ‘small company’ has been introduced for the first time by the Companies Act, 2013.
The Act identifies and classifies some companies as small companies based on their capital and turn-
over position for the purpose of providing certain privileges and exemptions to these companies.
‘Small company’ means a company, other than a public company,—
(i) paid-up share capital of which does not exceeds fifty lakh rupees or such higher amount as
may be prescribed, which shall not be more than five crore rupees; or
(ii) turnover of which as per its last profit and loss account does not exceeds two crore rupees
or such higher amount as may be prescribed, which shall not be more than twenty crore
rupees.
However, the following companies cannot be classified as a ‘small company’ i.e. even though they
may fulfil the capital or the turnover requirement of the latter,-
(i) a holding company or a subsidiary company;
Self-Learning (ii) a company registered under Section 8 ( a charitable company); or
222  Material (iii) a company or body corporate governed by any special Act [Section 2(85)].
 Thus, only a private company can be classified as a ‘small company’. And for qualifying as a small Nature and Kinds of
company, it is enough if either the capital is less than fifty lakh rupees or turnover is less than Companies, Company …
twenty crore rupees. However, these limits may be raised but not exceeding five crore rupees in
case of capital and twenty crore rupees in case of turnover. Moreover, a company may be classified
Notes
as a small company in a particular year but may become ineligible in the next year and may become
eligible yet again in the subsequent year. Thus, the benefits which are available during a particular
year may stand withdrawn in the next year and become available again in the subsequent year.

One Person Company

One Person Company (OPC) is a new concept introduced by the Companies Act, 2013. As the name
suggests, an OPC can be formed with only one person (a natural person who is an Indian citizen
and a resident of India) as its member.
For the first time, the Act has allowed individuals to incorporate a company as an OPC – a new
vehicle for individuals for carrying on business with limited liability. This is expected to have a sig-
nificant effect on the way individuals and family owned businesses operate. The memorandum of
such an OPC is required to indicate the name of the person who shall become member in the event
of death or incapacity of the sole member. It is also required to specifically mention the word ‘One
Person Company’ below the name wherever it is used [Section 2(62)].

Parent and Subsidiary Companies

A company shall be deemed to be a subsidiary of another company if:
(i) That other company controls the composition of its Board of directors, or
(ii) That other company holds more than half of its equity share capital in face value
(iii) Where the first mentioned company is a subsidiary company of any company, which in turn
is a subsidiary of that other company. For example, if company B is subsidiary of company
A, and company C is subsidiary of company B, therefore, company C is also a subsidiary of
company A.
The control of the composition of the Board of directors of the company means that the parent
company has the power, at its discretion, to appoint or remove all or majority of directors of the
subsidiary company without the consent or concurrence of any other person.

Government Company
“Government Company’’ means any company in which not less than 51 per cent of the paid-up share
capital is held by
(i) the Central Government; or
(ii) any State Government or Governments; or
(iii) partly by the Central Government and partly by one or more State Governments.
A subsidiary of a Government company (i.e. which is otherwise a non-government company) shall
also be treated as a Government company [Section 2(45)].
The following are some of the essential features of a government company:
1. It is formed under the provisions of the Indian Companies Act, 2013.
2. The total share capital or 51 per cent or more of the share capital is held by the Government.
3. It enjoys the status of a legal entity and therefore it can sue or be sued by others.
4. The finance of a government company is obtained from the government and from private
shareholders.
5. The employees are governed by the rules prescribed for the company by the Board of
directors.
6. It is not subject to budgeting, accounting, and audit rules applicable to a government depart-
ment.
7. The directors are nominated by the government depending on participation of the private
capital.

Foreign company
‘Foreign Company’ means any company or body corporate incorporated outside India which, -
Self-Learning
Material  223
Legal and Regulatory (a) has a place of business in India by itself or through an agent, physically or through electronic
Environment of mode; and
Business (b) conducts any business activity in India in any other manner [Section 2(42)].
Notes Dormant Company  ‘Dormant company’ status is a new phenomenon in the Companies Act, 2013
and is considered to be an excellent means of keeping assets in a company towards its future usage.
As per Section 455, “Where a company is formed and registered under this Act for a future projec-
tor to hold an asset or intellectual property and “has no significant accounting transaction”, such a
company or an inactive company may make an application to the Registrar in the prescribed manner
for obtaining the status of a dormant company”.
Thus, a ‘dormant company’ is one that doesn’t trade and has no accounting transactions.
In this behalf, ‘inactive company’ means a company which, has not been carrying on any business
or operation, or has not made any significant accounting transaction during The Last Two financial
years, has not filed financial statements and annual returns during the last two financial years.
“Significant accounting transaction” means any transaction other than-
(a) Payment of Fees by a company to the Registrar;
(b) Payments made by it to fulfill the requirements of this Act or any other law;
(c) Allotment of shares to fulfill the requirements of this Act; and
(d) Payments for maintenance of its office and records [Explanation added to Section 455].
That is, above mentioned transactions have been excluded from ‘significant accounting transac-
tions’. If a company has made above mention transactions in last two year then also that company
will fall under definition of inactive company.
A ‘dormant company’ may be either a public company or a private company or even a ‘One Person
Company’.
Process to get the status of ‘dormant company’
The Registrar on consideration of the application shall allow the status of a dormant company to the
applicant and issue a certificate in such form as may be prescribed to that effect.
In case of a company which has not filed financial statements or annual returns for two financial
years consecutively, the Registrar shall issue a notice to that company and enter the name of such
company in the register maintained for dormant companies [Section 455(4)].
A dormant company shall have such minimum number of directors, file such documents and pay
such annual fee as may be prescribed to the Registrar to retain its dormant status in the register
and may become an active company on an application made in this behalf accompanied by such
documents and fee as may be prescribed [Section 455(5)].
However, the Registrar shall strike off the name of a dormant company from the register of dor-
mant companies, which has failed to comply with the requirements discussed above [Section 45(6)].
Advantage of ‘dormant company’
A dormant company offers exceptional advantage to the promoters who wish to hold an asset or
intellectual property under the corporate shield for its usage at a later stage. For instant: if a pro-
moter wants to buy lands now for its future project at a comparatively lesser price, he may do the
same through dormant company so that he can use the land for its future project.

Lifting the Corporate Veil

The doctrine of ‘corporate veil’ implies that a company has a separate personality distinct from
its members or shareholders. This signifies that the company has a life and existence of its own;
can possess a property and deal with it the way it desires; and can sue and be sued in its personal
capacity. Moreover, no shareholder can either individually or jointly claim any ownership rights in
the assets of the company during its continuance of business or on its winding up. To facilitate all
this, the Act has drawn a thick veil (curtain) between the company and those who have formed or
run it. However, the separate personality of a company may create a range of problems due to some
unexpected and sometimes unwelcome effects. In a number of circumstances, therefore, the courts
have disregarded the Salomon principle as laid down by the House of Lords. Where the corporate
personality is being used unjustly or as a sham device, the court will ignore the cloak (legal fiction)
to reach the person(s) under it or reveal the true form and character of the concerned company. This
is known as the corporate law concept of ‘lifting or piercing the corporate veil’. Under this doctrine,
Self-Learning
which is also known as ‘disregarding the corporate entity’, a stakeholder (shareholder or director)
224  Material
of a company is held liable for the debts or liabilities of the company despite the general principle Nature and Kinds of
that shareholders are immune from suits in contract or tort that otherwise would hold only the Companies, Company …
company liable. The rationale behind this is probably that the law will not allow the corporate form
to be misused or used for the purposes which are not set out in the statute.
Notes

CORPORATE PERSONALITY: LANDMARK COURT CASE

Salomon vs. Salomon & Co. Ltd2

The corporate personality concept—a company is an independent legal entity—was firmly en-
dorsed in Salomon vs. Salomon & Co. Ltd2 by the House of Lords.
Aron Salomon, a sole proprietor decided to incorporate his boot manufacturing business as a limited
company - Salomon & Co. Ltd. Apart from Mr. and Mrs. Salomon, their daughter and four sons were
the only shareholders in the newly established company. Two elder sons became directors and Mr.
Salomon himself was the managing director. Mr. Salomon owned 20,001 of the company’s 20,007
shares of £1 each—the remaining six were shared individually between the other six shareholders.
Mr. Salomon sold his business to the new corporation for almost £30,000, of which £10,000 was
a debt to him, secured by a charge over the assets of the company. He was, thus, simultaneously
the company’s principal shareholder and its principal secured creditor. The company subsequently
became insolvent following a depression in the industry as its assets were found to be worth £6000
and its debts amounted to £ 17,000 of which £ 10,000 were due to Mr. Salomon (secured by assets)
and £7000 due to unsecured creditors. The unsecured creditors sued Mr. Salomon on the ground
that he and his company were one and the same person and the company was a mere agent for him
(Salomon), and, hence, they carry the preferential right as to repayment of their debts over Salomon.
The House of Lords held:
‘The company is at law a different person altogether distinct from the shareholders and, though it
may be true that after incorporation the business is precisely the same as it was before, and the same
persons are managers, and the same hands received the profits, the company is not in law the agent
of the shareholders or trustee for them. Nor are the shareholders, as members, liable in any shape or
form, except to the extent and in the manner provided for by the Act.’
Accordingly, Mr. Salomon’s claim—to be treated as a secured and preferential creditor—was held
justified.

Formation of a Company: Introduction

Any business enterprise in which the capital is raised by the individual contributions of a group of
shareholders is called a joint stock company. In accordance with Section 3 of the Companies Act,
2013, a company may be formed for any lawful purpose by (a) seven or more persons, where the com-
pany to be formed is to be a public company; or (b) two or more persons (but not more than 200),
where the company to be formed is to be a private company; or (c) one person, where the company
to be formed is to be ‘One Person Company’ that is to say, a private company, by subscribing their
names to a memorandum and complying with the requirements of the Act in respect of registration.
Bringing a company into existence, however, is not as straight and hassle-free as the creation of a
sole proprietary or a conventional partnership firm. The reason being, a company is a legal entity
which does not come into life on its own or through an agreement. Keeping in view the interest of
potential stakeholders, the Act has laid down certain norms to be complied with by every company
before it comes into existence. Accordingly, the formation of a joint stock company is full of legal
and documentary compliance procedures. For the purpose of proper understanding, the whole
process of formation of a joint stock company (in India) can be divided into three stages, namely,
1. Promotion
2. Incorporation
3. Commencement of Business

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Material 225
Legal and Regulatory Promotion
Environment of
Business Promotion refers to the entire backing process by which a company is brought into life. It begins
with the conceptualization of the birth of a company, and sets out the purpose for which it is to be
Notes formed. The persons who conceive the idea to form a company and initiate the process of formation
of a company are called ‘promoters’. The promoters enter into preliminary contracts with vendors
and make arrangements for the preparation, advertisement, and the circulation of the prospectus,
and arrangement of the necessary capital. However, a person who merely acts in his professional
capacity on behalf of a promoter, say for example, a lawyer, a consultant, or a chartered accoun-
tant, etc. engaged for drawing up the agreement and other documents, or one who prepares the
blueprints of the projected company on behalf of the promoters, and is paid in this behalf is not a
promoter.

Promoter’s Legal Position and Role

Promoters occupy a fiduciary position – a position based on trust and confidence – in the company.
Accordingly, they have some basic duties towards the company, listed as follows:
1. They should not make any profits secretly at the expense of the company they promote.
Secret profits are normally made by buying the assets as per the requirements of the com-
pany on their own behalf and then selling them to the company at a profit without making
disclosure of same to the company or its members. Promoters may, however, make profits in
their dealings with the company provided they disclose them to the company, for instance,
promoters may transfer their own property to the company at a profit.
2. They should make full disclosure to the independent Board of directors, or in the prospectus
of all material facts relating to the formation of the company including, of course, any profits
made by them in transaction with the company.

Promoter’s Remuneration
A promoter besides being reimbursed for preliminary expenses incurred by him in setting up and
registering the company may be rewarded by the company for the efforts undertaken by him in
forming the company in several ways under a valid contract. The common forms and modes of com-
pensating a promoter in consideration of his services are as follows:
1. The company may pay him a lump sum amount for the services rendered. The articles of the
company may provide for a fixed sum to be paid by the company to the promoters, although,
such a provision has no contractual effect, and the promoters cannot sue to enforce it.
2. The promoter may make profits or earn commission on the transactions entered by him with
the company after making full disclosure to an independent Board of directors or to the
intended members.
3. The promoter may sell his own property to the company for cash or against fully paid shares
in the company at an overvaluation after making full disclosures.
4. The promoter may be allotted fully or partly paid-up shares or debentures.
However, whatever be the remuneration or benefit paid to the promoter, it must be disclosed in
the prospectus if it is paid within two years prior to the date of issue of prospectus.

Promoter’s Liability
A promoter’s role is pivotal towards the formation of the company. They, however, undoubtedly oc-
cupy a fiduciary position. In case of default by a promoter in fulfilling his duties, the company may
rescind the contract, and if the former has made some secret profits on any related transaction, he
may be compelled to account for it. If it is not possible to cancel the contract or where the promoter
has already encashed the secret profits, the company can sue him for breach of trust. Damages up
to the difference between the market value of the property and the contract price can be recovered
from the promoter where he had sold his own property to the company.
The promoter shall be subject to civil as well as criminal liability for misstatement(s) or omission
made in the prospectus, if any.

Civil liability of misstatement(s) in the prospectus

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226  Material Where a person has subscribed for securities of a company, acting on any statement included, or
the inclusion or omission of any matter, in the prospectus which is misleading and has sustained Nature and Kinds of
any loss or damage as a consequence thereof, the promoter shall be liable to pay compensation to Companies, Company …
every person who has sustained such loss or damage [Section 35].

Criminal liability for non-compliance of matters to be stated in the prospectus Notes

Section 26 of the Act lays down matters to be stated in the prospectus. Non-compliance of the pro-
vision of this section may render a promoter punishable with imprisonment for a term which may
extend to three years or with fine which shall not be less than fifty thousand rupees but which may
extend to three lakh rupees, or both [Section 26].

Criminal liability for misstatement(s) in the prospectus

Where a prospectus issued, circulated or distributed includes any statement which is untrue or
misleading, the promoter (among others) shall be criminally liable and may be punishable with im-
prisonment for a term which shall not be less than six months but which may extend to ten years
and shall also be liable to fine which shall not be less than the amount involved in the fraud, but
which may extend to three times the amount involved in the fraud. Moreover, if the fraud in ques-
tion involves public interest, the term of imprisonment shall not be less than three years, unless
the promoter proves either that the statement was immaterial or that he had reasonable ground to
believe that the statement was true [Section 34 read with Section 447].

Incorporation
Incorporation or registration is the foremost obligation to be fulfilled to form any type of company
under the Companies Act. That is, no company can come into existence without being formally reg-
istered under the Act. Incorporation of a company is a procedure full of documentary compliance
formalities. That is, a company is incorporated by registering certain documents with the Registrar
of Companies, and paying certain fees and stamp duty. Unless and until these formalities are duly
complied with, a company does not have any legal recognition or existence of its own.

Documentation for Incorporation

For registration promoters have to file with the ROC, within whose jurisdiction the registered office
of a company is proposed to be situated, the following documents and information:
(a) The memorandum and articles of the proposed company duly signed by all the subscribers
to the memorandum in such manner as may be prescribed;
(b) A declaration in prescribed form by an advocate, a chartered accountant, a cost accountant,
or a company secretary in practice, who is engaged in the formation of the company, and by
a person named in the articles as a director, manager or secretary of the company, that all
the requirements of this Act and the rules made thereunder in respect of registration and
matters precedent or incidental thereto have been complied with;
(c) An affidavit from each of the subscribers to the memorandum and from persons named as
the first directors, if any, in the articles that he is not convicted of any offence in connection
with the promotion, formation, or management of any company, or that he has not been
found guilty of any fraud or misfeasance or of any breach of duty to any company under this
Act or any previous company law during the preceding five years and that all the documents
filed with the ROC for registration of the company contain information that is correct and
complete and true to the best of his knowledge and belief;
(d) The address for correspondence till its registered office is established;
(e) The particulars of name, including surname or family name, residential address, nationality
and such other particulars of every subscriber to the memorandum along with proof of iden-
tity as may be prescribed, and in the case of a subscriber being a company, such particulars
as may be prescribed;
(f) The particulars of the persons mentioned in the articles as first directors of the company,
their names, including surnames or family names, the Director Identification Number (DIN),
residential address, nationality and such other particulars including proof of identity as may
be prescribed; and
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Material  227
Legal and Regulatory (g) The particulars of the interests of the persons mentioned in the articles as the first directors
Environment of of the company in other forms or bodies corporate along with their consent to act as direc-
Business tors of the company in such form and manner as may be prescribed [Section 7(1)].
Notes
Certificate of Incorporation and Corporate Identity Number
Certificate of incorporation is the most important document to bring a proposed company into
existence. In accordance with Section 7(2), once all the required documents have been filed along
with the registration fee, filing fee, stamp duty, as specified and they are found to be in order, the
ROC will issue, under his seal and signature, the ‘certificate of incorporation’ of the company.
The certificate of incorporation is the conclusive evidence that the requirements of the Com-
panies Act have been complied with and the company bearing a specific name is duly registered.
On and from the date mentioned in the certificate of incorporation issued under subsection (2),
the Registrar shall allot to the company a corporate identity number, which shall be a distinct iden-
tity for the company and which shall also be included in the certificate [Section 7 (3)].
This certificate needs to be collected from the Registrar’s office. After obtaining the certificate,
the secretary of the company must send the notice of the registered address of the company, if it
was not sent earlier, within 30 days of registration.
The company shall maintain and preserve at its registered office copies of all documents and
information as originally filed under subsection (1) till its dissolution under the Act [Section 7 (4)].

Consequences of Incorporating a Company on the Basis of Fake

Documentation
This certificate of incorporation is the birth document of the company and the proof of the exis-
tence of the company. Once this certificate is issued, a company cannot cease its existence unless
it is dissolved by an order of the NCLT (National Company Law Tribunal) or otherwise. However,
as per Section 7(7) of the Act, if a company has been incorporated by furnishing any false or incor-
rect information or representation or by suppressing any material fact or information in any of the
documents or declaration filed or made for incorporating such company or by any fraudulent action,
the Tribunal may, on an application made to it, on being satisfied that the situation so warrants,—
(a) pass such orders, as it may think fit, for regulation of the management of the company in-
cluding changes, if any, in its memorandum and articles, in public interest or in the interest
of the company and its members and creditors; or
(b) direct that liability of the members shall be unlimited; or
(c) direct removal of the name of the company from the register of companies; or
(d) pass an order for the winding up of the company; or
(e) pass such other orders as it may deem fit.
However, before any order is passed by the Tribunal under Section 7(7), mentioned above,—
(i) the company shall be given a reasonable opportunity of being heard in the matter; and
(ii) the Tribunal shall take into consideration the transactions entered into by the company,
including the obligations, if any, contracted or payment of any liability.

Effect of Incorporation
From the date of incorporation mentioned in the certificate of incorporation, such subscribers to
the memorandum and all other persons, as may, from time to time, become members of the com-
pany, shall be a body corporate by the name contained in the memorandum, capable of exercising
all the functions of an incorporated company under the Act and having perpetual succession and
a common seal with power to acquire, hold and dispose of property, both movable and immovable,
tangible and intangible, to contract and to sue and be sued, by the said name [Section 9].

Commencement of Business
A company not having the share capital can commence its business immediately after obtaining the
certificate of incorporation. However, a company limited by the share capital can commence its op-
erations or exercise borrowing powers unless it has complied with capital subscription requirement.
Self-Learning A company having a share capital shall not commence any business or exercise any borrowing
228  Material powers unless—
 (a) a declaration is filed by a director in such form and verified in such manner as may be pre- Nature and Kinds of
scribed, with the Registrar that every subscriber to the memorandum has paid the value of Companies, Company …
the shares agreed to be taken by him and the paid-up share capital of the company is not
less than five lakh rupees in case of a public company and not less than one lakh rupees in
Notes
case of a private company on the date of making of this declaration; and
(b) the company has filed with the Registrar a verification of its registered office as provided in
sub-section (2) of section 12 [Section 11(1)].

Consequences of Non-compliance of Capital Subscription Requirement

If any default is made in complying with the requirements of this section, the company shall be li-
able to a penalty which may extend to five thousand rupees and every officer who is in default shall
be punishable with fine which may extend to one thousand rupees for every day during which the
default continues [Section 11(2)].
Moreover, where no declaration has been filed with the Registrar under clause (a) of subsection
(1) within a period of one hundred and eighty days of the date of incorporation of the company
and the Registrar has reasonable cause to believe that the company is not carrying on any busi-
ness or operations, he may, without prejudice to the provisions of sub-section (2), initiate action
for the removal of the name of the company from the register of companies under Chapter XVIII
[Section 11(3)].

Prospectus
After getting the company incorporated, promoters will raise finances. The public is invited to pur-
chase shares and debentures of the company through an advertisement. A document containing
detailed information about the company and an invitation to the public subscribing to the share
capital and debentures is issued. This document is called prospectus.

Prospectus under the Statute

“Prospectus” means any document described or issued as a prospectus and includes a red herring
prospectus referred to in section 32 or shelf prospectus referred to in section 31 or any notice,
circular, advertisement or other document inviting offers from the public for the subscription or
purchase of any securities of a body corporate [Section 2(70)].
Thus, when a company allots securities to the public based on an offer that has been made, then,
any document through which such an offer is made is considered to be a prospectus and it has to
fulfil all the requirements of a prospectus. Thus, the issue of prospectus is essential when the com-
pany wishes the public to purchase its shares or debentures.

Red Herring Prospectus

The expression “red herring prospectus” means a prospectus which does not include complete par-
ticulars of the quantum or price of the securities included therein.
According to Section 32 (1), a company proposing to make an offer of securities may issue a red
herring prospectus prior to the issue of a prospectus.
A company proposing to issue a red herring prospectus shall file it with the Registrar at least
three days prior to the opening of the subscription list and the offer [Section 32 (2)].
A red herring prospectus shall carry the same obligations as are applicable to a prospectus and
any variation between the red herring prospectus and a prospectus shall be highlighted as variations
in the prospectus [Section 32 (3)].

Shelf Prospectus
The expression “shelf prospectus” means a prospectus in respect of which the securities or class of
securities included therein are issued for subscription in one or more issues over a certain period
without the issue of a further prospectus [Section 31].
Any class or classes of companies, as the Securities and Exchange Board may provide by regula-
tions in this behalf, may file a shelf prospectus with the Registrar at the stage of the first offer of
securities included therein which shall indicate a period not exceeding one year as the period of Self-Learning
Material  229
Legal and Regulatory validity of such prospectus, which shall commence from the date of opening of the first offer of secu-
Environment of rities under that prospectus, and in respect of a second or subsequent offer of such securities issued
Business during the period of validity of that prospectus, no further prospectus is required [Section 31 (1)].
A company filing a shelf prospectus shall be required to file an information memorandum con-
Notes
taining all material facts relating to new charges created, changes in the financial position of the
company as have occurred between the first offer of securities or the previous offer of securities and
the succeeding offer of securities and such other changes as may be prescribed, with the Registrar
within the prescribed time, prior to the issue of a second or subsequent offer of securities under
the shelf prospectus [Section 31 (2)].

Contents of the Prospectus

Every prospectus issued by or on behalf of a public company either with reference to its formation
or subsequently, or by or on behalf of any person who is or has been engaged or interested in the
formation of a public company, shall be dated and signed and shall state the following information:
(i) names and addresses of the registered office of the company, company secretary, Chief
Financial Officer, auditors, legal advisers, bankers, trustees, if any, underwriters and such
other persons as may be prescribed;
(ii) dates of the opening and closing of the issue, and declaration about the issue and allotment
of letters and refunds within the prescribed time;
(iii) a statement by the Board of Directors about the separate bank account where all monies
received out of the issue are to be transferred and disclosure of details of all monies includ-
ing utilised and unutilised monies out of the previous issue in the prescribed manner;
(iv) consent of the directors, auditors, bankers to the issue, expert’s opinion, if any, and of such
other persons, as may be prescribed;
(v) the authority for the issue and the details of the resolution passed therefor;
(vi) procedure and time schedule for allotment and issue of securities;
(vii) capital structure of the company in the prescribed manner;
(viii) main objects of the public offer, terms of the present issue and such other particulars as may
be prescribed;
(ix) main objects and the present business of the company and its location, the schedule of
implementation of the project;
(x) particulars relating to—
(A) management perception of risk factors specific to the project;
(B) gestation period of the project;
(C) extent of progress made in the project;
(D) deadlines for completion of the project; and
(E) any litigation or legal action pending or taken by a Government Department or a statu-
tory body during the last five years immediately preceding the year of the issue of pro-
spectus against the promoter of the company;
(xi) minimum subscription, amount payable by way of premium, issue of shares otherwise than
on cash;
(xii) details of directors including their appointments and remuneration, and such particulars of
the nature and extent of their interests in the company as may be prescribed; and
(xiii) disclosures in such manner as may be prescribed about sources of promoter’s contribution;
set out the following reports for the purposes of the financial information, namely:—
(i) reports by the auditors of the company with respect to its profits and losses and assets
and liabilities and such other matters as may be prescribed;
(ii) reports relating to profits and losses for each of the five financial years immediately
preceding the financial year of the issue of prospectus including such reports of its sub-
sidiaries and in such manner as may be prescribed.
Through its prospectus, a company, therefore, tries to convince the public that it offers best op-
portunity for their investment. A prospectus in this behalf outlines broad terms and conditions on
which the shares or debentures have been offered to the public. The issue of prospectus is essen-
tial when the company wishes the public to purchase its shares or debentures. A private company,
therefore, is exempt from issuing or filing a prospectus.
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230  Material
Filing of Prospectus with the Registrar Nature and Kinds of
Companies, Company …
A prospectus must be filed with the Registrar of Companies before it is issued to the public.
No prospectus shall be issued by or on behalf of a company or in relation to an intended company
unless on or before the date of its publication it has been delivered to the Registrar for registration, Notes
a copy thereof signed by every person who is named therein as a director or proposed director of
the company or by his duly authorised attorney [Section 26(4)].
To reinforce the above-mentioned provision, section 26(8) specifically provides that no pro-
spectus shall be valid if it is issued more than ninety days after the date on which a copy thereof is
delivered to the Registrar.

Consequences of Issuing an Irregular Prospectus

If a prospectus is issued in contravention of the provisions of this section, the company shall be
punishable with fine which shall not be less than fifty thousand rupees but which may extend to
three lakh rupees and every person who is knowingly a party to the issue of such prospectus shall
be punishable with imprisonment for a term which may extend to three years or with fine which
shall not be less than fifty thousand rupees but which may extend to three lakh rupees, or with both
[Section 26(9)].

E xercises
I. Objective-type Questions
1. Which of the following is not a characteristic feature of a joint stock company?
(a) Artificial person (b) Separate property
(c) Carry on a business for gain (d) Limited liability
2. Which of the following is true about the common seal of a company?
(a) It acts as a symbol of its incorporation
(b) It is a statutory requirement
(c) It furnishes evidence of authenticity in respect of a document executed on
behalf the company
(d) All of the above
3. Which the following companies cannot be a ‘small company’?
(i) a holding company or a subsidiary company;
(ii) a company registered under Section 8 ( a charitable company)
(iii) a company or body corporate governed by any special Act
(iv) One person company (OPC)
Answer Codes:
(a) (i) and (iii)
(b) (i), (ii) and (iii)
(c) (i), (iii) and (iv)
(d) (i), (ii) and (iv)
4. Which of the following is not a valid ground for lifting the corporate veil under
judicial interpretations?
(a) Protection of revenue
(b) Prevention of fraud or improper conduct
(c) Determination of the enemy character of the company
(d) Ultra vires acts
5. A charitable company must fulfil which of the following conditions?
(a) The company is formed for the promotion of commerce, art, science,
sports, education, research, social welfare, religion, charity, protection of
the environment or any other such object
(b) It intends to apply its profits, if any, or other income in promoting its above
objects
(c) It intends to prohibit the payment of any dividend to its members
(d) All of the above
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Material  231
Legal and Regulatory 6. A company not having a share capital can commence its business and exercise
Environment of borrowing powers immediately after
Business (a) Promotion
(b) Obtaining ‘certificate of incorporation’
Notes (c) Complying with the requirement of Section 11
(d) Obtaining ‘certificate of commencement of business’
7. Promoters of a joint stock company shall not be liable for:
(a) Misstatement(s) in the prospectus
(b) Non-compliance of matters to be stated in the prospectus
(c) Compliance of matters to be stated in the prospectus
(d) Commencement of business by the company without conforming to capital
subscription requirements
8. When a company has been incorporated by furnishing any false or incorrect in-
formation or by suppressing any material fact or information in any of the docu-
ments, the Tribunal is empowered to:
(a) Direct that liability of the members shall be unlimited; or
(b) Direct removal of the name of the company from the register of companies.
(c) Pass an order for the winding up of the company.
(d) Exercise any of the above options
9. Towards the fulfilment of their fiduciary duty, the promoters
(a) Should not make any profits secretly at the expense of the company
(b) Should make full disclosure to the Board of directors of all material facts
relating to the formation of the company including any profits made by
them in transaction with the company.
(c) Should make full disclosure in the prospectus of all material facts relating
to the formation of the company including any profits made by them in
transaction with the company.
(d) All of the above
10. Declaration regarding the compliance with requirements of Section 11 must be
filed with the ROC by the newly incorporated company within:
(a) 60 days of the incorporation of the company
(b) 90 days of the incorporation of the company
(c) 120 days of the incorporation of the company
(d) 180 days of the incorporation of the company
II. Review Questions
1. Define a company and discuss the characteristic features of a company.
2. Distinguish between a private company and a public company. State the exemp-
tions and privileges available to a private company.
3. ‘A joint stock company is a legal person with perpetual succession and common
seal.’ Comment. Distinguish between a company and a partnership.
4. Write short notes on the following.
(a) Conversion of a public company into a private company
(b) Conversion of a private company into a public company
(c) Companies with Charitable Objects
(d) Small company
5. Describe the stages involved in the formation of a proposed public company.
6. Discuss the role and legal status of promoters. Describe also liabilities of promot-
ers.
7. Describe the documentary requirements for incorporation of a joint stock com-
pany. What is the consequence of obtaining the certificate of incorporation by
furnishing wrong information or concealing the material facts?
8. Write short notes on the following:
(a) Effect of incorporation
Self-Learning (b) Promoter’s remuneration
232  Material
 (c) Commencement of business by a company limited by the share capital Nature and Kinds of
(d) Red Herring Prospectus Companies, Company …
(e) Shelf Prospectus
Notes
10. (d) 9. (d) 8. (d) 7. (d) 6. (b)
5. (d) 4. (d) 3. (b) 2. (d) 1. (c)
Answers to Objective-type Questions

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Material  233
 Chapter
12 In Review
Learning Objectives ●● A company is a voluntary association of persons characterised by a separate legal
identity independent of its members; limited liability; everlasting existence; separate
Company: meaning and defining characteris- property; flexibility of investment; common seal; capacity to sue and being sued;
tics separation of ownership and management; proportionate representation; and right
Kinds of companies to own property.
●● Companies can broadly be classified as public and private limited companies, one
Lifting the corporate veil person company (OPC), small company, which is also a private company, parent and
Formation of company subsidiary companies, Government company and dormant company, and foreign
company. A private limited company can be converted into a public company and
Prospectus
vice-versa. Unlike a public company, a private limited company enjoys certain privi-
leges.
If a company’s corporate veil creates some unexpected problems or is being used
Key Terms ●●

unjustly, the court may disregard the legal fiction that all companies are wholly sepa-
Company: An artificial person created rate from their shareholders.
by law, having a separate entity, with a ●● There are three broad stages involved in the formation of a joint stock company in
perpetual succession and common seal India: Promotion, incorporation, and commencement of business. Promotion begins
Private company: A company having a with the conceptualization of the birth of a company and the purpose for which it
minimum paid up share capital of one is to be created. Promoters raise funds to finance the company’s initial needs. After
lakh rupees and which by its articles, the company is registered, it receives a ‘certificate of incorporation’ after which the
restricts the right to transfer its shares; company becomes a valid entity. Every company limited by shares needs to comply
and except in case of One Person with capital subscription formalities before it commences any business or exercises
Company, limits the number of its its borrowing powers.
members to two hundred ●● For raising capital, a proposed public company needs to prepare and issue a prospec-
tus. A prospectus must be duly filed with the Registrar before it is issued and must
Public company: A company which is not a
be issued in strict compliance of the statutory provisions in this behalf, failing which
private company; and has a minimum paid-
the company and every person who is party to the issue of the prospectus shall be
up share capital of five lakh rupees
punishable.
Limited company: A company wherein
the liability of its members is limited
Unlimited company: A company
wherein the liability of its members are
unrestricted
Government company: Any company
in which not less than 51 percent of
the paid-up share capital is held by
the government (central and/or state
government)
Dormant company: A company that
does not trade and has no significant
business transactions
Doctrine of corporate veil: A company
has a separate personality from its
members or shareholders
Promotion: The entire backing process
by which a company is brought into life
Incorporation: Giving legal form to an subscribing to the share capital and Shelf prospectus: A prospectus that
association of persons by registering it debentures enables a company to issue securities
under the Companies Act, 2013 Red herring prospectus: A prospectus utilising the same document more
Prospectus: A document containing that does not include complete than once, which will help cut costs
detailed information about the particulars about quantum or price of and save time
company and an invitation to the public the securities included therein

234  Legal and Regulatory Environment of Business

 Memorandum and

Memorandum and
13
Articles of Association
and Share Capital …

Articles of Association Notes

and Share Capital and

Debentures

©: iStock
Learning Objectives
1. Memorandum of Association 8. ESOP
2. Doctrine of Ultra Vires 9. Sweat Equity Shares
3. Alteration of Memorandum 10. Further Issue of Shares to Existing
4. Articles Shareholders
5. Doctrine of Constructive Notice — Rights Issue/Preferential Basis
6. Share Capital and Debentures: Intro- 11. Bonus Shares
duction 12. Buy-Back of Securities
7. Share Capital: Some Terminologies 13. Debentures

F or the incorporation or registration of a company two important documents are required to be

prepared and filed with the Registrar of Companies, namely:
1. Memorandum of Association; and
2. Article of Association

Memorandum of Association
The purpose and objectives of a company are to be determined precisely and in advance by the pro-
moters. For this purpose, the promoters of proposed company device a basic document, known as
“Memorandum of Association” of a company, often simply called the memorandum. It is a document
that regulates a company’s external activities, i.e., governs the relationship between the company
and the outside world.

Defining memorandum
“Memorandum” means memorandum of association of a company as originally framed or as altered
from time to time in pursuance of any previous company law or of this Act [Section 2(56)].
Memorandum is the most important document to be filed by any proposed company. It sets out
the constitution of the company and specifies its relationship with the outside world. The substance
of the memorandum can be explained as follows:
1. It defines the scope and limitations of the proposed company.
2. It is necessary to file a memorandum of association to incorporate a new company.
3. It is considered as an unalterable charter of the company. It is difficult to change or amend
the memorandum because it defines certain powers, the company cannot go beyond.
4. Memorandum becomes a public document as soon as the company gets registered. This
is because it enables shareholders, creditors, and other stakeholders to know what kind of Self-Learning
enterprise they are dealing with. Material 235
5. Memorandum forms the outer framework within which the company operates.
Legal and Regulatory Section 4 requires that the memorandum of a company shall be in respective forms specified in
Environment of Tables A, B, C, D, and E of Schedule I to the Act, as may be applicable to the company. Table A is ap-
Business plicable in case of a company limited by shares; Table B is applicable in case of companies limited
by guarantee and not having share capital; Table C is applicable to a company limited by guarantee
Notes
and having a share capital, Table D is applicable in case of an unlimited company and not having
share capital; and Table E is applicable in respect of an unlimited company and having share capital. .

Contents of the memorandum

As per Section 4 of the Companies Act, 2013, the memorandum of a limited company (either by
shares or guarantee) can be divided into six distinct clauses, which are as follows.
Name clause  The name clause contains the name of the company, which is of considerable impor-
tance as it establishes a company’s identity. The choice of a name for a joint stock company is subject
to a number of restrictions. The company cannot have a name, which is identical with or resemble
too nearly to the name of an existing company registered under this Act or any previous company
law; or is undesirable in the opinion of the Central Government. Moreover, a company cannot use a
name which is prohibited under the Names and Emblems (Prevention of Misuse) Act, 1950, or use a
name reflective of connection to government or state patronage unless prior approval of the Central
Government has been obtained for the use of such word or expression. A company can change its
name by passing a special resolution at a general meeting or by any other means provided in the
Articles. The name of a public company limited by shares or by guarantee must end with the word
“Limited” and that of a private limited company with the words “Private Limited”.
Registered office clause  The state in which the registered office of a company will be situated is
mentioned in this clause. The registered office of the company is the official address of the company
where the statutory books and records must normally be kept and which is capable of receiving
and acknowledging all communications and notices as may be addressed to it. The notice of exact
location must be given to the ROC within 30 days from the date of incorporation of the company
[Section 12].
Similarly, any change in the name of the state in which registered office was situated earlier must
also be intimated to the ROC within 30 days of incorporation. Every company must affix or print its
name and address of its registered office, and keep the same painted or affixed on the outside of
every office or place at which its activities are carried on, in a conspicuous position and in legible
letters. The name must be written in one of the local languages and in English.
Objects clause  This is the most important clause of a company. It defines the activities, which a
company can carry on and those, it cannot. This clause must state
(i) The objects to be pursued by the company on its incorporation.
(ii) Matters which are necessary for the furtherance of the objects.
In case of companies other than trading corporations whose objects are not confined to one state,
the states to whose territories the objects of the company extend must be specified.
Liability clause  This contains the nature of the liability of the members; whether limited or un-
limited. A declaration that the liability of the members is limited, in case the company is limited by
shares or guarantee, must be given under this clause. The memorandum of a company limited by
guarantee must also state the amount that each member undertakes to contribute to the assets of
the company in the event of its being wound-up. The effect of this clause is that in case of a com-
pany limited by shares, no member can be called upon to pay more than the uncalled amount on
his/her shares. If his/her shares are already fully paid up, the shareholder has no liability toward the
company even if the company is suffering from over-debtness.
The rule of limited liability of members is, however, subject to the following exceptions:
1. If a member agrees in writing to be bound by the alteration of Memorandum or Articles
requiring him/her to take more shares or increase his/her liability, he/she shall be liable up
to the amount agreed to by him/her.
2. If every member agrees in writing to re-register the company as an unlimited company and
the company is re-registered as such, such members will have unlimited liability.
3. If to the knowledge of a member, the number of shareholders has fallen below the legal
minimum (seven in the case of a public limited company and two in case of a private limited
Self-Learning company) and the company has carried on business for more than six months, while the
236  Material
 number is so reduced, the members for the time being constituting the company would be Memorandum and
personally liable for the debts of the company contracted during that time. Articles of Association
and Share Capital …
Capital clause  This clause is applicable in the case of a company having a share capital, which
states the amount of share capital with which the company is to be registered, division thereof into Notes
shares of a fixed amount and the number of shares which the subscribers to the memorandum agree
to subscribe, which shall not be less than one share. A company cannot issue share capital greater
than the maximum amount of share capital stated in this clause without altering the Memorandum.
Subscription clause  This clause is applicable in the case of One Person Company, and contains
the name of the person who in the event of death of the subscriber shall become the member of
the company.
Thus, memorandum is the life-giving document of the company. That is, it is the document which
brings the company into existence. It is the charter or constitution of the company containing the
fundamental conditions upon which the company is incorporated. It is the foundation on which the
structure of the company is built.

Doctrine of Ultra-Vires
The word ultra means beyond, and vires means the powers. The Latin term ultra-vires, therefore,
means to describe an act which is beyond the powers. Any transaction (or act), which is not set out
in the object clause of the company’s memorandum, and is not necessarily or reasonably incidental
to the attainment of the object(s), is ultra-vires the company, and therefore, void, i.e., of no legal
effect and does not bind the company. No rights and liabilities on the part of the company arise out
of such transaction or act and it is a nullity, i.e., unenforceable even if every member agrees to it.

Consequences of an ultra vires act

As stated earlier since an ultra-vires act is devoid of any legal effect. Accordingly:
l The company cannot sue any person for enforcement of any of its rights under an ultra-vires

act or transaction.
l The directors of the company may be held personally liable to outsiders for an ultra-vires (of

directors’ powers) act.

Exceptions  However, the doctrine of ultra-vires does not apply in the following cases:
1. If an act is ultra-vires of directors’ powers but intra-vires of company, may be ratified by the
company.
2. If an act is ultra vires the articles of the company but it is intra vires of the memorandum, the
articles can be altered to rectify the error.
3. Where a company acquires a property through an investment which is ultra vires then the
third party has no right over such property, i.e., such property shall still be secured. The
creditors just have a right to follow its money or property if it exists as it is, and obtain an
injunction from the court restraining the company from parting with it provided the ag-
grieved (third) party intervenes before the identity of the property is lost.

Alteration of Memorandum
A company which is desirous of altering the provisions of its memorandum may do so by passing
a special resolution in this behalf after complying with the procedure specified in Section 13 of the
Companies Act, 2013 [Section 13(1)].
However, a company limited by share capital may, if so authorised by its articles, alter the capital
clause of its memorandum in its general meeting (i.e., by way of passing just an “ordinary resolu-
tion”) to increase its authorised capital by such amount as it thinks expedient [Section 61].

Procedure for altering the memorandum

1. Approval of the Central Government in writing will be a must for any change in the name of
a company which shall be subject to the provisions of subsections (2) and (3) of Section 4.
However, no such approval shall be necessary where the only change in the name of the
company is the deletion therefrom, or addition thereto, of the word “Private”, owing to the Self-Learning
Material  237
Legal and Regulatory conversion of any one class of companies to another class in accordance with the provisions
Environment of of this Act [Section 13(2)].
Business 2. When any change in the name of a company is made under sub-section (2), the Registrar
shall enter the new name in the register of companies in place of the old name and issue a
Notes
fresh certificate of incorporation with the new name and the change in the name shall be
complete and effective only on the issue of such a certificate [Section 13(3)].
3. Approval of the Central Government (against an application in this behalf) shall be manda-
tory for the alteration of the memorandum relating to the place of the registered office from
one State to another [Section 13(4)].
4. The Central Government shall dispose of the application under Section 13 (4) within a period
of 60 days and before passing its order may satisfy itself that the alteration has the consent
of the creditors, debenture-holders and other stakeholders or that the sufficient provision
has been made by the company either for the due discharge of all its debts and obligations
or that adequate security has been provided for such discharge [Section 13(5)].
5. Save as provided in Section 64, a company shall, in relation to any alteration of its memoran-
dum, file with the Registrar, (a) the special resolution passed by the company in this behalf;
and (b) the approval of the Central Government under Section 13 (2), if the alteration in-
volves any change in the name of the company [Section 13(6)].
6. Where an alteration of the memorandum results in the transfer of the registered office of a
company from one State to another, a certified copy of the order of the Central Government
approving the alteration shall be filed by the company with the Registrar of each of the States
within such time and in such manner as may be prescribed, who shall register the same, and
the Registrar of the State where the registered office is being shifted to, shall issue a fresh
certificate of incorporation indicating the alteration [Section 13 (7)].
7. A company, which has raised from public through prospectus and still has any unutilised
amount out of the so raised, shall not change its objects for which it raised the money
through prospectus unless a special resolution is passed by the company and—
(i) the details, as may be prescribed, in respect of such resolution shall also be published in
the newspapers (one in English and one in vernacular language) which is in circulation at
the place where the registered office of the company is situated and shall also be placed
on the website of the company, if any, indicating therein the justification for such change;
(ii) the dissenting shareholders shall be given an opportunity to exit by the promoters and
shareholders having control in accordance with regulations to be specified by the Securi-
ties and Exchange Board [Section 13 (8)].
8. The Registrar shall register any alteration of the memorandum with respect to the objects of
the company and certify the registration within a period of 30 days from the date of filing of
the special resolution in accordance with clause (a) of sub-section (6) of this section [Section
13(9)].

Alteration of the memorandum to be void

In the case of a company limited by guarantee and not having a share capital, any alteration of the
memorandum giving any person otherwise than as a member a right to participate in the divisible
profits of the company, shall be void [Section 13(11)].

Articles of Association
A company is an incorporated body so there ought to be some rules and regulations formed for
the management of its (internal) affairs and conduct of its business as well as the relation between
the members and the company. Moreover, for smooth running of a company’s business the rights
and duties of its members and the company are to be well defined. ‘Articles of Association’, known
as articles of incorporation in the US and Canada, is a document that contains the purpose of the
company as well as the duties and responsibilities of its members defined and recorded clearly. This
is why articles are essential. It is an important document which needs to be filed with the Registrar
of Companies.

Self-Learning
238  Material
Defining Articles Memorandum and
Articles of Association
‘Articles’ means the articles of association of a company as originally framed, or as altered from time
and Share Capital …
to time in pursuance of any previous companies law or of this Act [Section 2(52)].
For practical purposes, however, articles are a document of contract between a shareholder and Notes
the company and among shareholders themselves that they shall abide by the official procedure of
internal management of the company as specified in the document (articles). Articles contain the
rules and regulations for the internal administration of the company hence govern the conduct of a
company’s business by specifying the rights and duties of its members and directors.

Contents of Articles
The items usually covered by the articles of a company include:
(i) Powers, duties, rights, and liabilities of directors
(ii) Powers, duties, rights, and liabilities of members
(iii) Rules for meetings of the company
(iv) Dividends and reserves
(v) Borrowing powers of the company
(vi) Share warrants
(vii) Alteration of capital
(viii) Calls on shares
(ix) Transfer and transmission of shares
(x) Forfeiture of shares
(xi) Surrender of shares
(xii) Voting powers of members
(xiii) Accounts and audit
(xiv) Winding-up, etc.
The articles must be printed, divided into paragraphs, and numbered consecutively and must
be signed by each subscriber to the Memorandum who shall add their address, description, and
occupation in presence of at least one witness who must attest the signatures and likewise add his
address, description, and occupation. The Articles of Association of the company, when registered,
bind the company and its members to the same extent as if it was signed by the company and by
each member.
The provisions of the articles must not be in conflict with the provisions of the memorandum. In
case such a conflict arises, the memorandum will prevail.

Model form of articles

Normally, every company drafts its own articles. However, a company may adopt any one of the
model forms of articles, with or without modifications, specified in Tables F, G, H, I, and J of Schedule
I to the Act, as applicable. For example, if a company limited by shares does not have its own articles,
the model set of 91 articles given in Table F can be adopted. Similarly, Table G is applicable to the
companies limited by guarantee and having a share capital, Table H gives model form of articles for a
company limited by guarantee and not having share capital, and Table I is applicable to an unlimited
company and having a share capital, whereas Table J shall be applicable to an unlimited company
and not having share capital

Alteration of articles
A company can alter or amend any of the provisions of its articles subject to provisions of the Act
and subject to the conditions contained in its memorandum. A company by special resolution at a
general meeting of its shareholders can alter its articles provided the said resolution is passed bona
fide for the benefit of the company.
In this behalf, the Companies Act, 2013, provides as under:
Subject to the provisions of this Act and the conditions contained in its memorandum, if any,
a company may, by a special resolution, alter its articles including alterations having the effect of
conversion of: -
(a) a private company into a public company; or
(b) a public company into a private company: Self-Learning
Material  239
Legal and Regulatory However, where a company being a private company alters its articles in such a manner that they
Environment of no longer include the restrictions and limitations which are required to be included in the articles
Business of a private company under this Act, the company shall, as from the date of such alteration, cease
to be a private company.
Notes
Any alteration having the effect of conversion of a public company into a private company shall
not take effect except with the approval of the Tribunal which shall make such order as it may deem
fit [Section 14(1)].
Thus, an alteration of articles can be effected by a 3/4th majority of the shareholders but can be
challenged on the ground that the alteration was not in the interest of the company. Furthermore,
such alteration should not have the effect of converting a public company into a private company
and vice versa unless the same has been approved by the Central Government.

Doctrine of Constructive Notice

Both, the memorandum and the articles, after being registered with the ROC, assume the character
of public documents hence are accessible by any member of the public by paying the requisite fees
[Section 399].
Therefore, notice about the contents of these principal documents is said to be within the knowl-
edge of both members and non-members of the company. Such notice is a deemed notice in case
of members and a constructive notice in case of non-members. Thus, every person dealing with
the company is deemed to have knowledge of the contents of the memorandum and the articles
of the company. An outsider dealing with the company is presumed to have read the contents of
the registered documents of the company. The further presumption is that he has not only read the
documents but has also understood them fully in proper sense. This is known as the doctrine or
rule of constructive notice. Accordingly, maxim of constructive notice is a presumption operating
in favour of the company against the outsider. It prevents the outsider from alleging that he did not
know that the constitution of the company rendered a particular act or a particular delegation of
authority ultra-vires. Thus, the doctrine (of ultra vires) arises from the doctrine of constructive notice,
i.e., it works only in conjunction with the latte

Doctrine of Indoor Management

The doctrine of indoor management or internal management of company’s affairs is an exception
to the rule of constructive notice, described above, and imposes an important limitation on it. Ac-
cording to this doctrine, ‘persons dealing with the company are entitled to presume that internal
requirements prescribed in the memorandum and articles have been properly observed’. The prin-
ciple of indoor management is one of justice, equity, and good conscience and has emerged out of
the concept of agency. The doctrine is partly dictated by practical necessity—persons contracting
with a company are not expected to spend their time checking that any required resolution has
properly been passed, that meetings have been duly convened by directors whose appointments
have been duly made. They can presume that all that is being done regularly and in keeping with
the memorandum and articles in view.

Implications of the Doctrine of Indoor Management: Recent Decisions

The Indian courts of law have been applying the doctrine of indoor management frequently and
interpreting it according to the cases in hand. The objective being the same, i.e., to protect the
third party transacting with the company in good faith and being unaware of the complex internal
management of the company.
In Monark Enterprises vs Kishan Tulpule and Ors2, the Company Law Board (now NCLT) held
‘That the validity of the impugned (doubtful) transaction was not affected even if no resolution
for entering into it was actually passed by the board of the company as the company had entered
into and adopted the transaction throughout and implemented it after receiving consideration
thereof. The doctrine of indoor management protected the transferee and the transferor. There was
nothing to show that the transferee was aware of the alleged infirmity in respect of the resolution.’
In Kirlampudi Sugar Mills Ltd vs G. Venkata Rao3, the Madras High Court averred:
Self-Learning ‘It is pertinent to note that the making of entries or maintenance of account books by the com-
240  Material pany predominantly relate to indoor management or the internal management of the affairs of the
company with which a creditor is not concerned and the creditor will not have any control over Memorandum and
the maintenance of the accounts and hence on that ground a creditor of the company cannot be Articles of Association
non-suited. The company will be in the custody of all the records and a third party creditor cannot and Share Capital …
be expected to know about the several internal affairs relating to the indoor management of the
Notes
company as such, and hence the respondent or plaintiff or third party creditor cannot be expected
to produce such a relevant material which would be in the custody of the opposite party and, hence,
in such a case, non-production of such records by the company should be taken serious note of and
this was rightly done by the trial court.’
Exceptions to the doctrine of indoor management  The doctrine of indoor management is sub-
ject to the following exceptions.
Knowledge of irregularity  If a person, dealing with a company, has actual or constructive notice
of the irregularity as regards internal management, he cannot seek benefit under the doctrine. He
may, in some cases, be himself a part of the internal procedure.
Negligence  The protection under the doctrine is also not available when the circumstances sur-
rounding the contract are so suspicious as to warrant inquiry, and the outsider dealing with the
company does not make proper inquiry.
Forgery  The doctrine does not apply where a person relies upon a document that turns out to be
forged since nothing can validate forgery. A company can never be held bound for forgeries com-
mitted by its officers.
Acts outside the scope of apparent authority  If an officer of a company enters into a contract with
a third party and if the act of the officer is beyond the scope of his authority, the company is not
bound. The plaintiff can sue the company only if the power to act has in fact been delegated to the
officer with whom he had entered into the contract.
Thus, the doctrine of indoor management seeks to protect the interest of the shareholders who
are in a minority, or who remain in dark about whether the working of the internal affairs of the
company are being carried out in accordance with the memorandum and articles. It is important
to note that the doctrine of constructive notice can be invoked by the company and hence does
not operate against the latter. It operates against the person who has failed to inquire but does not
function in his favour. But the doctrine of ‘indoor management’ can be invoked by the person deal-
ing with the company and cannot be invoked by the company.

Share Capital and Debentures: Introduction

Share capital, another term for equity capital, represents the funds raised by a company by selling
its stock to a number of persons (shareholders) for cash or other considerations. That is, the share
capital in relation to a company limited by shares is the aggregate sum of money divided into a
specified number of shares, each having a fixed value. In the strict sense, as used in accounting, the
share capital comprises the nominal values of all the shares issued i.e., the sum of their par values, as
printed on the share certificates. However, in common parlance, the share capital is the total of the
aforementioned nominal equity that a company raises in exchange for issuing an ownership interest
therein and the premium collected thereon, if any. Sometimes shares are allocated in exchange for
non-cash consideration, e.g. in case of mergers and acquisitions. For instance, company A acquires
company B for shares; here the share capital is increased to the par value of the new shares, and the
merger reserve is increased to the balance of the price of the company. A company may not always
depend upon the equity capital to cater to its financial needs; it has to resort to borrowings to raise
funds. The usual means of borrowing, provided authorised by the memorandum or articles, include
debts from banks or financial institutions, public deposits, and debentures or bonds. A debenture
in this behalf is a medium to long-term debt instrument used by large companies to borrow money.

Shares
A share is a fractional part of the share capital of a company. It signifies the interest of its possessor
(shareholder) in the company measured by a sum of money. According to Section 2(84), “share”
means a share in the share capital of a company and includes stock. Accordingly, for practical pur-
poses, a share is a right to participate in the profits made by the company so long as the latter is Self-Learning
a going concern and declares dividends and in the assets of the company in the event of its being Material  241
Legal and Regulatory wound up1. Every share in a company having a share capital shall be distinguished by its distinctive
Environment of number. However, this is not applicable in respect of shares held by a depository (Section 45). In
Business India, a share has been regarded as ‘goods’ within the meaning of the Sale of Goods Act; Section
2(7), which clearly states, “Goods means any kind of movable property other than actionable claims
Notes
and money, and includes stock and shares.”

Kinds of shares
In accordance with Section 43 of the Companies Act, 2013, the share capital of a company limited
by shares shall be composed of both equity or ordinary shares and preference shares.

Equity Shares
Equity share capital with reference to any company limited by shares means all the share capital
which is not preference share capital. Equity shareholders are the virtual owners of a company.
Equity shares may be sub-classified as:
(i) with voting rights; or
(ii) with differential rights as regards payment of dividend, voting or otherwise in accordance
with such rules as may be prescribed by the statute.
Shares with differential rights, however, cannot exceed 25 percent of the total issued share
capital.
Preference Shares  Preference share capital with reference to any company limited by shares,
means that part of the issued share capital of the company which carries or would carry a prefer-
ential right with respect to-
(a) Payment of dividend;
(b) Repayment of capital, in case of winding up of the company.
Thus, unlike equity shareholders, preference shareholders enjoy the preferential or superior
rights as regards payment of dividend as well as repayment of the paid up capital. Depending upon
the rights conferred by these shares, following are the major types of preference shares:
1. Cumulative or non-cumulative preference shares;
2. Redeemable or Irredeemable preference shares;
3. Participating or non-participating preference shares; and
4. Convertible or non-convertible preference shares.
A brief account of the above is given below.
1. Cumulative or Non-cumulative Preference Shares  When unpaid dividends on preference shares
due to inadequate profits are treated as arrears and are carried forward to subsequent years, then
such preference shares are known as cumulative preference shares. It means unpaid dividend on
such shares is accumulated till it is paid off in full. Non-cumulative preference shares on the other
hand are ones which are entitled to dividend at a fixed rate out of the profits of current year only.
They do not carry the right to receive arrears of dividend. If a company fails to pay dividend in a
particular year then that need not to be paid out of future profits.
2. Redeemable and Non-redeemable Preference Shares  As the term indicates, those preference
shares, which can be redeemed or repaid after the expiration of a fixed period or after giving the
prescribed notice as desired by the company, are known as redeemable preference shares. Terms of
redemption are, however, announced at the time of issue of such shares. Non-redeemable prefer-
ence shares, on the other hand, are those which cannot be redeemed during the life time of the
company. The amount of such shares is paid at the time of liquidation of the company.
3. Participating and Non-participating Preference Shares  Those preference shares which have a
right to participate in any surplus profit of the company along with equity shareholders, in addition
to the fixed rate of their dividend, are called participating preference shares. Likewise, in case of
winding up, if after paying back both, the preference and equity shareholders there is any surplus
left, the participating shareholders are entitled to share the surplus. On the other hand, preference
shares, which have no right to participate on the surplus profit or in any surplus on liquidation of
the company, are called non-participating preference shares.
4. Convertible and Non-convertible Preference Shares  Those preference shares which can be con-
Self-Learning
verted into equity shares at the option of their holders after a fixed period according to the terms
242  Material and conditions of their issue, are known as convertible preference shares. Contrarily, preference
shares, which are not convertible into equity shares, are called non-convertible preference shares.
Certificate of shares Memorandum and
Articles of Association
Certificate of shares is an official document issued under the common seal of the company, specify-
and Share Capital …
ing the number of shares held by any person. This document is the prima facie evidence of the title
of the person to such shares. Notes

Share Capital: Some Terminologies

Authorised share capital
Also referred to as nominal capital or at times, as registered capital, authorised capital is the total
of the share capital which a concerned company is allowed (authorised) to issue. It is stated in the
memorandum of a company and indicates the upper boundary for the actually issued share capital.
Authorised Capital = Issued Capital + Unissued Capital

Issued capital
Issued capital is the aggregate face (nominal) value of the company’s shares offered for subscription
by the general public or by a private placement, in case of a private limited company. This may be less
or equal to the authorised capital. The issued capital can be subdivided in another way, examining
whether it has been paid for by investors:

Subscribed capital.
It is the portion of the issued capital, which has been subscribed by all the investors including the
public. This may be less than the issued share capital as there may be capital for which no applica-
tions have been received yet i.e. ‘unsubscribed capital’.

Called-up capital
It is the total amount of issued capital for which the shareholders are required to pay. This may be
less than the subscribed capital as the company may ask shareholders to pay by installments.

Paid-up capital
It is the amount of share capital paid by the shareholders in aggregate that is with the application
(known as application money) and/or subsequently by way of allotment money and call money. This
may be less than the called up capital as payments may be outstanding i.e. ‘calls-in-arrears’. The
‘calls-in-arrears’ is called the unpaid capital.

ESOP
ESOP (Employee Stock Ownership Plan) is an employee-owner scheme that provides a company’s
workforce with an ownership interest in the company. Under these plans, the employer gives certain
stocks of the company to the employee for negligible or less costs which remain in the ESOP trust
fund, until the options vests and the employee exercises them or the employee leaves or retires from
the company or institution. These plans are aimed at improving the performance of the company
and increasing the value of the shares by involving stock holders, who are also the employees, in the
working of the company. The ESOPs help in minimizing problems related to incentives.

Sweat Equity Shares

Sweat equity shares are equity shares issued by a company to its directors or employees at a dis-
count, or for consideration other than cash, for providing their know-how or making available rights
in the nature of intellectual property rights or value addition to the company [Section 2(88)].
A company may issue sweat equity shares in respect of a class of shares already issued if these
conditions are met:
(a) The issue of such shares is authorised by a special resolution passed by the company in a
general meeting;
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Material  243
Legal and Regulatory (b) The resolution specifies the number of shares, the current market price, consideration, if any,
Environment of and the class/es of directors or employees to whom such equity shares are to be issued;
Business (c) Minimum one year has, at the date of such issue, elapsed since the company had commenced
its business; and
Notes
(d) Where the equity shares of the company are listed on a recognised stock exchange, the
sweat equity shares are issued in accordance with the regulations made by the Securities
and Exchange Board in this behalf and if they are not so listed, the sweat equity shares are
issued in accordance with such rules as may be prescribed [Section 54(1)].
The rights, limitations, restrictions and provisions as are for the time being applicable to equity
shares shall be applicable to the sweat equity shares and the holder of such shares shall rank pari
passu (equal in all respects) with other equity shareholders [Section 54(2)].

Further Issue of Shares to Existing Shareholders—

Rights Issue/Preferential Basis
When a company proposes to increase the share capital by issue of equity, convertible debentures
(fully or partly), convertible preference shares to its existing equity shareholders, then compa-
nies (including private limited companies) have to comply with the new procedures laid out under
Section 62 of the Companies Act 2013, given below:
1. Where at any time, a company having a share capital proposes to increase its subscribed
capital by the issue of further shares; such shares shall be offered –
(a) to person who at the date of the offer are holders of equity shares of the company in
proportion to the paid-up shares capital on those shares, by sending a letter of offer
subject to following conditions, namely:-
(i) the offer shall be made by a notice specifying the number of shares offered and
limiting a time not less than fifteen days and not exceeding thirty days from the date
of the offer within which the offer, if not accepted shall be deemed to have been
declined;
(ii) unless the article of the company otherwise provide, the offer shall be deemed to
include a right exercisable by the person concerned to renounce the shares offered
to him or any of them in favour of any other person and the notice shall contain a
statement of this right;
(iii) after the expiry of the time specified in the notice or receipt of earlier intimation
from the person to whom the notice is given that he declines to accept the shares
offered, the Board of Directors may dispose of them in such manner which is not
disadvantageous to the shareholders and the company;
(b) to employees under a scheme of employees’ stock option by a special resolution passed
by the company and subject to such conditions as may be prescribed; or
(c) to any persons, if it is authorised by a special resolution, either for cash or for a consid-
eration other than cash, if the price of such shares is determined by the valuation report
of a registered valuer.
2. The notice of letter of offer shall be dispatched through the registered post or speed post
or an electronic mode to all the existing shareholders at least three days before opening of
the issue.
3. These conditions shall not apply to the increase of the subscribed capital of a company
caused by the exercise of an option as a term attached to the debentures issued or loan
raised by the company to convert such debentures or loan into share in the company. How-
ever, the terms of issue of such debentures or loans containing such an option to convert
should have been approved before the issue of such debentures or raising of a loan by a
special resolution passed by the company in general meeting.
4. Where any debentures have been issued, or a loan has been obtained from any Government
by a company, and if that Government considers it necessary in the public interest so to do,
it may, by order, direct that such debentures or loans or any part thereof shall be converted
into shares in the company on such terms and conditions that appear to the Government to
be reasonable in the circumstances of the case even if terms of the issue of such debentures
Self-Learning
or the raising of such loans do not include a term for providing for an option for such conver-
244  Material sion.
 5. In determining the terms and conditions of conversion, the Government shall have due Memorandum and
regard to the financial position of the company, the terms of issue of debentures or loans, Articles of Association
as the case may be, the rate of interest payable on such debentures or loans and such other and Share Capital …
matters as it may consider necessary.
Notes
6. Where the Government has directed that any debentures or loan or any part thereof shall be
converted into shares in a company and where no appeal has been preferred to the Tribunal
or where such appeal has been dismissed, the memorandum of such company shall, where
such order has the effect of increasing the authorised share capital of the company, stand
altered and the authorised share capital of such company shall stand increased by an amount
equal to the amount of the value of shares which such debentures or loans or part thereof
have been converted into.

Bonus Shares
Bonus shares are additional shares given to the current shareholders without any additional cost in
proportion to their holdings. These are company’s accumulated earnings which are not given out in
lieu of dividends, but are converted into free shares.
A company may issue fully paid-up bonus shares to its members, in any manner whatsoever, out
of-
(i) Its free reserves
(ii) The security premium account
(iii) The capital redemption reserve account.
However, bonus shares cannot be issued by capitalizing reserves created by revaluation of assets
[Section 63(1)].
The following conditions must be satisfied before issuing bonus shares:
(a) The bonus issue must be authorised by the articles of the company.
(b) The bonus issue must be authorised by the shareholders in the general meeting on the rec-
ommendation of the Board of Directors of the company.
(c) The company must not have defaulted in payment of interest or principal in respect of fixed
deposits or any other debt securities issued by it.
(d) The company must not have defaulted in respect of the payment of statutory dues of the
employees, such as, contribution to provident fund, gratuity, bonus, etc.
(e) The company must have made partly paid-up shares, if any outstanding on the date of allot-
ment, fully paid-up [Section 63(2)].
The basic principle behind bonus shares is that the total number of shares increases with a con-
stant ratio of number of shares held to the number of shares outstanding. For instance, if Investor
A holds 200 shares of a company and a company declares a 4:1 bonus, that is, for every one share,
he gets 4 shares for free. That is total 800 shares for free and his total holding will increase to 1000
shares.
Companies issue bonus shares to encourage retail participation and increase their equity base.
When price per share of a company is high, it becomes difficult for new investors to buy shares of
that particular company. An increase in the number of shares reduces the price per share. But the
overall capital remains the same even if bonus shares are declared.

Buy-Back of Securities
Buy-back of securities refers to purchase by a company of its own shares or other specified securities
(ESOP, etc.). Buy-back is a very important tool for companies who want to reduce their share capital.
Buy-back can be made out by a company out of-
(a) its free reserves;
(b) the securities premium account; or
(c) the proceeds of the issue of any shares or other specified securities:
However, no buy-back of any kind of shares or other specified securities shall be made out of the
proceeds of an earlier issue of the same kind of shares or same kind of other specified securities
[Section 68(1)].
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Material  245
Legal and Regulatory Advantages of buy-back
Environment of
1. It is an alternative mode of reduction in capital without requiring approval of the Court/
Business
NCLT.
Notes 2. It improves the earnings per share.
3. It improves return on the capital, return on net worth and to enhance the long-term share-
holders value.
4. It provides an additional exit route to shareholders when shares are undervalued or thinly
traded.
5. It enhances consolidation of stake in the company.
6. It prevents unwelcome takeover bids.

Rules governing buy-back

Different rules governing buy-back of securities may be summarized as under:
Preliminary conditions as regards buy-back
In accordance with Section 68(2) for a buy-back to be legitimate and justifiable, the under-men-
tioned conditions must be fulfilled:
(a) It must be authorized by its articles;
(b) A special resolution must have been passed at a general meeting of the company authorizing
the buy-back, but the same is not required when:
(i) the buy-back is 10% or less of the total paid-up equity capital and free reserves of the
company; and
(ii) such buy-back has been authorized by the Board by means of a resolution passed at its
meeting;
(c) The buy-back must be twenty-five per cent or less of the aggregate of the paid-up capital and
free reserves of the company. However, in case of equity shares, the same shall be taken as
25% of the total paid up equity capital only;
(d) Debt equity ratio should be 2:1
Where: Debt is the aggregate of secured and unsecured debts owed by the company after
buy-back; and
Equity is the aggregate of the paid-up capital and its free reserves.
(e) All the shares or other specified securities for buy-back are fully paid-up;
(f) If shares or securities are listed, buy-back will be in accordance with the regulations made
by the Securities and Exchange Board in this behalf;
(g) The buy-back in respect of unlisted shares or other specified securities is in accordance with
Share Capital and Debentures Rules, 2014; and
(h) No offer of buy-back shall be made within a period of one year from the date of the closure
of the preceding offer of buy-back, if any.
Solvency Declaration  A company shall, before making such buy-back, file with the Registrar and
the Securities and Exchange Board, a declaration of solvency signed by at least two directors of the
company, one of whom shall be the managing director, if any, in such form as may be prescribed
and verified by an affidavit to the effect that the Board of Directors of the company have made a
full inquiry into the affairs of the company as a result of which they have formed an opinion that it
is capable of meeting its liabilities and will not be rendered insolvent within a period of one year
from the date of declaration adopted by the Board [Section 68(6)].
Extinguishment of Certificate  A company shall extinguish and physically destroy the shares or
securities so bought back within seven days of the last date of completion of buy-back [Section 68
(7)].
No further issue till 6 months  Where a company completes a buy-back of its shares or other
specified securities, it shall not make a further issue of the same kind of shares or other securities
including allotment of new shares or other specified securities within a period of six months except
by way of:
(a) a bonus issue or
(b) in the discharge of subsisting obligations such as conversion of warrants, stock option
Self-Learning
schemes, sweat equity or conversion of preference shares or debentures into equity shares
246  Material [Section 68(8)].
Register of Buy-back to be Maintained  A company shall maintain a register of the shares or Memorandum and
securities so bought, the consideration paid for the shares or securities bought back, the date of Articles of Association
cancellation of shares or securities, the date of extinguishing and physically destroying the shares and Share Capital …
or securities. The register of shares or securities bought back shall be maintained at the registered
Notes
office of the company and shall be kept in the custody of the secretary of the company or any other
person authorized by the board in this behalf. The entries in the register shall be authenticated by
the secretary of the company or by any other person authorized by the Board for the purpose [Sec-
tion 68(9)].
Return of Buy-back and a Declaration  A company shall, after the completion of the buy-back
under this section, file with the Registrar and the Securities and Exchange Board a return relating
to the buy-back within thirty days of such completion [Section 68(10)].
Punishment for any Default  If a company makes any default in complying with the provisions of
this section, the company shall be punishable with fine which shall not be less than one lakh rupees
but which may extend to three lakh rupees and every officer of the company who is in default shall
be punishable with imprisonment for a term which may extend to three years or with fine which
shall not be less than one lakh rupees but which may extend to three lakh rupees, or with both
[Section 68(11)].
Restriction on Buy-Back  No company shall directly or indirectly purchase its own shares or other
specified securities—
(a) through any subsidiary company including its own subsidiary companies;
(b) through any investment company or group of investment companies; or
(c) if a default, is made by the company, in the repayment of deposits accepted either before or
after the commencement of this Act, interest payment thereon, redemption of debentures
or preference shares or payment of dividend to any shareholder, or repayment of any term
loan or interest payable thereon to any financial institution or banking company. Provided
that the buy-back is not prohibited, if the default is remedied and a period of three years has
lapsed after such default ceased to subsist [Section 70(1)].
No Buy-Back if  No company shall, directly or indirectly, purchase its own shares or other specified
securities in case such company has not complied with the provisions of:
(a) Section 92: Annual Return
(b) Section 123: Declaration and Payment of Dividend
(c) Section 127: Failure to pay Dividend
(d) Section 129: Failure to give True and Fair Statement [Section 70(2)]

Debentures
The term ‘debenture’ is derived from the Latin word ‘debere’, which translates to ‘to borrow’ in Eng-
lish. Since a company finds it hard to borrow large sums of money from a single lender, it opts to split
the required funds into several units, each of being an even value and offered to public in terms of
debentures. As per Section 2(30) of the Companies Act, 2013, “Debenture includes debenture stock,
bonds, and any other securities of a company whether constituting a charge on the assets of the
company or not.” Accordingly, a debenture is a security issued by a company in whatever form it is
offered. Palmer described debenture as ‘an instrument under seal evidencing a debt, the essence of
it being the admission of indebtedness.’ Thus, a debenture is an instrument executed by the com-
pany under its common seal acknowledging indebtedness to some person or persons to secure the
sum advanced. A public limited company is allowed to raise debt or loan through debentures after
getting the certificate of commencement of business if permitted by its memorandum or articles.
Like shares, they are issued to the public at par, at a premium or at a discount. Debentures are usu-
ally secured by the company by a fixed or floating charge against its fixed assets. Debenture-holders
are creditors of the company. They have no voting rights but their claims rank prior to preference
shareholders and equity shareholders. Their exact rights depend upon the nature of debentures
they hold.

Kinds of Debentures
Debentures can be of following types: Self-Learning
Material  247
Legal and Regulatory 1. Redeemable and Irredeemable Debentures
Environment of
On the basis of redeemability, debentures may either be redeemable or irredeemable. Redeemable
Business
debentures are those which can be redeemed or paid back at the end of a specified period men-
Notes tioned on the debentures or within a specified period at the option of the company by giving notice
to the debenture holders or by installments as per the terms of issue. Conversely, irredeemable
debentures are those which are repayable at any time by the company during its existence. No date
of redemption is specified and the debenture holders cannot claim their redemption. However, they
become due for redemption if the company fails to pay interest on such debentures or on winding
up of the company. They are also called perpetual debentures.

2. Secured and Unsecured Debentures

From the point of view of security, debentures may either be secured or unsecured. Secured or
mortgaged debentures carry either a fixed charge on the particular asset of the company or floating
charge on all the assets of the company. Unsecured debentures, on the other hand, have no such
charge on the assets of the company. They are also known as ordinary or naked debentures.

3. Registered and Bearer Debentures

Registered debentures are registered with the company. Name, address and particulars of hold-
ings of every debenture holders are recorded on the debenture certificate and in the books of the
company. At the time of transfer, a regular transfer deed duly stamped and properly executed is
required. Interest is paid only to the registered debenture holders. Bearer debentures, on the other
hand, are transferred by mere delivery without any notice to the company. The company keeps no
record for such debentures. Debentures-coupons are attached with the debentures-certificate and
interest can be claimed by the coupon-holder.

4. Convertible and Non-convertible Debentures

Convertible debentures are those which can be converted by the holders of such debentures into
equity shares or preference shares. Contrarily, non-convertible debentures cannot be converted
into shares. A company can also issue partially convertible debentures under which only a part of
the debenture amount can be converted into equity shares.

E xercises
I. Objective-type Questions
1. Subscription clause is applicable in case of :
(a) Every limited company
(b) Every public limited company
(c) OPC
(d) Small company
2. Object clause contains:
(a) Authorised share capital
(b) Issued share capital
(c) Subscribed share capital
(d) All of the above
3. Match the items of List I with those in List II:
List I List II
(a) Table F (i) Companies limited by guarantee and having share
capital
(b) Table G (ii) Companies limited by shares
(c) Table H (iii) Companies limited by guarantee and not having
share capital
(d) Table I (iv) Unlimited Company and having share capital
(e) Table J (v) Unlimited company and not having share capital

Self-Learning
248  Material
 Answer Codes: Memorandum and
Articles of Association
(a) (b) (c) (d) (e) and Share Capital …
A (i) (ii) (iii) (iv) (v)
Notes
B (i) (ii) (iv) (v) (iii)
C (ii) (i) (iii) (v) (iv)
D (ii) (i) (iii) (iv) (v)
4. Which of the following statements is true?
(a) Doctrine of constructive notice arises from the doctrine of ultra vires
(b) Doctrine of constructive notice arises from the doctrine of indoor manage-
ment
(c) Doctrine of indoor management arises from the doctrine of constructive
notice
(d) Doctrine of ultra-vires arises from the doctrine of constructive notice
5. Which of the following can be invoked by the company and hence does not oper-
ate against the latter?
(a) Doctrine of constructive notice
(b) Doctrine of indoor management
(c) Doctrine of ultra-vires
(d) Both (A) and (B)
6. A company cannot issue bonus shares to its members out of-
(a) Free reserves
(b) The security premium account
(c) The capital redemption reserve account
(d) The revaluation reserve account
7. Preference shareholders enjoy the preferential or superior rights as regards:
(a) Payment of dividend
(b) Repayment of the paid up capital
(c) Payment of dividend as well as repayment of the paid up capital
(d) None of the above
8. Which of the following statements are true in respect of the share capital in rela-
tion to a company limited by shares?
(i) It is the aggregate sum of money divided into a specified number of shares
each having a fixed value.
(ii) It comprises the nominal values of all the shares issued i.e., the sum of
their par values, as printed on the share certificates.
(iii) It is the total of the nominal equity that a company raises in exchange for
issuing an ownership interest therein and the premium collected thereon,
if any.
Codes:
(a) Statement (i) is true alone
(b) Statements (i) and (ii) are true
(c) Statements (ii) and (iii) are true
(d) Statement (i), (ii) and (iii) are true
9. _________________ debentures are also called perpetual debentures
(a) Redeemable debentures
(b) Irredeemable debentures
(c) Registered debentures
(d) Secured Debentures
10. Which of the following conditions must be satisfied by a company to issue sweat
equity shares?
(i) A company may issue sweat equity shares in respect of a class of shares
already issued
(ii) Such an issue is authorised by a special resolution passed by the company
in a general meeting. Self-Learning
Material  249
Legal and Regulatory (iii) Minimum one year has, at the date of such issue, elapsed since the com-
Environment of pany had commenced its business.
Business (iv) Where the equity shares of the company are listed on a recognised stock
exchange, the sweat equity shares are issued in accordance with the regu-
Notes lations made by the Securities and Exchange Board in this behalf
Codes:
(a) Statements (i) and (ii) alone are true
(b) Statements (ii) and (iii) alone are true
(c) Statements (i), (ii) and (iii) alone are true
(d) All the statements are true
II. Review Questions
1. ‘The memorandum of association is an unalterable charter of a company.’ Com-
ment. Also discuss contents of memorandum.
2. What do you mean by articles of association? Discuss the rules governing altera-
tion of articles.
3. Explain the ‘Doctrine of ultra-vires’.
4. What is a prospectus? List out its contents.
5. Define share capital. Describe the different types of shares which can be issued
by a public limited company.
6. Discuss the provisions of the Companies Act, 2013 as regards further issue of
shares to existing shareholders.
7. Comment on the following:
(a) Bonus Issue
(b) Sweat Issue of Equity Shares
(c) ESOP
(d) Preliminary conditions as regards Buy-back

10. (d) 9. (b) 8. (d) 7. (c) 6. (d)

5. (a) 4. (d) 3. (d) 2. (a) 1. (c)
Answers to Objective-type Questions

Self-Learning
250  Material
 Chapter
13 In Review
Learning Objectives In the incorporation stage, memorandum and articles, the two key documents, need
l

to be filed with the Registrar of Companies. The memorandum acts as the charter
Memorandum of Association of the company and sets out the (a) name clause, (b) objects clause, (c) registered
Doctrine of Ultra Vires office clause, (d) liability clause (e) capital clause, and (f) association clause; whereas
the articles enumerate the internal rules of the company under which it will be
Alteration of Memorandum governed. Any act beyond the scope of the memorandum and not reasonably
Articles incidental to the attainment of the object(s) is ultra-vires the company and therefore
unenforceable. On the other hand, articles contain the set of rules for the internal
Doctrine of Constructive Notice
administration of the company. Articles may be altered subject to provisions of
Share Capital and Debentures: Introduction the Companies Act. Every person dealing with the company is deemed to have
Share Capital: Some Terminologies knowledge of the contents of the memorandum and the articles. This is known as
‘doctrine of constructive notice’ and protects the interest of the company and its
ESOP
functionaries. An exception to ‘doctrine of constructive notice’ is known as ‘doctrine
Sweat Equity Shares of indoor management’ which seeks to safeguard the interest of the stakeholders if
Further Issue of Shares to Existing Shareholders company’s administration attempts to misuse the former to their vested advantages.
— Rights Issue/Preferential Basis l The share capital in relation to a company (i.e. one limited by shares) is the nominal
value of equity that a company raises in exchange for issuing an ownership interest
Bonus Shares therein and the premium collected thereon, if any. Sometimes shares are also issued
Buy-Back of Securities in exchange for non-cash consideration, e.g. in case of mergers and acquisitions. The
Debentures share capital of a company limited by shares may be composed of both equity or
ordinary shares and preference shares. However, equity shareholders are the virtual
owners of a company. Preference shareholders, on the other hand, carry a preferential
right with respect to payment of dividend as well as repayment of the capital, in case
Key Terms of winding up of the company. Depending upon the rights conferred by these shares,
Memorandum of association: A document preference shares may be classified as: (a) cumulative or non-cumulative preference
that regulates a company’s external shares; (b) redeemable or irredeemable preference shares; (c) participating or non-
activities participating preference shares; and (d) convertible or non-convertible preference
Doctrine of ultra vires: An act which is shares. A company may not always depend upon the equity capital to cater to its
beyond the powers of the company and financial needs; it has to resort to borrowings to raise funds. The usual means of
therefore void borrowing, provided authorised by the memorandum or articles of company, include
Articles of association: A document that debts from banks or financial institutions, public deposits, and debentures or bonds.
contains the purpose of the company as A debenture is a medium to a long-term debt instrument used by large companies
well as the duties and responsibilities of its to borrow money. Like preference shares, debentures may be categorised as: (a)
members defined and recorded clearly redeemable and irredeemable debentures; (b) secured and unsecured debentures;
(c) registered and bearer debentures; and (d) convertible and non-convertible ones.
Doctrine of constructive notice: A legal
A company may purchase its own shares or other specified securities (ESOP, etc.),
fiction that attributes notice of something
known as Buy-back of securities.
to a person or entity, even though actual
notice did not exist
Doctrine of indoor management: A
presumption on the part of the the people
dealing with the company that the internal Paid-up capital: The amount of share available rights in the nature of
requirements with regard to ‘articles’ and capital paid by the shareholders in intellectual property rights or value
‘memorandum’ have been duly complied aggregate addition to the company
with Employee Stock Ownership Plan (ESOP): Bonus shares: Additional shares given
Share capital: The funds raised by the An employee-owner scheme that to current shareholders without any
company by selling its stock to a number of provides a company’s workforce with an additional cost in proportion to their
persons for cash or other considerations ownership interest in the company holdings
Shares: A fractional part of the share capital Sweat equity shares: Equity shares Buy-back of securities: Purchase of its
of the company issued by a company to its directors own shares or other specified securities
Authorised share capital: The total share or employees at a discount, or for by a company
capital a concerned company is allowed to consideration other than cash, for Debentures: A security issued by a
issue providing their know-how or making company in whatever form it is offered

Memorandum and Articles of Association and Share Capital and Debentures  251
Legal and Regulatory

Company Management,
14
Environment of
Business

Notes
Meetings, and
Winding Up of Company

©: iStock
Learning Objectives
1. Directors: appointment, qualifications, 7. Winding up; by the Tribunal,
disqualifications voluntary; grounds for winding up
2. Managing director by the Tribunal
3. Managerial remuneration 8. Winding up: commencement;
4. Corporate governance consequences
5. Kinds of company meetings; Board 9. Voluntary winding up
meetings, meetings of members 10. Dissolution of a company and further
6. Resolutions; minutes developments

Company Management: An Over view

A company being a separate legal personality should be operated at a distance from its members
or shareholders. To facilitate this, shareholders elect and appoint their representatives who
can be entrusted with the responsibility of running the company. These elected members, actually
concerned in the operation of the company (on behalf of the owners), are known as directors. The
directors of a company can do what the company can do itself, of course, subject to the restrictions
imposed by the Companies Act and articles of the company. The directors so appointed constitute
a ‘Board’ as they jointly oversee the activities of the company. If the ‘Board of directors’ wishes
one person to be particularly accountable for day to day affairs of the company’s business on their
behalf, that person is generally appointed as the Managing Director or the whole-time Director.
Such a Managing Director or whole-time Director works under the overall supervision and control
of the Board of directors. The Act though does not expressly define the term ‘director’; it contains
specific provisions regarding qualifications, appointment, powers, duties, remuneration, removal,
and liabilities of directors.

Who can be a Director?

Directors are those who perform the directing function irrespective of the label attached to them.
Except this obligation, there is no formal academic or professional qualification, or an upper age
limit fixed by company law for electing or appointing a person as director. Section 2(34) merely
provides that director means a director appointed to the Board of a company.
However, only individuals barring minors can be directors. Every company shall have a Board of
Directors consisting of individuals as directors [Section 149(1)].
Thus, no corporate body, association, or firm can be appointed as directors of a company.
Self-Learning
Every company shall have—
252 Material
 (a) a minimum number of three directors in the case of a public company, two directors in the Company Management,
case of a private company, and one director in the case of a One Person Company; and (b) a Meetings, and Winding
maximum of fifteen directors. Up of Company
However, a company may appoint more than fifteen directors after passing a special
Notes
resolution.
Moreover, such class or classes of companies as may be prescribed shall have at least one
woman director [Section 149(1)].
Every company existing on or before the date of commencement of this Act shall within
one year from such commencement comply with the requirements of the provisions of sub-
section (1) [Section 149(2)].
Every company shall have at least one director who has stayed in India for a total period of
not less than one hundred and eighty-two days in the previous calendar year i.e. a resident
director [Section 149(3)].
Every listed public company shall have at least one-third of the total number of directors
as independent directors and the Central Government may prescribe the minimum number
of independent directors in case of any class or classes of public companies [Section 149(4)].

Independent director
An independent director in relation to a company, means a director other than a managing director
or a whole-time director or a nominee director,—
(a) who, in the opinion of the Board, is a person of integrity and possesses relevant expertise
and experience;
(b) (i) who is or was not a promoter of the company or its holding, subsidiary or associate com-
pany; (ii) who is not related to promoters or directors in the company, its holding, subsidiary
or associate company;
(c) who has or had no pecuniary relationship with the company, its holding, subsidiary or as-
sociate company, or their promoters, or directors, during the two immediately preceding
financial years or during the current financial year;
(d) none of whose relatives has or had pecuniary relationship or transaction with the company,
its holding, subsidiary or associate company, or their promoters, or directors, amounting to
two per cent or more of its gross turnover or the total income or fifty lakh rupees or such
higher amount as may be prescribed, whichever is lower, during the two immediately pre-
ceding financial years or during the current financial year;
(e) who, neither himself nor any of his relatives—
(i) holds or has held the position of a key managerial personnel or is or has been employee
of the company or its holding, subsidiary or associate company in any of the three
financial years immediately preceding the financial year in which he is proposed to be
appointed;
(ii) is or has been an employee or proprietor or a partner, in any of the three financial years
immediately preceding the financial year in which he is proposed to be appointed, of (A)
a firm of auditors or company secretaries in practice or cost auditors of the company or
its holding, subsidiary or associate company; or (B) any legal or consulting firm that has
or had any transaction with the company, its holding, subsidiary or associate company
amounting to ten per cent or more of the gross turnover of such firm;
(iii) holds together with his relatives two per cent or more of the total voting power of the
company; or
(iv) is a Chief Executive or director, by whatever name called, of any nonprofit organisation
that receives twenty-five per cent or more of its receipts from the company, any of its
promoters, directors or its holding, subsidiary or associate company or that holds two
per cent or more of the total voting power of the company; or
(f) who possesses such other qualifications as may be prescribed [Section 149(6)].

Disqualification (for appointment) of Directors

A person shall not be eligible for appointment as a director of a company, if:
Self-Learning
(a) He is of unsound mind and stands so declared by a competent court;
Material 253
Legal and Regulatory (b) He is an undischarged insolvent;
Environment of (c) He has applied to be adjudicated as an insolvent and his application is pending;
Business (d) He has been convicted by a court of any offence whether involving moral turpitude or
otherwise and sentenced in respect thereof to imprisonment for not less than six months
Notes
and a period of five years has not elapsed from date of expiry of the sentence. However, if
a person has been convicted by a court of any offence and sentenced in respect thereof to
imprisonment for a period of seven years, he shall not be eligible to be appointed as director
in any company.
(e) An order disqualifying him for appointment as a director has been passed by a court or Tri-
bunal and the order is in force;
(f) He has not paid any calls in respect of any shares of the company held by him, whether alone
or jointly with others, and six months have elapsed from the last day fixed for the payment
of the call;
(g) He has been convicted of the offence dealing with related party transactions under Section
188 at any time during the last preceding five years; or
(h) He has not been allotted Director Identification Number under Section 154 [Section 164(1)].
Besides, no person, who is or has been a director of a company which –
(a) has not filed financial statements or annual returns for a continuous period of three financial
years; or
(b) has failed to repay the deposits accepted by it or pay interest thereon or to redeem any de-
bentures on the due date or pay interest due thereon or pay any dividend declared and such
failure to pay or redeem continues for one year or more, shall be eligible to be re-appointed
as a director of that company or appointed in other company for a period of five years from
the date on which the said company fails to do so [Section 164(2)].
Moreover, a private company may by its articles provide for any disqualifications for appointment
as a director in addition to those provided under Section 164(1) and (2) [Section 164(3)].

Director Identification Number

Director Identification Number is a unique identification number allotted to a potential director
of any company by the Central Government i.e. Ministry of Corporate Affairs. The concept of a
DIN was introduced for the first time with the insertion of Sections 266A to 266G of Companies
(Amendment) Act, 2006. The main purpose of introducing DIN is to keep a rich and authentic da-
tabase of the directors of incorporated companies. Many a times it is seen that a duly incorporated
company vanished with its director(s) after raising capital from the public and the probing agencies
find it hard to trace them. DIN in this behalf is the ultimate device to help probing agencies trace
the absconding director(s) and thereby address the issue. DIN not only helps fixing the identity
of a director but also relates his participation in other companies, past and present. DIN holder is
required to inform the Central Government about any change in his particulars as and when such
changes take place. This keeps the database of the directors live.
Sections 153 - 59 of the New Act (Companies, 2013) which correspond the Sections 266A to 266G
of Companies (Amendment) Act, 2006 have been discussed below:

Procedure for allotment of DIN

Every individual intending to be appointed as director of a company shall make an application for
allotment of Director Identification Number to the Central Government in the prescribed form and
manner and along with the prescribed fees [Section 153].
As per the revised procedure for DIN allotment, any individual intending to apply for DIN shall
have to make an online application in e-Form DIN 1 and follow the procedure by logging on to http://
www.mca.gov.in/MCA21/
The Central Government shall allot a Director Identification Number to an applicant within one
month from the receipt of the application provided the particular furnished therein found in order
[Section 154].
However, no individual, who has already been allotted a Director Identification Number un-
der section 154, shall apply for, obtain or possess another Director Identification Number
Self-Learning [Section 155].
254  Material
 Every existing director shall intimate his Director Identification Number to the company/ com- Company Management,
panies wherein he is a director within one month of its receipt from the Central Government Meetings, and Winding
[Section 156]. Up of Company

Notes
Company to inform DIN to the registrar
Every company shall, within fifteen days of the receipt of intimation under section 156, furnish the
Director Identification Number of all its directors to the Registrar or any other officer or authority
as may be specified by the Central Government with such fees as may be prescribed or with such
additional fees as may be prescribed within the time specified under Section 403 and every such
intimation shall be furnished in such form and manner as may be prescribed [Section 157(1)].
If a company fails to furnish Director Identification Number under sub-section (1), before the
expiry of the period specified under Section 403 with additional fee, the company shall be punish-
able with fine which shall not be less than twenty-five thousand rupees but which may extend to
one lakh rupees and every officer of the company who is in default shall be punishable with fine
which shall not be less than twenty-five thousand rupees but which may extend to one lakh rupees
[Section 157(2)].
Moreover, every person or company, while furnishing any return, information or particulars as
are required to be furnished under this Act, shall mention the Director Identification Number in
such return, information or particulars in case such return, information or particulars relate to the
director or contain any reference of any director [Section 158].

Consequences of contravention
If any individual or director of a company, contravenes any of the provisions of Sections 155 and 156,
such individual or director of the company shall be punishable with imprisonment for a term which
may extend to six months or with fine which may extend to fifty thousand rupees and where the
contravention is a continuing one, with a further fine which may extend to five hundred rupees for
every day after the first during which the contravention continues [Section 159].

Appointment of Directors
Appointment of directors may be discussed under the following heads.

Appointment of first directors

Generally, the names of the first directors of a new company are provided for in its articles. How-
ever, if the articles are silent on this count then the subscribers to the memorandum (who are
individuals) shall be deemed to be the first directors of the company until the directors are duly
appointed. In case of ‘One Person Company’ an individual being member shall be deemed to be its
first director until the director or directors are duly appointed by the member [Section 152].

Appointment of regular directors

The first directors appointed by the articles or otherwise shall act until the first annual general
meeting (AGM). In the first AGM the shareholders shall elect and appoint the directors on a regular
basis [Section 152 (2)].
Every person proposed to be appointed as a director by the company in general meeting or
otherwise, shall furnish his Director Identification Number (DIN) and a declaration that he is not
disqualified to be appointed as a director [Section 152 (4)].
In the case of a public company, unless the articles provide for retirement of all the directors at
every AGM, at least two-thirds of the total number of directors (excluding independent directors)
shall be liable to retire by rotation. Thus, only one-third of total number of directors shall be non-
rotational or permanent directors. For example, consider a company X Ltd., which has 10 directors.
In this case, seven directors become liable to retire by rotation. These seven directors, unless other-
wise become incompetent to act as directors, shall once again be appointed at the general meeting.
The remaining three directors shall also be appointed at the general meeting. Two directors shall
retire from office at every AGM, out of the seven directors who are eligible to retire by rotation
[Section 152(6)(c)]. Self-Learning
Material  255
Legal and Regulatory Note The first AGM mentioned at the beginning of Section 256 is actually the first general meeting
Environment of held after the appointment is made under Section 255, and does not refer to the first AGM of the
Business company.
Notes Re-appointment of retiring directors
When a director retires, he/she can be reappointed or another person can be appointed as a direc-
tor. The share holders in their general meeting can also resolve that the vacancy may not be filled.
However, if the post of a retiring director is not filled at the general meeting, and the meeting does
not even pass a resolution for not filling the vacancy, the general meeting will be adjourned till next
week at the same time and place. If that day happens to be public holiday, the meeting will be held
next day. If even on that day, the vacancy is not filled, or a resolution not to fill the vacancy is passed,
then the retiring director is deemed to be re-appointed. However, he will not be deemed to be re-
appointed under any of the following conditions:
A resolution for his re-appointment has been specifically lost;
l The director expresses his inability to continue as a director;

l He is not qualified for appointment;

l A specific resolution is required for the appointment of that director; or

A single resolution for appointing more than one director was passed in earlier meeting, in con-
travention of section 263 [Section 256(4)].

Appointment by the board of directors

The Board of directors is empowered to appoint directors in the following four categories:
1. Additional director
2. Alternate director
3. Nominee director
4. Casual director

Additional director
The articles of a company may confer on its Board of Directors the power to appoint any person,
other than a person who fails to get appointed as a director in a general meeting, as an additional
director at any time who shall hold office up to the date of the next annual general meeting or
the last date on which the annual general meeting should have been held, whichever is earlier
[Section 161(1)].
Accordingly, the Board either at the meeting of the Board or by passing a special resolution in
a general meeting can appoint an additional director on the Board if so authorised by the articles.
They will although enjoy the same powers and rights as other directors but shall hold office only up
to the date of the next AGM. Since the additional directors shall hold office only till the date of the
next AGM, if the AGM is adjourned for any reason, they shall vacate their office on the due date,
notwithstanding the adjournment of AGM.

Alternate director
The Board of Directors of a company may, if so authorised by its articles or by a resolution passed
by the company in general meeting, appoint a person, not being a person holding any alternate di-
rectorship for any other director in the company, to act as an alternate director for a director during
his absence for a period of not less than three months from India.
However, no person shall be appointed as an alternate director for an independent director
unless he is qualified to be appointed as an independent director under the provisions of this Act.
Furthermore, an alternate director shall not hold office for a period longer than that permissible
to the director in whose place he has been appointed and shall vacate the office if and when the
director in whose place he has been appointed returns to India.
Furthermore, if the term of office of the original director is determined before he so returns to
India, any provision for the automatic re-appointment of retiring directors in default of another ap-
pointment shall apply to the original, and not to the alternate director [Section 161(2)].

Nominee director
Self-Learning If the articles of a company so provide, the Board may appoint any person as a director nominated
256  Material by any institution in pursuance of the provisions of any law for the time being in force or of any
agreement or by the Central Government or the State Government by virtue of its shareholding in Company Management,
a Government company [Section 161(3)]. Meetings, and Winding
Up of Company
Casual director
Notes
In the case of a public company, if the office of any director appointed by the company in general
meeting is vacated before his term of office expires in the normal course, the resulting casual va-
cancy may, in default of and subject to any regulations in the articles of the company, be filled by
the Board of Directors at a meeting of the Board [Section 161(4)].
However, any person so appointed shall hold office only till the date up to which the director in
whose place he is appointed would have held office if it had not been vacated.

Appointment by the central government

Where all the directors of a company vacate their offices under any of the disqualifications speci-
fied in Section 167(1), in the absence of the promoter; the Central Government shall appoint the
required number of directors who shall hold office till the directors are appointed by the company
in the general meeting [Section 167(3)].

Appointment by the tribunal

The Tribunal, upon the receipt of an application from any member of a company or from the Central
Government for relief from oppressions etc., may appoint such number of persons as directors, who
may be required by the Tribunal to report to the Tribunal on such matters as the Tribunal may direct
[Section 242 (2) (k) read with Section 241].

Appointment by proportional representation

The Act enables minority shareholders to have their representation on the Board, otherwise de-
prived, due to maxim of a simple majority vote, by giving an option to companies to appoint direc-
tors through a system of proportional representation. The articles may provide for the appointment
of not less than two-thirds of the total number of the directors of a company, according to the
principle of proportional representation. The proportional representation may be exercised by a
single transferable vote or by a system of cumulative voting or otherwise. Such appointments shall
be made once in every three years and casual vacancies of such directors shall be as per the statu-
tory provision given under Section 161 (4) [Section 163].

Appointment of small shareholders’ director

The Companies Act, 2013 provides for appointment of a director elected by ‘small shareholders’ with
a view to enable them protect their interest. In accordance with Section 151, a listed company may
have one director elected by ‘small shareholders’ in such manner and with such terms and condi-
tions as may be prescribed.
For the above purposes “small shareholders” means a shareholder holding shares of nominal
value of not more than twenty thousand rupees or such other sum as may be prescribed [Explana-
tion added to Section 151].
As per Rule 7 of the Companies (Appointment and Qualification of Directors) Rules, 2014, a listed
company may upon notice of not less than 1000 small shareholders or 1/10th of the total number
of such shareholders, whichever is lower, have a small shareholders’ director elected by the small
shareholders.

Ceiling on directorships
The Companies Act puts a ceiling on directorships. Accordingly, no person shall hold office as a
director, including any alternate directorship, in more than twenty companies at the same time.
However, the maximum number of public companies in which a person can be appointed as a
director is ten which includes directorships in private companies that are either holding or subsid-
iary of a public company [Section 165(1)].
Thus, a person can hold directorship in ten public companies and ten private companies, whether
or not latter are holding or subsidiary companies of the former i.e. public companies.
Self-Learning
Material  257
Legal and Regulatory However, the members of a company may, by special resolution, specify any lesser number of
Environment of companies in which a director of the company may act as director [Section 165(1)].
Business If a person, who is already holding offices as director in more than the specified number of com-
panies (i.e. 20) immediately before the commencement of the Companies Act, 2013, shall within a
Notes
period of one year from such commencement-
(a) choose not more than the specified limit of those companies, as companies in which he
wishes to continue to hold the office of director;
(b) resign his office as a director in the other remaining companies; and
(c) intimate the choice made by him under clause (a), to each of the companies in which he
was holding the office of a director before such commencement and to the Registrar having
jurisdiction in respect of each such company [Section 165(3)].

Penalty for non-compliance

Any person who holds office or acts as a director of more than 20 companies in contravention of the
foregoing provisions shall be punishable with fine which shall not be less than five thousand rupees
but which may extend to twenty-five thousand rupees for every day after the first during which the
contravention continues [Section 165(6)].

Managing Director or Whole-Time Director

If the Board wishes one person to be particularly accountable for day to day affairs of the company’s
business on their behalf, that person is generally appointed as the Managing Director or the Whole-
Time Director. The latter will exercise his powers subject to the superintendence, control, and direc-
tion of the Board of directors.

Rules governing the appointment of the managing director or whole-time

director or manager
In regards of appointment, reappointment, tenure etc. of the managing director or whole-time
director or manager, Section 196 provides as under:
1. No company shall appoint or employ at the same time a managing director and a manager.
2. No company shall appoint or re-appoint any person as its managing director, whole-time
director or manager for a term exceeding five years at a time.
  However, no re-appointment shall be made earlier than one year before the expiry of his
(original) term.
3. No company shall appoint or continue the employment of any person as the managing
director, whole-time director or manager who —
(a) is below the age of twenty-one years or has attained the age of seventy years;
  However, appointment of a person who has attained the age of seventy years may be
made by passing a special resolution in which case the explanatory statement annexed
to the notice for such motion shall indicate the justification for appointing such person.
(b) is an undischarged insolvent or has at any time been adjudged as an insolvent; (c) has
at any time suspended payment to his creditors or makes, or has at any time made, a
composition with them; or (d) has at any time been convicted by a court of an offence
and sentenced for a period of more than six months.
4. A managing director, whole-time director or manager shall be appointed and the terms and
conditions of such appointment and remuneration payable be approved by the Board of
Directors at a meeting which shall be subject to approval by a resolution at the next general
meeting of the company and by the Central Government in case such appointment is at
variance to the conditions specified in that Schedule.
However, a notice convening the Board or general meeting for considering such appointment
shall include the terms and conditions of such appointment, remuneration payable and such other
matters including interest of a director or directors in such appointments, if any.
Moreover, a return in the prescribed form shall be filed within sixty days of such appointment
with the Registrar.
Self-Learning
258  Material
Managerial Remuneration Company Management,
Meetings, and Winding
Managerial remuneration refers to the remuneration payable to the managerial personnel of a com- Up of Company
pany, who generally comprise a managing director, directors, and a statutory manager, if any. It is
usually determined in accordance with the provisions outlined in the articles of the company or by a Notes
resolution (special resolution if the articles so require) passed by the company in a general meeting.
The remuneration payable to any such director determined as per the said provisions is inclusive
of the remuneration payable to such director for services rendered by him in any other capacity.

Overall maximum managerial remuneration

Section 197, which deals with overall maximum managerial remuneration and managerial remunera-
tion in case of nil or inadequate profits, provides as under.
1. The total managerial remuneration payable by a public company to its directors, including
the managing director, whole-time director and its manager in respect of any financial year
shall not exceed 11 per cent of the net profits of that company for that financial year com-
puted in the manner laid down in Section 198.
  However, the company in general meeting may, with the approval of the Central Govern-
ment, authorise the payment of remuneration exceeding eleven per cent of the net profits
of the company, subject to the provisions of Schedule V.
Moreover, except with the approval of the company in general meeting,—
(i) the remuneration payable to any one managing director; or whole-time director or man-
ager shall not exceed five per cent of the net profits of the company and if there is more
than one such director, remuneration shall not exceed ten per cent of the net profits to
all such directors and manager taken together;
(ii) the remuneration payable to directors who are neither managing directors nor whole-
time directors shall not exceed,—
(A) one per cent of the net profits of the company, if there is a managing or whole-time
director or manager; (B) three per cent of the net profits in any other case.
2. The percentages aforesaid shall be exclusive of any fees payable to directors under sub-
section (5)
3. If in any financial year, a company has no profits or its profits are inadequate, the company
shall not pay to its directors, including any managing or whole-time director or manager, by
way of remuneration any sum exclusive of any fees payable to directors.
4. The remuneration payable to the directors of a company, including any managing or whole-
time director or manager, shall be determined, in accordance with and subject to the provi-
sions of this section, either by the articles of the company, or by a resolution or, if the articles
so require, by a special resolution, passed by the company in general meeting and the remu-
neration payable to a director determined aforesaid shall be inclusive of the remuneration
payable to him for the services rendered by him in any other capacity.
However, any remuneration for services rendered by any such director in other capacity shall
not be included if—
(a) the services rendered are of a professional nature; and (b) in the opinion of the Nomina-
tion and Remuneration Committee, if the company is covered under sub-section (1) of
section 178, or the Board of Directors in other cases, the director possesses the requisite
qualification for the practice of the profession.
5. A director may receive remuneration by way of fees for attending meetings of the Board or
Committee thereof or for any other purpose whatsoever as may be decided by the Board.
  However, the amount of such fees shall not exceed the amount as may be prescribed.
  Moreover, different fees for different classes of companies and fees in respect of an in-
dependent director may be such as may be prescribed.
6. A director or manager may be paid remuneration either by way of a monthly payment or at
a specified percentage of the net profits of the company or partly by one way and partly by
the other.
7. An independent director shall not be entitled to any stock option and may receive remunera-
tion by way of fees provided under sub-section (5), reimbursement of expenses for participa-
tion in the Board and other meetings and profit related commission as may be approved by Self-Learning
the members. Material  259
Legal and Regulatory 8. The net profits for the purposes of this section shall be computed in the manner referred to
Environment of in Section 198.
Business 9. If any director draws or receives, directly or indirectly, by way of remuneration any such sums
in excess of the limit prescribed by this section or without the prior sanction of the Central
Notes
Government, where it is required, he shall refund such sums to the company and until such
sum is refunded, hold it in trust for the company.
If any person contravenes the provisions of this section, he shall be punishable with fine which
shall not be less than one lakh rupees but which may extend to five lakh rupees [Section 196(15)].

Vacation of Office by Directors

As per Section 167, the office of a director shall become vacant under any one of the following cir-
cumstances:
(a) He incurs any of the disqualifications specified in section 164;
(b) He absents himself from all the meetings of the Board of Directors held during a period of
twelve months with or without seeking leave of absence of the Board;
(c) He acts in contravention of the provisions of section 184 relating to entering into contracts
or arrangements in which he is directly or indirectly interested;
(d) He fails to disclose his interest in any contract or arrangement in which he is directly or
indirectly interested, in contravention of the provisions of section 184;
(e) He becomes disqualified by an order of a court or the Tribunal;
(f) He is convicted by a court of any offence, whether involving moral turpitude or otherwise
and sentenced in respect thereof to imprisonment for not less than six months.
The office shall be vacated by the director in the above case even if he has filed an appeal
against the order of such court;
(g) He is removed in pursuance of the provisions of this Act;
(h) He, having been appointed a director by virtue of his holding any office or other employment
in the holding, subsidiary or associate company, ceases to hold such office or other employ-
ment in that company.
A private company, however, may, by its articles, provide any other ground for the vacation of the
office of a director in addition to those specified above [Section 167(4)].

Penalty for not vacating office due to disqualifications

If a person functions as a director after his office has become vacant on account of any of the dis-
qualifications, specified in (a) to (h) above, he shall be punishable with imprisonment for a term
which may extend to one year or fine which shall not be less than one lakh rupees but which may
extend to five lakh rupees, or with both [Section 167(2)].

Removal of directors
Removal or termination of directors can be discussed under the following two heads:
1. Removal by company
2. Removal by the Tribunal

Removal by company
Under Section 167, a company (i.e., the shareholders) may, by an ordinary resolution requiring a spe-
cial notice, remove a director from the Board before the expiration of his term of office. However,
the director concerned shall be entitled to be heard before passing of the resolution of his removal
by the company.
However, the absolute power apparently given to the company to remove a director under Sec-
tion 167 does not apply in respect of a director appointed by the Tribunal under Section 242 and the
directors appointed according to the principle of proportional representation.

Removal by the Tribunal

Where on an application filed by any member of the company or the Central Government before the
Tribunal against oppression and mismanagement of a company’s affairs (i.e. under Section 241), the
Self-Learning Tribunal finds that the relief should be granted, it may pass an order for the removal of the managing
260  Material director, manger, or any of the directors of the company [Section 242(2)(h)].
 When the appointment of a director is so finished, he shall not be entitled to claim any dam- Company Management,
ages or compensation from the company for the loss of office. Moreover, such a director cannot be Meetings, and Winding
appointed, except with the leave (prior consent) of the Tribunal, in any managerial capacity (i.e., Up of Company
manager, managing director or director) for a period of five years from the date of Tribunal’s order
Notes
terminating or setting aside his contract with the company [Section 243].

Director’s resignation
Resignation means giving up a job or a position by someone. As per Section 168(1), a director may
resign from his office by giving a notice in writing to the company and the Board shall on receipt
of such notice take note of the same and the company shall intimate the Registrar in such manner,
within such time and in such form as may be prescribed and shall also place the fact of such resigna-
tion in the report of directors laid in the immediately following general meeting by the company.
A director shall also forward a copy of his resignation along with detailed reasons for the resigna-
tion to the Registrar within thirty days of resignation in such manner as may be prescribed.
The resignation of a director shall take effect from the date on which the notice is received by the
company or the date, if any, specified by the director in the notice, whichever is later [Section 168(2)].
Notwithstanding, the director who has resigned shall be liable even after his resignation for the
offences which occurred during his tenure.

Duties of Directors
Since directors exercise control and management over the company and companies are run (in prin-
ciple at least) for the benefit of the shareholders, the law recognises strict duties to be discharged
by the directors in relation to the exercise of their powers. Section 166 provides:
1. A director of a company shall act in accordance with the articles of the company.
2. A director of a company shall act in good faith in order to promote the objects of the com-
pany for the benefit of its members as a whole, and in the best interests of the company, its
employees, the shareholders, the community, and for the protection of the environment.
3. A director of a company shall exercise his duties with due and reasonable care, skill and
diligence and shall exercise independent judgment.
4. A director of a company shall not involve in a situation in which he may have a direct or
indirect interest that conflicts, or possibly may conflict, with the interest of the company.
5. A director of a company shall not achieve or attempt to achieve any undue gain or advan-
tage either to himself or to his relatives, partners, or associates and if such director is found
guilty of making any undue gain, he shall be liable to pay an amount equal to that gain to
the company.
6. A director of a company shall not assign his office and any assignment so made shall be void.
If a director of the company contravenes the above provisions, such director shall be punishable
with fine which shall not be less than one lakh rupees but which may extend to five lakh rupees
[Section 166(7)].

Powers of the Board of Directors

Powers Board of Directors can be discussed under the two heads:
1. General powers, and
2. Powers to be exercised at Board meetings.

General powers of the board

The general powers of the directors are described in Section 179(1) of the Act. Accordingly, the Board
of directors of a 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.
However, as per proviso attached to the above-mentioned Section, the Board shall not exercise
any power which is to be exercised by the company in the general meeting or which shall be incon-
sistent, if exercised, with the regulations contained in that behalf in the Act, or in the memorandum
or articles of the company.
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Material  261
Legal and Regulatory That is, the directors are not empowered to take action on issues that are stipulated to be the
Environment of purview of the general meeting of the company, or are counter to regulations contained in the Act,
Business or the memorandum and articles of the company.
However, no regulation made by the company in general meeting shall invalidate any prior act
Notes
of the Board which would have been valid if that regulation had not been made [Section 179(2)].

Powers to be exercised at board meetings

The Board is the principal organ of a company. Section 179(3) empowers it to exercise the following
powers on behalf of the company, but it can do so only by means of resolutions passed at meetings
of the Board.
(a) To make calls on shareholders in respect of money unpaid on their shares;
(b) To authorise buy-back of securities under section 68;
(c) To issue securities, including debentures, whether in or outside India;
(d) To borrow monies;
(e) To invest the funds of the company;
(f) To grant loans or give guarantee or provide security in respect of loans;
(g) To approve the financial statement and the Board’s report;
(h) To diversify the business of the company;
(i) To approve amalgamation, merger or reconstruction; and
(j) To take over a company or acquire a controlling or substantial stake in another company.
However, the Board may, by a resolution passed at a meeting, delegate to any committee of direc-
tors, the managing director, the manager or any other principal officer of the company or in the case
of a branch office of the company, the principal officer of the branch office, the powers specified in
clauses (d) to (f) on such conditions as it may specify.
Moreover, the acceptance by a banking company in the ordinary course of its business of deposits
of money from the public repayable on demand or otherwise and withdrawable by cheque, draft, order
or otherwise, or the placing of monies on deposit by a banking company with another banking com-
pany on such conditions as the Board may prescribe, shall not be deemed to be a borrowing of monies
or, as the case may be, a making of loans by a banking company within the meaning of this section

Restrictions on powers of board

Directors derive their powers or rights mainly from provisions in the articles, as the Act provides
little guidance as to which actions are within the director’s powers. More than defining the powers
and rights of directors as to what they are, the Act, on the whole, places more emphasis on impos-
ing restrictions on such rights and powers. Section 180 (1) provides that the Board of Directors of
a company shall exercise the following powers only with the consent of the company by a special
resolution, namely:-
(a) To sell, lease, or otherwise dispose of the whole, or substantially the whole (20% or more of
the value of the undertaking as per the audited balance sheet of the preceding financial year)
of the undertaking of the company, or where the company owns more than one undertaking
of the whole, or substantially the whole of any such undertaking.
(b) To invest, other than in trust securities, the amount of compensation received by it as a result
of any merger or amalgamation;
(c) To borrow money, where the money to be borrowed, together with the money already
borrowed by the company will exceed the aggregate of its paid-up share capital and free
reserves, apart from temporary loans obtained from the company’s bankers in the ordinary
course of business.
However, the acceptance by a banking company, in the ordinary course of its business, of
deposits of money from the public, repayable on demand or otherwise, and withdrawable by
cheque, draft, order or otherwise, shall not be deemed to be a borrowing of monies by the
banking company within the meaning of this clause.
Explanation—For the purposes of this clause, the expression “temporary loans” means loans
repayable on demand or within six months from the date of the loan such as short-term, cash
credit arrangements, the discounting of bills and the issue of other short-term loans of a sea-
sonal character, but does not include loans raised for the purpose of financial expenditure
Self-Learning of a capital nature.
262  Material (d) To remit, or give time for the repayment of, any debt due from a director.
Loans to Directors Company Management,
Meetings, and Winding
As per Section 185 (1), no company shall, directly or indirectly, advance any loan, including any loan Up of Company
represented by a book debt, to any of its directors or to any other person in whom the director is
interested or give any guarantee or provide any security in connection with any loan taken by him Notes
or such other person.
However, nothing contained in this sub-section shall apply to—
(a) The giving of any loan to a managing or whole-time director—
(i) As a part of the conditions of service extended by the company to all its employees; or
(ii) Pursuant to any scheme approved by the members by a special resolution; or
(b) a company which in the ordinary course of its business provides loans or gives guarantees
or securities for the due repayment of any loan and in respect of such loans an interest is
charged at a rate not less than the bank rate declared by the Reserve Bank of India.
Explanation — For the purposes of this section, the expression “to any other person in whom
director is interested” means—
(a) Any director of the lending company, or of a company which is its holding company or any
partner or relative of any such director;
(b) Any firm in which any such director or relative is a partner;
(c) Any private company of which any such director is a director or member;
(d) Any body corporate at a general meeting of which not less than twenty five per cent of the
total voting power may be exercised or controlled by any such director, or by two or more
such directors, together; or
(e) Any body corporate, the Board of directors, managing director or manager, whereof is ac-
customed to act in accordance with the directions or instructions of the Board, or of any
director or directors, of the lending company.

Consequences of contravention of the provision

If any loan is advanced or a guarantee or security is given or provided in contravention of the provi-
sions of sub-section (1), the company shall be punishable with fine which shall not be less than five
lakh rupees but which may extend to twenty-five lakh rupees, and the director or the other person
to whom any loan is advanced or guarantee or security is given or provided in connection with any
loan taken by him or the other person, shall be punishable with imprisonment which may extend
to six months or with fine which shall not be less than five lakh rupees but which may extend to
twenty-five lakh rupees, or with both [Section 185(2)].

Corporate Governance
Corporate governance, the buzzword of corporate identity, is used in a variety of contexts. In
relation to company’s decision-making it implies a set of processes, customs, policies, laws, and
institutions affecting the way a company is directed, administered or controlled. The report of the
SEBI Committee on Corporate Governance defines it as the acceptance by management of the
inalienable rights of shareholders as the true owners of the corporation, and of their own role as
trustees on behalf of the shareholders. It is about commitment to values, about ethical business
conduct and about making a distinction between personal and corporate funds in the manage-
ment of a company. The above definition is drawn from the Gandhian principle of trusteeship and
the Directive Principles of the Indian Constitution. Corporate governance is viewed as ethics and
moral duty. It also includes the relationships among the many stakeholders involved and the goals
for which the corporation is governed. Corporate governance as a matter of fact concerns all issues
about the best way to run a company.

Parties to corporate governance

Parties involved in corporate governance include the Chief Executive Officer (CEO), the Board of
directors, management, and shareholders and other stakeholders which include suppliers, employ-
ees, creditors, customers, and the community at large.
In corporations, the shareholders delegate decision rights to the manager to act in the company’s
best interests. This separation of ownership from control implies a loss of effective control by share- Self-Learning
Material  263
Legal and Regulatory holders over managerial decisions. Partly as a result of this separation between the two parties,
Environment of a system of corporate governance controls is implemented to assist in aligning the incentives of
Business managers with those of shareholders.
A Board of directors often plays a key role in corporate governance. It is their responsibility to
Notes
endorse the organization’s strategy, develop directional policy, appoint and remunerate senior ex-
ecutives, and to ensure accountability of the organization to its owners and authorities.
The Company Secretary is a high ranking professional who is trained to uphold the highest stan-
dards of corporate governance, effective operations, compliance, and administration.
All parties to corporate governance have an interest, whether direct or indirect, in the effective
performance of the organization. Directors, workers, and management receive salaries, benefits,
and reputation, while shareholders receive capital return. Customers receive goods and services,
suppliers receive compensation for their goods or services. In return these individuals provide value
in the form of natural, human, social, and other forms of capital.

Principles of corporate governance

Commonly accepted principles of corporate governance include
Rights and equitable treatment of shareholders  Organizations should respect the rights of
shareholders and help shareholders to exercise those rights. They can help shareholders exercise
their rights by effectively communicating information that is understandable and accessible and
encouraging shareholders to participate in general meetings.
Interests of other stakeholders  Organizations should recognise that they have legal and other
obligations to all legitimate stakeholders.
Role and responsibilities of the Board  The Board needs a range of skills and understanding to be
able to deal with various business issues and to have the ability to review and challenge manage-
ment performance. It needs to be of sufficient size and have an appropriate level of commitment
to fulfil its obligations. There are issues about the appropriate mix of executive and non-executive
directors. The key roles of a chairperson and a CEO should not be held by the same person.
Integrity and ethical behaviour  Ethical and responsible decision making is not only important
for public relations, but it is also a necessary element in risk management and avoiding lawsuits.
Organizations should develop a code of conduct for their directors and executives that promotes
ethical and responsible decision making.
Disclosure and transparency  Organizations should clarify and make the roles and responsi-
bilities of the board and management publicly known to provide shareholders with a level of ac-
countability. The disclosure of material matters concerning the organization should be timely and
balanced to ensure that all investors have access to clear, factual information.

Issues involving corporate governance

Keeping in view the wide spectrum of corporate governance, it is not possible to give a complete
listing of the issues involved therein. However, for reference, the following pressing issues can be
enumerated:
1. Internal controls and the independence of the entity’s auditors
2. Oversight and management of risks
3. Oversight of the preparation of the entity’s financial statements
4. Review of the compensation arrangements for the chief executive officer and other senior
executives
5. The resources made available to directors in carrying out their duties
6. The way in which individuals are nominated to positions on the Board
7. Dividend policy.

Company Meetings: Introduction

A company is an association of several persons for some common object(s) in which decisions are
made according to the view of the majority. Various issues have to be discussed and decided accord-
Self-Learning ingly. These deliberations take place through various meetings which occur between the members
264  Material and between the directors as well. Thus, meeting, in this regard, may be defined as an assemblage
or gathering of some authorised persons for conducting some lawful business. For a meeting to take Company Management,
place there must be, obviously, at least two persons attending it. However, in certain exceptional Meetings, and Winding
circumstances, one member can constitute a valid meeting even if he does not hold proxies for Up of Company
other members. The Companies Act, 2013 contains various provisions governing company meetings.
Notes
These regulations have to be observed and complied with while holding such meetings. Hence, the
importance of meetings cannot be under-emphasized in case of companies.

Kinds of Company Meetings

Company meetings can be categorised into the three types – meetings of members, board meetings,
and other meetings. Meetings of members are again classified into two types - general meetings and
class meetings. General meetings are sub-divided into annual meetings and extraordinary meetings.
Other meetings include class meetings, meetings of debenture holders and creditors.
Figure 14.1 contains a flowchart depicting the various types of company meetings.

Company Meetings

Meetings of Other
Board Meetings
Members Meetings

Meetings of
General Meetings Class Meetings Debenture
Holders

Annual General Meeting Meetings of

Extraordinary General Meeting Creditors

Fig. 14.1  Kinds of company meetings

Meetings of members
These are the meetings where members/shareholders of the company meet to discuss various mat-
ters and take decisions by means of passing resolutions. Meetings of members may be classified as
general meetings and class meetings.

General meetings
General meetings may take any of the following forms as and when required under the provisions
of the Act:
1. Annual General Meeting, and
2. Extraordinary General Meeting.

Annual general meeting

An annual general meeting (AGM) must be held each year by every company other than a One
Person Company. AGM is an important platform by which the general body of shareholders finds
an opening to exercise their power of control.
Rules relating to an annual general meeting  Following are the rules governing annual general
meetings:
(i) A company shall hold its first AGM within 9 months from the date of closing of the first
financial year. In such a case, it need not hold any AGM in the year of its incorporation [Sec-
tion 96(1)].
(ii) Not more than 15 months shall elapse between two AGMs. However, every AGM (other than
first AGM) shall be held within a period of six months from the date of closing of the first
financial year [Section 96(1)].
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Material  265
Legal and Regulatory (iii) In case there is some difficulty in holding any AGM (except the first one), the Registrar may,
Environment of for any special reasons shown, grant an extension of time for holding the meeting by a pe-
Business riod not exceeding three months [Section 96(1)].
(iv) Every annual general meeting shall be called during business hours, that is, between 9  a.m.
Notes
and 6 p.m. on any day that is not a National Holiday and shall be held either at the  registered
office of the company or at some other place within the city, town or village  in which the
registered office of the company is situated [Section 96(2)].
  However, the Central Government may exempt any company from the provisions of  this
sub-section subject to such conditions as it may impose.
(v) A notice of at least 21 clear days either in writing or through electronic mode shall be given
to the members unless consent is accorded to a shorter notice by all the members, holding
not less than 95 per cent of voting rights in the company. The notice must contain a state-
ment of the business to be transacted at such meeting. The time, date, day, and place of the
meeting must be mentioned in the notice [Section 101(1) & (2)].
(vi) The notice of the meeting shall be given to-
(a) Every member of the company, the legal representative of any deceased member or the
assignee of an insolvent member;
(b) The auditor or auditors of the company; and
(c) Every director of the company [Section 101(3)].
(vii) Any member of a company entitled to attend and vote at a meeting of the company shall be
entitled to appoint another person as a proxy to attend and vote at the meeting on his behalf.
However, a proxy shall not have a right to speak at such meeting and shall not be entitled to
vote except on a poll. A proxy form should be enclosed with the notice. The proxy form shall
be signed by the appointer or his attorney duly authorised in writing [Section 101(1) & (5)].
(viii) Unless the articles of the company provide for a larger number,—
(a) in case of a public company,—
(i) five members personally present if the number of members as on the date of meet-
ing is not more than one thousand;
(ii) fifteen members personally present if the number of members as on the date
of meeting is more than one thousand but up to five thousand;
(iii) thirty members personally present if the number of members as on the date of
the  meeting exceeds five thousand shall be the quorum for a meeting of the com-
pany; and
(b) in the case of a private company, two members personally present, shall be the quorum
for a meeting of the company [Section 103(1)].
Moreover, if the quorum is not present within half-an-hour from the time appointed for
holding a meeting of the company—
(a) the meeting shall stand adjourned to the same day in the next week at the same time
and place, or to such other date and such other time and place as the Board may deter-
mine; or
(b) the meeting, if called by requisitionists under section 100, shall stand cancelled.
However, in case of an adjourned meeting or of a change of day, time or place of meeting
under clause (a), the company shall give not less than three days notice to the members
either individually or by publishing an advertisement in the newspapers (one in English and
one in vernacular language) which is in circulation at the place where the registered office
of the company is situated [Section 103(2)].
If at the adjourned meeting also, a quorum is not present within half-an-hour from the time
appointed for holding meeting, the members present shall be the quorum [Section 103(3)].
(ix) Unless the articles of the company otherwise provide, the members personally present at
the meeting shall elect one of themselves to be the Chairman thereof on a show of hand
[Section 104].
Business to be transacted at an annual general meeting  At every AGM, the following matters
shall be transacted. Since such matters are transacted at every AGM, they are known as ‘ordinary
businesses’. All other matters and business to be transacted at the AGM are ‘special businesses’.
The following matters constitute ordinary business at an AGM:
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266  Material
 (i) The consideration of financial statements and the reports of the Board of Directors and audi- Company Management,
tors; Meetings, and Winding
(ii) The declaration of dividend Up of Company
(iii) The appointment of directors in the place of those retiring
Notes
(iv) The appointment and fixing of the remuneration of the auditors [Section 102(2)].
In case any other business (special business) has to be transacted, a statement setting out the
following material facts concerning each item of the special business to be transacted at a general
meeting shall accompany the notice calling the meeting, namely:-
(a) the nature of concern or interest, financial or otherwise, if any, in respect of each items of—
(i) every director and the manager, if any;
(ii) every other key managerial personnel; and
(iii) relatives of the persons mentioned in sub-clauses (i) and (ii);
(b) any other information and facts that may enable members to understand the meaning, scope
and implications of the items of business and to take decision thereon [Section 102(1)].
Consequences of not holding annual general meeting  Default in holding an AGM may result in
the following consequences:
1. Any member of the company may apply to the Tribunal which may in turn call, or direct the
calling of the meeting, and give such ancillary or consequential directions as it thinks ex-
pedient. The NCLT may also direct that one member present in person or by proxy shall be
deemed to constitute the meeting. A meeting held in pursuance of this order will be deemed
to be an annual general meeting of the company [Section 97].
2. If any default is made in holding an AGM in accordance with Section 96/97/98 or in compli-
ance with any directions of the Tribunal, as the case may be, the company and every officer
of the company who is in default shall be punishable with fine which may extend to one lakh
rupees and in the case of a continuing default, with a further fine which may extend to five
thousand rupees for every day during which such default continues [Section 99].

Extraordinary general meeting

An extraordinary meeting is usually called by the Board of directors in emergencies, say, for taking
up some urgent business that cannot be kept pending till the next AGM. Every business transacted
at such a meeting is a special business. An explanatory statement of the special business must also
accompany the notice calling the meeting. The notice should also give the nature and extent of the
interest of the directors or manager in the special business, as also the extent of the shareholding
interest in the company of every such person.
Who can call an extraordinary general meeting?  An extraordinary general meeting may be
called by:
(i) The Board on requisitions The members of a company have the right to seek calling of an
EGM by the Board. The Board of directors must call an extraordinary general meeting of the
company if required to do so by the following number of members.
(a) in the case of a company having a share capital, such number of members who hold, on
the date of the receipt of the requisition, not less than one-tenth of the paid-up share
capital of the company as on that date carrying the right of voting;
(b) in the case of a company not having a share capital, such number of members who have,
on the date of receipt of the requisition, not less than one-tenth of the total voting power
of all the members having on the said date a right to vote [Section 100(2)].
(ii) By the requisitionists If the Board does not, within twenty-one days from the date of receipt
of a valid requisition in regard to any matter, proceeds to call a meeting for the considera-
tion of that matter on a day not later than forty-five days from the date of receipt of such
requisition, the meeting may be called and held by the requisitionists themselves within a
period of three months from the date of the requisition [Section 100(4)].

Class meetings
Class meetings are meetings which are held by the holders of a particular class of shares (i.e., where
the share capital of a company is divided into different classes of shares), e.g., preference sharehold-
ers. Such meetings are normally called when it is proposed to alter, vary or affect the rights of that Self-Learning
particular class of shareholders. At such meetings, these members discuss the pros and cons of the Material  267
Legal and Regulatory proposal and resolve accordingly. Unless articles of the company otherwise provides, all provisions
Environment of pertaining to calling of a general meeting and its conduct do apply to class meetings in the same
Business way as they apply with respect to general meetings of the members. However, all resolutions in a
class meeting are required to be passed as special resolutions.
Notes
Meetings of the board
Meetings of the board refer to meetings of directors. The protection of investors is one of the pri-
mary themes of the Companies Act. The Act provides the shareholders a forum of self-protection.
The forum is the general meeting of shareholders. Apart from this, having regard to the position and
status envisaged for directors and the role that is assumed to them in the affairs of the company, it is
also essential to hold meetings of the Board at regular intervals and to discuss in these meetings, all
major concerns. This enables the directors to be in touch with the management of company affairs
as often as they should be. Rules related to board meetings can be summarized as under.
(i) Every company shall hold the first meeting of the Board of Directors within thirty days of
the date of its incorporation and thereafter hold a minimum number of four meetings of its
Board every year in such a manner that not more than one hundred and twenty days shall
intervene between two consecutive meetings of the Board [Section 173(1)].
  However, the Central Government may, by notification, direct that the provisions of this
sub-section shall not apply in relation to any class or description of companies or shall apply
subject to such exceptions, modifications or conditions as may be specified in the notifica-
tion.
(ii) The participation of directors in a meeting of the Board may be either in person or through
video conferencing or other audio visual means, as may be prescribed, which are capable of
recording and recognising the participation of the directors and of recording and storing the
proceedings of such meetings along with date and time [Section 173(2)].
  Provided that the Central Government may, by notification, specify such matters which
shall not be dealt within a meeting through video conferencing or other audio visual means.
(iii) A meeting of the Board shall be called by a minimum ‘seven days’ notice in writing to every
director at his address registered with the company and such notice shall be sent by hand
delivery or by post or by electronic means [Section 173(3)].
  However, a meeting of the Board may be called at shorter notice to transact urgent busi-
ness subject to the condition that at least one independent director, if any, shall be present
at the meeting:
  Furthermore, in case of absence of independent directors from such a meeting of the
Board, decisions taken at such a meeting shall be circulated to all the directors and shall be
final only on ratification thereof by at least one independent director, if any.
(iv) Every officer of the company whose duty is to give notice under this section and who fails
to do so shall be liable to a penalty of twenty-five thousand rupees [Section 173(4)].
(v) A One Person Company, a small company and a dormant company shall be deemed to have
complied with the provisions of this section if at least one meeting of the Board of Directors
has been conducted in each half of a calendar year and the gap between the two meetings
is not less than ninety days [Section 173(5)].
  However, nothing contained in this sub-section and in section 174 shall apply to One
Person Company in which there is only one director on its Board of Directors.
(vi) The quorum for a meeting of the Board of Directors of a company shall be one-third of its
total strength or two directors, whichever is higher, and the participation of the directors
by video conferencing or by other audio visual means shall also be counted for the purposes
of quorum under this sub-section [Section 174(1)].
(vii) Where a meeting of the Board could not be held for the want of quorum, then, unless the
articles of the company otherwise provide, the meeting shall automatically stand adjourned
to the same day at the same time and place in the next week or if that day is a national holi-
day, till the next succeeding day, which is not a national holiday, at the same time and place
[Section 174(4)].

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268  Material
Other meetings Company Management,
Meetings, and Winding
A company may provide through its articles for the meetings of other persons related to and in- Up of Company
terested in the affairs of the company, i.e., meetings of debenture holders and creditors of the
company. The basic aim of the provision of these meetings is to ensure the protection of interest of Notes
debenture holders and creditors, as the case may be, in the affairs of the company. These meetings
may be called by the company, either as a running concern or in the event of winding up to make
certain arrangements with its debenture holders and creditors.

Voting by Show of Hands

The term ‘vote’ means an expression of a wish or opinion in a democratic and formal way for or
against a proposal. Generally, preliminary matters are decided at a general meeting by a show of
hands. If the majority of the persons raise their hands in favour of a particular resolution, then un-
less a poll is demanded under Section 109 or the voting is carried out electronically it is taken as
passed [Section 107(1)].
A declaration by the Chairman of the meeting of the passing of a resolution or otherwise by show
of hands under sub-section (1) and an entry to that effect in the books containing the minutes of
the meeting of the company shall be conclusive evidence of the fact of passing of such resolution
or otherwise [Section 107(2)].

Voting through electronic means

The Central Government may prescribe the class or classes of companies and manner in which a
member may exercise his rights to vote by the electronic means [Section 108].

Demand for poll

Voting by a show of hands operates on the principle of ‘one member-one vote’. However, since the
fundamental voting principle in a company is ‘one share-one vote’, if a poll is demanded, voting
takes place accordingly.
Before or on declaration of the result of the voting on any resolution on a show of hands, a poll
may be ordered to be taken by the Chairman of the meeting on his own motion, and shall be ordered
to be taken by him on a demand made in that behalf, -
(a) in the case of a public company having a share capital, by the members present in person
or by proxy where allowed, and having not less than one-tenth of the total voting power or
holding shares on which an aggregate sum of not less than five lakh rupees or such higher
amount as may be prescribed has been paid-up; and
(b) in the case of any other company, by any member or members present in person or by
proxy, where allowed, and having not less than one-tenth of the total voting power
[Section 109(1)].
However, the demand for a poll may be withdrawn at any time by the persons who made the
demand [Section 109(1)].

Postal ballot
A company—
(a) shall, in respect of such items of business as the Central Government may, by notification,
declare to be transacted only by means of postal ballot; and
(b) may, in respect of any item of business, other than ordinary business and any business in
respect of which directors or auditors have a right to be heard at any meeting, transact by
means of postal ballot, in such manner as may be prescribed, instead of transacting such
business at a general meeting.
(c) If a resolution is assented to by the requisite majority of the shareholders by means of postal
ballot, it shall be deemed to have been duly passed at a general meeting convened in that
behalf [Section 110]. Self-Learning
Material  269
Legal and Regulatory Resolutions
Environment of
Business A motion, with or without amendments is put to vote at a meeting. A motion when passed by req-
uisite majority of votes by the shareholders becomes a company resolution. Thus, a resolution may
Notes be defined as the formal decision of a meeting on any proposal placed before it.

Kinds of resolutions
Broadly speaking, there are three types of resolutions under the Companies Act, 1956: ordinary,
special, and those requiring a special notice.

Ordinary resolution
An ordinary resolution is one which is passed by a simple majority. As per Section 114(1), a resolution
shall be an ordinary resolution if the notice required under this Act has been duly given and it is
required to be passed by the votes cast, whether on a show of hands, or electronically or on a poll,
as the case may be, in favour of the resolution, including the casting vote, if any, of the Chairman,
by members who, being entitled so to do, vote in person, or where proxies are allowed, by proxy or
by postal ballot, exceed the votes, if any, cast against the resolution by members, so entitled.

Special resolution
A special resolution is one which is passed by at least three-fourths clear majority, i.e., the number
of votes cast in favour of the resolution is at least three times the number of votes cast against it,
either by a show of hands or by a poll, in person or by proxy. As per Section 114 (2), a resolution shall
be a special resolution when—
(a) the intention to propose the resolution as a special resolution has been duly specified in the
notice calling the general meeting or other intimation given to the members of the resolu-
tion;
(b) the notice required under this Act has been duly given; and
(c) the votes cast in favour of the resolution, whether on a show of hands, or electronically or
on a poll, as the case may be, by members who, being entitled so to do, vote in person or
by proxy or by postal ballot, are required to be not less than three times the number of the
votes, if any, cast against the resolution by members so entitled..
Special resolutions are needed to decide on important matters of the company. Examples, where
special resolutions are required are as follows:
(a) To alter the object’s clause of the memorandum;
(b) To alter or change the name of the company with the approval of the Central Government
(c) To alter the articles of the company; and
(d) To change the name of the company by omitting the word ‘Limited’ or ‘Private Limited’.
The Central Government may allow a company with charitable objects to do so by a special
resolution under Section 8 of the Companies Act, 2013.

Resolution requiring a special notice

Resolution requiring a special notice is a species of ordinary resolution. There are certain matters
specified in the Act, which may be discussed at a general meeting for which a prior intention to move
the resolution has to be given to the members. As per Section 115, where, by any provision of the
Companies Act or in the articles of a company, a special notice is required of any resolution, notice
of the intention to move such resolution shall be given to the company by such number of members
holding not less than one percent of total voting power or holding shares on which such aggregate
sum not exceeding five lakh rupees, as may be prescribed, has been paid-up and the company shall
give its members a notice of the resolution in such manner as may be prescribed.
Such a prior intention in the form of a special notice enables the members to be prepared on the
matter to be discussed and gives them time to indicate their views on the resolution.
In case a special notice of resolution is required by the Companies Act, by the articles of a com-
pany, the intention to propose such a resolution must be notified to the company at least 14 clear
days before the meeting. ‘Clear days’ means that the day on which the notice is served or deemed
to be served and the day of the meeting shall be excluded.
Self-Learning
270  Material
 The following matters, in order to be taken up for discussion, require a special notice before the Company Management,
meeting: Meetings, and Winding
(a) To appoint an auditor other than a retiring auditor at an annual general meeting ; Up of Company
(b) To resolve at an annual general meeting that a retiring auditor shall not be reappointed;
Notes
(c) To remove a director before the expiration of his period of office;
(d) To appoint another director in place of a removed director; and
(e) Where the articles provide for serving a special notice for a resolution, in respect of any
specified matter.
A resolution requiring a special notice may be passed either as an ordinary resolution (with
simple majority) or as a special resolution (with three-fourths majority).

Minutes
Every company must keep records of all the proceedings of a meeting, known as minutes. The
minutes are a gist of the discussions at the meeting and the final decisions taken there at and act
as evidence of the proceedings recorded therein. It normally includes only the resolutions actually
passed. As per Section 118 (1), every company causes minutes of the proceedings of every general
meeting of any class of shareholders or creditors, and every resolution passed by postal ballot and
every meeting of its Board of Directors or of every committee of the Board, to be prepared and
signed in such manner as may be prescribed and kept within thirty days of the conclusion of every
such meeting concerned, or passing of resolution by postal ballot in books kept for that purpose
with their pages consecutively numbered.
The minutes of each meeting shall contain a fair and correct summary of the proceedings thereat.
All appointments of officers made at any of the meetings must be included in the minutes of the
meeting [Section 118(2) & (3)].
In the case of a meeting of the Board of directors or its Committee, the minutes must also state
the names of directors present at the meeting, and the names of directors, if any, dissenting from,
or not concurring with a resolution passed at the meeting [Section 118(4)].
The chairman may exclude from the minutes any matters which are defamatory, irrelevant
or immaterial or which are detrimental to the interests of the company. The discretion of the
Chairman with regard to the inclusion or exclusion of any matter is absolute and unfettered
[Section 118 (5) & (6)].
The minute books of the proceedings of general meetings must be kept at the registered office
of the company. Every member will have a right to inspect, free of cost during business hours at the
registered office of the company, the minute books. Furthermore, any member shall be entitled to
be furnished, within seven days after he/she has made a request to the company, with a copy of any
minutes on payment of Rupee one for every hundred words or fraction thereof.
If a person is found guilty of tampering with the minutes of the proceedings of meeting, he
shall be punishable with imprisonment for a term which may extend to two years and with fine
which shall not be less than twenty-five thousand rupees but which may extend to one lakh rupees
[Section 118(4)].

Winding Up of a Company: Introduction

Winding up — a means by which a company is dissolved — is an unfortunate, but many times in-
evitable part of company management. A company either has to grow or it will decay and run out
of business.
Some companies may flourish and grow, while some unfortunate ones may incur losses and may
have to be closed down. Ironically, a company which is growing and making good profits may also
land into trouble. Even blue-chip companies like Metal Box, GM Motors, and Guest Keen Williams,
etc., have become sick. Conversely, a company like Reliance, which was nowhere on the industrial
horizon about three decades ago, is now counted among the Fortune 500 companies in the world.
On the other hand, a well-heeled MNC like the Lehman Brothers is facing possible closure after
becoming bankrupt. Nonetheless, it does not mean that companies in financial difficulties alone are
wound up. Legally, even a financially sound company can be wound up on the basis of numerous
other grounds, though it is not usually done. Winding up or liquidation is not just a legal exercise
Self-Learning
to satisfy the debts of creditors, but also signifies the loss of brand value that the company enjoyed
Material  271
in its entire history.
Legal and Regulatory Implication of Winding Up
Environment of
Business Winding up is the process of bringing to an end the legal personality of a company as a corporate
body. During this process the company ceases to carry on its usual business, the assets are realized,
Notes the proceeds are utilized in paying off the debts, and the surplus, if any, is distributed amongst
contributories pro rata. Generally, ‘winding up’ is associated with sinking and loss making companies.
To that extent, winding up is similar to insolvency proceedings in respect of an individual. However,
even a solvent company can be wound up under certain compelling circumstances.

Modes of Winding Up
According to Section 270 of the Companies Act, 2013, a company may be wound up either:
1. Compulsorily i.e. by the Tribunal; or
2. Voluntarily. This can be either members’ voluntary winding up or creditors’ winding up.

Compulsory winding up
Compulsory winding up is one which takes place by an order of the Tribunal. Chapter XX, Part-I of
the New Act deals with the compulsory winding up process

Grounds for winding up by the tribunal

Section 271 of the Act which deals with the compulsory winding up of a company contains the cases
where the Tribunal may order the winding up of a company on a petition submitted to it. These are
as follows.
Inability to pay debt  A company can be wound up if it is unable to pay its debts (i.e., the realizable
value of its existing assets is not sufficient to discharge its existing liabilities) [Section 271(1)(a)].
A company is deemed to be unable to pay its debts in the following situations.
(a) If a creditor, by assignment or otherwise, to whom the company is indebted in a sum
exceeding one lakh rupees then due, has served on the company, by causing it to be delivered
at its registered office, by registered post or otherwise, a demand requiring the company to
pay the sum due and the company has failed to pay the debts within twenty one days after
the receipt of such demand or to provide adequate security or re-structure or compound the
debt to the reasonable satisfaction of the creditor;
(b) if any execution or other process issued on a decree or order of any court or tribunal in favour
of a creditor of the company is returned unsatisfied in whole or in part; or
(c) if it is proved to the satisfaction of the Tribunal that the company is unable to pay its debts,
and, in determining whether a company is unable to pay its debts, the Tribunal shall take
into account the contingent and prospective liabilities of the company [Section 271(2)].
Special resolution by the members  Generally, shareholders have full freedom to decide the
course of action, a company should adopt. They are the best judges about the future of the company.
Hence, they can pass a special resolution, with at least 75 per cent of members attending and voting,
for winding up. On passing of such a resolution, the company can file a winding up petition with
the Tribunal [Section 271(1)(b)].
Other grounds for winding up by Tribunal  The Act also provides the following grounds for wind-
ing up of a company by the Tribunal:
1. If the company has acted against the interests of the sovereignty and integrity of India, the
security of the State, friendly relations with foreign States, public order, decency or morality
[Section 271(1)(c)].
2. If a scheme of revival and rehabilitation of a sick company is not approved by the creditors
in the manner specified in sub-section (2) of section 262, the company administrator shall
submit a report to the Tribunal within fifteen days, the Tribunal may order for the winding
up of the sick company [Section 271(1)(d)].
3. If on an application made by the Registrar or any other person authorised by the Central
Government by notification under this Act, the Tribunal is of the opinion that the affairs of
the company have been conducted in a fraudulent manner or the company was formed for
Self-Learning fraudulent and unlawful purposes or the persons concerned in the formation or management
272  Material of its affairs have been guilty of fraud, misfeasance or misconduct in connection therewith
and that it is proper that the company be wound up [Section 271(1)(e)].
 4. If the company has defaulted in filing with the Registrar its financial statements or annual Company Management,
returns for immediately preceding five consecutive financial years [Section 271(1)(f)]. Meetings, and Winding
5. The Tribunal has wide discretionary powers and therefore may order winding up if it is of the Up of Company
opinion that it is just and equitable to do so [Section 271(1)(g)].
Notes
However, this is a residuary power, which should be exercised only in the interest of the com-
pany, its employees, shareholders and creditors and in public interest. Some of the instances, where
the Tribunal had ordered winding up under this clause are as under:
(i) When substratum of the company has disappeared, i.e., company is unable to achieve any
of its main objects, e.g., if it is substantially impossible to obtain necessary approvals or a
company is unable to establish the business for which it is formed, etc.
(ii) It is impossible to carry on business except at a loss and there is no reasonable hope of mak-
ing profits. However, mere losses in a few years are not sufficient, if there are some hopes
of earning profits in future.
(iii) Existing or probable assets are insufficient to meet known existing liabilities.
(iv) Complete deadlock in the management due to hostility among directors which cannot be
re-solved in general or Board meetings. However, mere conflicts and frictions among some
directors is not sufficient to order winding up.
(v) If the company is only a ‘bubble’, i.e., it does not have any real business or property to carry
on.
(vi) It is in public interest that the company be wound up. As a corollary, winding up can be de-
clined if it is against public interest.

Petition for winding up by the tribunal

A petition to the Tribunal for winding up of a company, as per Section 272, can be made by any of
the following.
1. Company itself;
2. Any creditor or creditors, including any contingent or prospective creditor or creditors;
3. A contributory or contributories;
4. Any combination of creditors, company, or contributories acting jointly or separately;
5. The Registrar;
6. Any person authorised by the Central Government in consequence of investigation under
Section 213 of the Act; or
7. By the Central Government or a State Government where the company has acted against the
interests of the sovereignty and integrity of India, the security of the State, friendly relations
with foreign States, public order, decency or morality.

Commencement of winding up and appointment of an official liquidator

Proceedings of winding up are conducted by an official administrator, called ‘liquidator’ under the
supervision of the Tribunal. The liquidator is attached to each High Court. He/she is appointed by
the Central Government and works under the supervision of the Regional Director of Department
of Company Affairs.
The rules governing the appointment of a liquidator are stated in Section 275 of the Companies
Act, 2013, reproduced below:
1. For the purposes of winding up of a company by the Tribunal, the Tribunal at the time of the
passing of the order of winding up shall appoint an Official Liquidator or a liquidator from
the panel maintained under sub-section (2) as the Company Liquidator.
2. The provisional liquidator or the Company Liquidator, as the case may be, shall be appointed
from a panel maintained by the Central Government consisting of the names of chartered
accountants, advocates, company secretaries, cost accountants or firms or bodies corporate
having such chartered accountants, advocates, company secretaries, cost accountants and
such other professionals as may be notified by the Central Government or from a firm or a
body corporate of persons having a combination of such professionals as may be prescribed
and having at least ten years’ experience in company matters.
3. Where a provisional liquidator is appointed by the Tribunal, the Tribunal may limit and re-
strict his powers by the order appointing him or it or by a subsequent order, but otherwise
he shall have the same powers as a liquidator.
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Material  273
Legal and Regulatory 4. The Central Government may remove the name of any person or firm or body corporate from
Environment of the panel maintained under sub-section (2) on the grounds of misconduct, fraud, misfea-
Business sance, and breach of duties or professional incompetence:
  However, the Central Government before removing him or it from the panel shall give
Notes
him or it a reasonable opportunity of being heard.
5. The terms and conditions of appointment of a provisional liquidator or Company Liquida-
tor and the fee payable to him or it shall be specified by the Tribunal on the basis of tasks
required to be performed, experience, qualification of such liquidator and the size of the
company.
6. Upon appointment as a provisional liquidator or Company Liquidator, as the case may be,
such liquidator shall file a declaration within seven days from the date of appointment in the
prescribed form disclosing conflict of interest or lack of independence in respect of his ap-
pointment, if any, with the Tribunal and such obligation shall continue throughout the term
of his appointment.
7. While passing a winding up order, the Tribunal may appoint a provisional liquidator, if any,
appointed under clause (c) of sub-section (1) of section 273, as the Company Liquidator for
the conduct of the proceedings for the winding up of the company.
Removal and replacement of a liquidator  The Tribunal may, on a reasonable cause being shown
and for reasons to be recorded in writing, remove the provisional liquidator or the Company Liqui-
dator, as the case may be, as liquidator of the company on any of the following grounds, namely:—
(a) Misconduct;
(b) Fraud or misfeasance;
(c) Professional incompetence or failure to exercise due care and diligence in performance of
the powers and functions;
(d) Inability to act as a provisional liquidator or as the case may be, Company Liquidator;
(e) Conflict of interest or lack of independence during the term of his appointment that would
justify removal.
2. In the event of death, resignation or removal of the provisional liquidator or as the case may
be, Company Liquidator, the Tribunal may transfer the work assigned to him or it to another
Company Liquidator for reasons to be recorded in writing.
3. Where the Tribunal is of the opinion that any liquidator is responsible for causing any loss
or damage to the company due to fraud or misfeasance or failure to exercise due care and
diligence in the performance of his or its powers and functions, the Tribunal may recover or
cause to be recovered such loss or damage from the liquidator and pass such other orders as
it may think fit.
4. The Tribunal shall, before passing any order under this section, provide a reasonable oppor-
tunity of being heard to the provisional liquidator or, as the case may be, Company Liquida-
tor.

Statement of affairs of the company

If the company files the Petition, it shall be accompanied with the statement of affairs (‘Statement’)
in Form No. 4 read with section 272(5) of the New Act. The Petition shall state the facts up to a
specific date, which shall not be the date more than fifteen days prior to the date of making of the
Statement. A Chartered Accountant in practice shall duly certify this Statement. The fee for filing the
Petition shall be submitted as prescribed in Annexure-B of the draft rules. The ‘Statement’ should
furnish the following information or particulars:
(a) Debts and liabilities of the company
(b) Assets of the company, showing separately the cash in hand and in bank and negotiable
securities
(c) Names and current residential and official addresses of the directors.
Advertisement of the petition  Subject to the directions of the Tribunal, the petition shall be
advertised in not less than fourteen days before the date fixed for hearing in one daily newspaper in
English language and one daily newspaper in the principal regional language circulating in the State
or union territory where the registered office of company is situated. The advertisement needs to
be carried out in Form No 6. The previous requirement of publication in the official gazette of the
Self-Learning State or union territory mentioned in Company Court Rules (1959), has been done away with under
274  Material the new Act.
Final (Winding-up) order and its content  The Tribunal after hearing the Petition has the power Company Management,
to dismiss it, with or without cost, or to make an interim order, as it thinks fit, or can appoint the Meetings, and Winding
provisional liquidator of the company till the passing of the winding up order. An order for wind- Up of Company
ing up of a company will be in Form 11 and contains the footnote prescribing the following duties:
Notes
a. To submit the complete and audited book of accounts up to the date of order;
b. To attend the Company Liquidator at the required time and place with all information;
c. To surrender the assets of the company and documents related to it, including those docu-
ments from which the benefit from the assets accrues.

Voluntary winding up
A company can be wound-up voluntarily-
(a) if the company in general meeting passes a resolution requiring the company to be wound
up voluntarily as a result of the expiration of the period for its duration, if any, fixed by its
articles or on the occurrence of any event in respect of which the articles provide that the
company should be dissolved; or
(b) if the company passes a special resolution that the company be wound up voluntarily [Sec-
tion 304].

Declaration of solvency
Where it is proposed to wind up a company voluntarily, its director or directors, or in case the com-
pany has more than two directors, the majority of its directors, shall, at a meeting of the Board, make
a declaration verified by an affidavit to the effect that they have made a full inquiry into the affairs
of the company and they have formed an opinion that the company has no debt or whether it will be
able to pay its debts in full from the proceeds of assets sold in voluntary winding up [Section 305(1)].
However, in accordance with Section 305 (2), the above declaration shall have no effect, unless—
(a) it is made within five weeks immediately preceding the date of the passing of the resolution
for winding up the company and it is delivered to the Registrar for registration before that
date;
(b) it contains a declaration that the company is not being wound up to defraud any person or
persons;
(c) it is accompanied by a copy of the report of the auditors of the company prepared in ac-
cordance with the provisions of this Act, on the profit and loss account of the company for
the period commencing from the date up to which the last such account was prepared and
ending with the latest practicable date immediately before the making of the declaration
and the balance sheet of the company made out as on that date which would also contain a
statement of the assets and liabilities of the company on that date; and
(d) where there are any assets of the company, it is accompanied by a report of the valuation of
the assets of the company prepared by a registered valuer.
Meeting of creditors  The company shall along with the calling of meeting of the company at
which the resolution for the voluntary winding up is to be proposed, cause a meeting of its credi-
tors either on the same day or on the next day and shall cause a notice of such meeting to be sent
by registered post to the creditors with the notice of the meeting of the company under Section
304 [Section 306(1)].
The Board of Directors of the company shall—
(a) cause to be presented a full statement of the position of the affairs of the company together
with a list of creditors of the company, if any, a copy of declaration under Section 305 and
the estimated amount of the claims before such meeting; and
(b) appoint one of the directors to preside at the meeting [Section 306(2)].
Where two-thirds in value of creditors of the company are of the opinion that—
(a) it is in the interest of all parties that the company be wound up voluntarily, the company
shall be wound up voluntarily; or
(b) the company may not be able to pay for its debts in full from the proceeds of assets sold
in voluntary winding up and pass a resolution that it shall be in the interest of all parties if
the company is wound up by the Tribunal in accordance with the provisions of Part I of this
Chapter, the company shall within fourteen days thereafter file an application before the
Tribunal [Section 306(3)]. Self-Learning
Material  275
Legal and Regulatory The notice of any resolution passed at a meeting of creditors in pursuance of this section shall
Environment of be given by the company to the Registrar within ten days of the passing thereof [Section 306(4)].
Business If a company contravenes the above provisions, the company shall be punishable with fine which
shall not be less than fifty thousand rupees but which may extend to two lakh rupees and the direc-
Notes
tor of the company who is in default shall be punishable with imprisonment for a term which may
extend to six months or with fine which shall not be less than fifty thousand rupees but which may
extend to two lakh rupees, or with both [Section 306(5)].
Publication of resolution to wind-up voluntarily  Where a company has passed a resolution
for voluntary winding up and a resolution under Section 306 (3) is passed, it shall within fourteen
days of the passing of the resolution give notice of the resolution by advertisement in the Official
Gazette and also in a newspaper which is in circulation in the district where the registered office or
the principal office of the company is situated [Section 307(1)].
If a company contravenes the above provision, the company and every officer of the company
who is in default shall be punishable with fine which may extend to five thousand rupees for every
day during which such default continues [Section 307(2)].
Commencement of voluntary winding-up and its effect  A voluntary winding up shall be deemed
to commence on the date of passing of the resolution for voluntary winding up under section 304
[Section 308].
In the case of a voluntary winding up, the company shall from the commencement of the wind-
ing up cease to carry on its business except as far as required for the beneficial winding up of its
business [Section 309].
Appointment of a company liquidator  As regards appointment of a Company Liquidator in case
of voluntary winding up of a company, Section 310 of the Companies Act, 2013 provides as under:
1. The company in its general meeting, where a resolution of voluntary winding up is passed,
shall appoint a Company Liquidator from the panel prepared by the Central Government for
the purpose of winding up its affairs and distributing the assets of the company and recom-
mend the fee to be paid to the Company Liquidator.
2. Where the creditors have passed a resolution for winding up the company under sub-section
(3) of section 306, the appointment of the Company Liquidator under this section shall be
effective only after it is approved by the majority of creditors in value of the company.
  However, where such creditors do not approve the appointment of such Company Liqui-
dator, creditors shall appoint another Company Liquidator.
3. The creditors while approving the appointment of the Company Liquidator appointed by the
company or appointing the Company Liquidator of their own choice, as the case may be, pass
a suitable resolution with regard to the fee of the Company Liquidator.
4. Upon appointment as a Company Liquidator, such liquidator shall file a declaration in the
prescribed form within seven days of the date of appointment disclosing conflict of interest
or lack of independence in respect of his appointment, if any, with the company and the
creditors and such obligation shall continue throughout the term of his or its appointment.
Notice of appointment of a company liquidator to be given to the registrar  The company shall
give notice to the Registrar of the appointment of a Company Liquidator along with the name and
particulars of the Company Liquidator, of every vacancy occurring in the office of the Company
Liquidator, and the name of the Company Liquidator appointed to fill every such vacancy within ten
days of such appointment or the occurrence of such vacancy [Section 312(1)].
If a company contravenes the above provisions, the company and every officer of the company
who is in default shall be punishable with fine which may extend to five hundred rupees for every
day during which such default continues [Section 312(2)].
Powers and duties of a company liquidator  As per Section 314, the Company Liquidator shall:
1. Perform such functions and discharge such duties as may be determined from time to time
by the company or the creditors, as the case may be;
2. Settle the list of contributories, which shall be prima facie evidence of the liability of the
persons named therein to be contributories;
3. Call general meetings of the company for the purpose of obtaining the sanction of the com-
pany by ordinary or special resolution, as the case may require, or for any other purpose he
Self-Learning may consider necessary;
276  Material
 4. Maintain regular and proper books of account in such form and in such manner as may be Company Management,
prescribed and the members and creditors and any officer authorised by the Central Govern- Meetings, and Winding
ment may inspect such books of account; Up of Company
5. Prepare quarterly statement of accounts in such form and manner as may be prescribed and
Notes
file such statement of accounts duly audited within thirty days from the closing of each quar-
ter with the Registrar, failing which the Company Liquidator shall be punishable with fine
which may extend to five thousand rupees for every day during which the failure continues;
6. Pay the debts of the company and shall adjust the rights of the contributories among them-
selves; and
7. Observe due care and diligence in the discharge of his duties.
If the Company Liquidator fails to comply with the provisions of the above Section except sub-
section (5) he shall be punishable with fine which may extend to ten lakh rupees [Section 314(8)].
Company liquidator to submit report on the progress of winding-up  The Company Liquidator
shall report quarterly on the progress of winding up of the company in such form and in such manner
as may be prescribed, to the members and creditors and shall also call a meeting of the members
and the creditors as and when necessary but at least one meeting each of creditors and members
in every quarter and apprise them of the progress of the winding up of the company in such form
and in such manner as may be prescribed [Section 316(1)].
If the Company Liquidator fails to comply with the provisions of sub-section (1), he shall
be punishable, in respect of each such failure, with fine which may extend to ten lakh rupees.
[Section 316(2)]
Report of the company liquidator to the tribunal  Where the Company Liquidator is of the
opinion that a fraud has been committed by any person in respect of the company, he shall im-
mediately make a report to the Tribunal and the Tribunal shall, without prejudice to the process of
winding up, order for investigation under section 210 and on consideration of the report of such
investigation, the Tribunal may pass such order and give such directions under this Chapter as it
may consider necessary including the direction that such person shall attend before the Tribunal
on a day appointed by it for that purpose and be examined as to the promotion or formation or the
conduct of the business of the company or as to his conduct and dealings as an officer thereof or
otherwise [Section 317(1)].

Final meeting and dissolution of the company

As regards the final meeting and dissolution of the company, Section 318 provides as under:
1. As soon as the affairs of a company are fully wound up, the Company Liquidator shall prepare
a report of the winding up showing that the property and assets of the company have been
disposed of and its debt fully discharged or discharged to the satisfaction of the creditors
and thereafter call a general meeting of the company for the purpose of laying the final
winding up accounts before it and giving any explanation thereof.
2. The meeting referred above shall be called by the Company Liquidator in such form and
manner as may be prescribed.
3. If the majority of the members of the company after considering the report of the Company
Liquidator are satisfied that the company shall be wound up, they may pass a resolution for
its dissolution.
4. Within two weeks after the meeting, the Company Liquidator shall—
(a) send to the Registrar—
(i) a copy of the final winding up accounts of the company and shall make a return in
respect of each meeting and of the date thereof; and (ii) copies of the resolutions passed
in the meetings; and
(b) file an application along with his report under sub-section (1) in such manner as may be
prescribed along with the books and papers of the company relating to the winding up,
before the Tribunal for passing an order of dissolution of the company.
5. If the Tribunal is satisfied, after considering the report of the Company Liquidator that the
process of winding up has been just and fair, the Tribunal shall pass an order dissolving the
company within sixty days of the receipt of the application under sub-section (4).
6. The Company Liquidator shall file a copy of the order under sub-section (5) with the Registrar
within thirty days. Self-Learning
Material  277
Legal and Regulatory 7. The Registrar, on receiving the copy of the order passed by the Tribunal under subsection
Environment of (5), shall forthwith publish a notice in the Official Gazette that the company is dissolved.
Business If the Company Liquidator fails to comply with the provisions of this section, he shall be punish-
able with fine which may extend to one lakh rupees [Section 318(8)].
Notes

Dissolution of a Company and Further Developments

Where a company has been dissolved, the Tribunal may at any time within two years of the date of
the dissolution, on application by the Company Liquidator of the company or by any other person
who appears to the Tribunal to be interested, make an order, upon such terms as the Tribunal thinks
fit, declaring the dissolution to be void, and thereupon such proceedings may be taken as if the
company had not been dissolved [Section 356(1)].
It shall be the duty of the Company Liquidator or the person on whose application the order
was made, within thirty days after the making of the order or such further time as the Tribunal
may allow, to file a certified copy of the order with the Registrar who shall register the same, and
if the Company Liquidator or the person fails so to do, the Company Liquidator or the person shall
be punishable with fine which may extend to ten thousand rupees for every day during which the
default continues [Section 356(2)].

E xercises
I. Objective-type Questions
1. Who among the following persons cannot be appointed as a director of any com-
pany?
(a) an undischarged insolvent
(b) a person found by a competent court to be of unsound mind
(c) a person who has been convicted by a court of an offence involving moral
turpitude and sentenced in respect thereof to imprisonment for not less
than six months, and a period of five years has not elapsed from the date
of the expiry of the sentence
(d) All of the above
2. Who among the following is not a competent authority to remove a director from
his office?
(a) Shareholders (b) Board of Directors
(c) Central Govt. (d) Tribunal
3. Which of the following duties is not a general duty of directors of a company?
(a) Duty of good faith
(b) Duty of care
(c) Duty to attend Board meetings
(d) Duty not to delegate
4. Annual general meeting (AGM) must be held by
(a) Every company
(b) Every public company
(c) Every company other than a ‘One Person Company’
(d) Every company other than a ‘One Person Company’ and a ‘Small Company’
5. When does the Board call an Extraordinary General Meeting?
(a) Whenever directors think fit, by passing a resolution to that effect in the
Board’s meeting
(b) On the requisition of members holding not less than one-tenth of the total
voting rights on the matter of requisition
(c) On the application of the Company Law Board
(d) In all the above cases
6. The persons entitled to the notice of a class meeting are
(a) Every member of the company
Self-Learning (b) Auditors of the company for the time being
278  Material
 (c) Shareholders of the particular class only Company Management,
(d) Auditors (for the time being) and the shareholders of that particular class Meetings, and Winding
Up of Company
7. A petition to the Tribunal for winding up of the company can be filed by:
(a) The members (b) The creditors Notes
(c) The Registrar (d) All of the above
8. Which of the following can be the solid reasons for passing the winding up order
by the Tribunal?
1. Inability to pay debts
2. If the company has, by a special resolution, resolved that the company be
wound up by the Tribunal.
3. If the company has acted against the interests of the sovereignty and in-
tegrity of India, the security of the State, friendly relations with foreign
States, public order, decency or morality.
4. If the company has made a default in filing with the Registrar its financial
statements or annual returns for immediately preceding five consecutive
financial years.
5. If the Tribunal is of the opinion that it is just and equitable that the com-
pany should be wound up.
Answer Codes:
(a) (1), (2), (3) and (5) (b) (1), (2), (3) and (4)
(c) (1), (3), (4) and (5) (d) (1), (2), (3), (4) and (5)
9. A company is deemed to be unable to pay its debts if it fails to pay its creditor
within three weeks of the demand a sum exceeding
(a) ` 10,000 (d) ` 25000
(c) ` 50,000 (d) ` 1,00,000
10. During the winding up process
(i) The assets of the company are realized
(ii) The surplus is paid back to the members pro rata
(iii) The proceeds are utilized in paying off the debts and liabilities
(iv) The company ceases to carry on its normal business.
What is the correct sequence of above stages?
(a) (i), (ii), (iii), (iv) (b) (i), (iii), (ii), (iv)
(c) (iv), (i), (ii), (iii) (d) (iv), (i), (iii), (ii)
II. Review Questions
1. Who can be a ‘Director’? Briefly discuss the modes of appointment of directors.
2. Can the directors of a company be appointed by the Board of directors? Elabo-
rate.
3. Discuss the restrictions imposed in respect of director’s powers.
4. Discuss briefly the provisions of the Companies Act, 2013 with regard to removal
of a director from his/her office.
5. Comment on the following:
(a) Alternate directors
(b) Additional directors
(c) Nominee director
(d) Resignation by director
(e) Appointment of directors by proportional representation
(f) Independent directors
6. Discuss the rules governing to Board meetings.
7. Describe the relevance of an annual general meeting. Discuss the statutory provi-
sions with respect to the notice of an annual general meeting as to the length,
time, place, form and persons entitled thereto and the business, generally trans-
acted.
8. Describe the essentials of a valid meeting.
Self-Learning
Material  279
Legal and Regulatory 9. Write explanatory notes on the following
Environment of (a) Quorum (b) Proxy
Business (c) Motion (d) Minutes
(e) Agenda
Notes
10. Define a resolution. Describe the purpose of ordinary and special resolutions, and
resolutions requiring a special notice.
11. What do you mean by the winding up of a company? Briefly discuss whether is it
possible to revive a dissolved company?
12. Describe the grounds for winding up by the Tribunal.
13. Discuss the consequences of a winding up order.

10. (d) 9. (d) 8. (d) 7. (d) 6. (d)

5. (d) 4. (c) 3. (c) 2. (b) 1. (d)
Answers to Objective-type Questions

Self-Learning
280  Material
 Chapter
14 In Review
Learning Objectives l Directors are the elected representatives of shareholders, entrusted with the re-
sponsibility of running the company.
Directors: appointment, qualifications, dis- l A person shall not be eligible to become a director of a company incorporated under

qualifications the Companies Act, 2013, if he/she suffers from any disqualifications outlined under
the Act. When any fact arises during the tenure of office of a director which makes
Managing director
him/her ineligible to continue as a director, the Board may, upon being satisfied of
Managerial remuneration that fact declare his/her office to be vacant.
Corporate governance l The Board chooses one of its members to be the chair or chairperson of the Board

of directors, traditionally called Managing Director. The managing director shall be

Kinds of company meetings; Board meetings, appointed for an initial period not exceeding five years and shall be deemed to have
meetings of members been re-appointed unless the Board of directors passes a resolution to the contrary.
Resolutions; minutes l The directors may be paid out of the funds of the company such remuneration and

Winding up; by the Tribunal, voluntary; allowances, including sitting fees for attending Board meetings, subject to provisions
grounds for winding up by the Tribunal given in the Act.
l Corporate governance concerns all issues about the best way to run a company.
Winding up: commencement; consequences l Company meetings may be classified as: Meetings of Board of Directors, Meetings

Voluntary winding up of members — Annual general meetings, and Extraordinary general meetings.
l Meetings of the Board refer to the meetings of directors. Directors are suppose to
Dissolution of a company and further devel-
meet every three months in a formal way to take certain important decisions con-
opments cerning company’s business and affairs collectively through passing resolutions.
l Every company must in each year hold in addition to any other meetings a gener-

al meeting as its Annual General Meeting (AGM). An AGM is an important means

Key Terms by which shareholders find an opportunity to exercise their power of control. All
Directors: People who perform the general meetings other than AGMs are called extraordinary general meetings. Such
directing function irrespective of the label meetings are usually called by the Board of directors in emergencies for some urgent
attached to them business which cannot be kept pending till the next AGM.
l A meeting to be valid must be properly convened, legally constituted and validly
Director Identification Number: A unique
conducted. There must be a Chairman to preside over the proceedings of the meet-
identification number allotted to a potential
ing. The rules of quorum must be maintained and the provisions of the Act and the
director of any company by the central articles of the company must be duly complied with.
government l A resolution is the formal decision of a meeting on any proposal put before it. There
Managerial remuneration: Remuneration are broadly three types of resolutions under the Act: ordinary, special, and those
payable to the managerial personnel of a requiring a special notice.
company l Every company must keep details of all proceedings at the meetings in the form of

Corporate governance: A set of processes, minutes.

customs, policies, laws, and institutions l A company is a juristic person that comes into existence by way of incorporation and

affecting the way a company is directed, can be dissolved by undertaking a winding up process as per the provisions of the
administered, or controlled New Act i.e. the Companies Act, 2013. The winding up process is the last stage in
Resolution: The formal decision of a the life of a company, wherein its existence is dissolved and all its assets are used to
meeting on any proposal placed before it satisfy the creditors and shareholders. A company can be wound up by the Tribunal
or by the members of the company voluntarily.
Minutes: Records records of all the
l Grounds for winding up by the Tribunal include —a Special resolution by the mem-
proceedings of a meeting
bers; inability to pay debt; or any other ground which is just and equitable.
Winding up: The means by which a l A petition for winding up can be made by the company itself; any creditor or credi-
company is dissolved tors, including any contingent or prospective creditor or creditors; a contributory
or contributories; any combination of creditors, company or contributories acting
jointly or separately; the Registrar of Companies; and any person authorised by the
Central Government.
l Voluntary winding up is permissible only when the company is solvent. If a company

proposes to have voluntary winding up, it will organise a meeting of creditors on

the same day or the next day of the general meeting where resolution for voluntary
winding up is proposed to be passed.
l A dissolved company may, however, be revived by the Tribunal under certain circum-

stances.

Company Management, Meetings, and Winding Up of Company  281

Legal and Regulatory

Intellectual
15
Environment of
Business

Notes
Property Rights

©: iStock
Learning Objectives
1. Subject matter of intellectual property 5. Copyrights
2. Aim and objectives of intellectual 6. Trademarks
property laws 7. Trade dress
3. International Dimension of Intellectual 8. Trade secrets
Property 9. Contemporary issues in intellectual
4. Patents property rights

I ntellectual Property Rights’, a buzzword in the contemporary business world, refers to moral
and legal claims or entitlements over intellectual property (IP). Intellectual property issues are
gaining importance since globalization of the economy. Many products that used to be traded as
low-technology goods or commodities now contain a higher proportion of invention and design
in their value. Films, music recordings, books, computer software, on-line services, clothing, food,
plants, biotechnology products, and many others are bought and sold because of the information,
creativity, and identity they contain—not usually because of the plastic, metal, cloth, paper, or other
material used to make them.
With the liberalization of the Indian economy, it is increasingly believed that adequate protec-
tion of intellectual property is a necessary element in encouraging foreign investment. Moreover,
in other newly liberalised and rapidly expanding markets, like China, counterfeiting and piracy of
branded goods is an issue in India. The types of counterfeit goods run the gamut from software, elec-
tronics, and clothing to pharmaceuticals and cosmetics. While counterfeits clearly do harm to brand
equity, some may also pose a risk to consumers, such as counterfeit pharmaceuticals. Intellectual
property laws—the Trademarks Act of 1999 and the Copyright Act of 1957—empower authorities to
take action to prevent infringement, including counterfeit goods.

Subject Matter of Intellectual Property

IP is the creation of human intellect. It encompasses ideas, knowledge, invention, innovation, crea-
tivity, and research, all being the product of human mind and is similar to any property, whether
movable or immovable, wherein the proprietor or the owner may exclusively use his property at
will and has the right to prevent others from using it but with his permission. The rights relating
to intellectual property are known as ‘Intellectual Property Rights’. IP is divided into two broad
categories: Industrial property, which includes inventions (patents), trademarks, industrial designs,
and geographic indications of source; and Copyright, which includes literary and artistic works
such as novels, poems, plays, films, musical works, and artistic works such as drawings, paintings,
Self-Learning photographs, and sculptures, and architectural designs. Rights related to copyright include those of
282 Material performing artists in their performances, producers of phonograms in their recordings, and those
of broadcasters in their radio and television programs. The innovations and creative expressions of Intellectual
indigenous and local communities are also IP, yet because they are ‘traditional’ they may not be Property Rights
fully protected by existing IP systems. Access to, and equitable benefit-sharing in, genetic resources
also raise IP questions.
Notes

Rationale Behind Intellectual Property Protection

Most of the IP laws (with the exception of trademarks law) aim to promote progress. By exchanging
limited exclusive rights for disclosure of inventions and creative works, society and the patentee/
copyright owner mutually benefit, and an incentive is created for inventors and authors to create
and disclose their work. Keeping in view the above aim, IP laws for time being in force seek to
achieve the following objectives.

Financial incentive
These exclusive rights allow owners of intellectual property to benefit from the property they have
created, providing a financial incentive for the creation of an investment in intellectual property,
and in case of patents, pay associated research and development costs. Some commentators, such
as David Levine and Michele Boldrin, dispute this justification.

Economic growth
The World Intellectual Property Organisation (WIPO) treaty and several related international agree-
ments are premised on the notion that the protection of intellectual property rights is essential to
maintaining economic growth. The WIPO Intellectual Property Handbook gives two reasons for
intellectual property laws. One is to give statutory expression to the moral and economic rights of
creators in their creations and the rights of the public in access to those creations. The second is to
promote, as a deliberate act of government policy, creativity and the dissemination and application
of its results and to encourage fair trading which would contribute to economic and social develop-
ment.
The Anti-Counterfeiting Trade Agreement (ACTA) states that ‘effective enforcement of intel-
lectual property rights is critical to sustaining economic growth across all industries and globally’.
Economists estimate that two-thirds of the value of large businesses in the US can be traced to
intangible assets. ‘IP-intensive industries’ are estimated to generate 72 percent more value added
(price minus material cost) per employee than ‘non-IP-intensive industries’.
A joint research project of the WIPO and the United Nations University measuring the impact
of IP systems on six Asian countries found ‘a positive correlation between the strengthening of the
IP system and subsequent economic growth.’

Protection of moral and material interests

Article 27 of the Universal Declaration of Human Rights clearly states that everyone has the right to
the protection of the moral and material interests resulting from any scientific, literary, or artistic
production of which he is the author. Although the relationship between intellectual property and
human rights is a complex one, there are moral arguments for intellectual property.
The arguments that justify intellectual property fall into three major categories. Personality
theorists believe that intellectual property is an extension of an individual. Utilitarian believe that
intellectual property stimulates social progress and pushes people to further innovation. Lockeans1
argue that intellectual property is justified based on deservedness and hard work.
Various moral justifications for private property can be used to argue in favour of the morality of
intellectual property, such as the following:
Natural Rights/Justice Argument This argument is based on Locke’s idea that a person has a
natural right over the labour and/or products which are produced by his/her body. Appropriating
these products is viewed as unjust. Although Locke had never explicitly stated that natural right
applied to products of the mind, it is possible to apply his argument to intellectual property rights,
in which it would be unjust for people to misuse another’s ideas.
Utilitarian–Pragmatic Argument According to this rationale, a society that protects private
Self-Learning
property is more effective and prosperous than societies that do not. Innovation and invention in
Material 283
Legal and Regulatory the 19th century America has been said to be attributed to the development of the patent system.
Environment of By providing innovators with ‘durable and tangible return on their investment of time, labor, and
Business other resources’, intellectual property rights seek to maximise social utility. The presumption is
that they promote public welfare by encouraging the ‘creation, production, and distribution of
Notes
intellectual works’.
Utilitarian Argument  Utilitarians argue that without intellectual property, there would be a lack
of incentive to produce new ideas. Systems of protection such as intellectual property optimise
social utility.
‘Personality’ Argument  This argument is based on a quote from Hegel, ‘Every man has the right
to turn his will upon a thing or make the thing an object of his will, that is to say, to set aside the
mere thing and recreate it as his own’. European intellectual property law is shaped by this notion
that ideas are an ‘extension of oneself and of one’s personality’. Personality theorists argue that
by being a creator of something, one is inherently at risk and vulnerable for having their ideas and
designs stolen and/or altered. Intellectual property protects these moral claims that have to do with
personality.

International Dimension of Intellectual Property

International dimension of Intellectual Property may be studied through the following international
treaties governing intellectual property rights in global context.

Paris Convention for the Protection of Industrial Property

The Paris Convention for the Protection of Industrial Property, signed in Paris, France, on 20 March
1883, was one of the first intellectual property treaties. It established a Union for the protection of
industrial property. It addresses patents, trademarks, unfair competition whether or not implicat-
ing marks, and the related industrial property of industrial designs, utility models, geographical
indications, trade names, possibly trade secrets within the context of unfair competition, but not
copyright. The Convention is still in force as of 2014 and is administered by the World Intellectual
Property Organization (WIPO), based in Geneva, Switzerland.

Contracting members
The Convention was initially (i.e. in 1883) signed by 11 countries, namely: Belgium, Brazil, France,
Guatemala, Italy, the Netherlands, Portugal, El Salvador, Serbia, Spain and Switzerland. As of Sep-
tember 2014, the Convention has 176 contracting member countries including India of course, which
makes it one of the most widely adopted treaties worldwide. Notably, Taiwan and Burma are not
parties to the Convention. However, according to Article 27 of its Patent Act, Taiwan recognizes
priority claims from contracting members.

Substantive provisions of the convention

The substantive provisions of the Convention fall into three main categories: national treatment,
priority right and common rules.

National treatment
According to Articles 2 and 3 of this treaty, juristic and natural persons who are either national of
or domiciled in a state party to the Convention shall, as regards the protection of industrial prop-
erty, enjoy in all the other countries of the Union, the advantages that their respective laws grant
to nationals. That is, when an applicant files an application for a patent or a trademark in a foreign
country member of the Union, the application receives the same treatment as if it came from a
national of this foreign country.

Priority right
The “Convention priority right”, also called “Paris Convention priority right” or “Union priority
right”, provides that an applicant from one contracting State shall be able to use its first filing date (in
Self-Learning one of the contracting State) as the effective filing date in another contracting State, provided that
284  Material
the applicant files a subsequent application within 6 months (for industrial designs and trademarks) Intellectual
or 12 months (for patents and utility models) from the first filing. Property Rights

Common rules
Notes
The convention besides invoking common rules concerning trademarks, and unfair competition
among the member countries, provides for the following substantive rules protecting patents and
patentees:
1. The principle of independence of patents  A patent application in one country of the Union
is examined and granted or denied independent of applications for patents for the same or related
inventions filed in other countries within and without the Union.
2. Right of the inventor to be mentioned  The inventor has the right to be named as such in the
patent.
3. Patentability not effected by restrictions on the product  A patent shall not be refused or
invalidated because the product patented or obtained by means of a patented process is subject to
restrictions on its sale or importation under the domestic law.
4. Importation of patented products or products made from patented processes  Impor-
tation into a member country of products for which a patent has been granted in that country
manufactured in another member country cannot result in forfeiture of patent rights in the country
of importation.
5. Failure to work and compulsory licenses  Member countries are allowed to enact protectionist
legislative measures granting compulsory licenses in order to prevent abuses that might result from
the exclusive rights conferred by a patent for invention.
6. Grace period for maintenance fees  Holding patents in member states shall be entitled to a
grace period of at least six months to pay prescribed maintenance fees, and allows member states
to provide for the restoration of patents that have lapsed by reason of non-payment of maintenance
fees.

Berne convention for the protection of literary and artistic works

The Berne Convention for the Protection of Literary and Artistic Works, usually known as the Berne
Convention, is an international agreement governing copyright, which was first accepted in Berne,
Switzerland, in 1886. The Berne Convention followed in the footsteps of the Paris Convention for the
Protection of Industrial Property of 1883, which in the same way had created a framework for inter-
national integration of the other types of intellectual property: patents, trademarks and industrial
designs except the copyright.
Like the Paris Convention, the Berne Convention set up two bureaus to handle administrative
tasks. In 1893 these two small bureaus merged and became the United International Bureau for the
Protection of Intellectual Property (BIRPI), situated in Berne. In 1960, BIRPI moved to Geneva, to
be closer to the United Nations and other international organizations in that city. In 1967 it became
the World Intellectual Property Organization (WIPO), and in 1974 became an organization within
the United Nations. As of September 2014, there are 168 nations including India that are parties to
the Berne Convention. This includes 167 UN member states.
The Berne Convention states that all works except photographic and cinematographic shall be
copyrighted for at least 50 years after the author’s death, but parties are free to provide longer
terms, as the European Union did with the 1993 Directive on harmonizing the term of copyright
protection. For photography, the Berne Convention sets a minimum term of 25 years from the year
the photograph was created, and for cinematography the minimum is 50 years after first showing,
or 50 years after creation if it hasn’t been shown within 50 years after the creation. Countries under
the older revisions of the treaty may choose to provide their own protection terms, and certain types
of works (such as phonorecords and motion pictures) may be provided shorter terms.

Patent Cooperation Treaty

The Patent Cooperation Treaty (PCT) is an international patent law treaty, concluded in 1970. It
provides a unified procedure for filing patent applications to protect inventions in each of its con-
tracting states. A patent application filed under the PCT is called an international application, or Self-Learning
PCT application. Material  285
Legal and Regulatory A single filing of a PCT application is made with a Receiving Office (RO) in one language. It then
Environment of results in a search performed by an International Searching Authority (ISA), accompanied by a writ-
Business ten opinion regarding the patentability of the invention, which is the subject of the application.
Finally, the relevant national or regional authorities administer matters related to the examination
Notes
of application (if provided by national law) and issuance of patent.
A PCT application does not itself result in the grant of a patent, since there is no such thing as an
“international patent”, and the grant of patent is a prerogative of each national or regional authority.
[5]
In other words, a PCT application, which establishes a filing date in all contracting states, must be
followed up with the step of entering into national or regional phases to proceed towards grant of
one or more patents. The PCT procedure essentially leads to a standard national or regional patent
application, which may be granted or rejected according to applicable law, in each jurisdiction in
which a patent is desired.
The contracting states, the states which are parties to the PCT, constitute the International Patent
Cooperation Union. A majority of the world’s countries are parties to the PCT, including all of the
major industrialized countries (with a few exceptions, including Argentina, and Taiwan). India being
a signatory to WTO is a member of PCT. As of 12 July 2013, there were 148 contracting states to the
PCT. Saudi Arabia became the 147th contracting state on 3 May 2013 and Iran the 148th contracting
state on 4 July 2013.

The International Union for the Protection of New Varieties of Plants (UPOV)
As early as 1930, the United States of America introduced a special form of exclusive right called a
plant patent, which was, however, available only for asexually reproduced varieties. Subsequently
a group of European States came together in 1961 to establish the International Convention for the
Protection of New Varieties of Plants (the Convention), which was revised in 1972, 1978 and 1991. The
Convention also establishes the International Union for the Protection of New Varieties of Plants
which is known as UPOV (the name “UPOV” is an acronym derived from the French translation of
these words). The Convention as revised in 1991 is called “the 1991 Act.” The Convention potentially
protects all plant varieties irrespective of their mode of reproduction or of the technology used in
their development.
UPOV is an independent, international, intergovernmental organization, with an international
legal personality. Its headquarters are in Geneva, and it employs its own staff. As of June 10, 2014,
UPOV has 72 members including India. UPOV cooperates very closely in administrative matters with
the World Intellectual Property Organization (WIPO), a specialized agency of the United Nations.
The Secretary-General of UPOV is the Director General of WIPO, the UPOV headquarters is in the
same building as WIPO, and UPOV receives a range of support services from WIPO.

WCT and WPPT

The Berne Convention for the Protection of Literary and Artistic Works, after its adoption in 1886,
was revised quite regularly, approximately every 20 years, until revisions which took place in Stock-
holm in 1967 and in Paris in 1971. The revision conferences were convened, in general, in order to find
responses to new technological developments, such as sound recording technology, photography,
radio, cinematography and television. In the 1970s and 1980s, a number of important new techno-
logical developments took place, namely: reprography, video technology, compact cassette systems
facilitating “home taping,” satellite broadcasting, cable television, the increase of the importance of
computer programs, computer storage of works and electronic databases, etc. After the adoption
of the TRIPS Agreement under the auspices of GATT, the preparatory work of new copyright and
related rights norms in the WIPO committees was intensified to deal with problems not addressed
by the TRIPS Agreement. Finally, in 1996 the WIPO Diplomatic Conference on Certain Copyright and
Related Rights Questions adopted two treaties – the WIPO Copyright Treaty (WCT) and the WIPO
Performances and Phonograms Treaty (WPPT).
WCT provides additional protections for copyright for deemed necessary due to advances in
information technology since the formation of previous copyright treaties before it. It ensures that
computer programs are protected as literary works, and that the arrangement and selection of ma-
terial in databases is protected. It provides authors of works with control over their rental and which
they may not have under the Berne Convention alone. It also prohibits unauthorized modification
Self-Learning of rights management information contained in works. As of December 2014, the treaty has been
286  Material
ratified by 93 states. India is also a proud member of the treaty.
 WPPT on the other hand supplements the Berne Convention for the Protection of Literary and Intellectual
Artistic Works (Berne Convention) and the International Convention for the Protection of Per- Property Rights
formers, Producers of Phonograms and Broadcasting Organizations (Rome Convention). Like WCT,
WPPT was created to address changes in digital technology and communications, particularly the
Notes
distribution of digitally protected works over the Internet. The WPPT IS implemented in the U.S. as
the Digital Millennium Copyright Act (DMCA). Besides India, the WPPT was adopted by a consensus
of 100 member states of the European Union (EU) in Geneva, Switzerland on December 20, 1996.

Categories of Intellectual Property Rights

In order to develop a proper understanding, all the IPRs can be classified under the following two
broad areas:
1. One area of IPRs can be characterised as the protection of distinctive signs, in particular,
trademarks (which distinguish the goods or services of one undertaking from those of other
undertakings) and geographical indications (which identify a good as originating in a place
where a given characteristic of the good is essentially attributable to its geographical origin).
2. Other types of IPRs are related to protection of industrial property to stimulate innovation,
design, and creation of technology. This category includes inventions (protected by patents),
industrial designs, and trade secrets, which are of value.
Accordingly, common types of intellectual property rights include the following:
∑ Patents
∑ Copyright
∑ Industrial design rights
∑ Trademarks
∑ Trade dress
· ∑ And in some jurisdictions, trade secrets

Patents
Patents form the heart of intellectual property. The term ‘patent’has originated from the Latin word
patere, which means ‘to lay open’, i.e., to make available for public inspection. In modern usage, a
patent grants an inventor or their assignee exclusive or say monopoly right to make, use, sell, and
import an invention for a limited period of time, in exchange for the public disclosure of the inven-
tion. An invention in this behalf is a new, useful, and non-obvious solution to a specific technological
problem, which may be a product or a process. Some other types of intellectual property rights are
also called patents in some jurisdictions: industrial design rights are called design patents in the US,
plant breeders’ rights are sometimes called plant patents, and utility models are sometimes called
petty patents or innovation patents.
A patent is an exclusionary right as it provides its inventor with the right to exclude others from
making, using, selling, offering for sale, or importing the patented invention for the term of the
patent, which is usually 20 years from the filing date. Like any other property right, it may be sold,
licensed, mortgaged, assigned or transferred, given away, or simply abandoned.

The Patents Act, 1970

In India, the Patents Act, 1970, deals with the patenting of inventions. An invention relating to a
product or a process that is new, non-obvious, i.e., inventive, and has industrial application can be
patented in India provided it does not fall into the category of non-patentable under the (Indian)
Patents Act. A patent application can be filed with the office of Controller of Patents, which is head-
quartered in Kolkata with sittings at Delhi, Chennai, and Mumbai, either alone or jointly, by true and
first inventor or his assignee. The application is referred by the Controller to the Examiner upon a
formal request by the Applicant to check whether the invention is non-obvious and useful and also
if the invention has already been claimed by some other person. After the First Examination Report
is issued, the Applicant is given an opportunity by the patent office to meet the objections raised in
the report. The Applicant has to comply with the requirements within 12 months from the issuance
of the First Examination Report. If the requirements of the first examination report are not complied
with within the stipulated time, then the application is treated to have been abandoned by the appli-
cant. After the removal of objections and compliance of requirements, the Controller publishes the Self-Learning
application in the official gazette to give an opportunity to public to register their pre-grant opposi- Material  287
Legal and Regulatory tion under Section 25(1), against the grant of patent, if any. After successful removal of objections, if
Environment of any, a patent is granted and notified in the Patent Office Journal. Now the patent holder (patentee) is
Business free to use, sell, assign, or license his right in patent. However, a post-grant opposition under Section
25(2) can be filed by any person interested within 12 months from the date of publication of grant.
Notes
What is not patentable in India?
By merely fulfilling the basic patentability requirements, i.e., the invention should be novel, inven-
tive, and capable of industrial application, one cannot get patent for all the inventions in India even
though they meet all the above criteria. In broad-spectrum, inventions which are contrary to public
order or morality or likely to cause serious intolerance to human, animal, or plant life or health or
to the environment are categorically prohibited under the (Indian) Patents Act. Sections (3) and (4)
of the Act have extensive list of areas which are not patentable in India. A recap of such areas is
given below:
(i) An invention which is frivolous or which claims anything obvious or contrary to the well es-
tablished natural law. An invention, the primary or intended use of which would be contrary
to law or morality or injurious to public health.
(ii) A discovery, scientific theory, or mathematical method.
(iii) A mere discovery of any new property or new use for a known substance or of the mere
use of a known process, machine, or apparatus unless such known process results in a new
product or employs at least one new reactant.
(iv) A substance obtained by a mere admixture resulting only in the aggregation of the proper-
ties of the components thereof or a process for producing such substance.
(v) A mere arrangement or re-arrangement or duplication of a known device each functioning
independently of the other in its own way.
(vi) A method or process of testing applicable during the process of manufacture for rendering
the machine, apparatus, or other equipment more efficient for the improvement or resto-
ration of the existing machine, apparatus, or other equipment or for the improvement or
control of manufacturer.
(vii) A method of agriculture or horticulture.
(viii) A method or process for the medicinal, surgical, curative, prophylactic, or other treatment
of human beings or any process for a similar treatment of animals or plants to render them
free of disease or to increase their economic value or that of their products.
(ix) An invention relating to atomic energy falling under the Atomic Energy Act, 1962.

Patent monopoly and doctrine of exhaustion

A patent is granted for an invention that is new, inventive, and is capable of industrial applications.
The patent holder is able to exploit and control the use of patented matter since a patent gives its
owner the right to exclude third party, not having his consent, from making, using, offering for sale,
selling, or importing the patented invention during the term of the patent. The underlying principle
behind providing these exclusive rights is to ‘promote the progress of science and useful arts’ by
providing inventors the incentive to invest in researching and developing innovative technology.
However, as a measure of natural law of justice doctrine of exhaustion operates which dictates that
the patent owner’s exclusive rights be limited in scope. Accordingly, upon receiving compensation,
patentee’s voluntary introduction of a patented good into commerce without restriction prevents
him from exercising his right to exclude others from using or reselling that good.
The doctrine was first recognised by the United States Supreme Court in 1873 in Adams vs. Burke.
In that case, the patentee authorised a licensee to make, use, and sell patented coffin lids only within
a ten-mile radius in Boston. A customer of the licensee bought the coffin lids within the ten-mile
radius, but later resold the lids outside the ten-mile radius. The patentee sued the customer, but the
Supreme Court found no infringement. In 2008 also, the United States Supreme Court issued its
unanimous decision in Quanta Computer, Inc. vs. LG Electronics, Inc. and held, the patent law can-
not be used to control the subsequent use or disposition of a product ‘that substantially embodies
a patent’once the product has been sold with authority of the patent owner. ‘The authorised sale
of an article that substantially embodies a patent exhausts the patent holder’s rights and prevents
the patent holder from invoking the patent law to control post sale use of the article’.
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Incremental innovation, generic drugs, and patent protection Intellectual
Property Rights
Courts in India are empowered to disallow patent guard to a patent holder in the interest of masses
if the patent holder fails to fulfill the stipulated measure or tends to exploit the patent. Very
recently, the Supreme Court (of India) upheld the Intellectual Property Appellate Board’s (IPAB) Notes
decision to deny patent protection to Novartis, the Swiss multinational pharmaceutical company
in respect of its anti-blood cancer drug, branded as Glivec, saying it is an example of ‘incremental
innovation’under Section 3(d) of the Indian Patents Act and thus not liable for protection. The court
clearly said that the company failed to satisfy the criteria stipulated in the Act such as research data
clarifying the increased ‘therapeutic efficacy’ of the innovation. The ruling ends Novartis’ attempts
to secure a patent for the drug and strikes a balance between patents and affordability. Patients
would have otherwise been forced to pay ` 1.20 lakh for a month’s dosage if the court case had
gone in favour of Novartis. Generic variants of Glivec, comparable in dosage, strength, and intended
use, offered by Cipla Ltd., an Indian Pharmaceutical Major, cost just ` 8,000 per month. Novartis’
earlier challenge to the constitutionality and TRIPs compatibility of Indian patent law was rebuffed
by the Madras High Court in 2007 and no appeal was pursued. The judgment on Glivec is a blow
for a patent regime with a higher threshold of inventiveness. Just prior to this, Roche Ltd., a Swiss
Global healthcare company, was stripped off its patent for Peginterferon, a powerful antiviral drug
treatment for chronic hepatitis B and C in February, 2013, by IPAB, good eight years after it was
granted. Previously, the multinational patentee (Roche) had been denied injunction by Delhi High
Court on the ground that it sold a more expensive drug than the infringing generic manufacturer.
The rulings on Glivec and Peginterferon marked a crucial conclusion to a saga that has been several
decades in the making. Here it is pertinent to mention that IPAB is authorised to hear and adjudicate
upon appeals from most of the decisions, orders, or directions made by the Patent Controller as
well as all pending appeals from the Indian High Courts under the Patents Act. The IPAB has its
headquarters at Chennai and has sittings at Mumbai, Delhi, Kolkata, and Ahmadabad.
The Indian patent law, which albeit has come under severe criticism (owing to above Supreme
Court ruling) from the US and UK based Pharma MNCs, has become a mode of sorts for developing
and under-developed countries who are trying to frame stringent norms that would keep bad
patents at bay. Taking a cue from India, the Philippines adopted a law similar to Section 3(d) [of
Indian Patents Act, 1970]—that denies patents on incremental innovations and was pivotal in the
Novartis judgment while formulating its patent law. Uganda, which will introduce its patent bill
in 2016, has partially adopted India’s Section 3(d) in it. Moreover, IP Australia, a government-
appointed body that looks into the issue of patent laws in Australia, released a draft report last week
that raised concerns against the indiscriminate grant of patents to minor innovations; it further
called for an independent body to vet new approvals. Similarly, several South Asian countries have
amended their patent laws to include compulsory license provisions to allow the entry of generic
drugs in case of an emergency, unusual circumstances, or public interest. For example, in October
2012, Indonesia issued compulsory licenses on seven HIV/AIDS drugs and a hepatitis B medicine
manufactured by Merck & Co, GSK, Bristol-Myers Squibb, Abbott, and Gilead.

National Policy on IPR by Government-constituted Think -Tank

The Commerce and Industry Ministry has most recently constituted a six-member ‘Think-Tank’
to draft the National Intellectual Property Rights (IPR) policy. This policy moots the concept of
‘innovation patents’ or ‘petty patents’ which is being seen as the latest development in the IP
Protection system in India and seems to give a ray of hope to the architects of small inventions
against all sorts of commercial misuse of their innovations. The panel, being chaired by retired
Justice Ms. Prabha Sridevan, will identify areas in IPRs where study needs to be conducted and
furnish recommendations in this regard to the Ministry of Commerce and Industry. The expert group,
set up by Department of Industrial Policy and Promotion (DIPP), will also advise the government
on best practices to be followed in trademark offices, patent offices and other government offices
dealing with IPRs to create an efficient and transparent system of functioning in the said offices.
Embracing an idea from the US, China, Japan, Australia, Germany and others, who protect Utility
Models, several experts have argued for some form of IP protection for what is commonly known
as ‘Jugaad Innovation’ that takes place across sectors in India. Probably taking a cue from them the
above panel on IPRs has proposed exclusive protection for small inventions through a new law on
utility models to boost B2B, industry-academia ties. Self-Learning
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Legal and Regulatory Also known as ‘petty patents’ and ‘innovation patents’, this form of intellectual property grants
Environment of exclusive rights to the owner to prevent others from commercially using protected innovation
Business for a limited period of time. Requirements will be less stringent than for patents and terms of
protection offered to them are also typically shorter (average 7-10 years), though rules vary across
Notes
nations. They are popular with Micro, Small and Medium Enterprises (MSMEs), being easier to
obtain and cheaper to maintain. MSMEs account for about 45% of the manufacturing sector’s
output, thereby contributing considerably towards the nation’s GDP, but according to the ‘Think-
Tank’, their potential IP assets are recognized only in a limited, often informal manner. India has a
large number of inventions that may not satisfy the criteria of patentability, but are novel, utilitarian
and inventive. The current framework leaves out a large number of inventors from protecting their
products through IPRs, particularly those from the MSMEs and informal sectors.
Other major reforms recommended by the above ‘Think-Tank’ include having a specialized patent
bench in the high courts of Bombay, Calcutta, Delhi and Madras for speedy disposal of patent-related
cases, creation of a body in the government to coordinate IP related matters with ministries.

Copyright
A copyright gives the creator of an original work exclusive right to it, usually for a limited time. The
rights of authors of literary and artistic works (such as books and other writings, musical composi-
tions, paintings, sculpture, computer programs, and films) are protected by copyright. In addition, pro-
tection is granted to related or neighbouring rights like the rights of performers (e.g., actors, singers,
and musicians), producers of phonograms (sound recordings), and broadcasting organizations. Copy-
right may apply to a wide range of creative, intellectual, or artistic forms, or ‘works’. Copyright does
not cover ideas and information themselves, only the form or manner in which they are expressed.
India’s copyright law, laid down in the Indian Copyright Act, 1957, as amended by Copyright (Amend-
ment) Act, 1999, fully reflects the Berne Convention on copyrights, to which India is a party. Addition-
ally, India is party to the Geneva Convention for the Protection of Producers of Phonograms and to
the Universal Copyright Convention. India is also an active member of WIPO, Geneva, and UNESCO.
The copyright law has been amended periodically to keep pace with changing requirements.
The recent amendment to the copyright law, which came into force in May 1995, has ushered in
comprehensive changes and brought the copyright law in line with the developments in satellite
broadcasting, computer software, and digital technology. The amended law has made provisions for
the first time to protect performer’s rights as envisaged in the Rome Convention.
Several measures have been adopted to strengthen and streamline the enforcement of copy-
rights. These include the setting up of a Copyright Enforcement Advisory Council, training programs
for enforcement officers, and setting up special policy cells to deal with cases relating to infringe-
ment of copyrights.

Industrial Design Rights

An industrial design right protects the visual design of objects that are not purely utilitarian or
functional in nature (and are not themselves copyrightable) but have some aesthetic or ornamental
value. For example, while the design of a piece of luggage is purely functional (a useful article) hence
not copyrightable, the addition of certain ornamental, artistic elements to the design may make
those parts of that luggage ‘artistic’ and thus copyrightable. An industrial design or say just design
consists of the creation of a shape, configuration, or composition of pattern or color, or combination
of pattern and color in three-dimensional form containing artistic value. The designs in India are
governed by the Designs Act, 2000 which has replaced the Design Act, 2011. The essential purpose
of design law it to promote and protect the registered designs. It is also intended to promote innova-
tive (design) activity in the field of industries. The Designs Act of 2000 inter alia includes not only
trademarks alone but also the ‘artistic works’. Therefore the definition of design under the new Act
is an improved one and more comprehensive. A design to be registrable must be new or original.
‘Original’, in relation to a design, means originating from the author of such design and includes the
cases which though old in themselves yet are new in their application. It should not previously be
published in India or anywhere in the world. It should be significantly distinguishable from known
designs or combination of known designs and should not comprise or contain scandalous or obscene
matter. It should also be not contrary to public order or morality.
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 On the design being registered, the Controller General of Patents, Designs and Trade Marks Intellectual
(CGPDTM) grants a certificate of registration to the proprietor. When a design is registered, the Property Rights
registered proprietor of the design shall have copyright in the design during ten years from the date
of registration. Provision for the extension of the period of the copyright for another 5 years is also
Notes
provided under the new Act. Copyright under the Act means the exclusive right to apply a design
to any article in any class in which the design is registered. The Designs Act, 2000 uses the term
piracy of registered designs instead of term infringement in relation to violation of a registered
design and provides for harsh disciplinary actions against the offenders.

Trademarks
A trademark (or trade mark) is a recognizable sign, design or expression which identifies products
or services of a particular source from those of others. As per Section 2(m) of Trademark Act, a mark
can include a device, brand, heading, label, ticket, name, signature, word, letter, numeral, shape of
goods, packaging, or combination of colours, or any such combinations. Trademarks are used to
claim exclusive properties of products or services. They serve to identify a particular business as
the source of goods or services. A trademark may be located on a package, a label, a voucher, or on
the product itself. Trademarks can be owned, but also licensed. Licenses can be bought from trade-
mark owners and brokers. It should be noted here that one may confuse between trademarks and
brands. However, whereas trademarks have purely legal implications, branding focuses exclusively
on aspects of marketing
The Government of India provides protection to trademarks statutorily under the Trademark Act,
1999, and also under the common law remedy of passing off. Statutory protection of trademark is
administered by the Controller General of Patents, Designs, and Trademarks, a government agency
which reports to the Department of Industrial Policy and Promotion (DIPP), under the Ministry of
Commerce and Industry. The law of trademark deals with the mechanism of registration, protection of
trademark, and prevention of fraudulent trademark. The law also provides for the rights acquired by
registration of trademark, modes of transfer, and assignment of the rights, nature of infringements,
penalties for such infringement, and remedies available to the owner in case of such infringement.
Trademark registration gives exclusive proprietary rights to the mark’s owner. Applications for
registration of trademarks are to be filed in the prescribed manner. Any person claiming to be the
proprietor of a trademark used or proposed to be used by him, who is desirous of registering it, shall
apply in writing to the Registrar in the prescribed manner for the registration of his trade mark. The
application inter alia shall
(i) Explain with sufficient precision, a description by words, of the trademark if necessary, to
determine the right of the application;
(ii) Be able to depict the graphical representation of the trademark;
(iii) Be considered as a three-dimensional trademark only if the application contains a statement
to that effect;
(iv) Be considered as a trademark consisting of a combination of colours only if the application
contains a statement to that effect.
Applications are examined to ensure compliance with the law and to ensure they do not conflict
with marks that are already registered or pending. Details and exhaustive explanation for adoption
of the mark by the applicant must appear to be reasonably justified and convincing. Accepted ap-
plications are advertised in the Trade Marks Journal and opposition may be filed within three-month
time from the date of publication in the Journal; a one-month extension for filing opposition can be
obtained within the three-month period. Registration is good for 10 years, renewable every 10 years.
However, a trademark that has not been used for five years or more from the date of registration
can be cancelled for non-use.
Trademark owners alleging infringement of their registered mark by another mark can file suit,
seeking an injunction, damages, and an order for delivery-up of the infringing labels and marks
for destruction. Unregistered trademarks well known in India or internationally may be protected
against misuse in a passing off action.

Trade Dress
Trade dress is a legal term of art that generally refers to characteristics of the visual appearance of
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a product or its packaging (or even the design of a building) that signify the source of the product
Material  291
Legal and Regulatory to consumers. A product’s trade dress—its distinctive appearance, color, design, shape, packaging,
Environment of and even its aroma—is a crucial component of its brand equity. India’s Trademarks Act of 1999
Business specifically included elements of trade dress, for both products and packaging, within its definition
of trademark.
Notes
Courts in India have consistently reinforced trade dress protection. One of the most cited cases
is Colgate Palmolive Co. vs. Anchor Health and Beauty Care Pvt. Ltd. in the Delhi High Court. The
plaintiff disputed the use by the other company of a distinctive red and white pattern in a precise
proportion, together with the style of lettering on dentifrice packaging. Colgate argued it has used
the red and white pattern since 1951, where the defendant started using its design in 1996. The court
ruled for the plaintiff, indicating that the infringement on Colgate’s well-established and distinc-
tive color scheme could cause both confusion in the marketplace and dilution of Colgate’s brand. In
another case, Kangaro Industries Ltd. vs. Evershine STY, the Delhi High Court issued an injunction
to stop the defendant’s use of a distinctive design and color combination featuring the image of a
frog. Kangaro, a well-known office equipment and stationery brand, was found to have prior rights
to this distinctive trade dress. Other similar cases have upheld the trade dress rights of other well-
known brands, including Cadbury Gems and its distinctive ‘pillow’ packaging.

Trade Secrets
A fifth type of intellectual property, in addition to patents, trademarks (including trade dress), in-
dustrial design rights, and copyrights, is trade secrets. Broadly speaking, any confidential business
information which provides an enterprise a competitive edge may be considered a trade secret. It
may be a formula, practice, business process, design, device, pattern, or compilation of informa-
tion which is not generally known or reasonably ascertainable, by which a business can obtain an
economic advantage over competitors or customers. The unauthorised use of such information by
persons other than the holder is regarded as an unfair practice and a violation of the trade secret.
In the US, trade secret law is primarily handled at the state level under the Uniform Trade Secrets
Act, which most states have adopted, and a federal law, the Economic Espionage Act of 1996, which
makes the theft or misappropriation of a trade secret a federal crime.
In India, the protection of trade secrets is Common Law based. However, Section 27 of the Indian
Contract Act provides some sort of limited remedy; it bars any person from disclosing any informa-
tion which he acquires as a result of a contract. Courts can protect trade secrets by enjoining mis-
appropriation, ordering parties that have misappropriated a trade secret to take steps to maintain
its secrecy, as well as ordering payment of a royalty to the owner. Courts can also award damages,
court costs, and reasonable attorneys’ fees. This protection is, however, very limited because a trade
secret holder is only protected from unauthorised disclosure and use which is referred to as misap-
propriation. If a trade secret holder fails to maintain secrecy or if the information is independently
discovered, becomes released, or otherwise becomes generally known, protection as a trade secret
is lost. Trade secrets do not expire so protection continues until discovery of loss.
Protection of trade secrets is very important and one of the most challenging tasks for the In-
dian government as this will enhance the foreign investment in India giving a boost to the Indian
economy. Foreign investors have to be assured of the protection of their trade secrets, so that they
can do business with our country. A proper policy for trade secret protection will further enhance
the security in our own industry. Almost all the countries in the world have a policy for the protec-
tion of trade secrets and India also being a signatory to the TRIPs is under an obligation to amend its
laws or create a new law in order to safeguard the trade secrets of various businesses. So a proper
policy for the protection of trade secrets in India is the need of the hour in order to provide a sense
of security among the foreign investors and the local businessmen regarding their trade secrets
which will further boost the Indian economy.

Emerging Issues in Intellectual Property

Intellectual property plays an important role in an increasingly broad spectrum, ranging from the
Internet to healthcare to nearly all aspects of science and technology and literature and arts. Un-
derstanding the role of intellectual property in these areas—many of them still emerging—often
requires significant new research and study. In an effort to promote informed discussion of the
Self-Learning intellectual property issues involved in these fields, WIPO regularly produces various explanatory
292  Material publications on current issues of interest.
 Briefly, following are some of the issues, recently discussed in the TRIPs Council and brought Intellectual
out by WIPO. Property Rights

TRIPs and public health Notes

No Conflict  The 2001 Doha Declaration on TRIPs and Public Health was a political statement
affirming that intellectual property protection and public health objectives do not contradict each
other: ‘We agree that the TRIPs Agreement does not and should not prevent members from taking
measures to protect public health’. It gave governments the confidence to use the flexibilities avail-
able in the TRIPs Agreement, e.g., compulsory licensing and parallel imports.
Rule-Change Needed: The ‘Paragraph 6 System’  One issue needed a change in the rules. The
declaration’s paragraph 6 dealt with TRIPs Article 31(f), which limited the amount nations could
export under a compulsory license to countries needing the medicines. A ‘waiver’ agreed in 2003,
and a pending amendment agreed in 2005, allow generic medicines to be made under compulsory
licenses exclusively for export to countries that cannot produce the medicines themselves.
WHO-WIPO-WTO Cooperation  An important result of the 2001 declaration has been closer work
between the World Health Organization, World Intellectual Property Organization, and WTO. This
has focused both on access to medicines and incentives for research and development so that new
medical technologies become available. Ensuring poorer patients are able to access medicines and
other health products involves proper (rational) use of the products, affordable prices, properly de-
signed health systems, suitable financing, and careful selection strategies for procuring the products.

TRIPs, biodiversity, traditional knowledge, plants, and life forms

In the TRIPs Council, these topics are usually discussed—a ‘triplet’ of related issues. They come un-
der the Doha Development Agenda although members disagree on whether they are negotiations.
These issues are also discussed in separate consultations chaired by the Director-General or a deputy.
Animals and Plants  TRIPs Article 27.3(b) deals with patentability or non-patentability of plant
and animal inventions, and the protection of plant varieties. It has been under review in the TRIPs
Council for several years. The Doha Declaration added:
TRIPs and CBD  The relationship between the TRIPs Agreement and the UN Convention on
Biological Diversity.
Traditional Knowledge  The protection of traditional knowledge and folklore.
The TRIPs Council’s review of the three is guided by the TRIPs Agreement’s objective (i.e., in-
novation and technology transfer for social and economic benefits) and principles (i.e., health and
other social and economic objectives, and the abuse of rights), and must take development fully
into account.

Technology transfer to least-developed countries

Intellectual property protection should contribute to technical innovation and the transfer of technol-
ogy. Producers and users both should benefit; so should economies and societies at large. Developing
and least developed countries, in particular, see technology transfer as part of the bargain in which
they have agreed to protect intellectual property rights. The TRIPs Agreement includes a number of
provisions on this. For instance, it says one of the purposes of protecting intellectual property is to pro-
mote innovation and technology transfer, and it requires developed countries’ governments to provide
incentives for their companies and institutions to transfer technology to least-developed countries.

Geographical indications
Geographical indications are place names (in some countries also words associated with a place)
used to identify the origin and quality, reputation or other characteristics of products (for example,
‘Champagne’, ‘Tequila’, or ‘Roquefort’).
The TRIPs Agreement handles this in three articles.
Standard  Article 22 defines geographical indications and sets a standard level of protection. All
have to be protected in order to avoid misleading the public and to prevent unfair competition.
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Material  293
Legal and Regulatory Higher  Article 23 applies only to protection for wines and spirits and says that subject to a number
Environment of of exceptions their names have to be protected against incorrect use even where this would not
Business mislead the public.
Notes Exceptions  Article 24 implies, for example, that a term does not have to be protected in a country
if it has become generic or has already been protected as a trademark in that country.
Two issues are debated in the TRIPs Council under the Doha mandate: negotiations to create a
multilateral geographical indication register for wines and spirits; and discussions on extending the
higher level of protection beyond wines and spirits.

‘Non-violation’ complaints
WTO agreements allow countries to bring cases against each other if one feels that another govern-
ment’s action or a specific situation has deprived it of an expected benefit, even if no agreement has
been violated. However, opinions differ among WTO members on whether non-violation cases are
feasible in intellectual property. The TRIPs Agreement contains a temporary restraint on bringing
non-violation complaints. This has been extended several times, more recently from one Ministerial
Conference to the next.

Enforcement of IPRs
Intellectual property rights have to be enforceable. Or, more precisely, the TRIPs Agreement says
that governments have to provide effective procedures for enforcement. However, the question of
discussing enforcement routinely in the TRIPs Council has sometimes been controversial.
Some developed countries considered counterfeiting and piracy to be a serious problem and
wanted to discuss it; developing countries resisted, fearing that this would target them and be used
to argue for new standards more stringent than those in TRIPs.
Recently (in 2011) the discussion has focused on an Anti-Counterfeiting Trade Agreement (ACTA)
negotiated by a group of countries. The ACTA countries said that the opposition to undertaking work
on enforcement in the WTO was one reason why they negotiated the agreement outside the WTO.
A number of developing countries said they were concerned about the possibility that access to
medicines could be impeded, that pressure would increase on countries to protect intellectual prop-
erty to a higher standard than required in the WTO (the ACTA countries said they would not), and
about the implications for the WTO system of discussing an agreement negotiated outside the WTO.

E xercises
I. Objective-type Questions
1. Which IPR Act deals with protection of computer software in India?
(a) Patents Act, 1970 (b) Copyright Act, 1970
(c) Trademarks Act, 1999 (d) The Designs Act, 2000
2. Negotiations about intellectual property rights are most important to:
(a) India (b) Russia
(c) China (d) The United States
3. The objective(s) of intellectual property law is/are
(a) financial incentive
(b) economic growth
(c) protection of moral and material interests
(d) all of the above
4. Locke’s idea that ‘a person has a natural right over the labour and/or prod-
ucts which are produced by his/her body’ is justified by which of the following
arguments?
(a) Utilitarian–pragmatic argument
(b) Justice argument
(c) Personality argument
(d) Utilitarian argument
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 5. What is the term of a patent? Intellectual
(a) 10 years (b) 20 years Property Rights
(c) 25 years (d) Unlimited
6. What does ‘utilitarian’ indicate in context of copyrights? Notes
(a) Novelty (b) Functional
(c) Not useful (d) Obsolete
7. Infringement in relation to copyright implies:
(a) breach (b) honour
(c) credit (d) nobility
8. The owner of a patent can grant license:
(a) to registered companies only
(b) to individuals only
(c) to anyone
(d) to anyone but only after taking permission from the Controller General of
Patents, Designs, and Trademarks
9. A  patent  application  was  filed  in  February  2000.  The  patent  was  granted in
September 2011. In 2012, the inventor wants to file for some improvements in
the invention. The patent on improvement would be valid until:
(a) 2032 (b) 2020
(c) 2031 (d) none of the above
10. When can an opposition to the grant of a patent be filed in India?
(a) Anytime after the publication of the article but before the grant of patent
(b) Anytime after the grant of the patent
(c) Within one year after publication of the grant of the patent
(d) Both (a) and (c)
II. Review Questions
1. What does property refer to in legal sense?
2. What is the relation of copyright to protection of industrial design?
3. Describe the aim and objectives of intellectual property laws for time being in
force.
4. What is not patentable in India? Describe the procedure for grant of patents in
India.
5. Enumerate the seven types of intellectual properties recognised by TRIPs
Agreement.
6. Give a brief overview of intellectual property laws in India.
7. ‘A patent to be granted protection under Indian patent law, the patent in ques-
tion should be worthy of patent protection’. Do you agree? Elaborate in the light
of leading recent rulings of the Supreme Court and the High Courts of India.
8. Write an explanatory note on ‘incremental innovation, generic medicines, and
patent protection’. 

10. (d) 9. (b) 8. (c) 7. (a) 6. (b)

5. (b) 4. (b) 3. (d) 2. (d) I. (b)
Answers to Objective-type Questions

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 Chapter
15 In Review
Learning Objectives l Intellectual property rights refers to moral and legal claims over intellectual property.
The rights relating to intellectual property (IP) are known as ‘intellectual property
Subject matter of intellectual property rights’. IP is divided into two categories: Industrial property, which includes inven-
Aim and objectives of intellectual property tions (patents), trademarks, industrial designs, and geographic indications of source;
laws and copyright, which includes literary and artistic works such as novels, poems,
plays, films, musical works, and artistic works— drawings, paintings, sculptures, and
Intellectual Property Rights architectural designs.
Patents l The stated objectives of most intellectual property laws is to promote progress and

offer an incentive for inventors and authors to create and disclose their work.
Copyrights
l A patent grants an inventor or its assignee exclusive or monopoly right to make, sell,
Design use, and import an invention for a limited period of time, in exchange for public dis-
Trademark closure of the invention.
l A copyright gives the creator of an original work exclusive right to it, usually for a
Trade dress
limited period of time. Copyright may apply to a wide range of creative, intellectual,
Trade secrets or artistic forms, or ‘works’.
Contemporary issues in intellectual property l A design constitutes the ornamental or aesthetic aspect of an article. A design may

rights consist of three-dimensional features, such as the shape or surface of an article, or

of two-dimensional features, such as patterns, lines or colour.
l A trademark is a recognizable sign, design, or expression which identifies products or

Key Terms
services of a particular source from those of others.
l Trade dress is a legal term of art that generally refers to characteristics of visual ap-
Intellectual property rights: Moral and legal pearance of a product or its packaging that signify the source of the product to con-
claims or entitlements over intellectual sumers.
property l A trade secret may comprise any confidential business information which provides

Patent: An exclusive right granted by a an enterprise a competitive edge. Trade secrets may include formulae, practices,
sovereign state (Central Government) to business processes, designs, devices, patterns, and compilations of information
an inventor for a limited period of time in which is not generally known, by which a business can obtain economic advantage
exchange of detailed public disclosure of an over competitors or customers.
invention l Some of the contemporary issues in intellectual property, recently discussed in the

Copyright: It gives the creator of an original TRIPs Council and brought out by WIPO, include TRIPs and public health; TRIPs, biodi-
work exclusive right to it, usually for a versity, traditional knowledge, plants and life forms; technology transfer to least-de-
limited time veloped countries; geographical indications; ‘non-violation’ complaints; and above
all enforcement of intellectual property rights.
Trademark: A recognizable sign, design or
expression which identifies products or
services of a particular source from those
of others
Trade dress: A legal term of art that
generally refers to characteristics of the
visual appearance of a product or its
packaging that signify the source of the
product to consumers
Trade secret: Any confidential business
information that provides an enterprise
with a competitive advantage
Geographical indications: Place names used
to identify the origin and quality, reputation
or other characteristics of products

296  Legal and Regulatory Environment of Business

 Endnotes

Endnotes
NOTES

©: iStock
Chapter 1 25. 1962, 1 W.L.R. 1184
26. 1866, L.R. 1 Ex 109
1. Throughout our discussion on the law of 27. 1862, 11 C.B.N.S. 869
contract in this book the word ‘Act’ refers to
the Indian Contract Act, 1872. Similarly, the
references to sections in these chapters, un- Chapter 2
less otherwise specifically mentioned, pertain
to the Indian Contract Act, 1872. 1. 1903, ILR 30 Cal. 539
2. The State of Jammu and Kashmir enjoys a 2. 1906, 16 Mad. L.J. 422
special status under Article 370 of the Consti- 3. 1924, AIR Lah. 611
tution of India.
4. 1948, AIRP C 25
3. 1919, K.B. 571. 5. 1948, 51 Bom. LR 256
4. 1925, 27 N.L.R. 325 6. 1912, 29 Cal. 232
5. 1934, 36 N.L.R. 225, at 234 7. 1916, 39 Mad. 409
6. Quantum meruit is an equitable remedy, 8. 1942, A I R Mad. 47
which literally means ‘as much as is de-
9. 1844, 13 M and W 252, 258
served.’ See Chapter 10.
7. 1939, 2 K.B. 403 10. 1908, 2 K.B. 1
8. The terms ‘offer’ and ‘proposal’ are often 11. 1863, 14 C.B. 45
used interchangeably. 12. 1799, 8 T. R. 335
9. 1831, 2 B & A 232. 13. 1907, 17 Mad. L. J. 78
10. 1937, 81 S.J. 786
14. 1957, AIR Pat 491
11. 1979, 1 W.L.R. 294
15. 1903, 1 All L.J. 43
12. 1989, Q.B. 433 AT 436
13. 1873, LR 8 Q.B. 286 16. 1889, AIR 13 Mad. 214
14. 1834, 6 C. & P. 499 17. 1731, 2 STR 915
15. 1952, 2 Q.B. 795 18. 1939, A. W. R. 247
16. 1870, L.R. 5 C. P. 561 19. 1912, AIR 16 I.C. 344
17. 1995, 1 A.C. 119 at 126 20. 1917, 41 Mad. 33
18. 1857, 2 H. & N. 564 21. 1890, 12 All. 523
19. 1925, AIR All 539 22. Mitcnell V. Humfray, 1881, 8 QBD. 587
20. 1928, I.L.R., 10 Lah. 23. Raghunath V. Varjivanda, 1906, 30 Bom. 579
21. 1921, 125 L.T. 690 24. Pushong V. Mania Halwani, 1860, BLR. AC 95
22. Anson, William Reynell (1939), Principles of the 25. Mannu Singh V. Umadatt Pande, 1890, 12 All,
Law of Contracts, 19th ed., Chicago 523
23. 1877, 2 App. Cas. 666 26. Subbamma V. Mohd. Abdul, AIR, 1950, Hyd. 55
24. 1832, 5 C. & P. 228 Self-Learning
27. Lakshmi Doss V. Rooplal, 1907, 30 Mad. 169
Material 297
Legal and Regulatory 28. 1902, 4 Bom LR 146 11. 1951, ILR 2 Cal 386
Environment of 29. 1906, 33 Cal. LR 773 12. 1882, ILR 8 Cal809
Business
30. 1913, L. R. 41 I.A. 23, 28-29 13. 1902, ILR 26 Mad 168
NOTES 31. 1937, AIR Nag. 270 14. 1890, ILR 8 Mad 472
32. 1884, 9 App. Cas. 187 15. 1931, AIR All 539
33. 1889, 14 App Cas 337 16. 1908, AIR 8 CWN 388
34. 1952, AIR Punj. 277 17. 1898, ILR 23 Bom 103
35. 1862, AR 1 H & C 90
18. 1885, ILR, 11 Cal 545
36. 1960, 2 SCR 797 19. 1987, C.A.
29. 1864, 2 H & C 906 20. 1941, AC 251
37. 1877, L. R. 2 HL 149 21. 1936, 1 KB 416
38. 1871, L. R. 6 Ex. 269 22. 1931, AIR Bom. 264
39. 1956, AIR, Cal. 575
40. 1927, AIR A. C. 487 Chapter 5
1. This subsequent or supervening impossibility
Chapter 3 is known as ‘Doctrine of Frustration’ under
the English Law.
1. Re Hudson (1885), 54. L.J. Ch. 811
2. 1853, 2 E. & B. 678
2. 1842, 2 Q.B. 851
3. 1958, 1 WLR 753
3. 1896, ILR 20 Bom 755
4. 1975, 1 WLR 482
4. 1840, 10 A & E 309
5. 1984, 1 All ER 978
5. 1995, S.E. 299, 21 Ga
6. 1977, No. 2 ch 106
6. 1911, ILR 34 All 63 7. 1975, 1 WLR 482
7. 1861, 1 B & S 393 8. 1852, 1 DM & G 604
8. 1910, 37 I. A. 152 12 Bom. L.R. 638
9. 1928, Cal. 1315 Chapter 6
10. 1915, 38 Mad. 788
11. 1964, 1 MLJ 121 (Mad.) 1. 1928, ILR 56 Cal. 262
12. 1952, AIR Mys. 109 2. Guarantor is a person who agrees to be
13. 1943, 2 MLJ 41 (Mad.) responsible for somebody or makes sure that
something happens or is done, and Surety is a
14. 1900, 4 Cal WN 488 person who accepts responsibility if some-
15. 1915, 42 Cal. 742 body else does not pay a debt, apper in a court
of law, etc. Therefore the term surety has
16. 1866, L.R. 1, Ex 213
been used deliberately and appropriately.
17. 1901, 3 Bom LR 164
3. 1970, 1 SCC6
18. 1868, LR 3 CP 235, 250
4. 1967, A.S.C. 1322; 1967, 2 S.C.R.233
5. 1878, 38 LT 851
Chapter 4 6. 1958, ILR AP 671
1. Section 2(h) of the Indian Contract Act 7. 1908, 12 Cal. W. N. 28
2. Section 2(g) of the Indian Contract Act 8. 1869, LR 4 Ch. 548
3. 1963, 2 W.L.R. 1238, 1244 9. 1913, 4 KB 103
4. 1942, I. L. R. 10. Singh, Dr Avtar, 2008, Law of Contract 10th
5. 1869, LR 9 Eq 345, 354: 39 LJ (Ch) 86:21 LT 661 ed. pp 568
6. 1876, 1 Mad. 134 11. 1931, 145 LT 51 CA
7. 1885, I.L.R. Cal. 545 12. 1917, 19 Bom. L.R. 948
8. 1917, 21 C.W.N. 979 13. 1887, 12 App. Cas. 746
9. 1897, 22 ILR Bom. 861 14. 1951, A.I.R. S.C. 144, 147
15. 1835, 2 CM & R 152
Self-Learning 10. 1872, ILR 2 Mad 44
298  Material 16. 1882, 103 ILJ 485
 17. 1910, 1 K.B. 215 2. The State of Jammu and Kashmir enjoys a Endnotes
18. 1915, 23 cal. 190 special status under Article 370 of the Consti-
tution of India.

Chapter 7 NOTES
Chapter 9
1. Throughout our discussion on the law of
sale of goods in this book, unless otherwise 1. Throughout our discussion on law of negoti-
able instruments in this book the word ‘Act’
specifically stated, the sections mentioned
refers to the Negotiable instruments Act, 1881.
are those of the Sale of Goods Act, 1930. The
Similarly, the references to sections in these
word ‘Act’ wherever used in these chapters
chapters, unless otherwise mentioned, pertain
refers to the Sale of Goods Act, 1930.
to the Negotiable Instruments Act, 1881
2. The state of Jammu and Kashmir enjoys a 2. This happens when the bill gets dishonoured
special status under Article 356 of Indian and a formal certificate of dishonour, known
constitution. as protest, is issued by the Notary Public to
3. The term ‘actionable claims’ refers to a claim, the holder of a bill in question. Hence the
which can be enforced through a court of law, term supra protest.
e.g., a book debt. 3. 1961, A.I. R. Punjab, 571
4. Valued up goods means the goods, the price 4. Notary public is a person who is officially
of which can definitely be measured in terms designated for this purpose and is appointed
of money. under No Tariff Act to attest certain docu-
5. 1857, 7E & B. 885 ments.
6. 1925, 1 KB 260 5. When the acceptor of a bill of exchange has be-
7. 1900, 1 Q.B. 513 come insolvent, or his credit has been publicly
impeached, before the maturity of the bill, the
8. 1887, 12 AC 284 holder may, within a reasonable time, cause a
9. 1854, 158 E.R. 426 notary public to demand better security of the
10. 1903, 2 K.B. 148 acceptor, and on its being refused may, with a
reasonable time, cause such facts to be noted
11. 1936, 70 MLJ 513
and certified as aforesaid. Such certificate is
12. 1928, 2 KB 636 called a protest for better security.
13. 1905, I K.B. 608 6. Banking Laws Committee Report on Negoti-
14. 1905, 21 T.L.R. 633 able Instruments Law-1975, p 48
15. 1917, 2 K.B. 606 7. Banking Laws Committee Report on Negoti-
able Instruments Law-1975, p 48
16. 1949, 2 K.B. 545
8. Section-62 (2) of the English Bill of Exchange
17. Collinge vs. Heywood Act, 1882
18. 1903, 1 K.B. 155 9. Verso Pvt. Ltd vs. Newandram, AIR (1974),
Madras
19. 1803, 13 & P.N.R. 69; RR 763
10. 1885, A.I.R. 5E and B-83
20. 1833, 4 B & Ad. 568; R.R. 309
11. 1910, A.C. 181(P.C)
21. 1803, 13 & P.N.R. 69; RR 763
12. 1965, A.I.R. Patna 2241
22. 1841, 2 Q.B. 218
13. 1844, 13 M. & W. 343
23. 1943, 1 K.B. 148
24. 1806, 2 B & P.N.R. 119
25. ALLER 779
Chapter 13
26. 1923, 2 K.B. 409, C.A. 1. Bacha F. Guzder v. Commissioner of Income
27. 1955, 2 W.L.R. 185 Tax, AIR 1955 SC 75.

28. 1977, AIR Pat. 241

Chapter 15
Chapter 8 1. John Locke (1632–1704), widely known as the
father of classical liberalism, was an English
1. This Act shall be referred to as the ‘Act’ philosopher and physician. He is regarded as
throughout the present chapter and refer- one of the most influential Enlightenment
ences to Sections in this chapter pertain to thinkers. His theory of mind is often cited as
the Consumer Protection Act, 1986. the origin of modern conceptions of identi-
ty and self. Followers of Locke are known as
Self-Learning
Lockeans.
Material  299