B.COM (HONS.) 1ST

YEAR

PAPER V

BUSINESS LAW

2

Part I

Indian Contract Act - 1872

Lesson 1- Meaning and Kinds of Contracts

Lesson 2- Offer and Acceptance

Lesson 3- Consideration

Lesson 4- Capacity of Parties

Lesson 5- Free Consent

Lesson 6- Legality of Objects

Lesson 7- Void Agreements

Lesson 8- Discharge of Contract

Lesson 9- Contingent Contracts

Lesson 10- Quasi Contract

Lesson 11- Breach of Contract

Lesson 12- Bailment and Pledge

Lesson 13- Indemnity and Guarantee

Lesson 14- Contract of Agency

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Lesson 1

MEANING AND KINDS OF CONTRACTS

by

Preeti Singh

This Lesson discusses the following aspects of contract;

1.1 Introduction

1.2 Meaning and definition of Contract

1.3 Characteristics / essential elements of a valid contract

1.4 Classification of Contracts

1.5 Classification According to Enforceability

1.6 Classification According to Mode of Creation

1.7 Classification According to Performance

1.1 INTRODUCTION

The Indian Contract Act was passed in the year 1872 and it also came into force on the 1st day of

September, 1872. The Act extends to the whole of India except the State of Jammu and Kashmir.

It consists of 238 sections. It has been divided into 10 chapters. Chapter VII of the Act is wholly

repealed by the India Sale of Goods act, 1930 (vide section 65). The Act deals with particular

contracts in separate chapters. The provisions of the Act do not apply to contracts made before

the Act came into force. Broadly speaking, The Indian Contract Act deals with all facets of

contract more particularly the stages of formation of a contract, the elements of a contract, the

performance of the contract, the breach of the contract and also the available remedies when

there is a breach of contract.

A contract in which two or more countries are involved in respect of its performance, questions

arise as to the law of which country would govern such a contract. In the first instance, the law

which would govern such a contract would be the law expressed by the parties themselves in the

contract. In the absence of an expressed intention, the rule to apply is infer an intention from the

terms and nature of the contract and the general circumstances of the case. Such circumstances

may be (i) the country in which the Contract was entered into or (ii) where the payment was to be

made. In such a contract, if a payment is to be made, it should be of the legal tender governing

the country in which payment is to be made. [Principle of LexLoci i.e. the law of the land]

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1.2 MEANING AND DEFINITION OF CONTRACT

The meaning and definition of a contract are discussed below with references to some

eminent jurists.

1.2.1 Meaning

An agreement enforceable by law is a contract. An agreement is an accepted

proposal. Thus it can be said that a contract is an agreement; an agreement is a

promise and a promise is an accepted proposal. Every agreement in its ultimate

analysis, is the result of proposal from one side and its acceptance by the other.

Hence it is a bilateral transaction.

Illustration 1: If Prem offers to sell Pummy twenty-five pens for Rs. 20 each to be

delivered on Saturday and Pummy agrees to the deal. It is a valid contract.

If one party fails to offer something of benefit to the other, there is no contract.

Illustration 2: If Ram promises to fix Meena's car, there is no contract unless Meena

promises something in return for Ram’s services of fixing the problem of the car.

1.2.2 E-Contract

The latest mode of making instant contract within and outside country is to enter into

contracts through computer internet. This mode is known as E-contract. By

exchange of communication of offer and acceptance between the parties through

internet contract can be created and the legality and enforceability of the E-contracts

is no way affected merely because the formation of the contract depended on the

electronic record.

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1.2.3 Definition

Section 2 (h) of the Indian contract Act of 1872 defines a contract as an agreement

enforceable by law.

According to Section 2(h) of the Act there are mainly two aspects of contract -

(a) An agreement

(b) Agreement enforceable by law

Some eminent jurists have also made an attempt to define the term contract which are

useful for interpretation of the various provisions of the Contract Act. These

definitions are given below:-

• Sir John William Salmond: “An agreement creating and defining

obligations between the parties”.1

• Halsbury: “An agreement between two or more persons which is intended to

be enforceable at law and is constituted by the acceptance by one party of an

offer made to him by the other party to do or abstain from doing some act.”2

• Sir William Anson: “A contract is an agreement enforceable at law made

between two or more persons by which rights are acquired by one or more to

acts or forbearances on the part of the other or others.”3

• Sir Federick Pollock: “Every agreement and promise enforceable by law is a

contract.”4

Thus in law a contract means the following:

• Existence of two parties

• Existence of an agreement between two or more parties

• Existence of a legal obligations between parties who enter into an agreement

Points to be noted:-

• All agreements are not contracts; only agreements that give rise to legal

obligations are contracts.

• All obligations are also not contracts; only obligations that have legal

consequences are contracts.

1 See Jurisprudence 13

th edition 1970 p 269

2 See Halsbury’s Law of England On Contracts, Ist edition p.1

3 See Principles of English Law Of Contract 8

th edition AL guest edition p 2, 1957

4 See Pronciples Of Contract 12

th edition 1990 p.3

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1.2.4 What is an Agreement?

An agreement is defined in section 2 (e) of the Indian Contract Act of 1872. It states

that every promise and every set of promises forming the consideration for each

other is an agreement.

1.2.5 What is a promise?

Section 2 (b) of the Indian Contract Act of 1872 defines a promise as: A proposal

when accepted becomes a ‘promise’.

Under section 2 (c) the person who makes the proposal is called the ‘promisor’.

The ‘promisee’ is the person that accepts the proposal.

Illustration: Rani makes an offer to sell her plot of residential land for Rs. 50 lakhs to

Malthi. If Malthi accepts this offer, then after the offer is accepted, the acceptance

becomes a promise. The promise between Rani and Malthi is an agreement.

Therefore, agreement consists of offer and acceptance or it can be stated as:

Agreement = Offer / Proposal + Acceptance of Offer / Proposal

When the two parties make an agreement, they have to perform their promise. If

either party defaults in carrying out its obligation there will be a breach of contract if

it is enforceable by law.

Only agreements that can be enforced by law are contracts.

Illustration 1: Geeta invites Shyam for dinner to her house. Shyam

forgets and Geeta is very upset. Does Geeta have a remedy? Can she go

to court to get the expenses of the dinner to be paid by Shyam?

Answer: Geeta cannot go to court for compensation as the invitation

to dinner and its acceptance is only an agreement and not a contract.

Illustration 2: Meeta makes an agreement to sell five mobile phones for

Rs. 6000 each to Madhuri. Madhuri accepts the offer. If Madhuri fails to

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purchase the mobile phones, can Meeta go to court to enforce the

contract?

Answer: Meeta can ask for enforceability of the contract. This

agreement is a contract because there is an offer by Meeta for some

consideration and Madhuri accepts it. Similarly if Meeta was to breach

the contract then Madhuri could apply for enforceability of the contract.

Every contract is an agreement but every agreement may not be a

contract.

The law of contract in India does not give any guidelines to people entering into a

contract or in terms and conditions of the contract but it regulates the contract by

providing general principles of contract law.

An agreement becomes a contract according to section 10, if a promise is made

between two people who are competent to enter into a contract. It should be a contract

with free consent of the two parties, with a lawful consideration and a lawful object

and the agreement is not void.

Under section 2 (g) an agreement that is not enforceable by law is void.

What is enforceability of agreement?

An agreement can be enforceable by law only if there is some legal obligation.

The law of contracts does not take into consideration any agreement in which there

is no legal obligation.

An obligation is to do, or to restrict, a certain act or activity. The Contract Act deals

with only those agreements where there is an intention to create a legal obligation.

When there is an agreement that involves some business or commercial contracts it

creates a legal obligation because the parties to the contract have the intention to

create a legal obligation.

However, the parties entering into a contract in domestic, social or religious events

that do not have the intention to create any legal obligations cannot be called as a

legal obligation unless proved otherwise.

The Contract Act will govern only those legal obligations that are created out of

agreements.

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Therefore, all contracts create legal obligations but all obligations do not become a

contract.

Thus it proves the statement made by Salmond “law of contract is not the whole law

of agreements, nor is it the whole law of obligations.”

Illustration 1: Mr. Ali gets married on the 15th of April.2006. His wife

gave birth to a baby girl in 2007. It is now his responsibility to take good

care of his family. The obligation to maintain his family is not out of any

agreement but out of love and affection for his family. This is a social

obligation. Only agreements, which create legal obligations, are termed as

contracts.

Illustration 2: Mr. Modi agrees to sell his old washing machine for Rs.

8,ooo/-to Sweetie. This agreement becomes an obligation on Modi to

deliver the machine to Sweetie on the stipulated date at an agreed price.

Sweetie is under the obligation to pay Modi and take the delivery of the

machine. This agreement is a legal obligation, so it becomes a contract.

Illustration 3: Mr. Bedi carried out the provisions of the court order by

providing maintenance to Mrs. Bedi during their separation period. This is

not a contract but an obligation carried out of the acceptance of a court

order.

In brief contract means: the following: -

• A contract must have at least two parties.

• There has to be an agreement between two or more parties to constitute a

contract.

• The agreement between parties should have a legal obligation.

1.3 CHARACTERISTICS OF A CONTRACT

Section 10 of the Indian Contract Act, 1872 enumerates certain essential elements of a

valid contract. These are given below:

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1.3.1 Agreement

An agreement constitutes a contract. It consists of two elements. These are:

An offer, or proposal, by a person and acceptance of the offer, by another.

Thus a contract must have two parties. One, who proposes or makes an offer, and

another that accepts the offer.

The Contract Act defines offer or proposal in the following words:

“When a person signifies to another his willingness to do or to abstain from doing

something with a view to obtain his assent thereto, he is said to have made a

proposal.”

Acceptance has been defined in section 2(b) of the Act as “When the person to whom

the proposal is made signifies his assent thereto, he is said to have accepted the

proposal.”

1.3.2 Legal Relationship

The intention of the two parties should be to create legal relationship. While

deciding if the contract is valid or not, attention should be made to look into the

objective and not subjective nature of the intention to create a legal relationship. It

should also take into consideration what would be a reasonable intention of the person

who enters into a contract. A domestic, religious or a social agreement where there is

no intention to create a legal relationship cannot be called a valid contract. It is

presumed that business dealings and commercial agreements are made with the

intention to create a legal relationship. However social agreements can be enforceable

if legality of relationship is intended and established. Similarly business dealings may

not establish a legal relationship in an agreement and are therefore not enforceable.

Case Law

Some case laws are cited as references to show that the intention in the agreement to

create a legal relationship is important in deciding whether it is, or not, a valid

contract:

Case Law 1

Balfour Vs Balfour5: Mr. Balfour was on a vacation with his wife in England. His

employer directed him to return o Ceylon. His wife was advised to reside in England

5 (1919) 2 KB 571

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for health reasons. Mr. Balfour promised to send a monthly maintenance amount to

her. He sent her some installments but thereafter stopped as they had differences

between them. Mrs. Balfour filed a case against her husband to recover the amount

promised to her. The case was dismissed on the grounds that the “parties did not

intend that they shall be attended by legal consequences.”

This was considered to be a domestic matter. It did not create a legal relationship and

could not be considered as a valid contract.

Case Law 2

Jones Vs Padavatton6: The mother promised to pay the daughter’s education when

she studied abroad. This was held as a domestic understanding between mother and

daughter and could not be enforced by law as it did not have any intention to create a

legal relationship.

The following case is a little different. It is a domestic agreement but the objective

and reasonable testing of this case shows that the husband and wife intended to create

a legal relationship. Thus law of contracts has within its purview domestic cases,

social relationships and employer employee matters as well if it can be proved that the

intentions is to create legality and enter into a contract.

Case Law 3

McGregor Vs McGregor7. This was an agreement between husband and wife with the

intention of creating a legal relationship.

Mr. McGregor had promised his wife that he would give her an allowance. In return

Mrs. McGregor had agreed not to pledge his credit. This was a valid contract and

breach of the case was enforceable by law.

In the above paragraph it has been explained that business and commercial dealings

normally show that there is an intention to create a legal relationship. However in the

following commercial dealing the intention was not to create legal relationship. Hence

there is an agreement between the two parties but it is not a valid contract.

6 (1969)2 All ER 616 : Also see Chandra Kant Manilal Shah V. CIT A.I.R. 1992 SC 66

where Supreme Court has observed that a contract of any kind including that of

partnership between the individual members of a Hindu family is quite possible. 7 (1888) 21 QBD 424

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Case Law 4

Rose & Frank Co. Vs Crompton Bros.8 Rose Co. was appointed by Crompton Bros as

their agents. In their agreement one of the clauses specifically stated that the

agreement entered into was not a formal or legal agreement and would not be subject

to legal jurisdiction in the law courts.

The courts held that this was not a binding agreement and therefore could not be

termed as a legal contract as there was no intention to create a legal relationship

even though it was a business dealing.

Case Law 5

JonesVs Vernon’s Pools Ltd.9 There was a business dealing between the two parties

but the agreement stated that it would not give rise to any legal relationship and

rights and duties would not be enforceable or give right to litigation. The agreement

would be binding in honour only.

The court held that this was not a valid contract, as it was not legally binding. There

was no legal relationship and the agreement was not legally enforceable.

Free Consent

Section 14 of the Indian Contract Act states there should be free consent between the

parties making an agreement. The consent is considered to be free when there is no

coercion, undue influence, mistake, fraud, or misrepresentation in the agreement

prepared by the parties. If the consent is not free, the contract is not valid.

Amit gets his parents to sell the house to his friend forcibly. This is not a valid

contract, as the agreement was not made with free consent.

When a contract is made both parties must understand and agree on all the same thing

or all material facts of the agreement. It is called consensus ad idem when there is a

meeting of minds of both the parties. They should have agreed on all the terms and

conditions without any undue influence or mistake in understanding of the product.

Illustration: Mr. Rajhans is selling his blue sports model car to his secretary.

However his secretary Rita thinks that she is buying the new red sports model car.

There is no meeting of minds and hence there is no valid contract.

8 (1925) A.C. 445

9 (1938)2 All E.R. 626

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1.3.3 Capacity of Parties

The parties entering into a contract should be competent to make an agreement.

According to section 11 of the Act they should have (i) attained the age of

majority,(ii) They should be of sound mind, (iii)They should not have been

disqualified to enter into a contract.10

Illustration 1: Meera is a lunatic and gets attacks of lunacy at intervals. Is she

competent to contract?

Meera can enter into a contract in those periods when she is not suffering from

lunacy. She is competent to contract when she is not under the influence of lunacy

attack.

Illustration 2: Leena is 15 years old. Does she have the capacity to enter into a

contract?

Leena cannot enter into a contract because she is a minor. She will be able to enter

into a contract when she attains the age of majority.11

1.3.4 Status of other Entities

Any company is competent to enter into a contract according to the legislations under

which they are governed. In this case the Memorandum of Association and Articles of

Association of the company will provide further guidelines in addition to provisions

of Indian Contract Act. Partners are allowed to enter into contracts under Partnership

Act of 1932. Associations of persons are competent to contract subject to their

agreement.

1.3.5 Lawful Consideration

According to Section 2(d), 23 and 25 of the Act a valid contract must have a

consideration. The person making a promise must receive something in return for it. It

may or may not be an adequate return but there has to be some value and it should not

10

See Upendra Prasad and Indu: (2005) Systematic Approach to Business and

Corporate Laws, Bharat Law House Pvt Ltd. Page 4 11

Majority age is determined according to the law to which the person is subject to.

The Indian Majority Age Act, 1875 and amendment in 1999 (section 3) provides that

a person attains majority at the age of 18.

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be fraudulent, unlawful, immoral or opposed to public policy. The agreement is

legally binding and enforceable when both parties to an agreement give something

and also get something in return. Consideration may not be in cash only. It can be in

kind. It can also be an act or abstinence from doing something. It can be a promise to

do or not to do something.

Illustration 1: Ali sold 5 fountain pens for Rs. 125 each to Megha with a promise to

receive 12 red roses in return instead of the money in cash. Is this lawful

consideration?

This is a lawful consideration as Megha gives roses instead of cash. Some

consideration is being given to Ali. The consideration may not be of equal value.

Illustration 2: X has entered into a contract with Y to sell one camera, two cello

phones and 3 televisions for Rs. 55,000. All the things were taken by theft. Is this a

valid contract?

This agreement has a promise and a consideration but it does not have lawful

consideration since X was able to get the things unlawfully through theft. Unlawful

consideration makes an agreement void and it is not legally enforceable.

1.3.6 Object of an Agreement

According to section 23 of the Indian Contract Act 1872 the object of an agreement

should be within the purview of law. It should not be fraudulent or be forbidden by

law. The object should be legal, moral and according to public policy. It should not

have any legal flaws otherwise it will not be enforceable by law (Section 23). Legal

object implies the following:

• Agreements should be lawful.

• Agreements should not be fraudulent.

• Agreements should be such that they do not cause injury or harm to any

person or property.

• Agreements should be moral.

• Agreements should be within public policy.

• Agreements should be within the provisions of law. Since agreements are

being are being made according to the Indian Contract Act, they should be

within the Indian law.

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1.3.7 Formalities of an Agreement

The agreements under the Indian Contract Act may be oral or in writing. Whenever an

agreement is a valid contract and it is made in writing it should be complete with all

legal formalities. If the legal formalities are not complete, law cannot enforce it. The

contract will become void. Some contracts have to be made in writing otherwise they

will not be valid. In the following cases contracts have to be in writing:

• Cheques, bills of exchange, promissory notes and other negotiable

instruments.

• Insurance contracts providing name of the insurer and the personal insured and

the period of insurance with all clauses have to be in writing.

• An agreement with a promise to pay a time barred debt.

• All lease agreements that are for a period exceeding 3 years.

• Important documents of a corporate organization especially the Memorandum

of Association and Articles of Association.

• All valid contracts that relate to the transfer of immovable properties must be

in written form.

• Arbitration agreements must be in writing to be enforceable by law.

Certain documents have to be in writing and also registered in order to be enforceable

the following documents must specially be taken care of under section 17 of The

Registration Act of 1908.

• The Transfer of Property Act, 1882, specifically states that all immovable

properties must be registered.

• The companies Act of 1956 states that Memorandum of Association, Articles

of Association, Mortgages, Debentures and other documents that are

compulsory under The Registration Act should be registered.

• When a promise is made with natural love and affection and without

consideration the agreement should be registered.

• The Indian Trusts Act 1882, requires that the trust should be an agreement in

writing and should be duly registered.

1.3.8 Valid Agreement but not Enforceable

In many cases even a valid contracts may not be enforceable by law. If a country

declares an agreement void it cannot be enforced. Hence it is important to know the

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law of the country in which the agreement is made otherwise the legal rights cannot

be exercised (Sections 24 to 30 and 56).

The following agreements have been declared by Indian Contract Act to be void:-

• Agreements made for restraint in marriage (Section 26).

• Agreements for restraint in trade (Section 27).

• Agreements for restraint of legal proceedings (Section 28).

• Agreements that are ambiguous and the meaning are not clear (Section 29).

• Agreements by way of wager (Section 30).

• Agreements that is contingent on the happening of some events (Section 36).

• Agreements to do acts that are difficult or impossible (Section 56).

These agreements are lawful but they are not enforceable because they impose certain

restraints to the freedom of a person. Thus law denies enforceability to them.

Thus summarize the essential elements of a valid contract are as follows:-

• A valid contract must have an agreement.

• It should have the intention to create legal relations.

• The contract will be valid if there is free consent.

• The people entering the contract should be competent and have the capacity to

enter into a contract.

• There should be some lawful consideration for both parties to make the

contract enforceable.

• The object of the contract should be legal.

• The legal formalities of the contract should be complete. Some contracts have

to be in writing and registered.

• Certain agreements are lawful but they cannot be enforced due to the laws of

certain countries or some restraints not acceptable within the country.

1.4 CLASSIFICATION OF CONTRACTS

The Indian Contract Act classifies contracts into different categories. Contracts can be

categorized from the point of view of (i) enforceability/legal validity (ii) according to

formation, (iii) according to performance and (iv) according to obligation.

(A) Enforceable/legal validity contracts can be classified into the following:

• Valid Contract.

• Voidable Contract.

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• Void Contract.

• Void Agreement.

• Illegal Agreement.

• Unenforceable Contract.

(B) Contracts according to their mode of creation/formation are the

following:

• Express Contract

• Implied Contract

• Quasi Contract.

(C) Contracts classified according to performance:

• Executed Contract

• Executory Contract

• Unilateral Contract

• Bilateral Contract.

Unlike Indian law of contract in England contract has been broadly classified under

two heads:-

(a) Formal Contracts

(b) Simple Contracts12

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1.Formal Contract : Formal contracts recognized by English Contract Act. These

contracts are either under seal or contracts of record.

(i) Contracts under seal must be in writing. They have to be signed by the parties

making the contract. To be valid, the following contracts should be under a seal:

• Contracts without consideration

• Land that is one lease for a period exceeding three years.

• Contracts that are made with British Shipping

• Contracts entered into by Corporations.

(ii) Contracts of record are those that adhere to the past judgements. The obligations

of the parties under the agreement arise out of court judgements and not out of

contract.

2. Simple Contract: Contracts that are not formal are termed as simple contracts. They

are also called parol contracts.

Simple contracts can be entered into either by word of mouth i.e. orally, or by

written word. It can also be implied by conduct.

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1.5 (A) CLASSIFICATION: ACCORDING TO ENFORCEABILITY

A contract that is enforceable can be classified under different categories. Such

contracts may be valid contracts, voidable contracts, void agreements, void contracts,

agreements discovered to be void, unlawful or illegal agreements and unenforceable

contracts.

1. Valid Contract: A valid contract is one, which satisfies the essential elements

described in section 10 of the Indian Contract Act. It must be an agreement in which

an offer is made and accepted. It should have the intention to create legal relations.

There should be lawful consideration and the object should be legal. It should have

clear terms with free consent of both the parties. When all the essential elements are

complete in all respects it is a valid contract and it is enforceable by law.

2. Voidable Contract: If one party to the contract has the option of enforcing a

contract by law, but not at the option of the other or others, it is a voidable contract.

In those cases when the consent is not given freely but coercion has been used the

party has the option to continue with the contract or rescind it. Another example of a

voidable contract is when a person has promised to deliver certain goods on a certain

date and he does not deliver it, it is the option of the buyer to continue or to rescind

the contract (section 55).

Illustration 1: Ruhi wanted to buy a gold chain for her mother’s birthday. The

goldsmith promised to deliver it on the 20th

of May. On the due date the chain was not

ready. Ruhi rescinded the contract and decided to buy something else. The goldsmith

wanted compensation. Is he right?

The goldsmith is not correct. If he did not deliver the goods on time Ruhi has the right

to rescind the contract.

Thus in a voidable contract the aggrieved party can take benefit of the situation.

He/she may decide to go ahead with the contract as well. Thus in a voidable contract a

flaw can create a benefit for a party. However if the party decides to continue with the

contract, the terms and agreements will continue to be valid and the contract will also

be a valid one.

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Illustration 2: X sells to Y a Casio brand camera. The camera turned out to be a

cheap one with a fraud branding. What can Y do?

Y can reject the camera on the grounds of misrepresentation of the goods to be sold.

The contract is voidable due to misrepresentation. Y can also decide to continue with

the contract and if Y decides to continue with the deal it will be a valid contract.

3. Void Contract: These contracts are enforceable when the agreement is made but

due to certain lapses they become unenforceable at a later date.

The agreement becomes unenforceable for the following reasons:

• According to section 56 if a contract is illegal or impossible to conduct it

becomes void.

• The contract becomes void if it is voidable in nature and the party who could

exercise the option of avoiding it decides to do so.

• Any contract, which has a contingency clause and it, becomes impossible to

conduct it either on the happening or not happening of a particular event is a

void contract. This is explained in (section 32).

Illustration 1: Anil made an agreement with Suman to sell house no P-21 in Sushant

Lok in Gurgaon. The terms and conditions were finalized. Before the due date for the

transaction to take place there was an earthquake and the house fell down. Anil could

not keep his promise because the house did not exist any more.

This contract is void because the agreement was made on the basis of the house in

possession. Since Anil did not have the house after the natural calamity it was a near

impossibility to deliver the goods to Suman.

Illustration 2: Madhuri entered into a contract with Salma. She promised to delivers

silver jewellery to her from her newly designed pieces. On the due date, the specialist

making the ornaments died and she could not deliver the jewels. The contract is void.

It was valid and enforceable by law when it was made but due to circumstances of

death it became a near impossibility to carry it out.

Illustration 3: Meena has been under the influence of her parents to sell her car

valuing Rs 3,00,000 for Rs 2,00,000. The agreement becomes voidable at her option.

If she decides to quit the agreement, the contract will be void.

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4. Void agreement: Section 2(g) describes void agreements as those that are

unenforceable from the inception of the agreement. In other words these agreements

are void ab initio. . A mistake between the two parties to an agreement of a material

fact makes the agreement void. Therefore void agreements do not create any legal

rights between the parties to the contract. It also does not create any obligations.

There is a flaw in the agreement itself.

The most common example is that of a minor who does not have the legal rights to

enter into an agreement. If he/she does, the agreement is null and void ab initio.

The Indian Contract Act expressly declares agreements that have restraints in

marriage or trade or uncertainty as void.

Illustration: Neena agrees to deliver anklets to for a consideration of Rs. 2,00,000 to

Meenu by cutting a part of the foot to remove the anklets. Since this is an impossible

agreement, it is void.

The reasons that change a valid contract into a void one are thus the following:

• When the performance is due to supervening impossibility after the contract

has been formed.

• When a contract has after its formation, subsequently become illegal.

• When the person who has entered into a contract without free consent has

repudiated a voidable contract.

• When a contingent contract cannot be carried out due to the fact that the event

becomes impossible to achieve.

1.5.1 Void Agreement and Void Contract: Distinction

A void agreement is void ab inito from the beginning of the contract. A void contract

is valid when it is made but due to certain lapses it becomes unenforceable by law

subsequently.

A void agreement will have the following effects:

• It will be unenforceable by law

• If both parties know that the agreement is void money will not be recoverable

if already paid.

• Collateral transaction will be legal unless the agreement itself is illegal.

• All legal promises are enforceable if the agreement can be proved to be

severable.

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1.5.2 Void Agreement and Voidable Contract: Distinction

The difference between void agreement and void contract can be discussed on the

basis of (i) enforceability (ii) Compensation and restitution and (iii) the effect on

collateral agreement.

Enforceable: Void agreements are not enforceable from the time of their formation.

They are said to be void ab initio.

Void contracts are enforceable when they are formed but they become unenforceable

if the party who has the option to rescind the contract does so. It is a valid contract if

it is not repudiated.

A void agreement is not enforceable at all but a void contract can be enforced if the

parties agree to complete the contract and exercise the option accordingly.

Compensation and restitution: In a void agreement there is no compensation because

the agreement is not enforceable by law.

In a voidable contract the person who exercises the option of rescinding the contract

can get compensation if he has rightly taken the option of not going ahead with the

contract.

It follows therefore that restitution is allowed in a voidable contract unless the parties

knew of the illegality of the agreement at the time of formation.

Collateral agreement: An agreement that is void due to illegality has an effect on

collateral agreements as well. Such agreements will be correspondingly void because

of illegality in consideration or object in the agreement.

A voidable contract however has no effect on collateral contracts.

5. Illegal Agreements/Contracts: The word illegal agreement is used in place of

illegal contract because if the agreement is illegal it is unenforceable by law. Illegal

agreements cannot become contracts because they are unenforceable.

“All illegal agreements are void but all void agreements are not illegal.”

A minor entering into an agreement is void but not illegal. A wagering contract is also

void but not illegal.

An illegal agreement is void ab initio. It is unenforceable by law from the very

beginning. If a person has borrowed money illegally he cannot be asked to recover the

21

amount. If an agreement is illegal even the collateral agreements will have the effect

of being illegal.

Illustration: A pays to B a sum of Rs 1,00,000 who again gives the amount to Z for

black marketing of onions in short supply. Since the illegality was there in the

contract right from the beginning and the parties knew of the illegal purpose of giving

money, the agreement between B and Z is illegal and the collateral agreement

between A and B is also illegal.

In the case of a contract it may be enforceable by law when it was formed and become

void due to attaining subsequent illegality. For Example X transfers property to Y

legally but due to some illegality, which occurred later it became unenforceable.

Money can be recovered in this transaction because it was not illegal at the time of

entering into a contract. A void contract does not have any effect on collateral

contracts made between the parties.

1.5.3 Void and Illegal Agreements: Distinction

! Illegal agreements are void ab initio but valid contracts can become void due

to certain subsequent developments.

! Illegal agreements are punishable but void agreements do not punish the

parties entering into a contract.

! All illegal agreements are void but all void agreements are not illegal.

! Collateral agreements in a illegal agreement are void but collateral agreements

are not affected in void agreements.

6. Unenforceable contracts: Certain contracts are not enforceable by law because

they suffer from some technical faults. For Example if statements have to be

registered and they have not been done it becomes unacceptable by court. If

documents require stamp paper and it has not been used, the document will not be

enforceable by court. Therefore formalities should be complete to make a contract

enforceable by law.

1.6 B. CONTRACTS: ACCORDING TO MODE OF CREATION

Contracts on the basis of mode of creation refer to Express Contracts, Implied

Contracts and Quasi Contracts.

22

1. Express Contract: When an offer is made in words or in writing and another

person accepts it an express contract is formed. Promise is considered to be express

when it is made in words written or spoken.

Illustration 1: Priya writes to Prem offering to sell her car for a price of Rs.1,00,000.

Prem accepts the offer by responding through an email. This is an express Contract

Illustration 2: Pummy makes a phone call to Raj and offers to sell her Laptop for Rs

20,000. Raj accepts the offer. It is a promise made by verbal contact and the offer is

accepted. It is an express contract.

2. Implied Contract: A contract is said to be implied when it has to be inferred from

the action, gestures or conduct of the parties. It is not a verbal or a written contract. It

has to be implied from circumstances of the case. In the agreement some terms may

be implied or the complete agreement is implied.

Illustration 1: Janaki attended an informal meeting of a company. The company was

glad to receive her suggestions and accepted her presence and took some of her

suggestions. There is an implied contract that Janaki should be paid for her services

because the company allowed her to attend the meeting and also used her suggestions

for the benefit of the company.

Illustration 2: The hotel porter cleaned Mr. Madan’s car though he was not asked to

do so. Mr. Madan accepted the services. The porter was expecting to be paid for

services that he had not been asked to do. This is an implied contract as the porter

expects payment for his services and Mr. Madan accepted his services and allowed

him to clean his car

The contracts can be of mixed type as well. They can be express and implied

contracts both. Some part of the combination may be express and parts of it may be

implied.

Illustration: Ram offers to buy an I pod from Tilak for Rs 10,000. Tilak accepts the

offer by sending the I pod to Ram. Ram’s offer is expressed in words and Tilak’s

23

acceptance is implied by his conduct. It is a mixed type of contract. It combines the

characteristics of both express and implied mode of creation.

3. Quasi Contract: Contracts which are not in actual fact either express or implied but

there is circumstantial evidence to support that they are actually contracts are called

Quasi Contracts or semi contracts. There is actually no contract between the parties as

there is no agreement between the parties but the obligations cited in sections 68 to 72

of the Indian Contract Act provide legality to them.13

These are known as “certain

relations resembling those created by contracts”.

Illustration: Arti leaves her computer in Monica’s house. Monica treats it as her own

and begins to use it for her official purposes. Arti has no agreement with Monica. She

should pay for the use of the computer, which was kept with her for safe- keeping.

1.7 CONTRACTS ACCORDING TO PERFORMANCE

Contracts can be classified according to performance measures. Such contracts are

called executed contracts, executory contracts, unilateral contracts and bilateral

contracts.

1. Executed contract: An executed contract is one where both the parties have

performed and completed their obligations. The contract is completed and executed.

No responsibilities remain from either side of the contract.

Illustration: Rajesh goes to Westside store and buys a shirt for himself. He pays Rs

1450 and the shirt is packed and delivered to him. He leaves the store as the contract

is executed. The obligations of both the parties are complete.

2. Executory Contract: In a contract sometimes one party may carry out his/her

obligation but the other has still to conduct his/her obligation. This obligation will be

13

Section 68 deals with Claim for necessaries supplied to person incapable of

contracting, or on his account.

Section 69 deals with reimbursement of person paying money due by another, in

payment of which he is interested.

Section 70 deals with obligation of person enjoying benefit of non-gratuitous act.

Section 71 deals with responsibility of finder of goods.

Section 72 deals with liability of person to whom money is paid, or thing delivered

by mistake or under coercion.

24

performed in future. This type of a contract, which is not yet complete, is called an

executory contract. In some executory contracts both parties decide to complete their

contract in future because of certain important reasons.

Illustration 1: Minna sells her computer to Zara . Immediately Zara sends the

payment for it. Minna has to still deliver the computer. This is partly executed and

partly an executory contract.

Illustration 2: Khem promises to install the kitchen grill for Tina. He expects a

consideration of Rs 3,500 for it for which Tina agrees. This is an executory contract.

It is still not complete.

3. Unilateral Contract: In some contracts one party has already completed his/her

obligation but now the other party is left to complete his/her part of the contract.

When the other party executes his/her part of the contract that, is still outstanding, it is

called a unilateral contract. These contracts are also called contracts with executory

consideration. When the contract is formed, there is an obligation of only one party to

perform.

Illustration: Murli’s dog was lost while he was taking a morning walk. He offered a

reward of Rs 1,00,000 for bringing back his dog safely. Sashi found the dog and

returned it to the owner. The owner now has a unilateral contract to perform of

paying the reward money as the dog has been found.

4. Bilateral Contract: If both parties to a contract have outstanding obligations when

the contract is formed, it is called a bilateral contract. The contract has been formed

but the obligations will be performed on a future postponed date. The date of

execution is not material for determining the validity of the contract.

Illustration: Puran makes a promise to sell 100 pen-drives to Kamla. The

understanding is that the price will be paid only on delivery of the material required.

This is a bilateral contract. The contract was settled but both delivery and price paid

for it will be made at a future date.

25

Points to Remember

Introduction

! The Indian Contract Act was passed in 1872.

! It extends to whole of India except Jammu & Kashmir.

! When two countries are involved in a legal matter, the principle of Lexloci or

law of land will apply.

Meaning and Definition

! Agreement enforceable by law is a contract.

! Every promise or every set of promises with consideration is an agreement.

! E-contract is made through internet.

! Some eminent jurists who have defined contract are Sir John William

Salmond, Halsbury, Sir William Anson and Sir Federick Pollock.

Characteristics of a Valid Contract

! Agreement

! Legal Relationship

! Free consent

! Capacity of parties

! Lawful consideration

Classification of Contracts

! Contracts by enforceability

! Contracts by mode of creation

! Contracts according to performance

Classification According to Enforceability

! Valid contracts

! Voidable contracts

! Void contracts

! Void agreement

! Unenforceable contracts

Classification According to Mode of Creation

! Express contract

! Implied contract

! Quasi contract

26

Classification According to Performance

! Executed contract

! Executory contract

! Unilateral contract

! Bilateral contract

Objective type questions

State whether the following are True or False

1. All contracts are agreements.

2. All agreements are contracts.

3. The past judicial decisions on contract law are not important.

4. The Indian Contract Act of 1872 is not applicable to Jammu and Kashmir.

5. A void contract is unenforceable from the time it is formed. It is void ab initio.

6. A valid contract is one, which satisfies the essential elements described in

section 10 of the Indian Contract Act.

7. Agreements made for restraint in marriage are void under Indian Contract Act.

8. If one party to the contract has the option of enforcing a contract by law, but

not at the option of the other or others, it is a voidable contract.

9. All illegal agreements are void.

10. An executory contract is one in which both parties have fulfilled their

respective obligations.

Answers: 1.T; 2.F; 3.F; 4.T; 5.F, 6.F, 7.T, 8.T & 9. T. 10.F.

Questions

1. “All contracts are agreements but all agreements are not contracts”. Discuss

this statement.

2. What is a contract? Discuss the essential elements of a contract?

3. “The law of contracts is not the whole law of agreements, nor is it the whole

law of obligations”. Discuss.

4. What are void contracts? How do you distinguish them from voidable

contracts? What are the rights and obligations of the parties of such contracts?

5. Write notes on the following:

(a)Valid contract ((b) Void agreement (c) Void contract (d) Unenforceable

contract.(e) Implied contract (f) Quasi contract (g) Illegal contract.

27

6. Distinguish between (a) Void contracts and void agreements. (b) Valid

contract and voidable contract. (c) Void agreements and voidable contracts.

(d) Void and illegal agreements.

7. All illegal agreements are void but all void agreements are not illegal. Explain.

8. What is an Express Contract? How is it different to an Implied contract?

9. Distinguish between (1) Void agreement and voidable contract. (2) Void and

illegal agreements. (3) Illegal and unenforceable agreement.

Practical Problems

1. Rani agrees to sell “My red car for Rs 50,000 or Rs 1,00,000”. Is this

agreement valid?

Answer: The agreement is not valid because there is no certainty in the terms of

agreement. There are two prices quoted. Which is the one acceptable for

sale? The agreement is void of certainty.(Section 29)

2. Jasmine purchased three kilos of sugar and one kilo of rice from a grocery

store for her personal consumption. She is a minor. She does not want to

pay. Can the shopkeeper recover the amount?

Answer: The minor has purchased products of need as they are required for food. She

is liable to pay to the shopkeeper.

3. Shashi invited two of her friends for dinner. At the last moment, they

decided to come but not have dinner with her. She had made elaborate

arrangements of decorations, lighting and food. She was very angry. Can

Shashi sue her friends for the loss she has suffered?

Answer: Shashi cannot sue her friends because it is a social agreement and lacks the

intention to create legal relations.

4. Mohan entered into an agreement with Subhash to write 500 pages in 3 days

for a sum of Rs 1,00,000 as consideration. The manuscript was required

urgently for publication. Subhash could not deliver the manuscript. Can

Mohan sue Subhash for the loss?

28

Answer: Mohan cannot sue Subhash because the contract is not valid. According to

section 56 an agreement to do an impossible act is void.

5. Meeta made an agreement with Shanti to design her teeth and make her look

beautiful. On the day of the appointment, there was an earthquake and

Meeta,s clinic was completely finished. Can Shanti sue Meeta?

Answer: Meeta is unable to keep her promise because of supervening impossibility

and not because of any lapse on her part. She is unable to perform because a

natural calamity has completely ruined her clinic. Hence she cannot be made

liable.

6. Mona agrees to sell her car to her friend Anu for Rs 3,00,000 and deliver it

on the 15th

of June. On the 12th

of June she sold and delivered the car to

Amit because he was giving her Rs 3,20,000 for the car. If Anu sues Mona

will she succeed?

Answer: Anu has the right to get the car delivered to her because the agreement was

made with her first. This is an anticipatory breach of contract on the part of

Mona.

7. Roja inserts a coin to get a trolley at an airport. Is this a legally enforceable

contract?

Answer: It is legally enforceable as it is classified as an implied contract.

8. Mani promises to give her daughter a pocket money of Rs 1000 every week.

She gives her the money for 3 weeks and then decides that the amount is

very high and so she stops paying her the amount. Can her daughter sue her?

Answer: This is not a legally binding contract as it is a social agreement between a

parent and her daughter. The intention was not to create a legal relationship.

It was a family matter. Hence it is not enforceable.

29

References

Books:

1.Chadha P.R and Bagrial Ashok,(2007) Chapter 1 Pragati Publications, New Delhi,

India,

2..Maheshwari S.N. and .Maheshwari S.K.(2007) India Chapter 1 Himalaya

Publishing House, Mumbai,

3.Pillai R.S.N and Bhagvathi(1999), Chapter 2 S.Chand and Co Ltd, New Delhi,

India,

4.Singh A. (2004), Eastern Book Company, Chapter 1 New Delhi, India

5.Subba Rao G.C.V. (2005), S.Gogia & Company, Hyderabad, India Chapter 1

Websites:

http://www.vakilno1.com/bareacts/indiancontractact/s1.html

http://www.indianrealtylaws.com/faqs/indian-contract-act.aspx

http://www.netlawman.co.in/acts/indian-contract-act.php

30

Lesson-2

OFFER AND ACCEPTANCE

by

Anu Pandey

This Lesson discusses the following aspects of offer and acceptance

2.1 What is an Offer

2.2 Conditions regarding valid Offer

2.3 What is Acceptance

2.4 Conditions regarding valid Acceptance

2.5 Communication of Offer and Acceptance

2.6 Communication of Revocation / Withdrawal

2.7 Termination/Lapse of an offer

2.1 WHAT IS AN OFFER / PROPOSAL?

An agreement consists of two parties where one party makes an offer to the other

party and the other party either accepts the offer or rejects it. If the offer is accepted

then only it becomes an agreement otherwise it doesn’t.

Section 2(a) of the Indian contract act defines an offer / proposal as follows:

“When a person signifies to another person his or her willingness to do or abstain

from doing anything, with a view to obtaining the assent of that other to such act or

abstinence, he or she is said to make a proposal.”

31

Illustration: Savita makes an offer to Priya, she says “Priya would you like to buy

my gold necklace?” Priya rejects the offer thus there is no agreement.

If Priya had accepted the offer to buy the necklace then an agreement

would have been formed.

An offer consists of two parties:

1 Offeror- The person who makes an offer or a proposal

2 Offeree- The person to whom the offer or proposal has been made.

Illustration1: Ram says to Raghu ‘Will you buy my bicycle for Rs 3000?’ In this Ram

is an offeror and Raghu is an offeree.

Illustration2: Zeenat says to Shyama ‘Will you come with me to Goa?’ in this Zeenat

is an offeror and Shyama is an offeree

An Offer consists of two elements:

1 An expression of willingness by the offeror to do or abstain from doing

something. The offeror shows his readiness to the offeree to do something or

not do something.

Illustration1: Pradeep tells Pappu his son ‘ I will take you to Shimla in the summer

holidays’. In this the offeror Pradeep is showing his willingness to take

the offeree Pappu to Shimla for summer holidays.

Illustration2: Pappu tells Pradeep his father ‘ I will never smoke cigarettes’. In this

the offeror pappu is showing his willingness to the offeree Pradeep to

abstain from smoking cigarettes.

32

2 The expression of willingness is made to obtain the assent of the other person

to such act or abstinence. While making the offer to the offeree the offeror

must show his intension to obtain the offeree’s consent to the offer.

Illustration 1: Shyam has a car, which is worth rupees 20 thousand, but he doesn’t

want to sell his car to his neighbour Jhamu. So he makes an offer to

Jhamu ‘Will you buy my car for rupees 50 thousand’. As the car was

not worth rupees 50 thousand so Jhamu did not accept the offer. In this

the offeror did not intend to obtain the offeree’s consent to the offer.

Illustration 2: Nirmal told his father that ‘ I will leave smoking when I no longer have

the urge for need it’. The offer was not acceptable to Nirmal’s father.

2.11 How is an offer made?

An offer can be made in two ways:

1 Express – Offer is made orally or in written.

2 Implied – Offer is made by conduct of the parties or circumstances of the case.

Express Offer can be of two types:

1 Oral Offer - Offer is made by words spoken.

2 Written Offer - Offer is made in writing

Oral offer can be made in person

33

Oral offer can be made through a telephone and

mobile.

Written offer can be made through letters, telegrams

and emails.

Implied offer is not made in words. It is implied from the conduct of the parties or

circumstances of the case. The offeror does not make the offer to the offeree in the

usual mode. That is he/she neither makes an oral offer nor a written offer. The offeror

makes the offer silently by his/her conduct.

Illustration1:

A Metro train in Delhi runs on a particular route.

There is an implied offer from the metro train to

carry passengers on the route who pay the specified

fare.

Illustration2:

A weighing machine kept on the platform of a

railway station in Mumbai is making an implied offer

to the passerby to use the machine by inserting the

necessary coin

34

Illustration3:

A public telephone booth in a market place is making

an implied proposal to the visitors to use the phone

by inserting the necessary coin.

2.12 To whom can offer be made?

An offer can be made to a definite person or to the public at large. In the former case

it is called specific offer and the latter is called general offer.

Specific offer: Offer made to a specific person or a particular person and only this

person can accept the offer.

Illustration: Devendra says to Chaitali ‘will you buy my Laptop for 40 thousand

rupees?’ In this case Devendra has made a specific offer and only

Chaitali can accept the offer.

General Offer: Offer is made to the public in general and anyone in the public can

accept the offer.

Illustration: Gangadhar had his son Pankaj missing from school. He placed an

advertisement in the Hindustan Times, which said, anyone who finds

my son will be rewarded with 5 lakh rupees. This is a case of general

offer wherein anyone who reads the paper and finds Gangadhar’s son

is entitled to the reward.

35

Case Law 1

Carllil vs. Carbolic Smoke Ball Co.14

In this case A Company by the name of Carbolic Smoke Ball Company prepared a

medicine for influenza. The medicine was called ‘The Carbolic Smoke Ball’ and an

advertisement was paced in a newspaper and magazine saying that anyone who

contracted influenza after having used the medicine according to the printed

directions would be offered hundred pounds. A lady Mrs Carllil bought the medicine

and used it according to the printed directions but she was attacked by influenza. She

sued for hundred pounds and won the case. She won the case because the offer made

by the company was a general offer and anyone who read the advertisement could

accept the offer. As the medicine did not fulfill the condition offered by the company

therefore it was bound to compensate Mrs Carlill

Case Law 2

Harbhajan Lal vs. Harcharan Lal15

In this case the son of Harcharan lal ran away from home and the father issued a

pamphlet offering a reward of Rupees five hundred to anybody who would bring his

boy home. Harbhajan Lal saw the boy on railway station and sent a telegram to the

boy’s father. Thus he was entitled for reward because he managed to find the boy.

The offer made by Harcharan lal was a general offer made to the word at large and

anybody who read the offer was capable of accepting it.

14 [(1893) 1 Q.B. 256]

15 (AIR 1924 A11. 539)

36

2.2 CONDITIONS FOR VALID OFFER

There are various rules for valid offer. These rules are mentioned below:

! Offer must give rise to legal relations: The intension of the offeror must be

to create legal relationship with the offeree. An offer, which does not create

legal obligation, does not form a contract. For instance a social invitation even

if accepted will not result in a contract.

Case Law 3

Balfour vs. Balfour16

Illustration: Sati invited Rati on her birthday party and Rati accepted the invitation.

This is not a valid offer because if Rati fails to attend the birthday party sati cannot

take any legal action of breach of contract.

1 Offer must be definite and certain: The terms of an offer must not be

ambiguous and vague.

Case Law 4

Taylor vs. Portington17

In this case the offeror offered to take a house on lease for three years at 285 pounds

per annum if the house was repaired and drawing rooms handsomely decorated

according to the fashion prevailing. The offer does not result into a legal relation

because some terms of offer are quite vague.

16

Ibid lesson 1 Case Law 1 17

[(1985) All E.R. 128]

37

Case Law 5

Gould Vs Gould18

A husband while breaking up his marriage promised his wife to pay her fifteen

pounds a week so long as he can manage. Here again the terms of offer are vague and

discretionary.

Illustration: Shyam tells Geeta ‘Will you buy my laptop for rupees 35,000 or

40,000’. This cannot be a valid offer because the offer is not definite. Shyam has

quoted two prices for laptop rupees 35,000 and 40,000.

2 Offer is different from a mere declaration of intension: A declaration of

intension is a statement made by a person indicating his or her willingness to

make an offer in future.

Case Law 6

Farina vs. Fickus19

A person wrote to his would be son-in-law that his daughter would have a share of

what he left after the death of his wife. The letter is a statement of intension and not

an offer.

Illustration: Shobha a student doing her bachelor degree in commerce met Nirmalya

a Director of a Management Institute and told him that after completing her

graduation degree she would like to join his institute for an MBA degree. Shobha has

just put across her intension to Nirmalya of pursuing a degree course in MBA from

his institute.

3 Offer is different from invitation to offer: When a person proposes certain

terms for negotiation with the other party and thereby invites the other party to

make offer on those terms.

18

[(1970) 1 Q.B. 275] 19

[(1900) 1 Ch 331]

38

Case Law 7

Pharmaceutical Society of Great Britain vs. Boots Cash Chemists20

Goods were displayed in a shop for sale with price tags attached to it. A customer

selected the goods to buy. In this case it was held that the display of goods was just an

intension to offer and the selection of goods was an offer made by the customer to the

cashier to buy the goods selected. The contract was made when the cahier accepted

the offer to buy and received the price.

Illustration: A vegetable vendor sitting at a corner on the street is inviting the

passerby to make an offer to him for buying his vegetables

4 The offer should not contain a term the non-compliance of which would

amount to acceptance: The person who makes an offer cannot say to the

offeree that if he or she does not communicate acceptance by a certain time

the offer will be considered as accepted.

Illustration: Sati who stays in Kerala makes an offer to sell her house in

Cochin to Revati who stays in Madhya Pradesh through a letter. She

mentions in the letter that if Revathi does not reply in two weeks time she

would consider the offer to be accepted. This offer is invalid

5 Offer must be communicated: An offer must be communicated to the offeree

because acceptance by the offeree can be given only after he or she has come

to know of the offer.

Case Law 8

Lalman Shukla vs. Gauri Dutt21

A person sent his servant to trace his missing nephew. After the servant left he

announced that anybody who traced his nephew would be entitled to a reward of

rupees five hundred and one. The servant traced the nephew in ignorance of the

reward. Subsequently when he came to know of the reward, he claimed it. The Court

20

[(1953) 1 Q.B. 40 331] 21

[(1913) ALL. L.J. 389]

39

held that there can be no acceptance unless there is knowledge of the offer and since

the servant did not know about the reward when he found the boy therefore he was

not entitled for the reward.

Illustration: Saraswati made an offer to sell her Mercedes Benz to Shweta through a

letter. She put the letter in an envelope and kept it in the drawer. She forgot posting

the letter. Hence the offer never reached the offeree.

6 A statement of price is not an offer: A statement of price is just information

and not an offer.

Case Law 9

Harvey vs. Facey22

Harvey sent a telegram to Facey which said ‘will you sell us your Bumper hall Pen?

Telegraph lowest cash price.’ To this Facey sent a telegram which said ‘lowest price

for Bumper Hall Pen Nine hundred pound.’ Harvey again sent a telegram to Facie,

which said ‘ We agree to buy Bumper hall Pen for the sum of nine hundred pound

asked by you.’ Held there is no contract because the first telegram sent by Harvey to

Facie had two questions out of which Facie replied to only one question regarding the

price. He did not reply to the other question, which was for his acceptance to sell.

Thus Facie in his telegram only gave information to Harvey regarding the price of the

product he neither made an offer not accepted the offer made by Harvey.

2.3 WHAT IS AN ACCEPTANCE?

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.’ Thus acceptance is the

expression of assent for the offer/ proposal. The proposal when accepted becomes a

promise23

.

22

[(1893) App. Cas 552]

23

According to Sir William Anson ‘Acceptance is to an offer what a lighted match is to a train of

gunpowder. The gunpowder can be withdrawn from the train before the lighted match stick is set to it

likewise an offer can be withdrawn before it is accepted but once the offer is accepted it cannot be

withdrawn or undone because once the offer is accepted it is converted into a binding contract which

cannot be revoked.’

40

2.31 Who can accept?

Only the person to whom the offer has been made has the right to accept. Thus it is

only the offeree who can accept the offer made by the offeror. The person to whom

specific offer is made can only accept the offer on the other hand a general offer made

to the public at large, can be accepted by anyone having knowledge of the offer.

Case Law 10

Boulton vs. Boulton24

A sold his business to B without disclosing this fact to his customers. J a customer of

A was not aware of the sale and in ignorance placed an order for the supply of goods.

B supplied the goods. J refused to pay for the goods and so B sued him. It was held by

the Court that J was not liable since J had made an offer to A and not to B and B knew

very well that the offer is not made to him therefore he was not capable of accepting

the offer.

2.4 CONDITIONS FOR VALID ACCEPTANCE

There are various rules for valid acceptance. These rules are mentioned below:

1 Acceptance must be absolute and unqualified: The offeree should accept

the whole of the offer. Accepting few terms of an offer is not a valid

acceptance. The offeree must accept the offer without putting any conditions.

Conditional acceptance is not a valid acceptance. If acceptance is conditional

it leads to counter-offer which may or may not be accepted by the original

offeror.

Case Law 11

Vishwa Industrial Comp. Pvt. Ltd. vs. Mahanadi Coalfields Ltd & others25

In this case the Court held that an acceptance with a variation or a condition is not an

acceptance but is merely a counter proposal. In order to convert a proposal into a

promise, the acceptance must be absolute and unqualified.

24

[(1957) 157 E.R. 232] 25

(2007) A.I.R. Orissa 171

41

Illustration: Hari offered to sell his car to Ravi for Rs 40,000. Ravi told hari that he

is ready to buy the car for rupees 35000. Ravi’s acceptance is not a valid acceptance

because it is not accepted fully and unconditionally. Instead it is a counter-offer,

which he makes to Hari.

2 Acceptance must be in the mode prescribed or some usual and reasonable

mode: If the offeror prescribes a mode in which the offer has to be accepted

and the offeree uses a different mode of acceptance then the offeror can within

a reasonable time insist that the offer be accepted in the prescribed manner and

not otherwise. If the offeree still does not follow the prescribed mode of

acceptance then in that case the offeror may choose not to be bound by the

acceptance.

Illustration: Aruna sends a letter of offer to Awadh Raj asking him to buy her flat in

Delhi for rupees 20 lakhs. She also mentions that if the proposal is acceptable to him

he can send his acceptance through post. Awadh Raj after receiving the offer sent his

acceptance through an email. Aruna on receiving the email insisted that Awadh Raj

send his acceptance only by post and not any other mode. Awadh raj did not send his

acceptance by post. Hence Aruna was not bound by Awadh raj’s acceptance.

In case the offeree follows a different mode of acceptance from the prescribed

mode and the offeror does not insist then the offeror is deemed to have

accepted the deviated acceptance.

Illustration: Aruna sends a letter of offer to Awadh Raj asking him to buy her flat in

Delhi for rupees 20 lakhs. She also mentions that if the proposal is acceptable to him

he can send his acceptance through post. Awadh Raj after receiving the offer sent his

acceptance through an email. Aruna on receiving the email did not say anything to

Awadh Raj. Hence she was bound by Awadh raj’s acceptance.

When the offeror does not prescribe any specific mode of acceptance then the

offeree has to give the acceptance in some reasonable and usual mode. The

reasonable and usual mode depends upon the circumstances of the situation.

42

Some of the usual modes are by word of mouth, by post, by email, by courier

and by conduct.

Usual mode

POST

EMAIL

MOBILE COURIER

Illustration: Aruna sends a letter of offer to Awadh Raj asking him to buy her flat in

Delhi for rupees 20 lakhs. She does not mention any specific mode for acceptance.

Awadh Raj after receiving the offer sends his acceptance through an email. Hence

Aruna is bound by Awadh raj’s acceptance.

43

Unusual Mode

PIGEON HORSE

Illustration: Aruna sends a letter of offer to Awadh Raj asking him to buy her flat in

Delhi for rupees 20 lakhs. She does not mention any specific mode for acceptance.

Awadh Raj after receiving the offer sends his letter of acceptance through a pigeon.

Aruna is not bound by Awadh Raj’s acceptance because pigeon is not a reasonable

and a usual mode for communication in today’s world.

3 Silence cannot be a mode of acceptance: The offeror cannot impose on the

offeree a condition like: If you do not reply within a reasonable time then I

shall consider the offer to be accepted. The offeror cannot take the offeree’s

silence as acceptance of offer.

Illustration: Nisha a seminar coordinator sends an invitation for the seminar to Ravi

through an email. The email also said that if Ravi does not reply within a weeks time

it will assumed that he has accepted the invitation. Ravi does not reply. Hence Nisha

cannot assume that Ravi has accepted the invitation.

There are few exceptions to the rule that ‘silence does not imply acceptance’

which are as follows:

44

(1) If the offeree takes benefit from the offer, it will amount to acceptance:

Illustration: If Akhil subscribes to Readers Digest for a year and after one year he

does not inform that he would like to discontinue and continues taking the digest.

Hence he is liable to pay for the digests he took after the subscription time expired

because his silence is taken as acceptance for continuing his subscription.

(2) If the offeree due to previous dealings has given the offeror reasons to

believe that his / her silence amounts to acceptance. A leading case on this

point is

Case Law 12

Bharat Petroleum Corp Ltd Vs. Great Eastern Shipping Co. Ltd.26

In a historic judgment recently Supreme Court of India observed that offeree’s silence

in certain circumstances coupled with his / her conduct takes form of positive act

which may constitute acceptance. Therefore, terms of contract between the parties can

be proved not only by their words but also by their conduct.

(3) Performance of all conditions of the offer without communication of

acceptance is considered acceptance of offer.

Illustration: Ramu offers to sell his horse to Ghatak for rupees twenty

thousand and says that if the offer is acceptable to you then please send a

cheque of rupees five thousand in advance. Gahtak sends a cheque of

rupees five thousand. Hence the fulfillment of the condition of sending

cheque is acceptance of offer.

4 Acceptance must be given within the time prescribed or a reasonable

time: Acceptance by the offeree must be given within the period prescribed

by the offeror or if the period is not specified then the acceptance must be

given within a reasonable time.

Illustration: Venkat offers to sell his scooter to Rehman and tells him to reply

within a weeks time. Rehman does not reply within a week hence the offer

lapses.

26

[ (2008) A.I.R. S.C. 357]

45

5 Acceptance cannot precede an offer: An offeree can give acceptance only

after the offer has been communicated to him / her. A leading case on this

point

Case Law 13

Lalman Shukla vs. Gauri Dutt [(1913) ALL. L.J. 389]27

6 Acceptance must be communicated: The offeree must communicate the

acceptance to the offeror only then agreement can take place.

Illustration: Anita sends a letter of offer to sell her lap top to Geetha for

rupees thirty thousand. Geetha writes a letter of acceptance to buy the lap top

but by mistake forgets to post the letter. Hence the agreement has not been

formed.

2.5 COMMUNICATION OF OFFER AND ACCEPTANCE

A contract comes into existence only after the offer has been accepted by the offeree

that is when the acceptance of the offer has been communicated by the offeree to the

offeror. Communication of offer and acceptance is instantly done when the offeror

and the offree are face-to-face. The problem of communication arises when the parties

are separated due to distance. If the parties are at a distance and the offeror makes the

offer through a telephone the contract is concluded as soon as the offror hears the

acceptance from the offeree.

2.51 Communication of Offer

According to Section 4 communication of offer or proposal is complete when it

comes to the knowledge of the offeree that is the person to whom the offer is made. In

27

Ibid Case Law 8

46

case the communication is made by post the communication of offer is complete

when the letter containing the offer reaches the offeree.

Illustration: Neha in Gwalior offers by a letter on 18th

June 2008 to sell her house to

Aparna in Delhi for rupees ten lakh. The letter reaches aparna on 21st June 2008. The

communication of offer is complete on 21st June.

2.52 Communication of Acceptance

Communication of acceptance is complete against the offeror and the offeree in two

stages, which are as follows:

Communication of acceptance is complete against the offeror (proposer) when the

letter of acceptance is put in course of transmission by the offeree (acceptor) to the

offeror so as to be out of the power of the offeree (acceptor) to withdraw it.

Illustration: Aparna after receiving the letter of offer from Neha has readily agreed to

accept the offer to buy the house therefore she writes a letter of acceptance to Neha

and posts the letter on 23rd

June 2008. The communication of acceptance against the

offeror (Neha) is complete on 23rd

June.

Communication of acceptance is complete against the offeree (acceptor) when the

letter of acceptance comes to the knowledge of the offeror.

Illustration: The letter of acceptance posted by Aparna on 23rd

June 2008 reaches

Neha on 26th

June 2008. The communication of acceptance against the offeree

(Aparna) is complete on 26th June 2008.

A leading case on this point is

Case Law 14 and 15

Ram Kishore Singhal Vs. Executive Engineer28

and State Bank of India Vs. Aditya

Finance & Leasing Co. Pvt. Ltd29

28

(1991) ILR Delhi 275 29

(1999) A.I.R. Delhi 18

47

In this case the Court held that a contract comes into existence between parties by

exchange of letters.

2.6 COMMUNICATION OF REVOCATION / WITHDRAWAL

Communication of revocation is complete against the person who makes it and the

person to whom it is made in two different ways, which are as follows:

The person making the revocation: The communication of revocation is complete

against the person making the revocation (withdrawal) when he / she sends the letter

of revocation.

Illustration: Neha after posting the letter of offer feels that she no longer wants to sell

her house to Aparna and decides to withdraw her offer. She writes a letter of

revocation of offer on 19th

June 2008 and posts it to Neha. The communication of

revocation of offer is complete against Neha on 19th

June.

The person to whom the revocation is made: The communication of revocation is

complete against the person to whom the revocation is made when the letter of

revocation comes to his/her knowledge.

Illustration: The letter of revocation sent by Neha reaches Aparna on 20th

June 2008.

The communication of revocation of offer is complete against Aparna on 20th June.

2.61 Time for Revocation / Withdrawal of offer

According to section 5 a proposal / offer can be revoked by the offeror any time

before the communication of acceptance is complete against him / her but not

afterwards. Thus the offer can be withdrawn anytime before the acceptor sends the

acceptance.

In the example given above the communication of acceptance against the offeror

(Neha) is complete on 23rd

June 2008. Therefore if Neha decides to revoke her offer

she can do so before 23 rd

June and not afterwards.

Similarly an acceptance may be revoked anytime by the offeree before the

communication of acceptance is complete against him / her and not afterwards. This

means that acceptance can be revoked anytime before the acceptance comes to the

48

knowledge of the offeror. Therefore the letter of revocation should reach the offeror

before the letter of acceptance.

In the example the communication of acceptance is complete against the offeree

(Aparna) on 26th

June 2008. Therefore if Aparna wants to withdraw / revoke her

acceptance she can do it before 26th

June and not afterwards. Her letter of revocation

should reach Neha before the letter of acceptance.

2.62 Communication of Offer, Acceptance and Revocation on

Telephone

A contract made on telephone is different from a contract made by post. Contract by

telephone has the same effect as an oral agreement. In this a binding contract arises

when the offeror has heard the acceptance. If the offeror has not heard the acceptance

made by the offeree then a binding contract does not arise. In such cases the question

of revocation does not arise because a definite offer has been made and accepted at

the same time.

Case Law 16

Bahgwandas Kedia Vs Girdharilal30

The supreme Court of India in this case has held that in case of offer and acceptance

communicated by telephone, the contract is complete only when the offeror has heard

the offeree make the acceptance to his/her offer.

Illustration1 Ramu called up Shyamu his brother on his mobile and asked him to

accompany him to a tour to Gujarat. Before Shyamu could give his reply the phone

disconnected. Hence there was no contract made.

Illustration2 Ramu called up Shyamu his brother on his mobile and asked him to

accompany him to a tour to Gujarat. Shyamu agreed to accompany Ramu. Thus the

contract was made instantaneously.

30

A.I.R. 1996 S.C. 543

49

2.7 TERMINATION / LAPSE OF AN OFFER

An offer or proposal can either be accepted, rejected, revoked or it might just lapse.

The offer when accepted becomes a valid agreement. If the offeree does not like the

offer he or she may choose to reject the offer. The offeror also has an option to revoke

or withdraw the offer.

Section 6 of the Indian contract act deals with various circumstances in which the

offer lapses, which are as follows:

1 Rejection of offer: The offeree may choose to reject an offer if he or she

does not like the offer. Once the offer is rejected it comes to an end. The offer

once rejected cannot be revived by the offeree. It is only upto the offeror if he

or she wishes to renew the offer.

Illustration: Aradhna makes an offer to Sadhna she say “Will you buy my computer

for rupees twenty thousand?” Sadhna refuses to buy Aradhna’s computer. Thus the

offer is rejected

2 Counter-offer: This means an offer in response to an offer. Once an

offer is made by the offeror to the offeree it is upto the offeree to accept or

reject the offer. Sometimes the offeree neither accepts nor rejects the offer

rather he or she makes his or her own offer to the offeror. By doing this the

first offer which was made by the offeror lapses or comes to an end. If later

the offeree decides to accept the offer he or she cannot do so.

Illustration: Aradhna offers to sell her computer to Sadhna for rupees twenty

thousand. Sadhna makes a counter offer by saying that she is willing to buy the

computer if Aradhna sells it for rupees fifteen thousand. Thus the offer initially made

by Aradhna comes to an end and now it is upto her to accept or reject the counter

offer made by Sadhna.

50

3 Revocation of offer: An offer can be withdrawn anytime by the offeror before

the communication of acceptance of offer is complete against him. He cannot

revoke or withdraw his or her offer once the offeree has sent his or her

acceptance. A general offer must be revoked using the same channel and mode

in which the original offer was made.

Illustration: Aradhna offers to sell her computer to Sadhna for rupees twenty

thousand. But before Sadhna could accept the offer Aradhna decided to withdraw her

offer so she sent a notice of revocation of offer to Sadhna.

4 Offer not accepted in the prescribed mode: If the offeror has prescribed a

mode in which the offeree has to accept the offer and the offeree does not give

his or her acceptance in the prescribed mode then the offer comes to an end.

Illustration: Aradhna makes an offer for selling her computer for rupees twenty

thousand to Sadhna in writing and mentions in the offer that if the offer is acceptable

to her then she should give her acceptance in writing only. Sadhna however conveys

her acceptance through telephone. Thus the offer comes to an end.

5 Failure of the acceptor / offeree to fulfill a condition precedent to

acceptance: Sometimes the offeror may ask the offeree to fulfill certain

conditions before acceptance. If the offeree does not fulfill these conditions

then the offer comes to an end.

Illustration: Aradhna makes an offer of selling her computer to Sadhna for rupees

twenty thousand and mentions in the offer that if the offer is acceptable to Sadhna

then she should send an advance cheque of rupees five thousand. Sadhna does not

send the cheque. Thus the offer comes to an end.

51

6 Death or insanity of the Offeror: If the person who makes the offer dies or

becomes insane after making the offer, and the offeree comes to know of it

before accepting the offer then the offer automatically comes to an end. If the

offeree accepts the offer without the knowledge of the death or insanity of the

offeror then the acceptance is valid and the promise / offer will be executed by

the Offeror’s executor. The act is silent about the effect of death of the offeree.

But if the offeree dies or becomes insane the offer will end because it is only

the offeree who has the right to accept or reject the offer and not the offeree’s

executor.

Illustration 1: Aradhna makes an offer to sell her computer to Sadhna for rupees

twenty thousand but before Sadhna could give her acceptance she comes to know that

Aradhna has turned insane. The offer comes to an end.

Illustration 2: Aradhna makes an offer to sell her computer to Sadhna for rupees

twenty thousand and soon after she dies in a road accident. Sadhna was not aware of

this and sent her acceptance to Aradhna. Here the offer does not lapse and the

executor of Aradhna will have to execute the offer / promise made by Aradhna.

Illustration 3: Aradhna makes an offer to sell her computer to Sadhna for rupees

twenty thousand and before Sadhna could accept the offer she dies. In this case the

offer will come to an end because Sadhna’s executor has not got the right to accept

the offer.

7 Lapse of time: A proposal may come to an end due to lapse of time. In

case the offeror has given duration within which the offeree has to accept the

offer and the offeree does not give the acceptance within the given duration

then the offer will come to an end. In case the offeror has not specified the

duration for acceptance then the offeree can give the acceptance within a

reasonable time and if within the reasonable time the offeree does not give the

acceptance then the offer will come to an end.

52

Illustration 1: Aradhna makes an offer to sell her computer to Sadhna for rupees

twenty thousand and tells her to give her acceptance within a week. Sadhna sends her

acceptance after two weeks. Thus the offer lapses and Sadhna’s acceptance does not

culminate into an agreement.

Illustration 2: Bata Shoes gave an advertisement in the newspaper in the month of

December that they are giving 50% discount on shoes for the New Year. Ram visits a

Bata showroom in the month of March and demands for a discount of 50%. He is not

given the discount. This is so because even though the exact duration of the discount

offer is not given but a reasonable period would be till the month of January or may

be the month of February. March is too late to be within the reasonable period to

avail the New Year discount.

2.8 POINTS TO REMEMBER

Offer / Proposal Sec 2 (a)

A person signifies to another person his or her willingness to do or abstain from doing

anything, with a view to obtaining the assent of that other to such act or abstinence

Parties in an offer

Offeror

Offeree

How an offer is made?

Express Oral

Written

Implied Act or conduct

53

Types of offer

Specific offer Made to a specific person

General offer Made to public at large

Rules for valid offer

Offer must give rise to legal relations

Offer must be definite and certain

Offer is different from a mere declaration of intension

Offer is different from invitation to offer

The offer should not contain a term the non-compliance of which would amount to

acceptance

Offer must be communicated

A statement of price is not an offer

ACCEPTANCE Sec 2 (b)

Acceptance is the expression of assent for the offer/ proposal.

Rules for Valid Acceptance

Acceptance must be absolute and unqualified

Acceptance must be in the mode prescribed or some usual and reasonable mode

Usual mode- post, mobile, courier

Unusual mode- pigeon, horse

Silence cannot be a mode of acceptance

Acceptance must be given within the time prescribed or a reasonable time

Acceptance cannot precede an offer

Acceptance must be communicated

54

Communication of Offer and Acceptance Sec 4

Offer or proposal is complete when it comes to the knowledge of the offeree

Communication of acceptance is complete against the offeror (proposer) when the

letter of acceptance is put in course of transmission by the offeree (acceptor) to the

offeror so as to be out of the power of the offeree (acceptor) to withdraw it.

Communication of acceptance is complete against the offeree (acceptor) when the

letter of acceptance comes to the knowledge of the offeror.

Communication of Revocation / Withdrawal

The communication of revocation is complete against the person making the

revocation (withdrawal) when he / she sends the letter of revocation.

The communication of revocation is complete against the person to whom the

revocation is made when the letter of revocation comes to his/her knowledge.

Time for Revocation / Withdrawal of offer Sec 5

Offer can be withdrawn anytime before the acceptor sends the acceptance.

Acceptance may be revoked anytime by the offeree before the communication of

acceptance is complete against him / her and not afterwards.

Termination / Lapse of an offer

Rejection of offer

Counter-offer

Revocation of offer

Offer not accepted in the prescribed mode

Failure of the acceptor / offeree to fulfill a condition precedent to acceptance

Death or insanity of the Offeror

Lapse of time

55

2.9 QUESTIONS

Match the following

1 Offer a Email

2 Implied Offer b Genaral Offer

3 Express Offer c proposal

4 10% Discount on Watches d Metro train

5 Unusual Mode e Pigeon

Answers: 1c, 2d, 3a, 4b, 5e

Practical Problems

1 Janardan sent a letter to Ghanshyam in which he offered to sell his house for

rupees one crore. He also mentioned that if the offer is acceptable to

Ghanshyam then he could send him a draft of rupees fifty thousand.

Ghanshyam sent a draft of rupees fifty thousand. Is this a valid acceptance?

Ans: Yes, this is a valid acceptance because Ghanshyam fulfilled the

condition of the offer by sending Janardan the draft.

2 Rishita sent a letter of offer to sell her car through a pigeon to sell her car to

Sita. Is this a valid offer?

Ans: No, this is not a valid offer because the mode used in sending the offer is

an unusual mode.

3 Natasha made an offer to sell her car for rupees two lakh and the stereo in it

for rupees five thousand. Hem Chand agreed to buy only the car for rupees

two lakh. Is this a valid acceptance?

Ans: No, this is not a valid acceptance because acceptance must be absolute

and unqualified.

56

4 Sanatan sent a letter of offer to Vikram to join the company on the position of

the company Secretary. Vikram was not well so in his place his twin brother

Aditya went to join the company who was also a qualified company secretary.

Is this a valid acceptance?

Ans: No, this is not a valid acceptance because only the person to whom the

offer has been made can accept offer.

5 Ramesh made an offer to Shyam “I would like to buy your house for a

reasonable price”. Is this a valid offer?

Ans: No, this is not a valid offer because the offer made is quite ambiguous,

vague and not definite. The terms of an offer must be capable of being certain.

Questions:

! What is an offer? How is offer different from declaration of intension?

! What is the difference between offer and invitation to offer?

! What are the conditions for a valid acceptance?

! When is communication of acceptance complete?

! When is revocation of offer and acceptance complete?

4.7 REFERENCES

Singh Avtar (2008): Law of Contract, Eastern Book Company, Lucknow

Kuchhal M.C. (2005): Business Law, Vikas Publishing House PVT LTD, Delhi

4.8 Disclaimer

The photos used at various places in this lesson to the best of my knowledge have

been downloaded from free sites, which I believe do not require any prior permission

for use. The sites are duly acknowledged and listed below. However if any

photograph/picture used in this lesson require permission for use then kindly let me

know. I will gladly do the needful and use the picture only after authorization.

Websites from where pictures have been downloaded

57

http://images.google.co.in/images?hl=en&q=hospital&btnG=Search+Images&gbv=2

http://images.google.co.in/images?hl=en&q=house&btnG=Search+Images&gbv=2

http://images.google.co.in/images?ndsp=20&um=1&hl=en&q=school&start=20&sa=

N

http://images.google.co.in/images?gbv=2&hl=en&q=idiot+pictures&btnG=Search+I

mages

http://images.google.co.in/images?gbv=2&hl=en&q=psycho&btnG=Search+Images

http://images.google.co.in/images?hl=en&q=drunkard+pictures&btnG=Search+Image

s&gbv=2

58

Lesson - 3 CONSIDERATION

by

Preeti Singh

This Lesson will provide an understanding to consideration,

which is one of the basic concepts of a valid contract.

3.1 Definition of consideration

3.2 Essential elements of consideration

3.3 Stranger to consideration and stranger to contract

3.4 Exceptions to the rule of stranger to contract

3.5 Exceptions to the rule- no consideration- no contract

3.1 DEFINITION OF CONSIDERATION

Section 2(d) of the Contract Act defines consideration as “when at the desire of the

promisor, promisee of any other person has done or abstained from doing, does or

abstains from doing, or promise to do or abstain from doing, something, such an act

or abstinence is called consideration.”

Consideration from the above definition is a price paid for the fulfillment of a

promise. It consists of some act or abstinence that has legal recognition. Three

important aspects form a contract. These are offer, acceptance and consideration.

The reason why only contracts with consideration are valid contracts is because when

voluntary promises are made the court believes that voluntary promises are made on

the spur of the moment. They are often impulsive rash decisions made without due

deliberation. The law also does not consider favorably an exchange of promise

without any return to another. Therefore if a person makes an offer to another it is not

binding on him/her if there is no consideration. He/she can revoke the offer because

there was no consideration attached to the offer.

Illustration: Manu promised to give Tina money to study. There was no consideration

attached to it. Manu can revoke the offer as it is not binding in law.

59

Fig 3.1 Essential Elements of a valid consideration

3.2 ESSENTIAL ELEMENTS OF CONSIDERATION

There are five essential elements of consideration.

1. It is an act or abstinence.

2. It is moved at the desire of the promisor.

3. It may move from promisee to another person or persons.

4. It can be past, present or future.

5. There must be some consideration in a contract even though it is inadequate

for the type of contract being made.

6. Consideration must be real and not illusory or impossible.

7. It must be lawful.

Act or

Abstinence

It is moved

by Promisor

It may be

Past, Present

or Future

It may move by

the Promisee or

Another Party

It must have

some value

It must be

lawful

It must be real

and not illusory

or impossible

60

1. Act or abstinence

Consideration is a promise to do something or to abstain from doing something

(according to section 2d).

Lush. J. has defined consideration as the result in a benefit to the promisor and a

detriment or loss to the promisee or a detriment to both.

Case Law

Curie vs Misa31

Consideration may be a promise to do something or not to do

something. It may be positive or negative. It is some right, interest, profit or

benefit accruing to one party corresponding to forbearance suffered or

undertaken by the other.

(i) When we say that consideration is an act it acquires an affirmative tone.

Illustration: Anil promises Dolly that he will guarantee the payment of 15

computers if she sells them to Dev who is his uncle. The selling of computers by

Dolly to Dev is consideration for the promise given by Anil.

(ii) When we say that consideration is abstinence or forbearance it becomes negative

in form because one party agrees to accept less in order to help the other. Thus one

party is able to benefit due to the abstinence of another who refrains from some gain.

Illustration: Sunil promises his friend that he will not file a suit against him if he gives

him 5 cameras and Rs 10,000. Sunil’s abstinence is consideration for his friend’s

articles and money.

Radha Rani Vs Ram Dass32

A wife wanted to sue her husband for a monthly

maintenance allowance. The husband agreed to pay the amount. The wife held back

from the court. Her very act was considered to be abstinence to sue and thus good

consideration.

(iii) A compromise may also be considered to be an act or or abstinence.

31

(1875) LR 10 Ex 153 32

A.I.R (1941) Pat 282

61

Illustration :Malik and company requested its creditors to accept 20% less than the

total amount due by them as they had become bankrupt but had the intention to clear

off debts as far as they could. The creditors agreed to accept the offer. This is good

consideration and a valid contract as a compromise was made and agreed by all of

the parties.

2. It is moved at the desire of the promisor.

The promisor must move the request for consideration. If it is moved at the desire of a

third person it will not form good consideration even if promisor desired it. Therefore

the promisor must first give consideration

Case Law

Durga Prasad Vs Baldeo33

On the order of the collector of a town built some shops

on his own expense in a market. The shopkeepers who occupied these shops promised

to pay to D commission on their sales. D sued the shopkeepers when he did not

receive the commission. The court held that the promise was not supported by any

consideration as the shops were built on the collectors order and not at the request of

the shopkeepers. Therefore there could not be a recovery.

Illustration1: Seema jumped in the unused dry well before her house. Meena jumped

too and was able to draw Seema out of the well. Meena cannot demand any payment

from Seema as she was not asked by her to save her life. She jumped on her own

without the promisor even requesting her to do so.

Illustration2: Leena has a small boutique in Tilak Nagar market. A fire broke out in

the market and some people got trapped. A person went into her boutique and saved

people. Can that person demand money for the services rendered as 5 people were

saved and many bales of cloth were removed to a safe area.No payment can be

demanded but as a courtesy Leena may give some reward if she so wishes to do. She

cannot be compelled as consideration was not moved by the promisor.

3. It may move by the promisee or another person

When a promisor gives a promise, the promisee or any other person may provide a

valid consideration in return.

33

(1880) 3 All 221 D

62

Case Law

Chinnaya vs Ramaya34

An old lady, made an agreement with her daughter that she

would gift her some landed property but the condition was that the daughter would

pay her sister some annual payment regularly as maintenance allowance. The

daughter promised her aunt (mother’s sister), the maintenance money. However, later

on she did not pay the money to her aunt. The aunt filed a case for recovery of the

amount. The decision was in a perfectly genuine consideration. The promisee had

agreed to carry out the instructions of the promisor in return for receiving land.

Under the English Law consideration must move from the promisee. This is supported

by the case Tweddle vs Atkinson (1861) I B&S 392. The Indian Law states that

consideration may move from the promisee or any other person. It may even move

through a stranger. However the stranger to the contract can only sue if he/she is party

to the contract. This means that it is important to have some valid consideration to an

agreement to make it a valid contract. (http://books.google.com/books?id=LtbM-

PHDZooC&pg=PA46&lpg=PA46&dq=chinnaya+vs+ramaya+(1882)&source=web&

ots=yioamNoR9K&sig=nMbzt_H0g5E17f6GuTe-

DYlGQqI&hl=en&sa=X&oi=book_result&resnum=3&ct=result )

Illustration: Juhi gives jewellery worth Rs.50,00,000 to her daugher-in-law Rani and

in return asks Rani to give her daughter Rs 2,00,000 when she inaugurates her new

house. Rani promises her mother-in-law to give the amount as consideration for the

gift that she receives. On the date of the inauguration Rani does not keep her promise.

Juhis daughter goes to court. Can she get relief?

Since the promisee had promised the money as consideration for the gift received she

can get relief. Consideration had moved from the promisee. It is a valid agreement.

A person who does not provide consideration in an agreement is a stranger to the

agreement. A stranger gets rights in the contract if he/she becomes a party to the

contract.

34

(1882)4 Mad 137

63

4. Consideration can be past, present or future.

On of the important elements of consideration is that it can be past, present or future.

Past consideration: When consideration is provided before a person becomes a

promisor.it is called past consideration. Such a situation can arise when a person has

done some work that is desired by another but is compensated later on. He does not

receive the benefit immediately. English Law does not consider past consideration to

be good. However it accepts time barred debts as good past consideration.

Illustration: Sonam goes to a friend’s house. She suddenly

has a severe stomachache. A doctor in the neighbourhood

examined her and administered some medicine. At that

time there was no talk of compensation for services of the

doctor. Later Sonam went to the doctor’s clinic expressed

her thanks to him and also gave him Rs 500 as his fees for his services. This is past

consideration. The doctor received the fees for services that were rendered by him

earlier.

Present consideration: When an agreement is made and consideration is paid for it or

a promise is made for that work at the time of making the contract it is called present

consideration. This situation arises when the promisor makes an offer and it is

immediately accepted with consideration at that particular time. This is also called

executed consideration.

Illustration Reena offers to sell her old computer to

her friend Anjali if she pays Rs 7500 for her old

computer at the time that she accepts the offer. Anjali

brings the money immediately and pays Reena the full

money. Now Reena should deliver her computer.

Acceptance of the offer and consideration are both in

the present.

Figure 3.2

Figure 3.1

64

Future Consideration: When promise is to be executed on a future date it is called

executory consideration or future consideration. In this the promisor makes an offer

for a future date and the promisee promises to accept and execute the contract after

that it is future consideration. In this manner both parties move the consideration to a

future date. The liability becomes outstanding on both parties on a future date.

Illustration: Ruhi promises to sell and deliver a new

wristwatch to Rekha after a week. Rekha accepts the offer

and promises to pay after one month of receiving the

watch. This is executory or future consideration.

5. Consideration need not be adequate.

Consideration means something in return. This may not be equal to the value of of the

promise that is given. As long as there is some consideration courts support it and are

not concerned about its adequacy. The parties to the agreement should have been

satisfied with the consideration when they made the contract. The consideration may

not be adequate but it should be lawful. The English Law of contract states that

consideration should be of some value in the eyes of the law. The court does not take

the responsibility of repairing any bad bargains made between parties. If the contract

was agreed upon between people the court will not interfere in the agreement.

However it will ascertain that the consideration was given freely with the consent of

the other person without any duress.

Illustration: Madhu sold her old car to Meera for

Rs 25000. The value of the car was Rs 2,00,000. The

consideration was lawful and with the free consent

of Madhu who knew that the market value was much

higher. Therefore it was a valid agreement even

though consideration was not adequate

65

6. Consideration must be real and not illusory or impossible.

Real consideration means that the consideration should not be physically or legally

impossible.

Consideration is not real in the following cases because of physical and legal

impossibility or uncertainty

Physical impossibility: If a promise is made to do impossible things that are not

possible to do physically, it is not real.

Illustration: An agreement is made with a dead man to buy a house. There is physical

impossibility in the promise.

Legal impossibility: A promise made to another party should be legally possible.

Illustration: Manu asked Anil to steal money from the industrialist’s house for which

they would share the money, the major amount would go to Anil for taking the risk.

This is an impossible promise and legally impossible consideration.

Uncertain consideration: Consideration has to be certain otherwise it is impossible to

carry out an agreement.

Illustration: A dentist says he will charge a reasonable sum

for his services is uncertain consideration and difficult to

carry out because of uncertainty

Consideration involving pre-existing duty: The court does not recognize an existing

duty carried on to the new contract as good consideration. Consideration should be a

new obligation. It should be something more than a person is already required to do.

Moreover a promise to pay for doing a public duty to a government employee is not

good consideration.

Illustration: The pilot of a plane had to land in Jaipur

because of technical problems. The pilot asked for

money from the passengers to bring the plane back

safely to Delhi which was its actual landing

destination. This was not a valid consideration as the

66

pilot had to come back to Delhi safely as part of his duty. A higher consideration was

not required for doing his duty.

7. Consideration must be lawful.

Consideration should be lawful otherwise the agreement becomes void.

According to section 23 considerations is not lawful in the following situations:

1 When it is fraudulent

2 When it is made of an act forbidden by law.

3 When it causes injury to a person or property of another

person.

4 When it is declared as immoral or opposed to public

policy.

When a part of the agreement is unlawful the whole agreement will become void

except in those cases when the unlawful part can be separated from the lawful one.

Then the unlawful part will become void and the other part can be carried out.

3.3 STRANGER TO CONSIDERATION AND STRANGER TO CONTRACT

Under the English Law, consideration has to move from the promisee and if any other

person moves it, the promisee becomes a stranger to consideration and cannot

enforce the promise.

A person becomes a stranger to a contract when he is not a party to a contract even

though it is made for his benefit. He is a stranger to the contract and cannot claim any

rights under it.

Stranger to consideration and stranger to contract are called Privity of consideration

and Privity of contract. In India Privity of consideration is not applicable because

Section 2(d) has the provision that provides that the promisee or any other person can

move a contract. Accordingly in India a stranger to consideration can sue and enforce

an agreement if he is a party to the contract35

.

Privity of contract is applicable in India also. According to this principle, only the

parties to a contract can sue or be sued in a contract. Third parties/ strangers do not

35

Ibid Chinnaya vs Ramayya (1882) 4 Mad 137

67

have any rights or obligations to a contract. They are not even permitted to sue in a

court even if the contract is for their benefit. Principle of privity was supported by the

decisions in the following case laws:

Case Law1

Subramaniam Iyer vs Lakshmi Amol 36

A borrowed Rs 40000 from B as security for a

loan and he executed a mortgage of his property in his favour. Later, he sold the

property to a third person C. for Rs 44000. A retained Rs 4000 and permitted to C to

retain Rs 40,000 to settle with B. Later C refused to pay B. B wanted to sue C for

recovery of the money taken by A.Due to privity of contract B cannot claim the

amount from C as he is stranger to the contract

Case Law2

Dunlop Pneumatic Tyre company vs Selfridge and company37

In this case the tyre

manufacturer Dunlop Pneumatic company sold tyres to Selfridge and Company. They

further sold the tyres to their sub dealer with a promise that they should not sell lower

than the price offered by Dunlop. If they did they would have to pay damages of £5

per transaction to Dunlop. The sub dealer undersold two tyres. Dunlop sued him for

breach. Dunlop cannot sue as it is a stranger to the contract.

However since 1969 under the Monopolies and Restrictive Trade Practices Act To

explain, let us give an example with an illustration.

Illustration: Leela sold an Apple Mac computer to Mona who asked her to take the

money from Amulya. Mona instructed Amulya to give the money she owed to her to

Leela for the computer that she has purchased. Amulya did not pay the amount to

Leela. Can Leela get relief from the court? Leela cannot sue for recovery because she

is stranger to the contract.

However since 1969 under the Monopolies and Restrictive Trade Practices Act the

ruling in the Dunlop case does not hold good. According to the ruling in the court a

36

(1973)2 SCC 54 37 915 AC 847

68

retailer obtaining goods from a wholesaler with restrictions on conditions on sale of

goods by original supplier has to be bound by the conditions even though the

conditions were between the wholesaler and the supplier and the retailer was not a

party to it.

3.4 EXCEPTIONS TO THE RULE OF STRANGER TO CONTRACT

There are certain exceptions to the rule that a stranger cannot sue. In the following

cases the court does not prevent a stranger from enforcing a contract that is made for

his benefit but he is not a party to it.

a) Trust or a charge: In the case of a trust or a charge created in favour of

another person the beneficiary can enforce the rights conferred upon him

by the trust even though he is not a party to the contract between the settler

and the trustee.

Case Law

Rana Uma Nath Baksh Singh Vs Jang Bahadur38

A father had appointed his son as

successor for his entire possession provided he gave part of it to his illegitimate son

as consideration. The son agreed but later refused to part with it. The illegitimate son

can claim a part of the estate, which was made in his favour.

Illustration: Sunita made a trust for the benefit of her son Sushant and appointed

Raja, Mahesh and Arjun to be the trustees. Sushant was not being given the property

by the trustees. Can he claim all the propertyin his favour?He can claim that was

given in his favour even though he was not a party to the benefits created for him by

his mother.

b) Marriage settlement partition or other family issues: When an agreement

is made relating to marriage, partition or any other family issues with some

provision for the benefit of any person, the beneficiary can enforce the

agreement. This is possible even though he is not a party to the agreement.

An illustration is given to explain this point.

38

AIR 1938 PC245

69

Illustsration: Raja promised Mahesh that he would

give a house to his daughter Naina after marriage to

his son Rohit. After the marriage Raja forgot his

promise. Can Naina enforce the promise? This is a

family arrangement and so Naina has the right to get

the house and she can enforce the promise in the

court of law.

Case Law

Khwaja Muhammead Khan vs Hussaini Begam39

Two parents had made an

agreement for their minor children. One had promised to give his daughter- in- law,

expenses for running a house and marked some of is deposits in favour of the young

lady. She was later allowed to recover the amount even though she was a stranger to

the contract because it was considered as a family matter.

Case Law

Commissioner of Wealth Tax vs Vijayaba40

A mother agreed o pay to her younger son

if the elder son failed to give the younger son’s share the amount that became short of

the share the father had left to the elder son in order to buy peace in the family. This

was a family arrangement and the younger son was entitled to his share even though

he was a stranger to the contract

c) Acknowledgement of payment or estoppel: This is an agreement between

two parties that one of them would give a benefit to a third person. If the

promiser expresses or implies by words or actions and acknowledges that

he has a liability towards a third person it is sufficient for the third person

to recover the benefit as his right.

Illustration: Anu is the subtenant of Prem but she pays the rent directly to Anil. Anu

stops paying the rent. Anil has the right to recover the amount from Anu as this is an

exception to the law of privity of contract.

39

1910 37 IA 152 40

A.I.R. (1979) S.C.982

70

Contract through agents: The principal can enforce Contracts that are entered into by

agents on behalf of him if the agent has acted within the scope of his duty and in the

name of the principal. The rights of the principal are intact even though he is not party

to the contract.

Illustration. Mr. Jaiswal sold television sets on behalf of L.G. company. He sold 35

television sets to Reena and she did not pay the money. L.G. company went to court

because they could enforce their rights as Jaiswal had acted as an agent of L.G. even

though the company was not directly involved in the contract.

Agreements relating to land: When a person purchases land and he knows that

certain rights and obligations bind the seller, the buyer has to honour the

commitments of any covenants by which the seller is bound. The rule of privity of

contract does not apply in this case. The buyer may not be a party to the contract but

he is bound by the principles relating to immovable property.

Case Law

Smith and Snipe Hall Farm Ltd vs River Douglas Catchment Board41

A board agreed

with landowners near the stream to improve the banks of streams and maintain them

in good condition. Landowners paid proportionate costs for maintenance.

Subsequently landowner sold the land to someone who further sold it to another

person. Due to negligence of the board the banks of the stream broke and the land got

flooded. The subsequent owners filed a suit against the board for negligence. Though

they were not party to the contract they were entitled to sue because they were bound

by the original owners agreement with the board.

Illustration Reema sold an apartment to Jeena and explained to her that she had an

agreement with the developers of the land to pay a maintenance charge of Rs 25000/-

for regular water and electricity backup. After Jeena bought the apartment, the

developer did not give the requisite backup provision. Jeena went to court to get the

rights enforced even though he was a stranger to contract.

41

(1949) 2 K.B,-500

71

3.5 “AN AGREEMENT WITHOUT CONSIDERATION IS VOID’-

EXCEPTIONS TO THE RULE

The general rule is “no consideration no contract” or “an agreement without

consideration is void” but there are exceptions to the rule. According to section 25, in

the following cases the rule does not apply

(a) Natural love and affection: A written and registered contract without

consideration, based on natural love and affection by two parties related to

each other is a valid contract. [section 25(1)]

Note: Closeness of relationship need not necessary mean love and affection.

Case Law

Rajlukhy Vs Bhootnath 42

A husband agreed to pay a fixed sum and maintenance to

his wife for living in a separate residence due to frequent quarrels between them. He

registered the written document. Since he did not pay the amount the wife went to

court .She was unable to get any relief because the agreement was not made with

natural love and affection.

Illustration: Naina promised Maina that she would give her Rs 5000 to buy books

for her research work. The promise was made of natural love and affection .It was in

writing and registered.

This is an enforceable contract even though there is no consideration.

• Voluntary compensation: A promise to compensate a person wholly

or partly for services done voluntarily, or for doing voluntary services

that are legally compellable is a valid contract even without

consideration.[Section 25 (2)]

Illustration: A thief snatched Leela’s gold chain. Meera, an onlooker, rushed to

help,retrieved the chain and gave it back to Leela. On receiving the chain Leela gave

Meera Rs 2000/-. This is a valid contract even without consideration.

42

(1900) 4 Cal WN 408,

72

Time barred debt: A written and registered document by the debtor signing himself or

his agent with a promise to pay a time barred debt, is a valid contract and does not

require any fresh consideration. [Section 25(3)]43

The intention should be clearly

expressed. It may be the full amount or part of the amount of the debt that is to be

returned.

Note: An oral promise is not acceptable.

Illustration: Sita took a loan of Rs 5000 from Geeta. She could not pay in time and it

became time barred under the Limitation Act. She made a signed and written promise

to Gita that she would return Rs 3000 on account of the debt. This is a valid contract.

No new consideration is required.

Agency: No Consideration is required to create an agency between the principal

and agent according to section 185. If a person volunteers to work on behalf of

another person as his agent without any remuneration, a relationship of agency

will be created even if there is no consideration. The agent can work on behalf of

the principal and bind the principal on any contracts that are taken by the agent on

his behalf.

Note: Before the execution of the agreement the contract will be void since there

is no consideration.

Completed gift: No consideration is required between the donor and the donee of

any gifts already made. The person who receives the gift becomes its owner. a gift

or a donation already given cannot be undone on the grounds that there was no

consideration. There is no need for natural love and affection between the parties

but there should not be any prior agreement to give a gift.

Note A promise to give a gift, on a future date is void if it does not have any

consideration.

Illustration: Vibha has gifted a watch to Nirmalya on his birthday. This is a valid

contract even though there is no consideration.

43

Time barred debt is a period of 3 years according to law.

73

Remission of a promise: A promise by the promisee to the promisor to give a

concession (section 63) in the performance of his obligations is called remission.

This remission of a promise can be without consideration. This is discussed in

detail in the chapter on ‘Discharge of Contract’.

Points to remember

Three important aspects form a contract.

These are Offer, Acceptance & Consideration.

Legal rules regarding consideration

• Consideration must move at the desire of the promisor.

• Consideration may move at the desire of the promisee or any other

person.

• There are different kinds of consideration. They may be past present or

future.

• Consideration need not be adequate. Contracts are enforceable when

there is some consideration. It may not necessarily be equal to the

value of the contract.

• Consideration must be real and not illusory. Consideration is not real

due to physical impossibility, legal impossibility, uncertainty in

consideration and consideration consisting of a pre existing duty or

obligation.

• Consideration must be lawful

• Consideration may be either positive or negative.

Exceptions to consideration

Contracts without consideration are void except in the following cases:

(a) If they are based on natural love and affection.

(b) When compensation is voluntary.

(c) In the case of a time barred debt.

(d) When there is a contract of agency.

(e) In case of completed gift.

Stranger to contract is called Privity of contract.

! There are exceptions to privity of contract.

74

! Contracts can be enforced by strangers in the following cases.

! When a trust or charge is created in favour of another.

! When there is a marriage or family settlement.

! By the principle of acknowledgement of payment or estoppe.

! When a contract through agents is involved.

! When agreements are made for land deals.

Stranger to consideration is called Privity of consideration.

(a) In India, a stranger to consideration can sue and enforce an agreement if he is

a party to the contract.

(b) Third parties/ strangers do not have any rights or obligations to a contract.

Only the parties to a contract can sue or be sued in a contract.

Objective type questions

State whether the following are True or False

• A valid contract must have adequate consideration.

• A person can be stranger to consideration but not stranger to contract.

• A consideration may be past present or future.

• The principal requires consideration to enforce his rights on the

actions of his agent.

• Consideration must be furnished at the desire of the promisor.

• Past consideration is good consideration.

• Agreements without consideration are void.

• A stranger to consideration can always sue.

• A marriage settlement must have adequate consideration for enforcing

the contract.

• A complete gift does not require consideration

Answers. 1.F; 2.F 3.T; 4.F; 5.T; 6.T, 7.T, 8.F 9. F. 10.T;

Questions

• Define consideration; discuss the essential elements regarding

consideration.

• Consideration may be past present or future. Explain with examples.

75

• Examine the statement Consideration may move from the promisee or

any other person.

• Under what circumstances can a stranger to a contract enforce a

contract?

• Comment on the statement “A contract without consideration is void”.

• A stranger to a contract cannot enforce the contract. Discuss the

exceptions to the rule.

• Explain the following statements:

• (i)A stranger to a contract cannot enforce it (ii) Past consideration is

no consideration (iii) Adequacy of consideration is not a legal

requirement.(iv) gratuitous promises are not enforceable bylaw (v) An

agreement made without consideration is void.

Practical Problems

1 Mohinder took money from his brother to furnish his house. There was no talk

between them for returning the money. After one year Mohinder began to

work and started getting a good salary and wanted to return the money. Is he

liable?

Answer: Mohinder is liable because this agreement is based on past

consideration. The brother gave money because it was at the desire of

Mohinder.

2 Rani promised to donate Rs 1,50,000 to her school to buy computers. The

school purchased the computers and incurred an expenditure of Rs.90,000.

Can the school recover the amount from Rani if she doesn’t pay?

Answer: The school can recover the amount because the computers were

purchased in good faith on the promise given by Rani

3 Madhu was swimming and started shrieking because she was drowning in the

water. Her mother called out to the fishermen around to save her daughter’s

life. She promised Rs 5000. Although it was not the fisherman’s duty, he

dived in the water and brought the girl out safely. Madhu’s mother refused to

pay because she said that she had promised on the spur of the moment and did

not mean it. Is she liable to pay?

76

Answer: The mother is liable because she had made a promise and on the faith

of it the fisherman had dived in. It was not his duty to do so. At the risk of his

life he went to save Madhu.

4 Leela promised to sell her apartment in Gurgaon for Rs. 15,00,000 because

she was migrating to Malaysia and needed the money quickly. Meena quickly

agreed to buy this apartment because it fitted in her budget and the market rate

was 80,00,000. On the due date, Leela changed her programme and refused to

sell the apartment at the agreed price. Meena decided to go to court to enforce

the agreement. Will she be able to get the apartment?

Answer: Meena has the right to the apartment because there is consideration in

the agreement even though it is inadequate. Leela has to sell the apartment at

the agreed price.

5 Raj Kumar and his daughter Kiran makes an agreement with Mahipal that

after she completes her MBA she would marry his son Manu. Later she

refused to marry him. Can Manu claim damages from Kiran?

Answer: Manu can claim damages because though he is a stranger to the

contract, the contract was made for his benefit and so the exception to

consideration is there.

6 Ramesh gives a loan to Pushpender of Rs 50,000. The debt does not get paid

and it gets barred with the Limitation Act. Pushpender makes a written

promise to pay Rs. 30,000 on account of his debt. Can Ramesh claim it?

Answer: Ramesh can claim the amount from Pushpender.

7 Srimala had a fall. Her friend Sridhar, an orthopedic doctor, rushed to her

help. Sridhar did not charge anything but later Srimala promised to give Rs

20,000 to Shankha the son of Sridhar to travel abroad. However Srimala could

not keep her promise. Shankha decided to recover the money by going to

court. Can he claim the money?

Answer: Sridhar does not have any claim to the money for past voluntary

services of his father, as he is not part of the agreement and he has not

participated in any activity to claim this amount.

77

8 Robin wanted to rent his house to a bank in return for a monthly rent.

However he wanted to keep two rooms of the premises for his personal use.

He also wanted his nameplate on the main gate to remain fixed without any

change. The bank agreed to all the terms and conditions. Robin later changed

his mind and did not want to rent the premises. Can the bank enforce the

agreement?

Answer: Consideration is present in this agreement. Hence the bank can

enforce it.

References:

Books

(1) Aggarwal S.K. and.Singhal K (2007) Business and Industrial Laws, Chapter

5 Galgotia Publications, New Delhi,India

(2) Bansal G.L. (2006) Business and Corporate Laws, Chapter 3, Excel Books,

New Delhi, India

(3) Pathak H.S. (1989) Mulla on The Indian Contract Act Pages 7-15

11th

edition Lexis Nexis Butterworth, New Delhi

Websites:

1. http://en.wikipedia.org/wiki/Consideration

2. http://books.google.com/books?id=LtbM-

PHDZooC&pg=PA46&lpg=PA46&dq=chinnaya+vs+ramaya+(1882)&source=web&

ots=yioamNoR9K&sig=nMbzt_H0g5E17f6GuTe-

DYlGQqI&hl=en&sa=X&oi=book_result&resnum=3&ct=result

78

Lesson - 4

CAPACITY OF PARTIES

by

Anu Pandey

This Lesson discusses the following aspects of capacity of parties

4.1 Who is competent to contract?

4.2 Who is a minor?

4.2.1 What is the Position of agreements with a Minor?

4.3 Who is of unsound mind?

4.4 Whom does law disqualify?

In India people can make agreements with their friends, neighbors, colleagues but not

all agreements can be termed as contract. An agreement becomes a contract only

when it fulfills the requirements. One of the very important requirements is

competency to contract.

4.1 WHO IS COMPETENT TO CONTRACT?

Section 11 of the Indian contract Act provides that a person is competent to contract

if:

1 He or she is of the age of majority according to the law he or she is subject to

2 He or she is of sound mind

3 He or she is not disqualified by the law he or she is subject to.

Thus in order to enter into a valid contract one has to have all the three requirements

and if any of these requirements is not fulfilled then he or she is incapable to enter

into a valid contract, a contract to be recognized and enforceable by law.

79

We can now reverse the question and ask-

‘Who is not competent to contract?’

The people who are not competent to contract are:

(a) Minor

(b) Person with unsound mind

(c) Person disqualified by law

4.2 WHO IS A MINOR?

Section 11 of the Indian Contract Act provides that to be competent to contract a

person should be a major. However, section 11 does not say that a minor’s contract is

void. To put it in other words section 11 of the Indian Contract Act is silent about the

legality of minor’s contract. Privy Council in Mohiri Bibi vs. Dharamdas Ghose

clarified this position for the first time44

Case Law 1

In the above-mentioned case the plaintiff was a minor. He borrowed Rs. 8,000 and

executed a mortgage for Rs. 20,000 in favour of the defendant who was aware of the

plaintiff’s minority. The plaintiff filed a suit to set aside the mortgage45

. So the

minor’s mortgage was set aside. The defendant contended that the Court while setting

aside the mortgage, should direct the minor to make compensation by refunding the

amount, which he had received. The defendant further contended that the minor’s

contract was voidable and became void when the minor avoided it. The Privy Council

rejected this agreement and held that the minor’s contract was ab initio void. There

was no question of avoiding it or ratifying it. It needed no avoidance and cured by no

ratification. Thus it was already laid down by the Privy Council that a minor’s

contract was void ab initio.

44

(1903), I.L.R. 30 Cal 539 (PC) 45

A mortgage is a transfer of property and to execute a transfer the law requires that a

person should have contractual capacity.

80

Under section 3 of the Indian Majority Act 1875 a person in India is a minor if` he or

she has not attained the age of 18. However there are two situations where a person

attains age of majority at the age of 21.

The two situations are as follows:

• A minor whose person or property or both a guardian has been

appointed under the Guardians and Wards Act, 1890. If a minor hasn’t

got a parent then in such a case a local guardian is appointed to look

after the minor as well as his/her property till he/she attains the age of

21.

Illustration: Shivani a four-month-old girl (minor) lost her parents in an air

crash. Her parents left behind property and bank balance which was all now hers.

As Shivani was a minor so an aunty of hers was appointed as her guardian who

was to look after Shivani and undertake all transactions related to her property

and bank balance until Shivani attained the age of 21 (major)

• A minor whose property is under the superintendence of any Court of

wards. If a minor has not got parents or any guardian to look after

him/her then in such a case he/she is put under the guardianship of the

Court. The Court becomes the custodian of his/her property till he/she

attains the age of 21.

Illustration: Shivani a four-month-old girl (minor) lost her parents in an air

crash. Her parents left behind property and bank balance which was all now hers.

Shivani did not have any relative who could be appointed as her guardian

therefore her guardianship and the responsibility of her property and bank

balance was entrusted to the Court of wards till she attained the age of 21

(major).

81

4.2.1 WHAT IS THE POSITION OF AGREEMENTS WITH A MINOR?

The law is quite protective towards the minors. The position of agreements with a

minor are given below:

1 Void Agreement Agreement with a minor is void. An agreement with a

minor is not enforceable by law from the very beginning.

An agreement between two people who are both minors is void.

Both the parties cannot enforce the agreement in the Court of law.

Illustration: Geeta and Priyanka were classmates and Geeta did not have money to

buy her geography textbook so she borrowed rupees two hundred from Priyanka and

promised to return it in a week. After a week when Priyanka asked for her money

Geeta refused to return it. In this case Priyanka cannot sue Geeta for the breach of

contract because the agreement they had between them cannot be enforced in the

Court of law.

An agreement between two people of which one is a major and the other is a minor

is void

In such cases the minor can be a beneficiary or a promisee. The minor can enforce

the contract and if the minor has benefited from the other party then he or she may be

asked to restore (restitute) the benefits he/she has obtained from such agreement to the

other party. However restitution is allowed only if the money or property (benefit)

could be traced. For instance if the minor has borrowed money from a major and used

it all then he/she cannot be asked to restore it.

82

Illustration1: Ram a seven-year-old boy asked Raghuvansham a cricket coach to give

him coaching classes and Raghuvansham agreed to give coaching. Ram paid in

advance the tuition fee. Raghuvansham gave coaching only for a day and then

discontinued on the pretext that the agreement is void. Ram could enforce the

agreement though void for breach of contract. In this case Ram a minor was a

beneficiary / promissee and therefore had a right to enforce the agreement in the

Court of law

Illustration2: Ram a seven-year-old boy asked Raghuvansham a cricket coach to give

him coaching classes and told him that his father will pay him the coaching fee after a

week. The coach agreed and started coaching Ram. After a week passed neither Ram

nor his father paid the coach. The coach could not enforce the agreement, as it was

void.

Illustration3: Sukrita a sixteen-year-old girl posed as a nineteen-year-old borrowed

rupees 500 from an old lady called Vibha for buying a party dress. The dress cost

Sukrita rupees 490. On asking for her money Sukrita refused to pay Vibha. This is a

void agreement therefore Sukrita cannot enforce this agreement but she can ask for

restitution. As Sukrita was left with only rupees 10 therefore she could be asked to

restore only rupees 10 to Vibha.

2 Partnership / company Minor cannot enter into a partnership46

agreement therefore he / she cannot be made a partner but he / she can be

admitted to the benefits of partnership with the consent of all the partners.

Similarly a minor cannot become a shareholder in a company47

, as he is

incompetent to enter into a contract. In case a minor inherits shares (fully

paid) then he can become a shareholder acting through a lawful guardian.

Here again a minor enjoys only the benefits of shareholding. He cannot be

made liable for payment of call money.

46

According to Indian Partnership Act, 1932 partnership is the relation between

persons who have agreed to share the profits of a business carried on by all or any of

them acting for all. 47

A company is an incorporated association, which is an artificial person created by

law, having a separate entity, with a perpetual succession and a common seal.

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Illustration: Devendra run a business with four partners. Devendra died in a road

accident. A fifteen-year-old son Gajendra survived him. As Gajendra was a minor so

he could not be made a partner in place of his father but with the consent of all the

partners he was admitted to the benefits of the partnership firm. He was entitled to all

the benefits, which accrued to the firm but was not liable for any losses.

3 Ratification Ratification means approval or confirmation. If a minor has

entered into an agreement he or she cannot ratify the same agreement after

attaining the age of majority. It is because an agreement entered into by a

minor is void and a void agreement cannot be made valid after minor has

attained the age of majority. If he or she wishes to continue then they will

have to make a fresh agreement with a fresh consideration.

Illustration: Gajendra a fifteen-year-old boy was admitted into the benefits of

partnership after his father died. After attaining majority Gajendra cannot ratify the

same agreement or continue with the agreement, which he had entered before

attaining majority. If Gajendra still wants to continue enjoying the benefits of

partnership then he will have to make a fresh agreement.

Case law 2

Mohendra vs. Kailash48

In this case it was held by the Court that a minor’s agreement being a nullity

and void ab-initio has no existence in the eye of law. The minor on attaining

the age of majority, cannot ratify it, because an agreement void ab-initio

cannot be made valid by subsequent ratification.

4 Agency Minor can be appointed as an agent. He is not liable for any of

his / her acts rather it is the principal who would be held responsible to the

third party for the acts of the minor49

48

(1927) 555 Cal 841 49

See lesson 14 for more details on Agency

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Illustration: Sylvia a six-year-old girl went with a piece of cloth to the tailor and

asked him to stitch a blouse for her mother. The tailor stitched the blouse but Sylvia’s

mother refused to pay the money on the pretext that the agreement was void. This was

not a void agreement but a contract of agency where the tailor could enforce the

agreement and Sylvia’s mother who was the principal would be liable to pay.

5 Negotiable Instrument Minor can draw a negotiable instrument and can

enforce instrument drawn in favour of him/her. He/she cannot be made

personally liable thus a minor can be a promisee or a payee and he /she can

also become indorsee by transfer of negotiable instruments.50

lllustration: Shyam is a sixteen-year-old boy who has been hired by Krishna to clean

his cars every day in the morning. Krishna pays Shyam by drawing a cheque in his

name for rupees 1000. Shyam deposits the cheque in his bank and the bank dishonors

the cheque. Shyam can sue Krishna for dishonoring of the cheque and demand a fresh

one with compensation.

6 Necessaries The Person who has supplied necessaries to a minor or to

his/her dependents is entitled to be reimbursed from the property of the minor.

According to section 68 the term necessaries include goods and services,

which are required to maintain a person in a condition, state and a station in

life in which he/she is. Station in life means the standard of living the person

has. Necessaries include food, clothing, shelter, education and marriage of a

female. Minor has to reimburse the supplies of such necessaries and the loans

for such necessaries. Claim for payment for necessaries can be made against

the minor’s property. Minor cannot be held personally liable for such

necessaries.

50

See lesson 20 for more details on negotiable instruments

85

Education- A Necessity

Education is considered a necessity and therefore a minor is liable for such necessary

however he is not personally liable the payment for such necessaries are made against

his/her property.

Illustration: Priya who lost her parents in an accident

studied in a School in Delhi. She failed to pay her

tuition fee for two consecutive months. She was liable

to pay her fee because education is a necessity.

However she is not personally liable. She will pay out

of her property.

Medicine- A Necessity

A minor is also liable for any medicinal service he has procured. It can be the doctor’s

consultation fee or it can be the payment for medicines or the treatment .

Illustration: Cindia a fourteen-year-old orphan

girl was suffering from appendicitis. She was

taken to the hospital and was operated upon.

Cindia was liable to pay the hospital charges as it

was a necessity. Again she was not personally

liable. Either her guardians would pay or it would

be paid out of her property.

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Shelter- A Necessity

Home is very essential for any human being and a minor is not an exception. He/she

is liable for the payment for his/her shelter. If he/she has taken house on rent he/she is

liable for its rent.

Illustration: Srikant a seventeen-year-old native of

Hyderabad came to Delhi and took admission in Delhi

University to do his graduation. Srikant had no hostel in

his college and did not have any relatives so he took a

paying guest accommodation and agreed to pay a

monthly rent of Rs. 4000 to his landlady. After staying

for three months Srikant refused to pay the rent. Srikant cannot plead minority here

because home is a necessity and he is liable for the necessity.

7 Torts Minor is held liable for tort (civil wrong). A minor cannot be held

liable under a contract because an agreement with a minor is ab initio void. If

a minor has been negligent in a contract he/she cannot be made liable hence it

cannot be treated as a tort. Tort means a civil wrong whose formation is not on

the basis of a contract. Stealing, abusing and destroying public property is a

civil wrong and therefore minor is liable for it.

Illustration 1: Neha a sixteen-year-old hired a music system for her birthday party

from Ramesh. She promised to use the music system properly and return it to him

once the party was over. Neha used the system negligently and corrupted it. Neha

was not liable for tort.

Illustration 2: Neha a sixteen-year-old hired a music system for her birthday party

from Ramesh and promised to return it once the party was over. She took the music

system to her school and used it for dance practice. She used the system improperly

and so the system got corrupted. In this case Neha was held liable for tort.

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Case law 3

Burnard vs. Haggis51

In this case a minor hired a horse under express instruction not to jump, the

Court held him liable under torts for lending the horse to one of his friends

who jumped it, whereby the horse was injured and ultimately died.

8 Insolvency Minor can never be declared insolvent because he/she is not

capable of entering into a valid contract. Agreements with a minor are void

therefore he/she does not incur any liability under any agreement.

Illustration: Pradeep a fourteen-year-old boy had taken loan from Satish for paying

his school fees. As this was a necessity therefore he was liable to pay the loan money

back out of his property. He did not have enough property to pay the full amount so

he paid only partly. In this case Satish could not hold Pradeep personally liable for

the unpaid money and therefore Pradeep could not be declared insolvent.

4.3 WHO IS OF UNSOUND MIND?

Lets us first answer the question ‘Who is a person with a sound mind?’

According to section 12 a person is of sound mind when he / she is capable to

(a) Understand the terms of a contract

(b) Form a rational judgment about the effects of the terms of contract on his / her

interest

If a person does not satisfy both the above conditions then he or she is of unsound

mind

Unsoundness of mind can be

Permanent

Temporary

51

(1863) 14 C.B. 45

88

Permanent unsoundness of mind is found amongst

(1) Idiots

Temporary unsoundness of mind is found amongst

(1) Lunatics

(2) Drunkards / persons under intoxication

Who is an idiot?

As per the English dictionary an idiot is an utterly foolish or a senseless person. A

person, who lacks the normal power of thinking and is devoid of a healthy mental

development. He /she has a mental age below three years and generally is unable to

learn connected speech or guard against common dangers. This problem is generally

by birth and its recovery is almost impossible therefore it is considered to be a

permanent unsoundness of mind.

Illustration: Ram and Shyam were twin bothers who

were mentally challenged. They were twenty years old

but their minds were that of a three-year-old child.

They were like this right from their birth. Only a

miracle could have cured them otherwise in normal

circumstances they could never be cured. As a result

they were permanently incapable to enter into a

contract. Any agreement with them would be void.

Position of agreements with an Idiot

An idiot is permanently of an unsound mind therefore he / she is incapable of entering

into any valid contract. Any agreement entered into with an idiot is void.

89

Illustration: Gyaneshwar a twenty-year-old man was born an idiot. He went to a five

star hotel and ordered a lavish dinner for himself. After the dinner he failed to pay the

bill. Gyaneshwar could not be held liable because he was of unsound mind.

Who is a Lunatic?

As per the English dictionary a lunatic is a person who is mentally ill, dangerous,

foolish or unpredictable. He or she loses the normal power of thinking due to mental

strain, accident or a tragic incident in life. Lunatics are not born insane. They suffer

from intervals of sanity and insanity.

Illustration: Gayatri was a 54-year-old lady who lost

her husband in a car accident. Ever since she lost her

husband she went into a depression. Her husband was a

businessman and so during that time she entered into an

agreement with one of her husband’s client. The

agreement could be declared void because she signed it

while her mental condition was not normal.

Position of agreements with a Lunatic

A lunatic is incapable of entering into a valid contract. However Lunacy is a curable

ailment therefore after recovering from insanity he / she can enter into a valid

contract. A contract with a person before he / she turned a lunatic is a valid contract

and a contract with a person after he / she recovered from lunacy is also a valid

contract.

Illustration: Gayatri who had lost her husband in an accident went into depression

but after few months she recovered and entered into an agreement to sell her house to

Lakshman. The agreement with Lakshman was valid and was very mush enforceable.

Who is a Drunkard / Person under intoxication?

A drunkard is a person who is under the influence of alcohol and therefore cannot

properly think and make rational judgments. A person is said to be under intoxication

90

when he/she has consumed drugs or medicines, which have the same effect of

depriving him/her of the power of thinking.

Illustration: Rohit was a drug addict once while he

had taken drugs he happened to sell his house to

Chander. Later when he regained consciousness he

repented his act. The agreement could be declared

void, as he was not of sound mind while he entered

into the agreement with Chander.

Position of agreements with a Drunkard

A drunkard is incapable of entering into a valid contract while he or she is under the

influence of alcohol. Similarly a person who has been drugged is also incapable of

entering into a valid contract. Any agreement entered into with a drunkard or an

intoxicated person is a void agreement. A drunkard will not be under the influence of

alcohol all the time similarly an intoxicated person too will not be under the influence

of drugs all the time. A valid contract can be entered into with them during the time

they are not under the influence of alcohol and drugs.

Illustration: Sarita was an epileptic patient and was taking strong medicines to

counter her illness. After taking the medicines she used to feel very drowsy. This

drowsiness used to persist for about four hours. If during that time she entered into

any agreement that agreement would be declared void on the ground of unsoundness

of mind. She was quite capable to enter into any valid contract after the hours of

drowsiness.

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Case Law 4

Jugal Kishore vs. Cheddu52

It was held by the Court that an agreement entered into by a person of unsound mind

is treated on the same footing as that of minor’s, and therefore an agreement by a

person of unsound mind is absolutely void and inoperative as against him but he can

derive benefit under it.

Some of the other facets regarding the position of agreement with people of unsound

mind are as follows:

Beneficiary Persons with unsound mind can enforce contracts for their benefit. Any

contract where the person with unsound mind is a beneficiary or a promisee he/she

can enforce it in the Court of law.

Illustration: Rohit was a drug addict once while he had taken drugs he happened to

buy Chander’s house. Later Chander declared the agreement to be void on the

ground of unsoundness of mind. In this case Chander could not declare the agreement

void because Rohit though of unsound mind was a promissee / beneficiary in the

contract.

Necessities Persons with unsound mind are not personally liable for necessary goods

and services supplied to them instead their property shall be attached for realization of

money due for necessities supplied to them and to their dependents.

Illustration: Rupesh was a mentally challenged boy. Though he was thirty years old

but his mind was that of a fifteen-year-old child. Once he went to a shop and

purchased a packet of biscuits and ate them. After eating he did not pay the money to

the shopkeeper. Though he was not personally liable but his property could be

attached for realization of money.

52

(1903) 1 All. L.J. 43.

92

4.4 WHOM DOES LAW DISQUALIFY?

There are people who are physically and mentally sound yet they are disqualified by

law to enter into any valid contract. The people who are disqualified by law are the

following:

1 Alien enemy: An alien enemy is a citizen of a country, which is in a

state of conflict with the land in which he or she is located. Usually but not

always, the countries are in a state of war.

Illustration: Mir Zafar an Afghani businessman had an American business associate

by the name of Tom. They both entered into a business contract but before they could

execute the contract America attacked Afghanistan. As a result their contract became

void. They no longer remained business associates instead they became alien

enemies.

An alien enemy cannot enter into a contract while his / her country is at war

with our country. A contract with a foreign national is valid but becomes void

as soon as the war starts. These contracts may again be revived after the war

ends if the central government is of the opinion that the contract is not against

the public interest of the country. A new contract can also be entered into with

an alien enemy after the war ends if it is not against public interest.

Illustration: Mir Zafar an Afghani businessman had an American business associate

by the name of Tom. They both entered into a business contract but before they could

execute the contract America attacked Afghanistan. As a result their contract became

void but after the war ended they could easily revive the old contract or could enter

into a new contract because they were no longer alien enemies.

2 Foreign Sovereign and Ambassador: Foreign Sovereigns and their

representatives are citizens of foreign countries. They can be tourists,

ambassadors and delegates who visit our country for a specific purpose and

duration.

93

Illustration: Suzanne is a Canadian ambassador in India. While she was driving in

the streets of Delhi she happened to hit a motorcyclist. As Suzanne was a foreign

national she could not be tried in the Indian Court.

Foreign Sovereigns and Diplomats are free to enter into a valid contract in

our Country and can enforce those contracts in our Courts but the problem is

that we cannot sue them in our Courts without the sanction of the government

unless they wish to submit themselves to the jurisdiction of our Courts. If the

foreign national has entered into a contract through an agent residing in India

then in that case the agent can be held responsible and can be sued in the

Court of law.

Illustration: John an American tourist came to India and stayed in a five star hotel for

five days but when he was leaving the hotel he did not have money to pay his bills. As

John was a tourist so he could not be tried in our Court. He could not be sued for

recovery of the bills.

3 Convict: A convict is a person who has been declared guilty and

convicted of an offence by the Court. A person who has just been accused of

committing a crime but not been declared guilty is not a convict.

Illustration: Pankaj a dacoit had robbed many people and one fine day he was caught

by the police and tried in the Court of law and the Court found him guilty. He was

imprisonment for fourteen years. During the years of imprisonment he was not

competent to enter into any contract.

Convict cannot enter into a valid contract while undergoing imprisonment. As

soon as the convict’s tenure of imprisonment finishes he / she is no longer

disqualified to enter into a contract.

Illustration: Radha was found guilty of crime of theft and was undergoing

imprisonment. During the years of imprisonment she was not competent to enter into

94

any contract but as soon as her term in the prison gets over she will be competent to

enter into a valid contract.

4 Insolvent: The Court declares those people insolvent who are unable

to discharge their liabilities. Their debts exceed their assets therefore they are

unable to pay their creditors. After the Court declares them insolvent their

property stands vested with the official assignee or an Official receiver.

Illustration: Shambhu a businessman was running into huge losses for the past five

years. He was unable to pay his creditors and so his creditors sued him. The Court

declared Shambhu insolvent and his property was vested with the official assignee.

Insolvents cannot enter into a valid contract unless they have been discharged

of their insolvency. Such people cannot enter into contracts relating to their

property. They cannot sue others and others cannot sue them. They cannot

enter into a valid contract unless they have been discharged of their

insolvency.

Illustration: Rakesh was unable to pay his creditors and so his creditors sued him.

The Court declared Rakesh insolvent and his property was vested with the official

assignee. As a result he was incompetent to enter into a contract. However he could

enter into a contract once he was discharged of insolvency

5 Company: The contractual capacity of a company is normally

mentioned in the object clause of the Memorandum of Association. Any act

done outside the purview of the memorandum is ultra vires and any agreement

entered into for the execution of such an act is void.

Illustration: Ram and Shyam Company was in the business of manufacturing leather

bags. The object clause in the Memorandum of Association provided that the

company is to manufacture leather bags. One day the director of the company entered

into an agreement with a buyer for selling them leather shoes. The agreement was

95

void because it was beyond the scope of business. The company as per its

memorandum was to sell only leather bags and not leather shoes. Therefore the

agreement was not valid.

4.5 POINTS TO REMEMBER

Competent to contract (Section 11)

Major

Sound mind

Not disqualified by law

Who is a Minor

Minor Below 18 years

Minor Below 21 years

A minor whose person or property or both a guardian has been appointed under the

Guardians and Wards Act, 1890.

A minor whose property is under the superintendence of any Court of wards

Position of agreement with a minor

Agreement with a minor is void

A minor can be a beneficiary or a promissee

A minor cannot enter into a partnership agreement

A minor cannot become a shareholder in a company

A minor cannot ratify the agreement after attaining majority

A minor can be an agent

A minor can draw a negotiable instrument and can enforce instrument drawn in

favour of him/her

A minor is liable for necessaries

96

A minor is liable for torts

A minor cannot be declared insolvent

Unsound Mind

Idiot Agreement with an idiot is void

An idiot is permanently incapable to enter into an

agreement

Lunatic Agreement with a lunatic is void

A lunatic is temporarily incapable to enter into an

agreement

Drunkard / intoxicated Agreement with a drunkard is void

A drunkard is temporarily incapable to enter into an

agreement

Disqualified by law

Alien enemy Agreement before the war- valid

Agreement during the war- void

Agreement after the war- valid

Foreign Sovereign and Ambassador Agreement is void

Convict Agreement before imprisonment- valid

Agreement during imprisonment-void

Agreement after imprisonment-valid

Insolvent Agreement during insolvency is void

Company An agreement ultra vires is void

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4.6 QUESTIONS

Match the following

1 Unqualified by law a Minor

2 Below 18 years b Liable for necessities

3 Unsound Mind c Convict

4 Permanent illness d Temporary illness

5 Lunatic e Idiot

Answers: 1c, 2a, 3b, 4e, 5d

Practical Problems

1 Ram is a fourteen-year-old boy who goes to the market and buys a geography

textbook from a stationary shop. He does not pay the price to the seller for the

book. Is Ram liable to pay for the book?

Answer: Ram though a minor is liable to pay for the book because the book is

a necessity and minors are liable for necessities.

2 Rishita met with an accident and lost her memory. She entered into an

agreement with Rakesh for selling her car. Is this agreement a valid contract?

Answer: This is not a valid contract because Rishita lost her memory so she is

not having a sound mind. The agreement, which she entered with Rakesh is a

void agreement.

3 Nikita a Bangladeshi national who came to India on a tourist visa bought a

gold necklace from a jeweler in Mumbai. She paid half the money and

promised to pay the other half within one month. She left for Bangladesh

98

without paying the balance. Can the jeweler sue Nikita for not paying the full

amount of the necklace?

Answer: As Nikita is a foreign sovereign therefore she cannot be tried in our

Court of law. If at all she needs to be tried in our court then special permission

from the government has to be taken.

4 Raghuveer a fourteen-year-old boy sells potatoes on wooden cart. Mrs Sharma

happens to buy two kilograms of potatoes from Raghuveer and promised to

pay him later. Later Mrs Sharma refused to make the payment on the ground

that the agreement was void. Is Mrs Sharma right?

Answer: Though Raghuveer is a minor but if the minor is the beneficiary /

promissee which in this case Raghuveer is then the promisor has to fulfill the

promise under the contract. Thus Mrs Sharma is liable to pay Raghuveer the

price for potatoes.

5 Rajan is in a prison for the last four years and he sells his house to Shikha

from the prison. Is this a valid contract?

Answer: A convict cannot enter into a valid contract and as Rajan is still a

convict therefore the agreement he has entered into with Shikha is void.

Questions:

! Who is a minor? What is the position of agreements with a minor?

! Who are people disqualified by law? What is the position of

agreements with an alien enemy?

! Who is a lunatic? What is the position of agreement with a drunkard?

4.7 REFERENCES

1 Chadha P.R. & Bagrial A.K. (2005): Business Law, Pragati Publictions, New

Delhi

2 Tulsian P.C. (2007): Business and Industrial Law, Tata McGraw-Hill

Publishing Company Limited, New Delhi

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For more information refer the following websites

http://www.saskschools.ca/curr_content/law30/contract/lesson2/2a.html

http://en.wikipedia.org/wiki/Capacity_(law)

DISCLAIMER

The photos used at various places in this lesson to the best of my knowledge have

been downloaded from free sites, which I believe do not require any prior permission

for use. The sites are duly acknowledged and listed below. However if any

photograph/picture used in this lesson requires permission for use then kindly let me

know. I will gladly do the needful and use the picture only after authorization.

Websites from where pictures have been downloaded

http://images.google.co.in/images?hl=en&q=hospital&btnG=Search+Images&gbv=2

http://images.google.co.in/images?hl=en&q=house&btnG=Search+Images&gbv=2

http://images.google.co.in/images?ndsp=20&um=1&hl=en&q=school&start=20&sa=

N

http://images.google.co.in/images?gbv=2&hl=en&q=idiot+pictures&btnG=Search+I

mages

http://images.google.co.in/images?gbv=2&hl=en&q=psycho&btnG=Search+Images

http://images.google.co.in/images?hl=en&q=drunkard+pictures&btnG=Search+Image

s&gbv=2

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Lesson - 5

Free Consent

by

Preeti Singh

This chapter will give an understanding of the

Following aspects of free consent:

5.1 Meaning of Consent & Free Consent

5.2 Duress and Coercion

5.3 Undue Influence

5.4 Fraud

5.5 Misrepresentation

5.6 Mistake

5.1 MEANING OF CONSENT AND FREE CONSENT

Free Consent is one of the essential elements of a valid contract. The essence of this

requirement is that a person should enter into an agreement of is own interest with a

free as well as an open mind without any fear. If any one has not allowed the other

party the freedom of expression, the agreement will not be fair. No person under law

is compelled to enter into a contract and be bound by any obligations pertaining to it

without his / her free consent.

CONSENT

When two or more persons agree upon something it is said that there is a consensus

between them. According to section 13 this means that the people agree on the same

thing and in the same sense. It also means that there is consent on the acceptance of

an offer. When there is no consent, there cannot be a contract.

101

Illustration: Braj has two televisions. One is of L.G. make and the other is of Sony

make. His friend Ashu offers to buy the L.G. product. Braj thinks he is selling the

Sony television. This agreement is void ab initio because there is no consent since

both of them have not understood the same thing in the same way. There is no

agreement of minds.

FREE CONSENT

Section 10 of Indian Contract Act, states, that a valid contract should have the free

consent of both the parties, entering into the contract. This means that in a contract

not only should there be consent but it should also be free consent.

‘All agreements are contracts if they are made by the free consent of the parties.’

Free consent according to section 14 is when a contract is made without coercion,

fraud, undue influence, misrepresentation or mistake. Therefore, if a contract is

influenced by any of these elements there cannot be free consent. Salmond has

described this as an error in consensus.

An agreement, which is made by coercion, fraud, undue influence and

misrepresentation, is voidable at the option of that party whose consent was not free

(Section 19).

If there is a mistake in an agreement it becomes a void contract. It is not enforceable

by law. The reason for this is that a mistake means that there is no consensus between

the parties entering into a contract.

When consent is not free it is called error in causa. This makes the contract voidable

at the option of that person whose consent in the contract is not free. However, the

contract continues to be a valid contract until it is repudiated by the person who is

consent is not free.

Error in consensus and error in causa can exist together in a contract because the

contract can have both the properties of mistake and fraud present in the agreement.

102

Illustration 1: Anita had to sign her property papers in favour of her children

because of their undue influence on her. They threatened her that they would drop her

at a lunatic asylum if they did not agree. In this case the consent is not free. The

contract is voidable if she repudiates it. Until then it is a valid contract.

Free Consent

Illustration 2: Jeetendra was suffering from severe pain in his stomach. His family

doctor Dr Geetha diagnosed him with stones in his gall bladder. She advised

Jeetendra to go for an operation. Jeetendra happily gave his consent to get himself

operated. This is a case of free consent without undue influence.

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Flaws in Consent

5.2 COERCION

Coercion Undue influence Misrepresentation Mistake

(Sec. 15) (Sec. 16)

Fraudulent Innocent or

or willful unintentional

(Sec. 17) (Sec. 18)

Mistake of law Mistake of fact

(Sec. 21) (Sec. 20)

of the country of the foreign country of both the parties of only one party

country (bilateral mistake) (unilateral mistake)

(Sec. 22)

Exceptions

Mistake as to the Mistake as to Mistake as to Mistake as to

Subject - matter the possibility of the person to the

regarding performing the contracted nature of

contract with the contract

Physical Legal

impossibility impossibility

existence identity quality quantity title price

Figure 5.0

104

According to section 15, coercion means to use force to make another person agree to

the terms and conditions while entering into a contract. A contract is caused by

coercion in the following cases:

1. When any act is done that is forbidden by Indian Penal Code.

2. Threatening to commit an act forbidden by Indian Penal Code

3. Unlawful detaining of property by using force or physical pressure on another

person.

4. Threatening another person for detaining the property.

Illustration: The gangster made the property owner sign

the papers for his ownership at pistol point. This is

coercion it is forbidden by Indian Penal Code. The

contract is voidable at the option of the property dealer as

force was used for obtaining property.

When can coercion be exercised?

Coercion can proceed from any person. It can be directed against another person

including a stranger.

Illustration: Manju threatens to kill Muna, who is Rani’s son if Rani does not give the

entire property to her. The consent given by Rani is due to coercion by Manju. The

coercion is directed against Muna who is a stranger to the contract.

What would be the effect of threat to file a suit?

India Penal Code forbids any act which threatens any person to file a suit under false

charges as this amount to coercion.

When a person threatens that he will file a civil / criminal suit it cannot be called

coercion. However, if the suit is to be filed on a false charge it will be an act of

coercion.

Illustration: Hina threatened Beena that she would file a suit against her for not

making a payment of Rs. 10,00,000 falsely if she does not give her the rights of her

105

building where she wanted to open her office. This is based on a false charge and

hence it is caused by coercion.

What would be the effect of threat to commit suicide?

According to the Indian Penal Code suicide and threat to commit suicide is not

punishable, but if an attempt is made to commit suicide it will become punishable

Case Law 1

In Chikham Ammiraju v Seshamma53

. A man threatened that he would commit

suicide if his wife and son did not make a properly deed in favour of his brother. The

court held that a threat to commit suicide was not punishable under be Indian Penal

Code, however it was deemed to be forbidden by it. This threat was considered to be

coercion and so it was a voidable contract at the option of the aggrieved party.

Illustration: Reema threatens her sister Leena that she would commit suicide if she

was not given her mothers Jewels. Leena gives the entire collection. Is this act

punishable? Although threatening to commit suicide is not punishable it is deemed to

be punishable as it amounts to coercion. The contract is voidable at the option of

Leena.

5.2 DURESS

In the English Law, Duress is used to mean the same thing as coercion. Duress has a

limited scope. It includes within its purview threatening to cause or actually causing

bodily injury or imprisonment. It extends to he life of the other party or to the family

members of the parties or their agents to the contract. It does not extend to threats to

detain or destroy property.

Duress v Coercion

Duress is the word used by English law for coercion but they are different.

1. Duress can be used only by a person who is party to a contract. His agents can

also be part of duress.

53

1917 41 Madras 33

106

2. Duress does not have within its purview detaining of property or any threat to

detain property.

3. Coercion is a comprehensive term. It includes unlawful detention of goods.

However Duress includes physical violence and imprisonment only it does not

include unlawful detention of goods within its scope.

However, in India Economic Duress arises in cases where a person is forced to

render labour or service to another due to compulsion arising from hunger or

poverty.

Burden of Proof

The aggrieved party has to prove that the consent to the contract was obtained by

coercion and he / she would not be part of the contract if coercion was not applied on

them.

Case Law 2

In Kishan Lal Kalra v NDMC54

. The Court that where the plaintiff was dispossessed

of the premises running an open air restaurant in the central place of Delhi by

threatening office arrest and detention by MISA, the act amounts to coercion.

Effects of Coercion

Section 19 and 72 of the Indian Contract Act, deal with the effects of coercion.

According to Section 19 ‘when consent to an agreement is caused by coercion the

agreement is a contract voidable at the option of the party whose consent was so

caused’.

However, the burden of giving a proof of consent obtained by coercion is on the

aggrieved party. Section 72 specifically states that if money has been paid or any item

has been delivered because of coercion, it has to be repaid to the aggrieved party

whose consent was obtained by coercion, but he must restore any benefit received by

him.

Illustration: Summy gave Rs. 1,00,000 to Teena under threat of murder. If Teena

rescinds the contract and sues her in the court Summy has to repay the amount to

Teena.

54

A.I.R. 2001 Delhi 402, 407

107

Therefore, the effects of coercion can be summarized in the following:

! The aggrieved party can rescind the contract as it is voidable at his / her

option. (Section 19)

! The aggrieved party should be restored the benefits by the person who had

used coercion.(Section 64)

! If money has been paid on account of coercion the aggrieved party should be

returned the money by the person who had used coercion for taking it.

! The aggrieved party has to prove that coercion had been exercised and the

consent was not freely made by him / her.

5.3 UNDUE INFLUENCE

Undue influence means using superior power for obtaining the consent of the person

who is weak in position and physical ability.

Section 16 (1) of the Contract Act defines undue influence as

• The relation between parties where one of the parties is in a dominating

position over the will of the others.

• Using the dominating position to take an unfair advantage over the other55

.

Section 16 (2) of the Contract Act defines the position to dominate the will of the

other in the following manner.

6 Real or apparent authority: Where a person holds some real or apparent

authority over the other. This means that he / she is in some position where he /

she has the power to dominate over the will of another person.

Example:

6.1 Relationship of Employer and Employee

6.2 Relationship of Officer and Peon.

7 Fiduciary Relationship: Where a person is in a fiduciary relation to another.

This means that there is the relationship of mutual trust and confidence amongst

the people making the agreement.

55

See Subhas Chandra v Ganga Prasad A.I.R. 1967 SC878.

108

Example:

(4) Relationship of doctor with his patient.

(5) Relationship of mother and daughter.

(6) Relationship of Father and son.

(7) Relationship of Trustee and beneficiary.

8 Agreement with another, having mental incapacity: Where a person makes a

contract with another, whose mental capacity is affected because of his age,

illness, mental or body distress temporarily or permanently.

Example:

! Relationship of normal person with a person temporarily in depression.

! Relationship of a young man with an old and sick person, who suffers from

dementia.

From the above it can be summarized that undue influence can be exerted in the

following cases:

! Where one party is in a position to dominate the will of another person.

! Where the dominating party is able to have an unfair advantage over another

person.

! Where the dominating party uses his position to get an unfair advantage in the

contract.

Illustration:

! Mr. Balram used his parental influence by making his son a party to

dowry taken by him at his wedding from the wife’s father. This is a

case of undue influence exerted by a father because of his fiduciary

relationship with his son.

! Mr. Shammi an old man is influenced by his son Pummy to sign his

property papers in his name or else he would stop paying the medical

bills of his father. This is a case of undue influence of a normal person

in a dominating position over an old sick man.

The relationships in which undue influence can be exerted over another are the

following.

! Teacher and student.

109

! Employer and employee.

! Doctor and patient.

! Mother and daughter.

! Father and son.

! Guardian and ward.

! Trustee and beneficiary.

! Solicitor and his client.

According to law in the following cases there is no presumption of undue influence.

Therefore if someone has exerted undue influence it will have to be proved.

! Creditor and debtor.

! Landlord and Tenant.

! Husband and wife (when wife is not parda-nashin).

Presumptions of Undue Influence 16 (3)

In some cases it is presumed that there is undue influence. These are discussed below:

1. Unconscionable transactions: When it can be proved that the dominating

party entered into an unfair contract with a weaker party, it is assumed by law

that undue influence has been used to exert the contract. Unfair transactions

between superior and weaker party are called unconscionable transactions. An

example of such contracts is when a person makes an unusually high profit

and the other party suffers because of these contracts, in such cases when on

the face of the agreement it appears unconscionable it has to be proved that

consent was taken by fair means by the superior party.

2. Contracts with Parda-Nashin Women: Women who wear a burkha or cover

themselves and are in complete seclusion from the rest of the world are a

separate category in the eyes of the law. If a contract is made with parda-

nashin women, it is presumed that undue influence is used. The court grants

relief to any unreasonable demands of the party using undue influence through

its discretionary powers.

3. Money Lending Transactions: Unfair agreements are often made in money

lending transactions. Sometimes undue advantages are taken from people who

have taken loans. A high rate of interest charged shows unfair transaction.

Also, when a money lender executes a property in his favour when the

borrower cannot repay is also or transaction of undue influence.

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In all the above cases the court presumes that undue influence has been used and

using its discretionary powers it can grant relief to the weaker parties.

Effects of Undue Influence

Under Section 19A, if a person has given his consent due to undue influence exerted

by another person the contract is voidable at the option of that party who had to give

consent under undue influence. Further, the court may also take the decision that a

refund has to be made to a person who is the aggrieved party. The court may also take

a decision to allow the aggrieved party to rescind a part of the contract or the whole

contract as the case may be.

Burden of proof

The burden of proof of undue influence will be on the person who is aggrieved and

wants relief from the court. The court also states that there is a difference between

persuasion and undue influence. A person can be persuaded to do a certain activity

but this does not necessarily mean that undue influence has been used. Therefore,

aggrieved party will have to prove that the superior party was able to influence him

due to his position to dominate his will.

Rebuttal of Presumption

When the weaker party makes a plea in the court that it did not use undue influence it

has to prove the following.

o That full disclosure was made to the weaker party before getting consent and

entering into a contract.

o That the price paid in the contract was in accordance with the requirement and

it was adequate.

o That the weaker party took advice from a competent person before finalizing

the contract with the so called superior party.

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Table 5.3:1 Comparison between Coercion and Undue Influence

Particulars Coercion Undue Influence

1. Relationship of parties

2. Type of force

3. Position of stranger to

the contract

4. Liability

5. Burden of proof

6. Effect of contract

Relationship of parties

making the contract may

or may not be there.

Consent is through

physical or violent threat.

The contract can be

exercised by stranger to

the contract.

The party using coercion

commits a crime that is

punishable and the

contract can be rescinded

as it is voidable contract.

The party withdrawing the

contract has to prove that

coercion has been

exercised.

The contract is voidable

but the benefits have to be

restore under Section 64s.

Relationship of parties to

the contract must exist.

Consent is through mental

or moral pressure.

Only a party to the

contract can exercise it and

not a stranger to the

contract.

There is no criminal

liability of people involved

in the contract.

It is assumed by law that

undue influence has been

exercised due to superior

relationship.

The contract can be set

aside by the weaker party.

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5.4 FRAUD

Fraud is false representation of facts made willfully to deceive another person.

Definition of Fraud

Section 17 of the Indian Contract Act states that if any of the following acts are

committed by any party to a contract or with his agent’s connivance, willfully with

intent to deceive or induce another person or his agent to enter the contract it will

result into fraud.

1. It is a suggestion of a fact which is not true by a person who does not believe

that it is true.

2. It is an active concealment of facts by a person who has knowledge or belief

of the facts.

3. It is a promise in which there is no intention of performance of the contract.

Case Law 3

Shireen v John.56

, In this case a man and woman got married. The man had no

intention to continue with the marriage and hence he obtained consent from his wife

with the intention of consent being obtained by fraud.

4. Any other action which has the intent of deceiving the other person.

5. Any act or omission which is declared fraudulent by law.

Essentials of Fraud

The above description of definition of fraud can be explained through the essentials of

fraud.

1. False Suggestions: Fraud must state facts which are false and the person

making the suggestion knows that he is making a false representation or false

statement of facts. The false suggestion is made intentionally to induce or

deceive the other party to enter into a contract. This is supported by the

following case law:

56

AIR (1952) Punj227

113

Case Law 4

In Peek v Gurney,57

The prospectus of the company did not disclose the existence of

liabilities. This showed the company as a prosperous one. The court held that non

disclosure of facts amounted to fraud. Any person purchasing shares on the basis of

the prospectus could avoid the contract.

2. Active Concealment of a Fact: Active concealment is when a person has the

knowledge or belief of the fact which he knows is not true. This amounts to

fraud. Passive concealment is when a person makes an incorrect statement

thinking that the statement is correct.

Illustration: Mr. Bahri sells his old television to his friend for Rs. 5,000. He conceals

the fact that the television is not completely in working order. His friend inspects it

and pays for it and takes it home. When he wants to see a program after 15 minutes

the color begins to fade away.

This amounts to fraud as Mr. Bahri knew that the television was not in working order

and he did not let his friend know the defect that it only works effectively for a short

while.

Case Law 5

B. R. Chaudhary v Indian Oil Corporation Ltd.58

In this case the respondent Indian

Oil Corporation terminated the contract of the dealership of the appellant on the

ground of not furnishing his status of occupation in the relevant column of the

application. The court held that it amounts to suppression of the material information,

hence the recession of the contract is proper.

3. Making a Promise without Intention of fulfilling it: If a person makes a

promise but he does not intend to keep it. It is a clear case of fraud because at

the outset the intention was to make a false promise.

57

1873 58

(2004) 2 Section 177

114

Illustration: Harish purchases perfumes of over Rs. 1,00,000 with a promise to pay

within a week. He has no intention to make the payment. This contract is induced by

fraud.

4. Any other act fitted to deceive: An act used to trick or chit someone by unfair

means is considered to be fraud. This is an act which is done with the intention

of committing a fraud.

Case Law 6

Horsefall v Thomas,59

In this case a person bought cannon of another person who

knew that the cannon was worthless. He put a metal plug to conceal the effect. When

the purchaser used it, it burst. This was not a fraud because the purchaser was not

deceived. He would have bought the product even without the defective plug.

5. Any other act considered by law to be fraudulent: According to the law it is

obligatory that all material facts are disclosed while selling an immovable

property. Otherwise it amounts to fraud.

6. The Party that is misled by Fraud should have suffered some loss: There

cannot be fraud without any damage. The loss must be in terms of money or

money’s worth, or loss of some tangible assets. Fraud without damage does

not give rise to any deceit.

Is Silence Fraud?

Silence of facts which is intended to affect the willingness of a person to enter into a

contract is not fraud accept in some cases. As a general rule of law both parties have

the right maximize their gains and the law does not expect anyone to voluntarily

reveal the weak points of the other parties even if it causes some disadvantage to a

party.

59

1862

115

Situations where Silence Amounts to Fraud

In the following cases, silence amounts to fraud:

8.1.5 Duty to Speak: When it is a duty to speak and the person is silent, silence will

be fraudulent. Duty to speak is when a person in the contract has trust and

confidence and is in a fiduciary relationship with another person in the

contract. For example father and son, teacher and student. Duty to speak is

also when one party depends on the other to discover the truth in utmost good

faith. For example, insurance is a contract in which the insurer requires full

knowledge before he can make a contract. Duty to speak is in the following

situations:

8.1.5.1 Contracts relating to family settlements.

8.1.5.2 Contracts of insurance.

8.1.5.3 Allotment of shares of a company.

8.1.5.4 Contracts of guarantee.

8.1.5.5 Contracts of partnership

8.1.5.6 Contracts of fiduciary relationships.

8.1.5.7 Contracts for sale of immovable property and,

8.1.5.8 Contracts of marriage.

Silence is Equivalent to Speak: In some situations silence is considered

to be equivalent to speech.

Illustration: If Sunita says to Rekha, “if you do not speak I

will assume that the car you are selling is in good order”.

Rekha remains silent. Here Rekha’s silence is equivalent to

speech.

8.1.6 Half Truths: When a person speaks a half truth, it means disclosing some

portions of relevant material leaving the other portion undisclosed. According

to law a half truth is worse than full falsehood as it misleads the other person.

Therefore if a person speaks he must give all the facts and not just half truth.

Otherwise silence amounts to fraud.

116

8.1.7 Change in Situation: Sometimes when a statement is made it is the truth but

circumstances bring a change in situation and when it is actually acted upon, it

becomes false. It becomes the duty of the person to immediately communicate

the change in situation. This is supported by the following case.

Case Law 7

Rajgopala Iyer V The South Indian Rubber Works.60

In this case the prospectus of the

company gave the names of the directors. This was a true list but after allotment due

to certain changes directors had changed because of retirement. This should have

been communicated to the applicants of the shares. However, since these changes

were not communicated to share applicants, they could avoid the allotment

Remedies of Fraud

According to Section 19, when consent is taken by fraud from another person he has

the following remedies available to him.

o Rescind the Contract: The party whose consent was received by fraud has the

right to avoid the contract because it is voidable at the option of the person

defrauded.

o Performance of Contract: The person defrauded can ask for completion of the

contract but with restitution which means that he would like to be put in that

position in which he would actually be in if the representations were true.

o Compensation: The defrauded party has the right to demand compensation for

the loss that is caused to him by fraud. He has the right to claim damages even

if he opts to continue with the contract.

Limits to Rescind the Contract

In the following cases he does not have a right to rescind the contract.

1. Affirmation: When a person has a right to rescind but he firms the contract

either expressly or in an implied manner. The right to rescind is lost.

2. Lapse of Time: The right to rescind a contract can be claimed within a

reasonable period of time after fraud has been discovered. Reasonable time is

seen according to the situation of the contract.

60

(1942) ML J 228

117

3. Rights of Third Party: When the rights of third party have been acquired with

due consideration and in good faith without any knowledge of the fraud

between the other two parties the defrauded party loses the right to rescind the

contract.

Restitution

Section 64 of the Contract Act, states that the defrauded party, which rescinds the

contract has to return the benefits from wherever he has received it.

5.5 MISREPRESENTATION

Misrepresentation is a false or misleading statement that a person honestly believes it

to be true. He makes this statement without any intention to cheat or mislead another

person. The false statement is serious but not as serious as fraud.

According to Section 18 of the contract act misrepresentation the meaning of the

misrepresentation is given below:

1. It is a positive assertion of information by a person which is not true but the

person believes it to be true.

2. It is a breach of duty without any intention to deceive. However, the person

gains an advantage by misleading another person.

3. The statement innocently causes a party to an agreement to make a mistake to

the subject of the agreement.

Misrepresentation occurs in the following cases:

1. Unwarranted Statements: When a party makes a positive assertion that the

information from which he is making a statement is trustworthy he means that

he is making a warranted statement. Unwarranted statement means

information from untrustworthy source. Therefore, when a person believes

that the information is true but it is incorrect. It is misrepresentation. This is

supported by the case

118

Case Law 8

In Oceanic Steam Navigation Company V Soonderdas.61

The plaintiff from whom a

person chartered a ship stated that the ship was of 2800 tonnage register. However,

the ship was 3000 tonnage register. The plaintiff did not have any basis to believe the

fact stated by whom. The contract was the cancelled due to misrepresentation.

2. Breach of Duty: When a party does not intend to cheat another person but the

circumstances show that he has not done his duty correctly because of

nondisclosure of essential information. He has used the situation to his

advantage thus bringing him certain benefits. This type of situation is called

constructive fraud. The party making such statements will be guilty of

misrepresentation. This is supported by the following case.

Case law 9

Bannerman v White 1861.62

The plaintiff wanted to sell the defendant hops on the

understanding that sulphur was not used in their growth. The defendant was clear

that he was not interested in sulfa usage in cultivation of Hops. Although sulfa was

used in 5 out of 300 acres the plaintiff had forgotten. The court held that the contract

could be avoided on the ground of misrepresentation although representation was no

3. Innocent Mistake: If one party leads the other one to make a mistake in the

quality or subject matter it is a case of misrepresentation. This clause includes

the cases where vital facts are suppressed and a mistake has been made.

Essentials of Misrepresentation

Misrepresentation as already stated is a false representation of facts which the person

makes without knowing that it is false. He makes the statements believing them to be

true. The following essentials elements represent misrepresentation.

I. Material Facts: Misrepresentation must be of those facts which are

important in the formation of a contract. Some expressions or passing

statements that are not relevant will not be enough for avoiding a

contract.

61

(1980) 14 ILR Bomb 241 62

1861

119

II. Statement prior to executing the contract: The misrepresentation of

facts must be before the contract is executed by the parties to the

contract.

III. Misrepresentation by a party to the contract: Misrepresentation of facts

has to be made by a party or his agent to the contract. A statement made

by a stranger to the contract does not have any effect on the validity of

the contract.

IV. Objective of misrepresentation: The statements made by

misrepresentation of facts should be of the intention to deceive the other

party and to induce him to enter the contract.

V. Reaction of other party: As a result of the misrepresentation the other

party in the contract should have acted on the faith of the facts

represented.

Effect of Misrepresentation

According to Section 19 of the Indian Contract Act if on the misrepresentation of

statements a person to the contract has been affected, he can avoid the contract

because it becomes a voidable contract at his option.

! The person whose consent has been taken by misrepresentation has the right to

rescind to the contract.

! He has a right to ask for completion of the performance of the contract and

! He can also ask for being given the position which he would have if the

representation of facts was true at the time of asking for performance of the

contract.

The right to rescind the contract is in the following three cases.

1 Time Period: The contract has to be rescinded within a reasonable time

otherwise the right to rescind the contract will be lost.

2 Affirmation: The aggrieved party should not make an affirmation to the

contract otherwise he will lose the right to rescind.

3 Third Party Rights: The aggrieved party should be careful to find out that

third party rights are not acquired while he asks for rescission of the contract.

Exceptions to the Right to Rescind the Contract

In the following cases the party whose consent was received by misrepresentation

cannot get relief of rescinding the contract.

120

1 Where the affected person had the possibility of finding out the truth with

ordinary diligence.

2 Where the affected party is ignorant that he gave his consent due to

misrepresentation of facts.

3 Where the affected party becomes aware of misrepresentation but still decides

to receive the benefits under the contract.

4 Where a third party innocently enters into benefits of the contract before the

contract was rescinded.

5 Where it is difficult to restore the rights of the affected party to the original

position.

Difference between Fraud and Misrepresentation

Particulars Fraud Misrepresentation

Intention

Damages

Consequences

The Intention of the person

misrepresenting facts is to

deceive the other person to

the contract.

The aggrieved party can

get damages for the losses

on account of fraud

The aggrieved party has

the right of rescinding the

contract even if he had the

means of finding out the

truth with ordinary

diligence except when

silence creates fraud.

The intention of the person

is not to deceive. He

honestly believes in the

statement. He innocently

deceives the other party.

The aggrieved party cannot

claim damages due to

misrepresentation of facts

The contract cannot be

avoided if the aggrieved

party had the means of

finding out the true with

ordinary diligence.

5.6 MISTAKE

Mistake can be defined as an incorrect statement which creates misunderstanding

between the parties. Such mistakes take place when the parties to the contract are not

aware of the terms of the contract in agreement with each other. An agreement

121

between two parties according to the Indian Contract Act is valid only when both the

parties agree upon the same thing and in the same sense. According to section 20 the

agreement becomes void when there is a mistake in agreement. In normal

circumstances law does not give the right to anyone to avoid a contract because he

was mistaken about some fact in the contract. However, some mistakes are

fundamental to the contract in such a manner that the very basis of the formation of

the contract becomes faulty and there is no contract at all. In such cases the agreement

is considered to be void due to consensus ad idem.

Types of Mistake

Mistake can be of two types. These are mistake of facts and mistake of law. (1)

Mistake of fact can be bilateral or unilateral and (2) Mistake of law can be mistake of

law in India and mistake as to foreign law.

1. Mistake of Fact

Mistake of fact can occur when both the parties to the agreement are under a mistake

or only one of the parties is under a mistake to the essential elements of the contract.

When both parties are under a mistake it is called bilateral mistake and when only one

party to the contract is under a mistake it is called a unilateral mistake.

" Bilateral Mistake: A bilateral mistake is made in the following cases:

(i) Mistake of existence of subject matter: The agreement is void if it is agreed

upon a subject matter which does not exist and the parties to the agreement

do not have any knowledge about it. This is bilateral mistake because both

parties did not know this material fact at the time of making an agreement.

(ii) Mistake of identity of subject matter: The agreement is void if two parties to

the contract have confusion about the identity of the subject matter. The

agreement is void due to want of consensus.

(iii) Mistake regarding quality / description of subject matter: When two parties

make an agreement they should understand that the quality of the product. If

122

both parties make a mutual mistake about the description of the product, it is

bilateral mistake and the agreement is void.

1. Mistake regarding title of the product: An agreement of sale is void if there is

a mistake of mistake over the entitlement of goods.

Case Law 10

Cooper v Phibbs63

. A person believed that her father had give her rights of a fishery.

Her cousin brother also believed in her rights of title and agreed to take the fishery

on lease. However, the actual title of the fishery was the cousin brother’s. Due to the

mistaken title the agreement was void.

(iv) Mistake regarding substance of subject matter: If both parties to an

agreement make a mutual mistake of facts which is the essential part of the

subject matter the agreement is void.

Case Law 11

Sheikh Bros v Ochener 64

A person granted license to process and manufacture sisal

in a forest to another person. Out of which that person was to give in return 50 tons of

sisal fiber every month. However, when manufacturing began the growth of sisal was

not productive. The person went to court. It was decided that both the parties were

mistaken about a substantive part of the subject matter so the agreement is void.

(v) Mistake regarding quantity of subject matter: If two parties are mistaken

about the quantity of subject matter to be supplied, then the agreement is

void. Quantity is an essential fact of an agreement; if it is not correct the

agreement to buy / sell can not be held.

Case Law 12

Henkel v Pepe 65

A person enquired from another the price of 50 rifles. He sent a

telegram to send 3 rifles. The telegraph office sent the message as ‘send the rifles’.

The party dispatched 50 rifles. The contract is void as the quantity was incorrect.

63

(1867) LR2HL149 64

(1957) AC136 65

(1870) 6Ex7

123

(vi) Mistake regarding price of the subject matter: Price is an essential feature

in the sale of a product. If there is a genuine mistake regarding price the

agreement is void.

(vii) Mistake about possibility of performance: If there is a bilateral mistake

regarding the possibility of performance the agreement is void.

Impossibility of performance can be due to physical reason or legal

impossibility.

Case Law 13

Griffuth v Brymer66

A person hired a room to watch the procession of King Edward

VII at the time of his coronation. However, the procession had been cancelled. Both

the parties did not have this information. Their agreement is void.

Effect of Bilateral Mistake: When there is a bilateral mistake in understanding the

essential facts of the agreement, the contract becomes void ab initio. This agreement

is void from the beginning, does not have any legal significance. It cannot be enforced

at the option of any of the parties to the contract.

" Unilateral Mistake: According to section 22, unilateral mistake occurs when

one party to the agreement makes a mistake. The contract is not voidable

because one of the parties to it are under a mistake. However, there are certain

exceptions to the rule. These are due to the following reasons:

! Mistake of identity of a party: A very fundamental mistake occurs if an

agreement is made with a wrong person. When a party desires to deal with a

certain person and he does not do so due to false representation of another

person it is an error in consensus.

! Mistake about nature of transaction: If a person makes a transaction without

understanding nature of the transaction, it cannot be executed. This mistake is

possible when a person does not disclose to the other the true nature of the

document and induces the other person to sign the document which is not

correct. The agreement is null and void. Case law to support this

66

(1903) 19TLR434

124

Case Law 14

Raja Singh v Chaichoo Singh67

A person

appointed another to look after his farm

cultivation and other affairs because he had

become old. Later, he gave the land on lease to

the same person. Although he thought that he

was signing a lease deed the other person

fraudulently made him sign a gift deed. This is a void agreement.

Effect of Unilateral Mistake: In case of unilateral mistake the contract becomes

void. Under Section 65 a person who has received benefits of the contract has to

restore it by compensating the person from whom the advantages was received. If a

person has received money or any item has been delivered by mistake then according

to Section 72 he has to repay or return it.

2. Mistake of Law

Mistake of law can be mistake of the law of the land or mistake of foreign law.

! Mistake of law of the land: A person is bound to know the law of the country in

which his making a contract. The contract is not voidable because people should

know the law of their country.

! Mistake of foreign law: A mistake that occurs in foreign law is considered to be a

mistake of fact and the contract is void because the logic is that one can make a

mistake as he not expected to know the laws of a foreign country.

67

(AIR 1940) PAT201

125

5.7Points to Remember

Consent and Free Consent

! When two people enter into a contract, they should agree upon the same thing

in the same sense. This understanding by both parties is called consent.

! In addition to consent, both the parties entering into a contract should have

made the agreement by free consent.

! A valid agreement according to Section 14 of the Indian Contract Act should

have free consent. Consent is free when it is not caused by coercion, undue

influence, fraud, misrepresentation or mistake.

Coercion

! Coercion is committing or threatening to commit any Act forbidden by Indian

Penal code. It also includes unlawful detaining or threatening to detain any

property with the intention of causing another person to enter into an

agreement.

! When consent in an agreement is made due to coercion it is voidable at the

option of the party whose consent was so derived but he must return any

benefits received.

Undue Influence

(f) Undue influence is to obtain an unfair advantage over the other person through

a dominating position. For Example, Master and servant, father and son.

(g) The contract is voidable but the aggrieved party has to prove that the consent

was made by undue influence.

Fraud

1. Fraud is willful misrepresentation of facts material for the formation of the

contract

! Silence that is likely to affect the willingness of a person to a contract is not

called fraud unless it is the duty of the person keeping silence to speak or

unless silence itself is considered to be equivalent to speech.

Misrepresentation

! Misrepresentation is an untrue statement made by a party to a contract that

induces another person to act upon the statement and enter into the contract.

(c) The contract is voidable at the option of the aggrieved party either for

rescinding it or asking for its completion after restitution of his rights. In some

126

exceptional cases there is a right to claim damages as well.

Mistake

! A mistake is not intentional. It is an error, believing something that creates a

misunderstanding between people.

! Law does not give recourse to the parties because they make a mistake except

in the case of fundamental mistakes material to the contract

! Mistake can be unilateral or bilateral. It can also be a mistake of fact or

mistake of law.

! Bilateral mistakes can be about the existence, title, identity, quality, price or

quantity of the subject matter.

! Unilateral mistakes can be due to mistaken identity of parties and mistake

about the nature of the agreement.

! A contract made by mistake is void and the person receiving any advantage

under it has to restore or compensate the person from whom the benefit was

taken. If money has been taken it has to be returned.

5.8 Objective Type Questions

State whether the following are True or False

# There is undue influence in a contract between two close friends.

# Coercion means committing or threatening to commit an Act that is forbidden

by the Indian Penal Code 1860.

# Misrepresentation is a false representation of facts.

# Mistake of fact relates to misunderstanding of foreign law.

# Two or more persons give their consent when they understand the same think

in the same manner.

# When there is a mistake of identity of a person in a contract a unilateral

mistake is allowed as a defence mechanism.

# If a contract is made with undue influence it is voidable at the option of the

aggrieved party.

# A voidable contract due to fraud becomes void immediately.

# Threat to suicide does not amount to coercion.

# A fiduciary relationship exists between master and servant.

Answers: 1.F, 2.T 3.F; 4.F; 5.T; 6.T, 7.T, 8.F, 9.F. 10.F.

127

Questions

1. “Consensus ad idem is the basis of a contract” Explain.

2. What is the importance of Consent in a contract? In what circumstances can it

be stated that consent is not free.

3. What is coercion? When is the effect of coercion on the validity of the

contract?

4. What is fraud? How is it different from misrepresentation?

5. “A mere silence as to facts is not fraud”. Discuss this statement.

6. What are the different kinds of mistakes that affect a contract?

7. What is a bilateral mistake? Discuss the different kinds of bilateral mistake.

8. Distinguish between (a) fraud and misrepresentation, (b) Undue influence and

coercion, (c) unilateral and bilateral mistakes.

9. Explain the following: (a) contracts with Pardanashin women, (b) effect of

silence in a contract, (c) consequences of coercion, (d) burden of proof an

undue influence, and (e) consequences of misrepresentation.

Practical Problems

! Rajeev fraudulently represented himself as a minister and purchased a

Plasma Television for Rs. 1,00,000 on credit and promised to pay after one

week. He sold the same television to a third person by the name of Meera. Is

it possible for the seller to recover the plasma television from Meera.

Answer: The intention of Rajeev was to make a fraudulent representation by

concealing the material fact that he was an ordinary citizen and not a

minister, with the intention to make he other person act upon it. Hence, the

shopkeeper can recover it from Meera.

! Ramesh wants to buy an apartment from Reshma. He knows that this

apartment is seven years old and pays an advance of 20 lakhs. Reshma states

that she had purchased this apartment, a new one, three years ago. Can

Ramesh rescind the contract because of fraud?

128

Answer: Ramesh knew that the apartment was seven years old as he had contacted

the builders and the property agent had also told him. He was not required to

believe what Reshma said.

! Mukund tells his wife Neelam that he would commit suicide if she did not

sign the property papers in favour of their niece. Neelam signed the papers.

Can she avoid the contract?

Answer: The consent was taken by coercion. It is voidable at Neelam’s option.

! Amit buys a painting of horses from an art gallery thinking that it was

painted by M. F. Hussain. The seller also truly believed that the painting was

made by Hussain. Amit purchased it for a high price. It turned out that this

was not made by Hussain but a new artist Govinda. Does Amit have any

remedy?

Answer: Amit does not have any remedy because there is no coercion or undue

influence in the contract. He should be more aware about the purchase.

! Amit was forced to marry Meena under the threat of pistol point from his

parents of taking away his rights from their family concern. Is the marriage

valid?

Answer: The marriage is voidable at the option of Amit as his consent has been taken

by coercion. The Indian Penal code (Section 297) states that parents are

guilty if their threaten Amit to get married against his wishes.

! Raju agrees to buy a motorcycle from Manu for Rs. 45,000. He pays Rs.

5,000 as advance. Unknown to both the parties the motorcycle was

destroyed in a fire. What should Raju do?

Answer: Raju can ask for a refund of his advance and treat the contract as void. Since

both the parties are under a mistake it is treated as a bilateral mistake as to

the matter of facts essential to the subject matter of the agreement.

! Mr. Ramlal is eighty years old. He has feeble eye sight. He has been given a

paper to sign by his son who told him that it is a bill of exchange. It turned

out that it was a right to his property papers. Is he liable?

129

Answer: Mr. Ramlal is not liable as his consent was not taken for his property papers.

Hence it is a void contract.

! Rani believed that her property was 350 square meters. She sold it to Sheela

who also read the property papers and thought that the property size was 350

square meters. However, it was 350 square yards. Can Rani cancel the deal?

Answer: Rani can avoid the agreement as there is a mistake on both sides. The

agreement is void because the matter of area of plot is an essential fact to the

agreement.

References:

Books

o Chadda P. R. & Bagrial A. K. ( 2007), Business & Industrial Laws, Second

Edition, Chapter 5, Pragati Publications, New Delhi,

o Kapoor N. D. (2004), Business Law, Chapter 5. Pages 49-68, Sultan chand &

Sons Publications, New Delhi.

o Prasad U & Indu (2006), Systematic Approach to Business & Corporate Laws,

Chapter 1. Bharat Law House Publishers, New Delhi,

Websites:

1. http://www.blurtit.com/q684580.html

2. http://en.wikipedia.org/wiki/Undue_influence

130

Lesson-6

LEGALITY OF OBJECTS

by

Anu Pandey

This Lesson discusses the following aspects of legality of objects

6.1 Objects and Considerations that are unlawful

6.1.1 Forbidden by law

6.1.2 Defeat the provisions of law

6.1.3 Fraudulent purpose

6.1.4 Involves injury to person or property of another

6.2 Objects and Considerations which are unlawful in part

One of the essential elements of a valid contract is lawful object. The object is the

purpose for which two persons enter into an agreement. For an agreement to be a

contract it is important that the object be lawful. If the object is unlawful then an

agreement can never become a contract. The consideration is some act or abstinence

or reciprocal promise. The consideration should be lawful. An unlawful consideration

will not give rise to a valid contract. Both consideration and object of an agreement

must be lawful. An agreement having an unlawful object or an unlawful consideration

or both is void.

131

6.1 WHAT OBJECTS AND CONSIDERATIONS ARE UNLAWFUL?

According to Section 23 of the Indian Contract Act the following considerations and

objects are unlawful:

6.1.1 Forbidden by law an agreement to do what law has prohibited is unlawful.

Such acts are punishable either by the criminal law of the country or by a

special legislation. These agreements may also be called illegal agreements.

Illustration 1: John asked Shakeel to kill Javed for rupees two lakh and Javed

accepted the offer. This is an agreement forbidden by law and hence punishable.

Illustration 2: Sunita offered to steal Payal’s necklace and give it to Supriya for

rupees twenty thousand. Supriya accepted the offer. This is an agreement forbidden

by law.

Difference between Illegal agreement and void agreement

All illegal agreements are void but all void agreements are not illegal. Illegal

agreements are entered into to perform criminal acts that are forbidden by law

and therefore are punishable. Void agreements are agreements that are not

enforceable by law and do not involve criminality of any nature. Transactions

that are collateral to the main transactions that are illegal also become void

and illegal. Whereas transactions collateral to the main transaction that are

void remain valid contracts.

Illustration 1: Ghanshyam a fourteen-year old promised to sell his bicycle to Sooraj a

twenty-year old man if he paid him an advance of rupees five hundred. Sooraj was a

poor man without money so he borrowed five hundred rupees from Lakhanpal. Sooraj

gave Ghanshyam rupees five hundred. Later Ghanshyam refused to sell Sooraj the

bicycle. Sooraj cannot sue Ghanshyam for not selling the bicycle because the

agreement between them is void. On the other hand Lakhanpal can sue Sooraj for

returning the borrowed money because the agreement between them is a valid

contract. Thus the agreement between Sooraj and Ghanshyam, which is a main

132

agreement, is void and the agreement between Ghanshyam and Lakhanpal, which is a

collateral agreement, is valid.

Illustration 2: Sudhir hired Rammu to kidnap Sita for rupees two lakh. Sudhir

borrowed rupees two lakh from Sharif to pay Rammu. Later Rammu refused to carry

out the promise. Sudhir cannot sue Rammu because the agreement between them is

illegal. Similarly Sharif too cannot sue Sudhir for the borrowed money because the

agreement between them is also tainted with illegality. Thus the agreement between

Sudhir and Rammu, which is a main agreement, is illegal and the agreement between

Sudhir and Sharif, which is a collateral agreement, is also illegal.

Case Law 1

Universal Plast Ltd. Vs. Santosh Kumar68

In this case the textile commissioner had forbidden the sale of spindles

without prior permission of the textile commissioner. Without taking the prior

permission the plaintiff sold spindles to the defendant and the defendant paid

an advance to the plaintiff. Later the plaintiff sued the defendant for the

balance. It was held that the money could not be recovered because the sale of

spindles was illegal.

Case Law 2

Nutan Kumar vs. Second Additional District Judge, Banda69

It was held in this case that an agreement of lease between a landlord and

tenant without allotment or release order, as required by the law is void and

unenforceable.

6.1.2 Defeat the provisions of law: An act may not be forbidden by law but if

permitted it may defeat the provisions of any law. It means that an agreement

68

A.I.R. 1985 Delhi 383 69

A.I.R. 1994 All. 298

133

may not be of an illegal nature and not directly forbidden by law but if

allowed to be executed it would indirectly violate the law.

Illustration: Rekha a resident of Delhi wanted to own a house in the state of Jammu

and Kashmir. The rule in Jammu and Kashmir is that only the residents of Jammu

and Kashmir can buy property in the state. No other person belonging to other states

of India is eligible to buy property in the state. Rekha asked Namita who was a

resident of Jammu to buy the house and later transfer the property to her. Rekha also

paid consideration to Namita. Later Namita refused to buy the house. Rekha claimed

the consideration back from Namita. Rekha cannot claim the consideration because

the agreement is void.

Case Law 3

Sundara Gownder vs. Balachandran70

In this case Sundara (the plaintiff) an Abkari contractor was in default on the

payment of Toddy Welfare Fund so he was ineligible to participate in the

auction where shops were being sold. As he could not buy the shops in his

own name so he entered into an agreement with Balachandran (the defendant)

where it was agreed that Balachandran would buy shops and later transfer

some of these to Sundara. Sundara also paid some consideration to

Balachandran. Balachandran failed to fulfill the promise and did not transfer

the shops to Sundara. Sundara claimed the consideration back from

Balachandran. It was held by the Court that the agreement between Sundara

and Balachandran aimed at defeating Rule 5(4A) of the Abkari Shops

(Disposal in Auction) Rules, and therefore it was void.

6.1.3 Fraudulent purpose: An agreement, which is entered into to defraud others is

unlawful. The agreement is entered by one party to cheat the other party

therefore the agreement is void and unlawful right from the beginning.

70

A.I.R. 1990 Ker 324

134

Illustration 1: Ramaswamy offered to sell his car with a defective engine to Saloni

without disclosing the defect for rupees fifty thousand and Saloni accepted the offer.

Hence this is a void agreement, which has been made to defraud Saloni.

Illustration 2: Ruksana offered to sell her gold plated necklace to jasmine saying that

the necklace was pure gold. Jasmine accepted to buy it. Hence this is an unlawful

agreement that is void.

Case Law 4

Manni Ram vs. Purshottam Lal71

Manni Ram the plaintiff knew that the railway company would not grant him a

contract therefore he entered into a contract with Purshottam (the defendant)

that he should put forward an application for the contract and after the contract

was granted, he shall serve as the real contractor. It was held that the object of

the agreement was to commit fraud upon the railway company and therefore

the agreement was void.

6.1.4 Involves injury to person or property of another: An agreement, which is

made with the objective to injure a person or the property of a person is said to

be unlawful. Many times one party enters into an agreement with another with

the intension to harm him/her personally or to harm his /her property such an

agreement is unlawful.

Illustration: Sita’s mother who was undergoing an operation needed blood, which

was O negative. Sulochana agreed to donate blood provided Sita agreed to serve for

the rest of her life as a maid in Sulochna’s house. Sita agreed to do so. This is an

unlawful agreement.

71

A.I.R. 1930 All 732

135

Case Law 5

Ram Sarup vs. Bansi Mandar72

In this case the borrower of the money was made to execute a bond requiring

him to do manual labour until repayment, and imposes a heavy penalty on

default in the form of exorbitant rate of interest. It was held that that the

agreement contained in the bond was amounting to slavery and therefore such

an agreement was opposed to public policy and thus void.

i. Immoral: An agreement whose object or consideration is

immoral is unlawful. Morality means ethics, principles and

virtue and what is moral depends upon the standards prevailing

in a particular place. What may be moral at one place may be

immoral at the other. What is immoral has not been defined by

the Indian contract act. Immorality depends on the norms

accepted by the society at a particular point in time.

Illustration: Sonu wanted to marry Devika and Geetha was a good friend of Devika.

Sonu asked Geetha to persuade Devika to marry him. He also gave Devika rupees

twenty thousand as consideration. Geetha could not persuade Devika to marry Sonu.

Sonu asked Geetha to return the consideration. But as the object of the agreement

was immoral therefore it was a void agreement and so Sonu could not claim the

consideration.

Case Law 6

Bai Vijli vs. Nansa Nagar73

Bai Vijli (the plaintiff) advanced loan to Nansa Nagar (the defendant) who

was a married woman to obtain divorce from her husband and then marry him.

It was held that the object of the agreement was immoral therefore the plaintiff

was not entitled to recover the loan advanced from the defendant.

72

I.L.R. (1915) 42 Cal. 742. 73

(1885) 10 Bom. 152

136

ii. Opposed to public policy: The concept of public policy is a

changing concept, it keeps on changing from generation to

generation, and from time to time.

Case Law 7

Oil and Natural Gas Corporation Ltd. Vs. AW Pipes Ltd74

In this case the Supreme Court of India observed that the concept of public

policy is a vague concept and it is used sometime in a narrower sense and

sometimes in wider sense depending upon the context in which it appears.

An agreement is opposed to public policy when it is against public interest or

harmful to the welfare of the public. There is no precise definition of public

policy. Public policy just means an act, which is injurious to the interest of

society. An agreement if against the social or economic interest of the

community is considered as opposed to public policy. The following are some

cases where the agreements are considered to be against the public policy:

(1) Agreement to stifle prosecution:

The main purpose of the judiciary is to punish the guilty. Agreements, which

are made to save the guilty from being punished, are agreements to stifle

prosecution and thus such agreements are opposed to public policy.

Illustration: Sunder killed Jeetendra and Anita witnessed the killing. Anita was

offered rupees two crores to give false witness. This agreement is unlawful and

opposed to public policy.

Case Law 8

Windhill Local Board vs. Vin 75

In this case it was held that any compromise to frustrate an action against a

criminal would be deemed to be unlawful. Acceptance of consideration to

74

(2003) A.I.R. S.C. 2629 75

(1890) 45 Ch. D. 357.

137

make a compromise to frustrate action against a criminal will amount to taking

a bribe. Thus such agreements are stifling prosecution and hence are unlawful.

(2) Agreement of maintenance and Champerty

Maintenance means aiding a party in civil proceedings by providing financial

or other assistance without having any interest in the litigation. Such

intermeddling is unlawful. Champerty means aiding a party in civil

proceedings to receive a share in the gain made in the proceedings. Champerty

is a kind of a bargain where one party is to assist the other in recovering the

property and then sharing the proceeds of the action. When the person

assisting and the person assisted have a common interest in the proceedings

maintained, then it is not unlawful.

Illustration: Raghuveer and Rakesh were two brothers. Their father died without

writing a will. After their father died Rakesh occupied the ancestral property without

letting Raghuveer having any share in the property. Raghuveer was quite poor and

did not have enough money to fight the case. Sukul was a rich man and he promised

Raghuveer to finance his Court case against Rakesh provided Rahguveer would make

him a joint owner in the property once he won the case. The agreement between Sukul

and raghuveer is unlawful because it is an agreement of champerty.

Case Law 9

Khaja Moinuddin Khan vs. S.P. Ranga Rao76

In this case there was an agreement between Khaja Moinuddin and Ranga Rao

where they decided that Moinuddin would finance Ranga Rao’s litigation for

acquisition of land and in return if Ranga Rao won the land then he would pay

40% of the total compensation of the land to Khaja Moinuddin or alternatively

would pay 40% of the sale proceeds if the land was sold. It was held that the

said agreement was champertous in nature and so was void.

76

A.I.R. 2000 A.P. 344.

138

(3) Trading agreement with an enemy

It is unlawful and against public policy for men to trade with other men who

are citizens of enemy countries (The country with whom the country is at

war). They can very well enter into agreements after the war has ended but

any contract entered into before the war becomes void during the war.

Illustration: Rahim a merchant in Iraq had a business associate Thomas in the USA.

They both did business dealings with each other. Soon America declared war with

Iraq as a result all the contracts between Rahim and Thomas became void.

Case Law 10

Ertel Bieber & Co. vs Rio Tinto Co.77

In this case it was held that if agreements with the enemy country are not

made unlawful, then the commercial transactions between the two countries

might have the effect of promoting economic interest of the enemy country

and prejudicing the interest of one’s own

(4) Marriage brokerage contract

These are contracts under which a person agrees to materialize a marriage

between two people on some consideration. The consideration may be in cash

or kind and taking consideration amounts to a brokerage, for fixing marriage

between two people and therefore the agreement becomes unlawful.

Illustration: Rana Raushan Singh agreed to get his son married to the daughter of

Raghuveer Singh provided Raghuveer Singh transferred 10 acres of land in the name

of Rana Raushan Singh. The marriage was solemnized but Raghuveer Singh did not

transfer the property. As the agreement is opposed to public policy and hence void

therefore Rana Raushan Singh cannot sue Raghuveer for breach of contract.

77

(1918) A.C. 260.

139

Case Law 11

Dholidas Vs. Fulchand78

In this case it was held that if the father of a boy or a girl is to be paid some

money in consideration for his agreement to give his son or daughter in

marriage, the agreement is opposed to public policy and therefore void.

(5) Agreement tends to injure the public service

Agreements to buy a public office through bribing are against public policy.

Such agreements are not only opposed to public policy but are also unlawful.

Anybody found to be accepting bribes is punishable. Such agreements hinder

free and fair selection of qualified persons for an office.

Illustration: Sandhya applied for a job of a teacher in a public school. She promised

to pay Mrs Puri the principal rupees fifty thousand for selecting her for the post.

Interviews were held and Sandhya was selected but she did not pay Mrs Puri the

promised amount. Mrs Puri cannot claim the money because the agreement is void as

it is opposed to public policy.

Case Law 12

N.V.P. Pandian Vs. M.M. Roy79

Pandian paid a sum of rupees 15,000 to Roy for using his influence in the

selection committee to get a seat for Pandian’s son in the medical college.

Pandian’s son could not get a seat and so Pandian filed a suit against Roy for

the recovery of money. It was held that the agreement was opposed to public

policy and was void therefore Pandian was not entitled to claim the money

back.

78

(1898) 22 Bom. 658 79

AIR 1979 Mad. 42.

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6.2 CONSIDERATIONS AND OBJECTS THAT ARE UNLAWFUL IN PART

An agreement having an unlawful object or an unlawful consideration is void. Section

24 of the Indian contract act states that 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. However if there are two parts in a contract

and the consideration or the object of one part is unlawful and if that part can be

separated from the other part, which is lawful then the lawful part of the contract is

enforceable in the Court. If the two parts are inseparable and it is not possible to

separate lawful from unlawful then the whole agreement is void.

Each part of Section 24 is explained below:

If any part of a single consideration for one or more objects is unlawful, the

agreement is void. This can be explained with the help of the following illustration:

Cynthia wanted to buy a diamond necklace from Rajni. She agreed to pay rupees two

lakh for the necklace, which she would get from stealing her aunt. The object of the

agreement is valid but the consideration is partly unlawful. It is partly unlawful

because the consideration, which is rupees two lakh would be procured by stealing

and stealing is unlawful. Hence the agreement is void.

If any one or any part of any one of several considerations for a single object is

unlawful, the agreement is void. This is explained with the illustration below:

Cynthia wanted to buy a diamond necklace from Rajni. Rajni agreed to sell the

necklace to Cynthia provided Cynthia paid rupees fifty thousand in cash and slapped

Cynthia’s neighbor Agatha. There are two parts in the consideration. One of the parts

which is slapping the neighbor is unlawful therefore the agreement is void.

If there are two parts in a contract and the consideration or the object of one part is

unlawful and if that part can be separated from the other part, which is lawful then the

141

lawful part of the contract is enforceable in the Court. This is explained with the

illustration below:

Cynthia wanted to buy a diamond necklace from Rajni. Rajni agreed to sell Cynthia

the necklace for rupees fifty thousand. Cynthia agreed to buy the necklace but she did

not have money so she asked Rajni to give her the necklace on credit. Cynthia

promised to return the money to Rajni with interest in five years. Cynthia happened to

be a minor. She took the necklace and did not pay the money to Rajni. There are two

parts in the contract. In one part Cynthia is a buyer and Rajni a seller. Here Cynthia

is a beneficiary and an agreement with a minor who is a beneficiary is a valid

contract therefore this part of the contract is valid. However in the second part of the

contract Rajni is the creditor and Cynthia a debtor. An agreement with a minor is

valid only if he/she is a beneficiary. In this case the minor is a debtor hence the

agreement is void. Hence Cynthia is under no obligation to return the money.

If the two parts are inseparable and it is not possible to separate lawful from unlawful

then the whole agreement is void. This is explained with the illustration below:

Cynthia wanted to buy a diamond necklace from Rajni. The diamonds she wanted in

the necklace had to be smuggled. Rajni got the diamonds smuggled from Rita in

Dubai for rupees one lakh. She agreed to sell Cynthia the necklace for rupees two

lakh. The contract between Rajni and Rita is illegal and although the agreement

between Cynthia and Rajni is not illegal yet the illegality of using smuggled diamonds

cannot be separated from their agreement hence the agreement between them is void.

6.3 POINTS TO REMEMBER

What objects and considerations are unlawful (Section 23)

Forbidden by law

Defeat the provisions of law

Fraudulent purpose

Involves injury to person or property of another

Immoral

142

Opposed to public policy

Opposed to public policy

Agreement to stifle prosecution

Agreement of maintenance and Champerty

Trading agreement with an enemy

Marriage brokerage contract

Agreement tending to injure the public service

Considerations and Objects that are unlawful in part (Section 24)

Any part of a single consideration for one or more objects is unlawful, the agreement

is void

Any one or any part of any one of several considerations for a single object is

unlawful, the agreement is void

Two parts in a contract and the consideration or the object of one part is unlawful and

if that part can be separated from the other part, which is lawful then the lawful part

of the contract is enforceable in the Court

Two parts are inseparable and it is not possible to separate lawful from unlawful then

the whole agreement is void

6.4 QUESTIONS

Match the following

1 Forbidden by law a Injurious to society

2 Void agreements b Prohibited by law

3 Immoral c Agreement with a minor

4 Opposed to public policy d Ethics, principles and values

143

Answers: 1b, 2c, 3d, 4a

Practical Problems

1 Ghunghroo gave rupees fifty thousand to Anil to beat up her neighbor

Krishna. Anil does not beat Krishna. Is Anil liable for the promise he made to

Ghungroo?

Answer: No, Anil is not liable because the agreement between Ghungroo and

Anil is an agreement forbidden by law.

2 Rani sold her mobile to Kavya without disclosing that its speaker is defective.

Is this a valid contract?

Answer: No, this is not a valid contract because Rani’s intension is to defraud

Kavya and an agreement, which is made for fraudulent purpose is void.

3 Sandhya had her birthday party on the terrace. She had hired Rocky the DJ to

play music in the party at night. She paid him rupees five thousand for playing

music at night. Rocky played music in the party but after 12 A.M. stopped

playing music. Sandhya insisted that Rocky continued playing music or else

returned the money she had paid him. Is Rocky liable to return the money?

Answer: No, Rocky is not liable to return the money because playing music

publicly after 12 at night is against public policy.

4 Rakesh promised to marry his son with Ramu’s daughter provided he paid

rupees five lakh in cash. Ramu agreed to pay but soon after the marriage

Ramu refused to pay the money. Can Rakesh sue Ramu for breach of

contract?

Answer: No, Rakesh cannot sue Ramu for breach of contract because the

agreement between them is void. The agreement between them was a marriage

brokerage agreement, which is opposed to public policy therefore the

agreement is void.

5 Ghanshyam had applied for a job of a schoolteacher and to get the job he paid

the head master of the school rupees ten thousand. Ghanshyam did not get the

job. Can Ghanshyam get the money back from the head master?

Answer: The agreement he had with the head master was tending to injure the

public service which is against public policy therefore the agreement was

void. As a result Ghanshyam cannot get the money back from the Headmaster.

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Questions:

1 What is the difference between illegal agreement and void agreement? Explain

with the help of illustrations.

2 Which are the agreements that are opposed to public policy? Explain with the

help of illustrations

3 Elucidate ‘considerations and objects that are unlawful in part’.

6.5 REFERENCES

1 Bangia R.K. (2002): Indian Contract Act, Allahabad Law Agency, Faridabad

2 Kuchhal M.C. (2005): Business Law, fourth edition, Vikas Publishing House,

Delhi

For more information refer the following websites

http://en.wikipedia.org/wiki/Illegal_agreement

http://www.reportbd.com/articles/40/5/Legality-of-Object-and-

Consideration/Page5.html

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Lesson – 7

VOID AGREEMENTS

by

Preeti Singh

This chapter will give an understanding of the

Following aspects of void agreements:

7.1 What is a Void Agreement?

7.2 Agreement by minor or persons of unsound mind

7.3Agreements without consideration

7.4 Agreements in Restraint of Marriage

7.5 Agreements in Restraint of Trade

7.6 Agreements in Restraint of Legal Proceedings

7.7 Agreements with Uncertain Meaning

7.8 Wagering Agreements

7.9 Agreements to do Impossible Acts

7.1 WHAT IS A VOID AGREEMENT?

Section 2 (g) of the Indian Contract Act, states that a void agreement is one, which is

not enforceable by law. A void agreement does not create rights, obligations or duties.

It does not give rise to any legal consequences. Such agreements are void ab initio.

The courts can only enforce those agreements that according to Section 10 fulfill the

conditions of the Indian Contract Act. It should not be declared void by any law in the

country. There is a difference between void agreements and void contracts.

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Void Agreement

! A void agreement is not valid.

! The agreement is not enforceable by law.

! It is void from the very beginning of making the agreement.

! The following agreements are expressly declared as void by the Indian

Contract Act:

! Agreement by a minor or a person of unsound mind.[Sec(11)]

! Agreement of which the consideration or object is unlawful[Sec(23)]

! Agreement made under a bilateral mistake of fact material to the

agreement[Sec(20)]

! Agreement of which the consideration or object is unlawful in part and

the illegal part can not be separated from the legal part [Sec(24)]

! Agreement made. without consideration.[Sec(25)]

! Agreement in restraint of marriage [Sec(26)]

! Agreement in restrain of trade [Sec(27)]

! Agreement in restraint of legal proceedings[Sec(28)]

! Agreements the meaning of which is uncertain [Sec(29)]

! Agreements by way of wager [Sec(30)]

! Agreements contingent on impossible events [Sec(36)]

! Agreements to do impossible acts [Sec(56)]

Void Contract

! Void contract is valid when it is entered into but after it is formed due to some

limitation it becomes non enforceable.

! Void contract is enforceable by law but due to impossibility or illegality it

becomes unenforceable at a later date.

! A void contract remains valid until its validity stops functioning.

147

7.2AGREEMENT BY MINOR OR A PERSON OF UNSOUND MIND

A minor can be defined as a person who has not completed his or her 18 years of age.

Law acts as the guardian of minors and protecting their rights, as it is believed that

their mental facilities are not as matured as a person above 18 years of age. A minor

does not have the capacity of judge whether the agreement should be entered into or

what would be his obligations to the contract. Therefore an agreement with a minor

involving his obligations and the other contracting party who requires enforcement of

those obligations is deemed as void.

A person of unsound mind does not have the mental powers or mental condition

under his or her own control. Any agreement entered into by person of unsound mind

void

Illustration 1: Madhu made an agreement to buy a house of Rs

80,00000 with Sonu who is 11 years of age. The agreement is void

Illustration 2 Singla is a mentally depressed man. He made an

agreement with Shanti to marry her. This is a void agreement.

7.3AGREEMENT MADE WITHOUT CONSIDERATION

An agreement made without consideration is void, except in the following cases:

(i) It is registered and is in writing under the law enforceable at the time and

registration of(documents), is amongst near relations due to natural love

and affection between parties.

(ii) It is a promise to compensate, another person fully or partly that has

already voluntarily done something for the promisor, or something that the

promissory was legally compellable to do.

(iii) It is a written and signed promise, by the person to be charged or his agent

authorized by him, to pay whole or in part a debt of which the creditor

might have enforced payment but for the law for the limitation of suits.

Illustration 1: Sukrita promises to give Nirmay Rs. 20,000. There was no

consideration and they were not related to each other. This is not a valid agreement.

148

Illustration 2:Sunita gives her daughter Rs 2,50,000 as

part payment for her car. She gives this promise in

writing and registers it also. This is a contract of natural

love and affection.

7.4AGREEMENT IN RESTRAINT OF MARRIAGE

According to Section 26, an agreement that is in restraint of marriage is void.

However, this rule does not apply to restraint of a minor from marriage.

Law does not allow any restriction on the freedom of a person’s choice or freedom in

selecting a marriage partner.

Illustration: Lata agrees to marry Rahul because her parents did not allow her to

marry Kiefer, a foreigner, who is a German gentleman. This is a restriction on choice

of marriage and is a void agreement.

The agreement is void if the restraint to marry another is partial or general. From this

it follows that an agreement to marry a certain person or not to marry at all or to

marry for a particular period of time is a void agreement. However a promise to marry

a certain person is a valid contract and does not depict any restraint in marriage.

Illustsration: Anika wants to marry Gautam only and no one else. This is a choice

and there is no restraint in marriage. This is a valid contract of marriage.

7.5AGREEMENTS IN RESTRAINT OF TRADE

Any agreement that restrains a person from following a lawful profession, trade or

business is void according to section 27 of the Indian Contract Act. Restraints on skill

or talent or work of a person are void contracts. The constitution (Article 19) states

that it is the fundamental right of a person to be at a liberty to work and not deprive

himself, of his fruits of labour by entering into a restraining contract.

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The effect of agreements in restraint of trade is that they are always void whether they

are partial or general, qualified or unqualified; whether they are for a limited period or

extend over a particular area of work. However there are certain statutory exemptions.

Case Law 1

Madhub Chander V Raj Coomar.80

In this case two people A and B were

neighbouring shopkeepers. They were rivals. B agreed to pay A an amount of money

for closing his business located near his shop. A closed his business. B refused to pay

the agreed amount. The court held that the agreement was void.

Statutory and Judicial Interpretation- Exceptions

There are certain statutory or judicial exceptions to the rule that restraint of trade is

void.

In the following cases restraints will not affect the validity of an agreement:

Statutory Exceptions:

! Sale of goodwill.

! Exceptions under Partnership Act.

Exceptions under Judicial Interpretation:

! Trade combinations

! Sole dealing agreements and

! Restraints on employees.

7.5.1 Statutory Exceptions

(a) Sale of goodwill: The seller of a business can put some restrictions on himself. He

may agree not to continue with the same products in business or restrict the area of

operation. The restrictions have to be reasonable. They are applied to protect the

buyer of the business.

Illustration: Shanti sold her drycleaning business in Sarva

priya Vihar to Sushant. She agreed not do similar business

in the same area for 15 years as a condition of the sale.

80

(1874) 148 LR 76

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This is not a reasonable restriction and it can be contested

in a court.

(b) Exceptions under Partnership Act: The following exceptions pertain to the Indian

Partnership Act under restraint of trade. These restraints are required to carry out

business or trade. They do not affect the validity of the agreement.

! Continuing partner: A person is not allowed to carry out any other

business while he is continuing as a partner of a firm.

! Outgoing partner: A partner may agree not to do business that was

similar to the firm in which he had been a partner. He may agree not to

conduct business in a particular area or during a specified period of

time. However the restraint should be reasonable for the agreement to

be valid.

! Dissolution of firm: When a firm is dissolved some or all the partners

may be restrained from doing the same business so that none of the

partners are under any disadvantage.

! Sale of goodwill of firm: A partner may be restrained from doing

business in the same area or within a specified period as the

partnership firm. The agreement will be valid if the restrictions are

reasonable.

7.5.2 Exceptions under Judicial Interpretations

(a) Trade Combinations: A combination of trade organizations for monopolizing

trade are against public interest and are void but trade combinations that are formed

for regulating business, fixing prices, creating quality in products, standardization and

market timings are not void agreements. If however, these combinations have

unreasonable restrictions on members the combinations will be null and void There

are several judicial cases.

Case Law 2

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Bhola Nath Shankar Das v Lachmi Narayan 81

., Allahabad High court an association

of traders’ restricted dealing with outsiders providing several penalties as

restrictions. The legality of the decision was challenged that the combination had the

aim of creating monopoly. However, the court stated that agreement was valid as

every traded was allowed to carry on business according to his choice.

Illustration 1: Kalu, Shamu, Shashi and Prateek decided to avoid competition and

create a monopoly house of wool for exports from a small town in Punjab. Their

agreement to combine is a trade combination which creates monopoly. It is against

public interest. Hence, it is void.

Illustration 2: Kavi, Kali, Anupriya and Kanupriya decide to fix a uniform rate for

selling their accessories at an exhibition to divide the profits amongst themselves.

This agreement is valid because it is not a restraint of trade, nor is it against public

policy.

(b) Sole dealing agreements: Manufacturers usually appoint a distributor or an agent

for selling goods in a particular area. The agent stocks only goods of that particular

organization as a part of agreement between them. As long as there is a fair and

reasonable agreement between the two parties it is an understanding of terms of

business and advantages to both the parties to increase their business. However, if it is

detrimental to the interest of one of the parties it becomes objectionable and such

agreements become unenforceable

Case Law3

In Shaikh kalu v Ram Sharan Bhagat82

. A seller of combs entered into a contract to

sell to another person and to his heirs all the combs produced and not to sell it to

anyone else This was considered to be a void agreement as it was oppressive and was

with the intention of creating a monopoly.

Illustration 1: Sita agrees to supply uniforms to a school and the school promises not

to buy goods from any other person for a fixed period of time. This is a valid

agreement.

81

(1931) All L. J. 84, 82

(1908) 8 C. W. N., 388.

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Illustration 2: Ram enters into an agreement with Shyam to supply mosquito nets to

his hostel. Shyam was to give this product all his life to the hostel and no other

parties. This is a void agreement because it restricts the right of a person to do

business with other parties all his life. If the agreement of supply was for a fixed

period it would be reasonable.

(c) Restraints upon employees: Some employers prevent them employees from

working in other organization while in employment with them. The employee can be

restrained from carrying on business which is in competition with the employers

company or a servant can be restrained by his master from allowing him to divulge

secrets of his business. There are many forms of restrains between the employer and

employee. As long as these are reasonable, depending on the facts and circumstances

of the case the agreement will not be void because it is justified as it protects the

employer’s goodwill.

Case Law4

Deshpande v Arvind Mills Ltd 83

. A person took employment as weaving master for

three years and agreed not to take a similar assignment anywhere in the world for

three years, this was considered to be a valid agreement.

In restraints upon employees it is implied that a former employee should not use the

trade secret of his master while competing in future possible contracts. However,

restriction should be reasonable and after the expiry of period of service, restraints

will be void.

Illustration 1: Manu was restrained by his employer not to divulge his trade secrets

to his competitors as he was sure that he would get the contract to build the new

airport. This is a valid agreement as it is a reasonable restraint of terms of service.

Illustration 2: Manju was working in Taj Palace Hotel as a

manager. She was restrained by the hotel to offer her services

to other hotels while in service. This is a valid agreement as

it is reasonable and fair. It is part of the service agreement.

83

In. (AIR 1946 Bom. 423).

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7.6 AGREEMENTS IN RESTRAINT OF LEGAL PROCEEDINGS

Every person has a right to take recourse to legal proceedings in a court of law when

there is a conflict with another person. If a party is restricted to use this right the

agreement will be void (Section 28).

Two types of agreements restraining another person from legal proceedings are void.

These are the following:

" Agreements restricting parties from enforcing the legal rights under the

contract.

" Agreements limiting the time within which a party can enforce contractual

rights.

(a) Agreements on Legal Proceedings: Any agreement which restricts a person from

enforcing his right in the court is void.

Illustration: Sita sold 1000 parker pens to Geeta for Rs. 300 each. She has a right to

receive the payment from Geeta otherwise she has the right to file a suit in the court

to get the payment.

If Sita makes an agreement will Geeta that she will never go to court for receiving the

payment even if she is not paid, the agreement is void.

Restraint on legal proceeding should be complete and not partial for making the

agreement void.

(b) Limitation of time: An agreement is declared void when parties restrict the time

within which an appeal can be made. The period of limitation prescribed by law is

three years from the date of breach. If there is a clause that a party cannot go to court

after two years for recourse to a law court the agreement becomes void as it is not in

accordance with the law of limitations.

Illustration: Braj supplied material to Dhanuj. They may an agreement that if Braj

does not receive the payment he can go to court within two years for suing the other

party. Otherwise he will not have a right to go to court. This is a void agreement.

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7.6.1 Exceptions to Restraint in Legal Proceedings (Section 28)

In the following to cases in which the agreement is not void when it is in restraint to

legal proceedings.

When a reference is made to future disputes for arbitration.

Illustration: Leela entered into an agreement with Mila for supplying 14 computers

every month for six months for Rs. 35,000 per computer. It was agreed that both

parties would have a right to go in for arbitration if there was any dispute regarding

price or quality of the computer. This is a valid agreement.

When a reference is made of existing disputes for arbitration:

Illustration: Reeta makes an agreement with Sunny to sell a watch for Rs. 5,000.

Sunny refuses to pay the price on delivery as promised earlier. Both the parties

agreed to go in for arbitration. This is a valid agreement.

7.7 AGREEMENTS WITH UNCERTAIN MEANING

Agreements whose meanings are not clear so that there is uncertainty creating

confusion between people is a void agreement.

Section 29 states that agreements the meaning of which is not certain or capable of

being made certain are void.

Illustration: Kamal agrees with Aditya to send 100 tea packets for Rs. 50,000 to his

landlord. Kamal sends green tea because Aditya had not specified any brand.

However, it was unacceptable to the landlord who refused payment stating that he

had asked for some other tea. Since this was an uncertain agreement which did not

state the quantity in terms of kilo weight, not did it state the kind of tea it is a void

agreement. However, if the court can understand the meaning of tea the agreement

will become valid. Therefore, if Kamal was a dealer of green tea only the agreement

would be valid.

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An agreement that makes a contract in future is void. The logic of this is that the

agreement is uncertain whether the parties to agreement will able to agree to the terms

of the contract in future.

Illustration: Madhu gave her friend Neelam Rs. 10,000 as payment for her old

computer. However, he went away on a trip to a foreign country without taking the

computer making in agreement that Rs. 10,000 should be treated as a deposit. Later

Madhu wanted her money back to which Neelam refused. What kind of an agreement

is this? This is a void agreement because it is a full of uncertainties about the time,

value and price of the computer to be purchased.

7.8 WAGERING AGREEMENTS

A wager is explained by Sir William Anson as promise to give money or money’s

worth on determining or ascertaining an uncertain event. In a wagering contract it is

necessary that each party should either lose or win depending on a certain event.

Therefore, the event is uncertain and it most affects both the parties, if only one of the

parties is affected it is not a wagering contract.

Wagering agreements have the following essential features;

(a) Uncertain event: A wagering agreement is dependent on an uncertain event

that may or may not happen. It pertains to the happening of some future event.

It can also be dependent on some past event whose result is not known. An

example may be of a possible winner of a cricket team of a match that is still

to happen.

(b) Mutual loss or gain: In a wager agreement both the parties have an equal

chance to win or lose. The gain / loss may or may not be equal but it is

necessary that both have the chance. If one of the parties can only win but

there is no possibility of its losing and the other party does not have the same

possibility it will not be a wager agreement.

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(c) The event is beyond the influence of the parties: Wagering agreements can

not be influenced by any of the parties to the agreement. If one of the parties

knows the outcome of the event, the agreement is not a wager.

Illustration: Meenu, Rajiv, Suraj and Veena

decided to run a 5 Kilometers Cycle race. Leena

promised to give the winner Rs. 5,000. Meenu won

and got the prize money. This is a wagering

agreement.

(d) No other interest in the event: The parties to a wagering agreement should

only have the interest in wining or losing. If any of the parties has any other

interest in the agreement it will not be called a wagering agreement.

Illustration: Rekha promises to pay Sikha Rs. 7,500 if it rains on Thursday. Sikha will

pay Rekha Rs. 7,500 if does not rain on Thursday, this is a wagering agreement.

7.8.1 Consequences of Wagering Agreements

Wagering agreements have the following legal position under Section 30 of the

contract Act;

1. Wagering agreements are void and unenforceable but they are not forbidden

by law. However, money cannot be recovered from a loser in a wagering

agreement.

2. Wagering agreement are not illegal. Therefore collateral transactions are valid

and unenforceable in a court of law. Therefore, if money is borrowed in a

collateral transaction, it is payable.

3. In India in Maharashtra and Gujrat wager agreements are considered to be

illegal. Therefore, no money can be recovered from either party.

4. If two parties have entered into a wagering agreement and have deposited

money with a third person the winner / losing party can recover only their

share of the stake money.

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7.8.2 Exceptions

There are certain exceptions to the rule that wagers are void.

1. Horse racing: If an agreement is made for contributing towards prize money

or momento of the value of Rs. 500 or more to the winner of a horse race, it is

not void.

2. Crossword competition: Competitions relating to application of skill or

intelligence are not wagering agreements but if prizes are given on the basis of

a chance factor, the agreement is a void.

7.8.3 Special Transactions

a. Lottery: A lottery is a wagering agreement because the chances of gain or loss

are equal depending on a future event but prize money cannot be recovered

through a court of law. Lotteries are void an illegal but the rule does not apply

to state authorized lotteries.

b. Speculation: A speculative transaction is like a wagering agreement because it

is based on the intention of settlement of price differences and not actual

delivery of a product, this is void and illegal. If delivery of the goods is taken

it will be an ordinary commercial transaction and a valid agreement.

7.8.4 Contracts of Insurance and Wagering Agreements

A wagering agreement is quite similar to that of contracts of insurance but wagering

agreements are void and contracts of insurance are not void. The following

differences can be noted between wagering agreements and insurance contracts.

(e) Interest in winning / losing: In a wagering agreement the parties do not have

any interest in the agreement except that of being rewarded or losing. The

contract of insurance protects the insurable interest of the insured person.

(f) Chance factor: In a wagering agreement there is an equal chance of gain /

loss. In insurance, the insured person gets compensation after a certain time

period or on the happening of certain event.

(g) Calculation: A wagering agreement is not calculated scientifically. It is a

gamble and it is void. An insurance premium is scientifically calculated and

based on scientific principle.

(h) Usefulness: A wagering agreement is an unhealthy practice. It is void.

Insurance contributes to social benefit and welfare of the society.

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7.9 AGREEMENTS TO DO IMPOSSIBLE ACTS

An agreement to do an impossible act is void according to Section 56. The impossible

act should be while entering into a contract or subsequently but before it is performed.

Such a contract is void ab initio. If the promisor has the knowledge that the contract is

impossible he must pay compensation to the promisee for loses due to non

performance of promise.

Illustration: An agreement to take tourists to Canada and bring them back to India in

15 hours is an impossible task. The agreement is void.

When a person promises to do an act that is legal and subsequently promises to do

certain

illegal acts, then the first part of the agreement is valid but the second is a void

agreement.

7.9.1 Restitution

When a contract is void no party is required to perform it but if a party has received a

benefit must restore it or compensate the other party. This rule is based on the

principle of justice and equity that no person should be allowed to get the benefit at

the expense of another.

7.10 Points to Remember

Void Agreements

A Void agreement is not enforceable by law (Section 2g).

The Following Agreements are Void

! Agreement with minor or a person of unsound mind.

! Agreement made without consideration.

! Agreements in Restraint of Marriage.

! Agreements in Restraint of Trade.

! Agreements in Restraint of Legal Proceedings.

! Agreements with Uncertain Meaning.

! Wagering Agreements.

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! Agreements to do Impossible Acts.

Agreements in Restraint of Marriage

! Freedom in marriage is encouraged. Therefore any agreement restraining it is

void.

! This law does not apply to a minor. An agreement restraining a minor is

valid.

Agreements in Restraint of Trade

! Restraint of trade partial or complete is void but there are the following

exceptions to the rule.

! Sale of goodwill, partner’s agreements, trade combinations and service

agreements.

! Partners agreements are not void when (a) continuing partners are restrained

from doing other business, (b)when a partnership is dissolved then one or

more partners may not do the same business (c) retiring partners are

restrained for a period of time to do similar business in the same locality or

area of operation.

! Trade combinations to regulate business are valid but combinations for

creating a monopoly are negative and the agreements are void.

Agreements in Restraint of Legal Proceedings.

! When people are restrained to go to a court of law for recourse in case of

non-fulfillment of the terms of the agreement it is a restraint of a

fundamental right of a person. The agreement is void.

! However, agreements on arbitration of a dispute are valid.

Agreements with Uncertain Meaning

Agreements whose meanings are not clear and the court cannot with certainty find

out the correct meaning of the agreement because of its uncertain terms regarding,

date, quality or time of the contract they are void.

Wagering Agreements

! Wagering agreements are a promise to pay money or moneys worth on the

happening of a certain event. The event and result is unknown to both the

parties. They are void agreements.

! There are certain exceptions like prize money for horse racing or games of

skill like crossword puzzles that are valid agreements.

! Special transactions like lotteries are void and illegal except if they are

160

authorized State run lotteries.

! Speculative trading is void if it is for payment of differences only but if it is a

genuine commercial dealing it.

! Insurance contracts are not wagering agreements although they appear to be

similar there are lots of distinctions between them. Insurance contracts are

valid contracts.

Agreements to do Impossible Acts

An agreement to do an impossible act is void ab initio.

Objective Type Questions

Match the following

1 Wagering agreement

2 Restraint in marriage

3 Insurance contract

4 In Maharashtra and Gujrat

5 Agreements restricting

rights

6 Trade combination

7 Sole dealing agreements

8 Void due to meaning

9 Game of skill

10 Magic

a. Valid when reasonable

b. Valid contract

c. Mutual chance of gain / loss

d. Restraint in legal proceedings

e. Valid for regulating business

f. Is a void agreement

g. Wagers are illegal

h. Impossible Act

i. Uncertain quantity, price or quality

j. Not void

Answer: 1 (c), 2 (f), 3 (b), 4 (g), 5 (d), 6 (e), 7 (a), 8 (i), 9 (j), 10 (h).

7.11Questions

1 What is a void agreement? Distinguish between a void agreement and a

void contract.

2 What is a wagering agreement? Discuss its effects under the Indian

Contract Act.

3 An agreement in restraint of trade is void. Discuss this statement and the

exceptions in which the restraint is allowed.

4 Insurance contracts are wagering agreements. Discuss.

5 What are the essential elements of a wagering agreement? Discuss of some

of the exceptions in wagering agreements that are not considered illegal.

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6 A wagering agreement is void and unenforceable but it is not forbidden by

law. Examine this statement.

Practical Problems

1 Malti makes an agreement with Monty to sell the entire manufacture of

babies garments produced in her unit to him in the winter season of the year

2007-2008. In November, when the winter season started, Malti sold some

of the garments to her earlier dealers. Monty sued Malti for breach of

contract. Will he succeed?

Answer: He will succeed as the restraint in trade is to further business prospects and

is a valid agreement.

2 Anil agrees to lend money to Romey for making a payment on his dues in a

wagering transaction with Shankar. Can Anil recover the money lent by

him?

Answer: Anil can recover the money because it is a collateral agreement to the

wagering agreement. It is only not recoverable in Maharashtra and Gujerat

where wagering agreements are illegal.

3 Geeta agrees to buy a car for Rs 300000 from Pankaj if it runs 22 kilometers

per litre of petrol. If the car runs less than that she will pay only Rs.

1,00,000. The car failed its test. Pankaj demanded Rs 1,00,000. Geeta

refused to pay. Pankaj filed a suit against her for non- payment of the

amount. Will he recover the amount?

Answer: Pankaj will not be able to recover the amount, as it is a wagering agreement

even though it appears to be a commercial transaction.

4 Suman and Sunayna enter into a wagering agreement and deposited Rs

5,00,000 each with Shruti. They instructed Shruti to give the total sum of

money to the winner. Suman won. She sued Shruti for the stake money.

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Sunayna also sued Shruti for returning her stake in the money deposited by

her. Can the amounts be recovered?

Answer: Suman and Sunayna can both recover only the amount deposited by them

with Shruti as their stake money. However they cannot recover the money in

Maharashtra and Gujerat where a wagering agreement is void and illegal.

5 Manu and Mani are partners selling plasma televisions in a firm. They enter

into a wagering agreement with Shobha. They lose and Shobha wins. Mani

gives the money to which both Manu and Mani are liable in the agreement.

Can Mani claim the money paid by her on behalf of Manu?

Answer: Mani can claim the money from Manu as it is a wagering agreement. It is

void but not illegal. Since this is collateral agreement money can be

recovered.

6 Amar promised to buy seven coffee tins after fifteen days from Jagat and

then deliver them to Anurag. Jagat delivered the coffee tins and Amar sent

them to Anurag. However Anurag refused to take delivery as he wanted

each tin to contain 500 gms but each delivered tin contained 1 Kilo gram of

coffee. This was not acceptable to Anurag.

Answer: This is an agreement with uncertain meaning. It is void for uncertainty. The

terms are vague as the price and quantity of the product is not given in the

contract.

7 Mr. Ali agrees with Mr. Prabhat to discover a treasure by magic and

distribute it between the family members. Is this agreement valid?

Answer: Under Section 56 an agreement to do impossible acts is void and hence the

agreement is not valid.

8 Bansi appoints an officer in her firm on the condition that if he would leave

her. He would not join another company of the same type in the same area

for at least five years. Is this restraint valid?

163

Answer: The restraint is void after termination of services of an employee.

9 Poonam promised that she would marry only Anuj and no one else and if she

did not keep her word she would pay Rs. 10,00,000. Poonam married

Deepak. Anuj claimed Rs. 10,00,000 but Poonam decided not to pay. What

is the legal position?

Answer: According to Section 26, Anuj cannot recover anything from Poonam as the

agreement was in restraint of marriage.

References:

Books:

1. Singh A (2008) Law of Contract, Nineth Edition, , Pages 253-301.

Eastern Book Company, Lucknow

2. Bansal G.L. (2006) Business and Corporate Laws, Pages 61-72 Excel

Books, New Delhi,.

3.. Pathak H.S (2006) Mulla The Indian Contract Act, Pages 34 to 44 Lexis

Nexis Butterworth, New Delhi,

4 Chadha . P.R. (2001) Business Law, Pages 107-12 Galgotia Publishing

Company, New Delhi,

Websites:

! http://www.reportbd.com/articles/42/1/Void-Contract/Page1.html

! http://www.llinkslaw.com/shangchuan/2008421145012.pdf

! http://www.encyclo.co.uk/define/Void%20contract

! http://www.hba.org.my/articles/bhag_singh/2007/void_contracts.htm

164

Lesson - 8 DISCHARGE OF CONTRACT

by

Anu Pandey

This Lesson discusses the following modes of discharge of contract

8.1 Discharge by Performance

8.2 Discharge by Mutual Agreement or Consent

8.3 Discharge by Lapse of Time

8.4 Discharge by Operation of Law

8.5 Discharge by Impossibility of Performance

8.5.1 Doctrine of Supervening Impossibility

8.6 Discharge by Breach of Contract

The termination of the contractual relationship is called discharge of contract. How

the contract comes to an end or how the contractual relationship in a contract

terminates is explained through the various modes of discharge of contract. The

various modes of discharge are the following:

8.1 DISCHARGE OF CONTRACT BY PERFORMANCE

This is the best way of bringing the contract to an end. Every person who is a party to

a contract is bound to fulfill his/her obligation at the time when he/she has promised

to perform it. The moment the parties execute their promises under the contract the

contract comes to an end. This mode of discharge is called discharge by performance.

165

The performance can be of two types.

1 Actual performance

2 Attempted performance

Actual Performance:

In actual performance the parties to a contract have actually performed their promises.

They have done what they had promised each other to do under the contract. They

have fulfilled all their obligations under the contract as a result the contract comes to

an end.

Illustration: On Monday Mala offered to sell her car for rupees thirty thousand to

Sweetie and Sweetie agreed to buy the car and pay in cash by Friday evening. On

Friday evening Sweetie paid rupees thirty thousand cash to Mala and Mala gave the

car to Sweetie. Thus the contract comes to an end by discharge of contract.

Attempted performance:

In attempted performance one party offers to perform what he/she had promised but

the other party no longer wants him/ her to perform. The party who is ready to carry

out his/her obligation is excused from performing and the contract is discharged.

However he/she can sue the other party for breach of contract.

Illustration: On Monday Mala offered to sell her car for rupees thirty thousand to

Sweetie and Sweetie agreed to buy the car and pay in cash by Friday evening. On

Friday Sweetie refused to buy the car. Hence this is attempted performance. The

promisor Mala offered to execute her promise but Sweetie refused to buy it. Thus

Mala can sue Sweetie for breach of contract.

166

8.2 DISCHARGE OF CONTRACT BY MUTUAL AGREEMENT OR

CONSENT

Parties agreeing to terminate the contract can discharge a contract without

performance. They can do it by mutually agreeing to replace the old contract with a

new one. The new contract extinguishes the rights and obligations of the parties under

the old contract.

Case Law 1

Keshav Lal Lallubhai Patel vs. Lalbhai Trikumlal Mills.84

In this case the Court pointed out that the promisee cannot by a unilateral act extend

the time of performance of his own accord and for his own benefit without the

consent of the other party.

There are various ways by which the old contract can be replaced by a new one. The

various ways are as follows:

1 Novation: In this the parties to a contract agree to substitute the existing

contract with a new one. The new contract is brought about by either changing

the contract between the same parties or by changing the parties in the same

contract.

Illustration 1: Yogita offered to keep Sunita as her maid for rupees two thousand on a

monthly basis. Sunita accepted the offer and promised to start work from the first day

of next month. However Sunita met with an accident and injured her leg. She

approached Yogita and showed her reluctance to join. It was felt that it would take

about two months time for the leg to heal and after a little persuasion from Yogita

Sunita decided to join as maid after two months. In this case the old contract is

substituted with a new one and parties to the contract are the same.

Illustration 2: Yogita offered to keep Sunita as her maid for rupees two thousand on a

monthly basis. Sunita accepted the offer and promised to start work from the first day

of next month. However Sunita met with an accident and injured her leg. She

approached Yogita and showed her reluctance to join. It was decided that Sunita’s

sister Punita would replace her and would join as maid from the first day of next

84

1959 S.C. R 213

167

month. In this case the old contract is substituted with a new one where only the

parties have changed but not the terms of the contract.

2 Alteration: In this the parties agree to make some changes in one or more

terms of the contract. By doing so the old contract is discharged and the

parties are bound by the changed contract.

Illustration: Yogita offered to keep Sunita as her maid for rupees two thousand on a

monthly basis. Sunita accepted the offer and promised to start work from the first day

of next month. Afterwards Sunita felt that the emoluments were too low and that she

would not like to work at such low rates. She told her unwillingness to Yogita and

after listening to Sunita Yogita decided to increase the emoluments by rupees five

hundred. Sunita happily agreed to work for the additional rupees five hundred offered

by Yogita. In this case the parties to the contract agreed to make some changes in the

terms of contract. By doing so the old contract is discharged and the parties are

bound by the changed contract.

3 Rescission: In this the parties decide to terminate the contract before the

contract is discharged by performance. This can be done in the following

circumstances:

Rescission can take place by mutual consent. Here both the parties mutually

agree to terminate the contract.

Illustration 1 Yogita offered to keep Sunita as her maid for rupees two thousand on a

monthly basis. Sunita accepted the offer and promised to start work from the first day

of next month. However Sunita met with an accident and injured her leg. She

approached Yogita and showed her reluctance to join. It was mutually decided to

terminate the contract. Sunita was no longer bound to join as a maid from next

month.

168

Rescission also takes place when one party fails to perform his/her obligation and the

other party cancels the contract.

Illustration 2 Yogita offered to keep Sunita as her maid for rupees two thousand on a

monthly basis. Sunita accepted the offer and promised to start work from the first day

of next month. However Sunita met with an accident and injured her leg. She did not

inform Yogita about her unwillingness to join. On the first of the next month she did

not join as a result Yogita cancelled the contract.

Rescission can also take place when the contract becomes void that is that when the

contract was entered it was valid however after some time before the contract could

be executed due to some unavoidable circumstances the contract becomes void. This

could be due to war or physical impossibility.

Illustration 3 Yogita offered to keep Sunita as her maid for rupees two thousand on a

monthly basis. Sunita accepted the offer and promised to start work from the first day

of next month. However Sunita met with an accident and died. Due to impossibility of

performance the contract becomes void.

4 Remission: remission means acceptance by the promisee of a lesser

fulfillment of the promise made by the promisor. This can be done in the

following three ways:

The promisee can remit wholly or in part the performance of the promise

made to him/her by the promisor. If the promisor has performed less than what

he/she had promised and the promisee accepts it without complaining then this

is called discharge of contract by remission.

Illustration 1: Yogita offered to keep Sunita as her maid for rupees two thousand on a

monthly basis. Sunita accepted the offer and promised to start work from the first day

of next month. Sunita worked for a month and at the end of the month Yogita paid

Sunita rupees fifteen hundred. This was less than the amount initially promised by

Yogita. Sunita accepted the reduced emoluments without any complaint.

169

The promisee can extend the time for performance. If the promisor does not

fulfill his/ her task within the time promised then in that case instead of suing

the promisor for non-performance the promisee can extend the time of

performance for the promisor.

Illustration 2: Yogita offered to keep Sunita as her maid for rupees two thousand on a

monthly basis. Sunita accepted the offer and promised to start work from the first day

of next month. Sunita worked for a month and at the end of the month Yogita paid

Sunita rupees fifteen hundred. This was less than the amount initially promised by

Yogita. Sunita accepted the reduced emoluments and told Yogita to pay the remaining

balance of rupees five hundred within fifteen days.

The promisee can accept any other satisfaction instead of performance.

Sometimes the promisor does something else than what he/she had promised

and the promisee accepts that without any objection.

Illustration 3: Yogita offered to keep Sunita as her maid for rupees two thousand on a

monthly basis. Sunita accepted the offer and promised to start work from the first day

of next month. Sunita worked for a month and at the end of the month Yogita gave

Sunita a silk saree worth rupees two thousand. This was not the consideration

promised by Yogita. However Sunita accepted the saree without any complaint.

5 Waiver: In this case the promisee entitled to claim performance from the

promisor might waive the performance. He no longer wants the promisor to

execute his/her performance and therefore the promisor is no longer under any

obligation to perform his/her promise.

Illustration: Yogita offered to keep Sunita as her maid for rupees two thousand on a

monthly basis. Sunita accepted the offer and promised to start work from the first day

of next month. The very next day Yogita forbade Sunita from working as a maid. Thus

Sunita is no longer under any obligation to perform her promise.

170

8.3 DISCHARGE BY LAPSE OF TIME

A contract is to be performed within a reasonable period. If the contract is not

performed within that period then the contract comes to an end and no legal action

can be taken by the promisee after that. In case of contracts the period of limitation is

three years. If none of the parties file a suit within this time, the contract becomes

time barred. Once the contract becomes time barred the contract becomes

unenforceable. It cannot be enforced in the Court of law.

Illustration: Jhankar took a loan of rupees ten thousand from Gurmeet on first

January 2005. She was to repay the loan with interest on first January 2006. Gurmeet

went to the United States in October 2005 and Jhankar did not repay the loan money

on first January 2006 to Gurmeet. Three years elapsed and Gurmeet did not take any

legal action against Jahnkar for non-payment of loan. Thus the debt became time

barred.

8.4 DISCHARGE BY OPERATION OF LAW

At times law discharges the contract, i.e. the law regards the contract as terminated. In

the following cases law regards contract as discharged.

1 Death: When in a contract the performance of the contract is to be made

personally by the promisor and his/her skill and knowledge is required for

discharging his/her obligation in such a case if the promisor dies then

automatically the contract comes to an end. Law discharges the contract. If the

personal skill and knowledge of the promisor is not required in discharging the

contract then after he/she dies the contract is not discharged and the rights and

liabilities of the deceased promisor passes on to his/her legal representatives

and it is the duty of the legal representatives to discharge the obligations under

the contract.

Illustration: Heeralal promised to make a painting of Santosh on her birthday. Before

Santosh’s birthday Heeralal died of a heart attack. Hence the contract terminated and

Hiralal was discharged of all his liabilities.

171

2 Insolvency: Once a person has been declared insolvent by the Court of law he

/ she is released from all the liabilities. The contracts, which were entered by

him / her before being adjudicated as insolvent are discharged after he/ she

becomes insolvent.

Illustration: Jeetendra entered into an agreement with Radhika to buy thousand shoes

manufactured by Radhika in the first week of March. In the month of February

Jeetendra was declared insolvent as a result the contract between him and Radhika is

dissolved and Jeetendra is released from his liability to buy shoes from Radhika.

3 Merger: In this case the contract giving inferior rights to a person merges into

a superior right. The contract giving the inferior right is discharged and is

replaced by the one giving superior right.

Illustration: Ragini mortgaged her gold bangles and took rupees two lakh from

Shambhu. She promised to pay Shambhu rupees two lakh with interest within two

years. Two years expired and Ragini was unable to pay the money. Hence Shambhu

who was a bailee under the contract after the time elapsed became the owner of the

gold bangles. The contract originally entered between Shambhu and Ragini gave the

right of a bailee to Shambhu but after the expiry of two years the contract gave

Shambhu the right of an owner, which was a superior right.

4 Unauthorized material alteration: Any alteration made in the contract by one

party without informing the other party or without the consent of the other

party will make the contract void. The contract will no longer be enforceable

in the Court of law.

Illustration: Ram offered to sell his house to Shyam for rupees ten lakh and Shyam

agreed to buy it. The agreement between them was a written agreement. Later

172

without informing Shyam Ram raised the amount from rupees ten lakh to fifteen

lakh. Hence the contract became void.

8.5 DISCHARGE BY IMPOSSIBILITY OF PERFORMANCE

It is very important that the contract, which is entered into is capable of performance.

A contract, which cannot be performed, is void. Impossibility of performance is of

two types:

1 Initial impossibility

2 Subsequent impossibility

Initial impossibility: Initial means right in the beginning of making a contract. When

the two parties are entering into a contract the impossibility of performance may be

either known to them or not known to them. In case they know about the impossibility

right in the beginning the agreement between them is void. The agreement never

materializes into a contract. On the other hand if the parties enter into a contract

without the knowledge of the impossibility of performance the contract is valid till

they discover the impossibility. As soon as the parties discover the impossibility of

performance they consider it a mutual mistake of fact and the contract becomes void.

Illustration 1: Ram promised to marry Geeta if she could climb the Mount Everest in

two days. This is a void agreement because both Ram and Geeta know that it is

impossible to climb Mount Everest in two days.

Illustration 2: Abdul a native of Saudi Arabia and a trader of horses had come to

India and agreed to sell his horse Rustam to Bakul for rupees two lakh. Abdul was

unaware of the demise of Rustam. The agreement between Abdul and Bakul was a

valid contract but the moment Abdul discovers the death of Rustam the contract

becomes void due to impossibility of performance.

173

Subsequent impossibility: The contract when formed is possible to be executed by

the contractual parties but later it becomes impossible for the parties to perform the

contract. This is called doctrine of supervening impossibility. When the contract

comes into formation there is all the possibility of the contract being performed by the

respective parties but later due to unavoidable circumstances the contract is no longer

possible to be performed. Thus the contract becomes void.

8.5.1 Situations where the doctrine of supervening impossibility is applied are

as follows:

1 Destruction of subject matter: If the subject matter is destroyed after the

formation of the contract, without the fault or negligence of either of the

parties the contract comes to an end. Once the main objective of the contract

has been destroyed it is not possible for the parties to execute the contract. If

the destruction has been due to the negligence of the parties then the party due

to whose fault and negligence the subject matter has been destroyed is liable to

compensate the other party.

Illustration 1: John promised to sell his house to Gangadhar and Gangadhar agreed

to buy the house. But before John could sell it there was an earthquake and the house

collapsed. Thus the contract comes to an end.

Illustration 2: John promised to sell his house to Gangadhar and Gangadhar agreed

to buy the house. Before the sale could be done the house was set on fire and this

happened due to the negligence of John. He had kept two drums of kerosene and lit a

cigarette near them, which caught fire. As a result the house caught fire. Thus

Gangadhar is liable to compensate John.

174

Case Law 2

Taylor vs. Caldwell85

In this case a music hall was let out for a series of concerts on certain days. The hall

was burnt down before the date of the first concert. The contract was held to be void

due to impossibility of performance.

2 Non-existence or Non-occurrence of state of things necessary for

performance: Sometimes the subject matter, which is required for

performance changes its form or ceases to exist in the same state in which it

was at the time of entering the contract. In such a case the contract comes to

an end.

Illustration: On a very hot day of summer Aishwarya ordered ten bricks of vanilla ice

cream from mother dairy. The salesman at mother dairy agreed to deliver the ice

creams at 6 P.M. in the evening. Aishwarya’s house was five kilometers away from

the mother dairy. The salesman sent a man on the bicycle with five bricks to

Aishwarya’s house. On the way there was traffic jam and the ice creams melted. The

deliveryman reached Aishwarya’s house with melted ice creams. Aishwarya is longer

liable to take delivery of the melted ice creams. Hence the contract becomes void.

Case Law 3

Krell vs. Henri86

In this case a contract was entered into to hire a room to view a proposed coronation

procession of the King. Owing to King’s illness the procession was cancelled. It was

held that performance had become impossible.

3 Death or incapacity of party: Where the nature of contract is such that the

promisor’s personal skill is required and if the promisor dies or becomes

incapable of executing the contract then the contract becomes void. In case the

85

1863 QB 3B. & S. 826 86

1903 2 K.B. 740

175

personal expertise or skill of the promisor is not required then after his/her

death the liability of the promisor will be borne by his/her legal

representatives and the contract does not become void.

Illustration 1: Rajan promised Sarita the director of a play to act as a lead hero in

her play. But just before the play Rajan met with an accident and fractured his limbs.

The contract became void due incapacity of the promisor.

Illustration 2: Sandhya a manager of a shoe company promised to deliver thousand

shoes to a retailer named Bupinder. Before the delivery could take place Sandhya had

a stroke and was hospitalized. The incapacity of Sandhya did not change the status of

the contract. Another person by the name of Anita replaced Sandhya’s position of the

manager. Hence it was now the duty of Anita to deliver thousand shoes to Bupinder.

Case law 4

Robinson vs. Davison.87

In this case A an eminent pianist promised B to perform at a concert. On the morning

of the day of the concert she informed B that she was too ill to perform in the concert.

It was held that the contract was discharged due impossibility of performance.

4 Change of law: When the contract is formed between two parties there is

nothing illegal about it but subsequent to the formation of the contract a new

law is made or a change in the existing law is done which makes the

implementation of the contract illegal. Thus the contract becomes void.

Illustration: Azad Singh promised to rent his house to Zakir Hussain to run his

business. Very soon Delhi Government by an order prohibits the residents on that

locality from using the house for any commercial purpose. Hence the contract is void.

87

1871 L.R. 6 Ex. 269

176

5 Outbreak of war: Contracts entered into with citizens of other countries

becomes impossible to perform on the declaration of war with them. Such

contracts are either suspended or are resumed after the war is over. During the

war the parties to such a contract cannot perform their obligations. Hence the

contract is void.

Illustration: Soham of Pakistan entered into an agreement with Angela of India to sell

woolen kaftans. Before the Kaftans could be delivered to Angela there was war

between India and Pakistan. Hence the contract was discharged due to impossibility

of performance.

Impossibility of performance cannot be made an excuse for not performing the

contract. Except in the above-mentioned cases if a party does not perform his/her

promise under the contract then he/she is liable for damages to the other party.

However in the following cases a contract is not discharged on the ground of

supervening impossibility:

(1) Difficulty of Performance: Sometimes it is difficult for the parties to perform

the contract. The difficulty in the execution of the contract cannot make the

contract void. Many times one party promises the other party to do

something, which later he/ she realizes is not easy to perform. The task

becomes difficult due to certain unavoidable circumstances. But such a

situation does not discharge the promisor from performing his/ her promise.

Illustration: Ashok a mechanic promised Shyam to repair Shyam’s automobile by

evening. By evening Ashok realized that it was very difficult to do the repair work due

to lack of dimness. As their was no electricity and the sun had also set it was difficult

for him to repair in the candle light. The contract is not void due to impossibility of

performance.

177

Case law 5

Blackburn Bobbin Co. vs. Allen & Sons88

In this case A entered into an agreement with B to supply Finland timber to between

July and September. Before the supply of timber war broke and due to disruption in

the transportation system no timber could be brought from Finland. The contract was

held not void due to difficulty in performance.

(2) Commercial Hardship: If a party finds the contract unprofitable he/ she

cannot discharge the contract on the ground of impossibility. A contract

cannot be adjudged impossible just because one of the parties finds the

execution of the contract more costly than what he/ she had though while

entering the contract.

Illustration: Rakesh a hotelier promised to cater food in the wedding of Ram’s

daughter. The price had been already fixed for the menu. Just few days before the

wedding the onion prices in the market shot up. Rakesh found the agreement

unprofitable. He was incurring a loss in supplying food as per the price already

decided. The contract cannot be discharged due to impossibility of performance on

the ground of commercial hardship.

(3) Impossibility due to third party: A contract cannot be discharged on the basis

of impossibility of performance due to the default of a third party. If a party

does not discharge his/ her promise due to the default of a third party then the

contract cannot be discharged. The party remains obliged for his promise to

the promisee even though the third party on whom he relied has failed him.

Illustration: Sangam had a furniture showroom. Rangeela a customer ordered a sofa

set to Sangam, which was to be delivered in a weeks time. After two days Sangam’s

carpenter Salim left for his village to see his ailing mother. The sofa could not be

made ready within a week’s time. The contract cannot be discharged due to

impossibility of performance.

88

1918 1K.B. 540

178

(4) Strikes lockout and civil disturbances: A party is not discharged from

performing his/her promise due to strikes, lockouts or any civil disturbances.

If one party has not been able to fulfill his / her promise due to the default of

workers who have gone on strike the contract cannot be discharged on the

basis of impossibility of performance. Similarly if the promisor has not been

able to discharge his/her promise due to sudden closure of the factory he/she is

still liable to fulfill his/ her promise. Civil disturbances like riots and curfews

also cannot discharge promisor from his/her liability.

Illustration: Sunil a manufacturer of shoes had an order for thousand shoes from Mr

Tandon. The delivery had to be made in two weeks time. Sunil’s workers wanted more

wages and a bonus, which Sunil found difficult to give as a result the workers went on

strike. The order could not be delivered on time. The contract cannot be discharged

due to impossibility of performance.

(5) Failure of one of several objects: Many times a contract has several objects.

If one object becomes impossible to perform it does not discharge the contract

due to impossibility of performance. The other objects, which are possible to

perform, are to be performed by the parties to the contract.

Illustration: Mr Nair came to Delhi on a vacation from Kerala. He booked a taxi and

the taxi driver promised to take Mr Nair to Qutub Minar, Raj Ghat and Red Fort. The

driver promised to pick up Mr Nair from his hotel next morning at 6:00 A.M. The next

day was 15th

August and the prime Minister was to deliver a speech from there. All

transport was banned from going in that area. It was not possible for the driver to

take Mr Nair to the Red Fort. The contract could not be discharged because the other

objects in the contract were still possible to be performed.

Case law 6

Henri Bay Steam Boat Co. vs. Hutton89

In this case a company agreed to let out a boat to B for two purposes of (I) viewing a

naval review on the occasion of coronation of King Edward VII and (II) to sail round

the fleet. Due to King’s illness the naval review was cancelled but the fleet was

89

1903 K.B. 683

179

assembled. Out of the two objectives only one had become impossible to perform and

not the other. Therefore it was held that the contract was not discharged.

8.6 DISCHARGE BY BREACH OF CONTRACT

If one of the party under a contract does not perform his / her obligation it is called

breach of contract. Breach of contract discharges the contract thus it brings to an end

the obligations created by the contract on the part of each of the parties. The party

who has been breached can sue the other party for the breach.90

Illustration: Gupta Sweets took order from Mr Ranjit to prepare thousand ladoos for

the puja and deliver them in the morning on the day of the puja. Guptaji was unable

to deliver the sweets hence the contract is discharged by breach of contract. Mr ranjit

can sue Guptaji was breach of contract.

8.7 POINTS TO REMEMBER

Discharge of Contract by Performance

Actual Performance

Attempted Performance

Discharge of Contract by Mutual Agreement or Consent

Novation

Alteration

Rescission

Remission

Waiver

90

For detail see lesson 11 on Breach of Contract

180

Discharge of Contract by Lapse of Time

A contract is to be performed within a reasonable period and if it is not performed

within that period then the contract comes to an end due to lapse of time.

Discharge of Contract by Operation of Law

Death

Insolvency

Merger

Unauthorized Material Alteration

Discharge of Contract by Impossibility of Performance

Initial Impossibility

Subsequent Impossibility

Situations where Doctrine of Subsequent Impossibility is applied

Destruction of Subject Matter

Non-Existence or Non-occurrence of state of things

Death or Incapacity of Party

Change of Law

Outbreak of War

Situations where Doctrine of Subsequent Impossibility cannot be applied

Difficulty of Performance

Commercial Hardship

Impossibility due to Third party

Strikes Lockout and Civil Disturbances

Failure of one of Several Objects

181

Discharge of Contract by Breach of Contract

The contract is discharged when one of the party does not perform his/her

obligation

8.8 QUESTIONS

Match the following

1 Discharge by performance a Alteration

2 Discharge by mutual agreement b lesser fulfillment of promise

3 Remission c Time barred debt

4 Discharge by lapse of time d Attempted Performance

5 Discharge by operation of law e Death

Answers: 1d, 2a, 3b, 4c, 5e

Practical Problems

1 Rakesh entered into an agreement with Suresh for selling his house for rupees

twenty lakh. After the agreement was written Rakesh without consulting

Suresh changed the sum of rupees twenty lakh to twenty one lakh. Can this be

treated as discharge of contract by alteration?

Answer: No, this cannot be treated as alteration because whenever a new

contract replaces a new one it is important that the changes have been made by

mutual consent. In this case Rakesh made the change without informing

Suresh.

2 Sunita an interior designer promised to decorate the house of Rani within

fifteen days. Sunita could not keep her promise and did not complete her

assignment on time. Can this be treated as Rescission?

Answer: No, this cannot be treated as rescission because in rescission both the

parties have to mutually agree to terminate the contract. This is a case of

breach of contract.

3 Jalandhar had a party in the evening in his house. Jaggu a cook promised to

prepare delicious food for the party for rupees ten thousand. He had promised

to deliver five items but in the evening he was able to deliver only four items.

He said that it was not possible to prepare all the five items in such a short

182

time. Jalandhar paid rupees ten thousand as promised to Jaggu. Is this a case

of Remisssion?

Answer: Yes, Jalandhar has accepted a lesser fulfillment of the promise made

by Jaggu because he paid to Jaggu the full amount without deducting anything

from it.

4 Sita promised to act as the heroin in Raj’s play but just before the play had to

be performed Sita met with an accident and died. Can this be treated as

discharge by operation of law?

Answer: Yes, as Sita’s skill was required for the discharge of contract and

after her death it was not the duty of her legal representative to discharge the

obligations under the contract therefore after Sita’s death the contract is

discharged by operation of law.

5 Baba Fakir a tantrik promised to bring life back into Rohit’s dead wife.

However Baba Fakir failed to do so. Can Rohit sue Baba Fakir for not

fulfilling his promise?

Answer: No, Rohit cannot sue Baba Fakir because the agreement between

them is void due to impossibility of performance.

Questions:

1 What do you mean by Discharge of contract by performance? What is the

difference between actual performance and attempted performance?

2 What do you mean by discharge of the contracts by mutual agreement or

consent? What are the various ways by which the contracts can be discharged

by mutual agreement? Illustrate with examples.

3 What is time-barred debt? Illustrate with an example.

4 How are contracts discharged by operation of law? Illustrate with examples.

8.9 REFERENCES

(1) Chadha P.R. & Bagrial A.K. (2005): Business Law, Pragati Publictions, New

Delhi

(2) Singh Avtar (2008): Law of Contract and Specific Relief, Ninth edition,

Eastern Book Company, Lucknow

183

Lesson – 9

Contingent Contracts

by

Preeti Singh

This lesson discusses the

following aspects of contingent contracts:

9.1 Meaning of Contingent Contracts

9.2 Rules Regarding Enforcement of Contingent Contracts

9.3 Differences between Wagers & Contingent Contracts

9.1 MEANING OF CONTINGENT CONTRACTS

A contingent contract as defined by Section 31 of the Indian Contract Act is a contract

to do or not to do an act depending on an event that is collateral to the contract, which

may or may not happen. If a contract is made between two people to exchange some

goods on the expiry of a period or on the death of a certain person it is not considered

to be a contingent contract because it is based on certainty of event.

Contingent contracts are based on events of uncertain nature. If two people make a

contract that a payment would be made in case a fire breaks out in the premises it

would become a contingent contract because this is based on the uncertainty of an

event. There may or may not be a fire. Contingent contracts are also called

conditional contracts and they are valid contracts.91

91

In Valiammal Rangarao V Muthu Arunaswamy (1982) 3 SCC 508 the court held that commission

payable on the success of a litigation is considered to be a contingent contract because it is based on

an uncertain event. A contract of life insurance was also termed as a contingent contract in

Commissioner of excess profits tax V Ruby General Insurance Co,1957 SCR 1002

184

However, when a contract is made to pay wages to another person for the work

carried out by him, it is not a contingent contract even though a person can demand

for his or her wages only after the completion of the work. There is nothing uncertain

in this contract and so it cannot be termed as a contingent contract.

Illustration: If a manufacturer of silver articles sends his

goods for approval to a buying house, the contract is

dependent on the buyer to accept or reject the goods. In this

sense it is a contingent contract because it is dependent on

the happening or not happening of a certain event.

9.1.1 Essentials of Contingent Contracts

Contingent contracts consist of important essential elements. These are the following:

1. Uncertain Event: The parties making the contract make an agreement that the

performance of the contract will be dependent on a future uncertain event92

.

Illustration: Latika participated and won a beauty contest. Another contest may

be held in Mumbai to select Miss India. If she participates she may win the

contest. The uncertain event is that the contest may or may not be held and also

she may or may not win because there will be other contestants as well.

Therefore the outcome is also uncertain.

Collateral to the Contract: The Contract Act does not define a collateral event. It

is in general use accepted to be an event whose performance is not promised

directly. It also does not form the consideration of the promise in the main

contract. It is considered to be important because it signifies the time when the

rights that are created by the contract become enforceable.

Contingency is collateral or incidental to the contract. The event is independent to

the contract. This means that there should be an existing contract but its

performance can only be demanded on the happening or not happening of an

92

This can also refer to a past event if the uncertainty depends on the fact that the parties

do not have any knowledge of the outcome of the past event.

185

event. The event on which the contingent contract is dependent is in addition to

the contract made by the two parties.

Illustration: Raju promises to pay Ravi Rs 1,00,000 if the plans of building the

first floor of the house get a no objection certification from the municipal

inspector for beginning the work.This is a contingent contract. The certification

by the municipal inspector is a collateral event. Ravi cannot enforce the contract

unless the work is first cetified.

2. Validity of the Contract: Contingent contracts are valid. Insurance contracts

are an example of contingent contract in which the liability arises when an

uncertain event happens.

Illustration: Nirmeet took an International medical policy as it was mandatory for

her while traveling to the United States of America. If she falls sick, only in that

event the liability of the insurance company will arise and it will have to pay.

3. Conditional Contracts: Contracts can be absolute or contingent in nature. An

absolute contract is one in which the promisor is bound to perform. In a

conditional contract, performance depends on the happening or not happening

of an uncertain event, collateral to the contract. Contingent contracts are

conditional in nature. They can be distinguished from absolute contracts,

which give reciprocal promises of a dependent nature.

Illustration: Naju made an agreement to pay Rs 55,000 to Amrita after delivery of

goods by her on the 16th

of October is an absolute contract but Naju will have to

pay Amrita if Aman does not pay is a conditional contract.

4. Event should not be at the discretion of the promisor: The performance of

the contract should not be at the will or pleasure of the promisor. Such

contracts do not constitute a promise at all. However if a third person

determines the promise it is acceptable and it constitutes a promise.

Illustration: Irfan promises to pay Prem Rs 25,000. This is not a contract

because the promisor determines the amount and promise himself. When Irfan

186

promises to pay Rs 42,000 to Prem and the amount has been determined by

Prabhat, it is a contingent contract because it is not at the discretion of the

promisor but by a third person.It is a valid promise.

9.2 RULES REGARDING ENFORCEMENT OF CONTINGENT

CONTRACTS

The following are the rules regarding enforcement of contingent contracts. They are

provided in Sections 32 to 36 of the Indian Contract Act.

1. The happening of a future uncertain event: Section 32 of the Act states that a

contingent contract to do or not to do anything on the happening of an

uncertain future event can not be enforced until the event actually happens. If

the event becomes impossible the contract will become void.

Illustration 1: Arti makes a contract with Indu to buy

her house if she survives her grandmother. Law cannot

enforce such a contract unless and until the

grandmother dies in the life time of Arti.

Illustration 2: Ganga made a contract with Jamuna to pay Rs.

2,00,000 when she marries Thangam. He dies before marrying

Jamuna. The contract becomes void.

Illustration 3: Anand makes a contract with Munish to

sell a car at Rs. 4,00,000, if Dhaniram to whom the car

has been offered decides to refuse to buy it. Such a

contract cannot be enforced by law unless Dhaniram

refuses to buy the car.

2. The non-happening of an uncertain event: Section 33 of the Act states that

contingent contracts to do or not to do can become enforceable only when the

187

event becomes impossible. If the event is possible the contract cannot be

enforced.

Illustration 1: Amu promises to write a research paper for Ankita, if Jitu does not

write it. Jitu has heavy work commitments and he refuses. Amu becomes liable to

write the research paper because Jitu has refused and the event has become

impossible.

Illustration 2: Shiva guarantees a loan taken by Amar from a bank to buy a house.

Amar suffers losses and becomes insolvent. Shiva has to pay the bank as the event of

Amar paying to the bank has become impossible.

3. When an event is deemed to be impossible: According to Section 34 when an

uncertain event is dependent on the future conduct of a third party, the event

will be impossible if the person does not act although it is possible for him to

do so within a particular time.

In other words when the contract is contingent due to the conduct of the third

person and the performance of the contract depends on the decision or action

of the third person.

Illustration 1: Rumi promised with her sister Runa to give

her the first floor of a house to build her apartment if

approved by the municipal authorities. Since the authorities

did not approve of the plan the contract between the two

sisters became void.

Illustration 2: Chunni Lal promised to sell 50 computers

to Murari Lal if he was able to get the supply of Maac

computers within a month from the company. The company

did not agree as they had already booked many orders and

were not able to supply it to Chunni Lal. The contract

became void.

188

4. The happening of an event within a specified fixed time: Section 35 states that

when a contingent contract to do or not to do any thing depends on specified

fixed time and if the event within or before expiry of the time becomes

impossible, it becomes void.

In other words the person has to perform within a fixed time. If the event does

not happen or becomes impossible before the specified time the contract

becomes void.

Illustration 1: Mallu promises to pay Kalu Ram an amount of Rs. 2,50,000, if he

decides to bring back an aeroplane to India from Milan within six months. The

contract will be enforced if the aeroplane is actually brought to India within the

specified six months and it becomes void if the rules and regulations prohibit the

movement of the plane in the respective countries within six months.

5. Non-happening of an event within a specified fixed time: The same section as

above (Section 35) also states that if an event does not happen and the promise

has to be performed during that fixed time the contract can be enforced only if

the event does not happen within that fixed specified period.

Illustration 2: Tunu promises to pay Munna Rs. 5,00,000 if his machinery does not

get imported to India within three months. If the machinery does not reach India or it

is difficult to bring it to India within three months Tunu has to pay Munna the amount.

6. Impossible events: A contract which is dependent on an event that is impossible

is void whether the impossible situation was known or un-known to the parties

to the contract when the agreement was made (Section 36).

Note: Such contracts can never be enforced as impossible events cannot

happen.

Illustration 3: Amit promises to pay Rs. 8,00,000 to Sumit if he will marry Jhumki but

Jhumki was already married to Amrit. Therefore, the agreement is void because

unknown to both of them the agreement was an impossible event.

189

9.3 DISTINCTION BETWEEN CONTINGENT CONTRACTS AND

WAGERING AGREEMENTS

Contingent contracts are quite similar to wagering agreements but there are some

differences between them. These differences are given in the following discussion:

Basis of Distinction Contingent Contracts Wagering Contracts

Reciprocal promise A contingent contract may

or may not contain

reciprocal promises.

A wagering agreement

consists of reciprocal

promises the performance

of both the parties

depending on the

happening of an uncertain

event.

Nature of contract Some contingent contracts

are valid contracts. An

example may be cited of

insurance contracts.

Wagering agreements are

contingent contracts as

they depend on the

happening or not

happening of a certain

event. Wagering

agreements are void.

Interest of parties to the

contract

In a contingent contract

the parties have an interest

in the occurrence or non-

occurrence of the contract

A wagering agreement the

parties to the contract are

only interested in the

winning or losing of the

betting amount.

Importance of future

event

In a contingent contract

the future uncertain event

is just an additional or

collateral part of the

contract and hence its

importance is secondary to

the main event.

In a wagering agreement

the future event is the main

central aspect that

determines the contract.

190

9.4 Points to Remember

Contingent contract

(i) It is a contract to do or not to do something if some event collateral to

the contract does or does not happen.

Elements of a contingent contract

3 The contract is dependant on a future uncertain event

4 The unknown event should be collateral to the contract.

5 The contract must fulfill all the essential requirements of a valid contract.

6 Contingent contracts are conditional in nature.

7 The contract should not be at the discretion of the promisor.

Rules regarding contingent contracts.

(h) The rules regarding contingent contracts are covered in sections 32 to 36 of the

Contract Act;

(i) Section 32: The contract cannot be enforced unless the event has happened. If the

event is impossible contract is void

(j) Section 33: Contract to do or not to do can be enforced when the happening of the

event is impossible

(k) Section 34: The event is linked with human conduct to do an act within a fixed

specified time

(l) Section 35: The contract is dependant on the happening of a specific event within

a particular fixed time.

(m) Section 36: Contingent contracts are void if the agreement is to do impossible

acts.

Distinction between contingent contracts and wagering agreements.

• A wagering agreement is a mutual promise whereas a wagering agreement

may or may not be based on reciprocal promise.

• In a wagering contract the parties are only interested in winning or losing.

Contingent contracts the parties are interested in the contract genuinely.

• In a wagering contract the future is main determining factor but in contingent

contract the future event is collateral to the main contract.

• All contingent contracts are not wagering contract but all wagering contracts

are necessarily contingent in nature.

• Contingent contracts are valid but wagering agreements are void.

191

Objective Type Questions

State whether the following are true or false.

1) A contract which is not contingent is called conditional contract.

2) A contract that is dependant on the happening of a collateral contract is

a voidable contract.

3) A contingent contract is illegal.

4) A contract of insurance is a contingent contract.

5) A wager is the same thing as a contingent contract.

6) In a contingent contract the performance depends upon an uncertain

event.

7) Contingent contracts are described in section 32 to 36 of the Indian

Contract Act.

8) Wagers are always void.

9) A wager and contingent contracts draw similarity from the fact that

both are contracts in which the parties make reciprocal promises.

10) In wagers parties do not have personal interest but in contingent

contracts the parties have their own personal interest.

Answers: 1.F, 2.F, 3.F, 4.T, 5.F, 6.T, 7.T, 8.T, 9.F, 10.T.

Questions

i) Define a contingent contract? Discuss the rules relating to such contracts.

ii) All wagering contracts are contingent contracts but all contingent contracts

may or may not be wagering in nature. Comment on this statement.

iii) What are the essential elements of a contingent contract? Give illustrations.

iv) Discuss the rules regarding enforcement of contingent contracts with relevant

sections and illustrations.

v) Discuss the following:

(1) How does impossibility of an event affect the contingent contract?

(2) In what way does the happening or not happening of an event affect a

contingent contract?

192

Practical Problems

10 Lekhi promises to pay Lakhinder Rs. 4,00,000, if the Volvo car returns to

India within a year from Germany. The car has an accident on the express

way and is completely destroyed. Advise Lakhinder.

Answer: Lakhinder has to treat the contract as void. Section 35 of the Indian Contract

Act, states that a contract that is contingent on the happening of an uncertain

event within a fixed time becomes void if the event is impossible before the

fixed time expires. Since the car is destroyed the promise cannot be carried

out. None of the parties have any rights or obligations and Lakhinder cannot

claim the money.

11 Brajendra entered into a contract to supply bricks to construct a hotel. The

terms of the contract were that the bricks had to be approved by the

government authority before accepting them for use in the hotel. The bricks

got rejected by the authority. Consequently, the hotel did not pay the

supplier. Brajendra fire the suit for the money.

Answer: This is a contingent contract. Brajendra cannot recover his money according

to Section 35 of the Act.

12 Munna promises Munni that he would pay her Rs. 1,00,000 if she could join

two parallel lines and they remained to have the same properties as that of

parallel lines. What should Munni do?

Answer: It is a void agreement as it is impossible to join the lines and have the same

properties.

13 Tunnu promises to pay Tumpa Rs. 5,00,000 for purchasing his car if it is

repaired in three days time by Runa. The mechanic Runa, died and the

repairs did not take place. What should Tunnu and Tumpa do?

193

Answer: The contract is contingent on the repairing of the car by Runa. Since Runa

dies the contract suffers from impossibility. Hence, the contract becomes

void.

14 Lallu is a surety for Anita that she would pay for the goods to Anika.

However, there was a fire and Anita lost all her money in making a repair to

her promises and could not pay. What is the liability of Lallu.

Answer: Lallu has to pay for the goods as he stood surety for Anita (Section 33).

15 Madhu promised to write a book of poems jointly with Sheena if Manu does

not do it. Manu had a fight with Sheena and refused to work with her.

Sheena asked Madhu to keep her promise, but Madhu was not keen to work

on the book of poems. Is Madhu liable?

Answer: Madhu has to keep her promise as it is a contingent contract on the non

happening of an event. She is liable under Section 33.

16 Anand has a plot of land at Greater Noida but there is a dispute about its

ownership. He makes a contract with Poonam to sell the land if the court

decides the case in his favour. What type of a contract is this?

Answer: This is a contingent contract depending on the happening of an event.

17 Neena promises Beena that she would give her a job if she wins the badminton

national championship. Beena has an accident and is disabled. She cannot play

any game, what type of contract is this?

Answer: This is a contingent contract on the happening of an event. Since the event

makes the completion of the contract impossible, it becomes a void contract.

194

References

Books

a) Chaddha P.R. (2001 Business Law, (2nd

Revised Edition) Chapter 8, p.122.

Galgotia Publishing Company, New Delhi.

b) Pathak H.S. (2006) (Mulla) The Indian Contract Act Eleventh Edition

Chapter 3, p.112. Lexis Nexis Butterworths New Delhi, India.

c) Aggarwal S. K. &. Singhal K (2006), Indian Business Laws, 2nd

Edition,

Chapter 8, p. 144 – 148, Galgotia Publication Limited, New Delhi.

d) Bansal G.L.( 2006) Business and Corporate Laws, First Edition, Chapter 8,

p.73-77,Excel Books, New Delhi.

Websites:

a) http://www.netlawman.co.in/acts/indian-contract-act.php?pageContentID=198

b) http://www.niee.org/cases/78-88/case81-1.htm

c) http://www.rediff.com/money/2006/may/09guest1.htm

195

Lesson – 10

QUASI CONTRACT

by

Anu Pandey

This Lesson discusses the various aspects of Quasi Contract

10.1 Definition

10.2 Types of Quasi Contract

10.3 Quantum Meruit

A contract is formed by an agreement, which is enforceable by law. However in some

cases contract is formed without any agreement. When there is no offer and

acceptance and the parties have no intension to enter into a contract yet a contract is

formed. Such contracts are called Quasi Contracts.

10.1 DEFINITION

Chapter V (section 68-72) of the Indian Contract Act deals with Quasi Contracts.

Quasi Contracts arise by law. The law binds the parties in these contracts. The law

imposes obligation on the one party and confers a right in favor of the other. Such

contracts are also called Constructive Contracts. The term ‘Quasi Contract’ is used

because such a contract resembles a contract but is not similar to a contract in respect

of mode of creation. Law creates these contracts.

Table 10.1 shows the difference between Quasi Contracts and Contracts

196

TABLE 10.1

Basis of difference Contract Quasi Contract

Formation It is formed by the parties It is formed by law

Elements of contract All the essential elements

(according to section 10 of

the Indian contract act) for

the formation of a contract

are present

The essential elements

(according to section 10 of

the Indian contract act) for

formation of a contract are

absent

Obligation Obligation of the parties is

imposed by law

Obligation of the parties is

created by the parties

themselves

However there is one similarity between Quasi Contract and Contract. In case of

breach of quasi contract the remedies available for the breach are the same as are

available for contracts under section 73 of the Indian Contract Act93

.

Quasi contract is based on the principle of ‘unjust enrichment’ that was given by Lord

Mansfield. According to this a person shall not enrich himself / herself unjustly at the

cost of another person.

The Supreme Court of India applied the principle of unjust enrichment to cases of

imported raw materials secretly consumed in manufacture of final produce94

Illustration 1: Heena with her mother went to a boutique and bought a party dress for

Rs.5000. She had only Rs.2000 with her so she paid that and promised the boutique

owner to pay the remaining Rs.3000 within a day. In the evening Heena’s mother

went to the boutique and paid Rs.3000. The next day Heena also went and gave

Rs.3000 to the boutique owner. She gave the money in ignorance, as she did not know

that her mother had already paid the money. In this case the boutique owner gets

unjust benefit at the cost of Heena therefore he is obliged and bound to return

Heena’s money.

93

For details on breach of contract see lesson 11 94

See Union of India vs. Solar Pesticides (P) Ltd. (A.I.R. 2000. S.C. 862)

197

Case Law 1

Mahabir Kishore Vs. State of M.P.95

In this case the Court held that in an action for unjust enrichment, the following

essentials have to be proved

b) The receipt of a benefit has enriched the defendant.

c) The enrichment has been at the expense of the plaintiff

d) The retention of the enrichment is unjust

10.2 TYPES OF QUASI CONTRACTS

The various types of Quasi-Contracts are as follows:

! Supply of Necessaries:

According to section 68 of the Indian contract act if a person has supplied

necessary goods and services to an incompetent person96

or to any one whom

the incompetent person is legally bound to support then the person is entitled

to be reimbursed from the property of the incompetent person.

Illustration: Raunak Ali was a lunatic and his children were studying in school and

their tuition fee had not been paid for the last three months. In this case Raunak Ali is

liable for the payment of his children’s school fee and the fee will be paid from his

property. He cannot be made personally liable for the school fee.

95

(1990) S.C. 313 96

Minor, person with unsound mind (for more information on incompetent person see

lesson 4 on capacity of parties)

198

2 Payment by an Interested Person:

According to section 69 a person who is interested in the payment of money

which another is bound by law to pay, and who therefore pays it, is entitled to

be reimbursed by the other.

The person who makes the payment and later claims to be reimbursed is the

plaintiff who has an interest in making the payment. He /she makes the

payment to protect his/her interest. The person who is bound by law to pay is

the defendant. After the plaintiff has discharged the defendant’s debt, he/she is

entitled to be reimbursed by the defendant. However if the plaintiff is bound to

pay and also makes the payment then he/she cannot have an action against the

defendant.

Illustration 1: Jhumpa had kept her car in Shambhu’s garage as there was renovation

going on in her house. Shambhu took Jhumpa’s car without her consent and hit the

car against the tree. He left the car at the nearest motor station for repair and

informed Jhumpa about it. Jhumpa went to the motor station and paid the bill for

repair amounting to Rs.5000. In this case Jhumpa is entitled to be reimbursed by

Shambhu.

Illustration 2: Jhumpa had kept her car in Shambhu’s garage as there was renovation

going on in her house. Jhumpa took the car from Shambhu’s garage without telling

him and hit the car against the tree. She took the car at the nearest motor station for

repair and informed Shambhu about it. She paid the bill for repair amounting

Rs.5000. In this case Jhumpa is bound to pay the bill therefore she cannot ask

Shambhu to reimburse the money.

199

Case Law 2

Abid Hussain Vs. Ganga Sahai97

In this case the goods belonging to Abid were wrongfully attached in order to realize

arrears of Government revenue due by Ganga. Abid paid the amount to save the

goods from sale. Held, he was entitled to recover the amount from Ganga.

3 Obligation to Pay for Non-gratuitous Acts:

According to section 70 when a person lawfully does anything for another

person or delivers anything to him, not intending to do gratuitously, and such

other person enjoys the benefit thereof, the latter is bound to make

compensation to the former in respect of, or to restore, the thing so done or

delivered. If the person does something for the other gratuitously then the

latter is not bound to compensate.

Illustration 1: Runjhun bought vegetables and then went to see her friend Munmun at

her house. While leaving Munmun’s house she forgot to take the vegetables. Munmun

instead of returning the vegetables to Runjhun cooked them and ate them. She is

liable to compensate Runjhun for the vegetables.

Illustration 2: Runjhun bought vegetables and then went to see her friend Munmun at

her house. While leaving Munmun’s house she forgot to take the vegetables. Munmun

called up Runjhun and told her about the vegetables. Runjhun asked her to eat them.

Hence Munmun is not liable to compensate Runjhun for the vegetables.

Case Law 3

Damodar Mudaliar Vs. Secretary of State for India98

In this case a tank irrigated a village. The government conducted certain repairs to the

tank for its preservation and had no intension to do so gratuitously for the Zamindars.

The Zamindars enjoyed the benefit thereof. Held, they were liable to contribute.

97

(1928) 26 All. L.J. 435 98

(1894) 18 Mad. 88

200

4 Responsibility of Finder of Goods

According to section 71 of the Indian contract act a person, who finds goods

belonging to another and takes them into his custody, is subject to the same

responsibility as a bailee99

. He is bound to take as much care of the goods as a

man of ordinary prudence would, under similar circumstances, take of his own

goods of the same bulk, quality and value. He must also take all necessary

measures to trace its owner. In case the finder of goods does not try to trace

the owner then he/she will be guilty of wrongful possession of goods. Till the

owner is found the finder of goods can retain the goods as his own property.

Illustration: Liliput was walking on the road and found a purse on the pavement. He

picked it and found two thousand rupees, a driving license and two credit cards in the

purse. It was Liliput’s responsibility and therefore obligation to find the owner of the

purse and return the purse to him or else he could deposit the purse at the nearest

police station but he was at no point in time entitled to retain the purse and its

ingredients as his own.

However the finder can retain the goods and use them for his/her own purpose or even

sell them if he/she wishes to. The cases where the finder has the right to sell the goods

are discussed below:

A When the good found is in a perishable condition:

Many times the good, which a person finds, is of a perishable nature. If

it is not used or consumed within a definite period of time then the

good might become stale or get destroyed. In such cases the finder has

a right to sell the good before it gets perished.

Illustration: On Monday morning a lady went to Sonpari a flower vendor and

purchased flowers from her. She was carrying a bag full of vegetables and by mistake

99

Bailment is the delivery of goods by one person to another for some purpose. The

person delivering the goods is called the bailor and the person to whom they are

delivered is called the bailee (for more information on bailment see lesson 12)

201

left it at Sonpari’s place. Sonpari on finding the bag tried to trace the lady but

couldn’t find her. By evening the vegetables were getting dry. Sonpari did not have a

refrigerator and if the vegetables were kept like this they would become stale by next

morning so she thought to sell the vegetables.

B When the owner could not be found with reasonable diligence:

It is the responsibility of the finder of good to find the owner of the

good or at least take all the appropriate measures to trace the real

owner of good. If the finder cannot trace the owner himself / herself

then he /she should definitely inform the police about it. If after taking

all these measures the owner is not found then the finder has a right to

sell the good.

Illustration: On Monday morning a lady went to Sonpari a flower vendor and

purchased flowers from her. She was carrying a bag full of vegetables and by mistake

left it at Sonpari’s place. Sonpari on finding the bag tried to trace the lady but

couldn’t find her she even informed a police check post but the lady could not be

found. Sonpari had the right to sell the vegetables as she tried her best to find the

owner.

C When the owner is found but he/she refuses to pay the lawful

charges of the finder.

When the finder of good spends money on its possession or for its safe

custody and the owner refuses to reimburse the money spent on good

by the finder of good then the finder has a right to sell the good.

Illustration: On Monday morning a lady went to Sonpari a flower vendor and

purchased flowers from her. She was carrying a bag full of vegetables and by mistake

left it at Sonpari’s place. Sonpari on finding the bag tried to trace the lady but

couldn’t find her. Sonpari did not have a refrigerator so she bought ice from the

market and kept the vegetables in it to protect them from drying. The next morning the

lady came to collect her vegetables. Sonpari asked her to reimburse the money she

had spent on ice. The lady refused to pay. Hence Sonpari had the right to sell the

vegetables.

202

D Lastly when the lawful charges of the finder, in respect of the thing

found, amount to two-thirds of the value of the thing found.

When the finder of good spends money for its safe custody and the

money spent exceeds two-thirds of the value of the thing found. Then

the finder has a right to sell the good.

Illustration: On Monday morning a lady went to Sonpari a flower vendor and

purchased flowers from her. She was carrying a bag full of vegetables and by mistake

left it at Sonpari’s place. Sonpari on finding the bag tried to trace the lady but

couldn’t find her. The bag contained about one kilogram tomatoes and few green

chillies and lemons. The cost of the vegetables would be around rupees thirty. Sonpari

did not have a refrigerator so she bought ice worth rupees eleven from the market and

kept the vegetables in it to protect them from drying. The next day again she bought

ice for rupees eleven and kept the vegetables in it. As Sonpari had spent rupees twenty

-two which was more than two-third of the cost of the vegetable so she had the right

to sell the vegetable

5 Mistake or coercion

According to section 72 a person to whom money has been paid, or

anything delivered, by mistake100

or coercion101

, must repay or return it to

the person who paid it by mistake or coercion.

Illustration: Rajbir went for shopping and bought a shirt worth rupees three hundred.

He gave cash to the salesman. He gave 2 hundred rupee notes and 1 five hundred

rupee notes thinking that it was a one hundred rupee note. It was a mistake therefore

the salesman is liable to return the extra money he had to Rajbir.

100

Erroneous belief about something 101

When a person is compelled to enter into a contract by the use of force by the other

party or under a threat (for more information see lesson on free consent)

203

Case Law 4

Norwich etc., Society Ltd. vs. Price (W.H.) Ltd.102

An insurance company paid the amount on a policy under the mistake that the goods

had been destroyed by a peril insured against. The goods in fact had been sold. Held,

the money could be recovered by the insurance company.

10.3 QUANTUM MERUIT

Quantum Meruit means “as much as earned” or as much as merited. When a person

has done some work under a contract, and the other party repudiates the contract, or

some event happens which makes the further performance of the contract impossible,

then the party who has performed the work can claim remuneration for the work

he/she has already done. Similarly if a person expressly or impliedly requested

another person to render him/her service without specifying any remuneration, but the

circumstances of the request imply that the service is to be paid for, there is implied a

promise to pay quantum meruit, i.e., so much as the party rendering the service

deserves. The right to claim quantum meruit does not arise out of contract as the right

to damages does; it is a claim on the quasi-contractual obligation, which the law

implies in the circumstances.

The claim for quantum meruit arises only when the contract is discharged and only

the party who is not in default can bring it. In the following cases claim for quantum

meruit can arise:

1. When an agreement or contract is void: When an agreement is discovered

to be void, or when a contract becomes void, any person who has received any

advantage under such agreement or contract is bound to restore it, or to make

compensation for it, to the person from whom he/she received it.

Illustration: Salim was a horse trader from Saudhi Arabia who had come to visit his

friend Raju in India. Raju wanted to buy a horse named Abdula and gave Salim an

advance of rupees twenty thousand for him. After Salim went back to Saudhi Arabia

102

(1934) A.C. 455.

204

he found that the horse had died. Hence the contract became void and so Salim was

liable to return twenty thousand rupees to Raju.

Case Law 5

Craven–Ellis vs. Cannon Ltd103

Craven–Ellis was employed as a managing director in a company. After he rendered

service for three months, it was found that the directors were not qualified to appoint

him. It was held that Craven could recover remuneration for the services rendered by

him on Quantum Meruit.

2. When something is done without any intension to do so gratuitously:

When a person without any intension to do so gratuitously to another person

does a thing and such other person enjoys the benefit thereof, he/she is bound

to make compensation to the former in respect of, or to restore, the thing so

done or delivered.

Illustration: Anita went to visit her friend Ekta and by mistake left her newly bought

jacket at Ekta’s place. Next day Ekta went to Shimla for a ten day vacation and took

the jacket with her. As the jacket was not a gift by Anita to Ekta therefore Ekta was

bound to either return the jacket or pay the price for the jacket to Anita.

3. When there is an express or implied contract to render services but there

is no agreement as to remuneration: If the parties to a contract agree upon

something which is to be done but do not decide about the payment or

remuneration for that work then in such cases a reasonable remuneration is

quantum meruit, which is determined by the Court.

Illustration: Ghanshyam a painter promised to paint Shyam’s house but nothing

about the remuneration was decided. As per the agreement Ghanshyam painted the

house and so was entitled for a reasonable remuneration to be paid by Shyam.

103

(1936) 2 K.B. 403

205

Case Law 6

District Council vs. Powell104

There was an implied agreement between Powell and a fire brigade for the services of

the brigade. It was held that reasonable remuneration was payable by Powell for the

services received by him.

4. When the completion of the contract has been prevented by the act of the

other party to the contract. When two parties enter into a contract and one of

them later prevents the other from executing the contract then in that case the

party who has been prevented is to be compensated for the quantum of work

done by him/her.

Illustration: Ghanshyam a painter promised to paint Shyam’s entire house for rupees

thirty thousand. Ghanshyam painted one room and a kitchen and was asked by

Ghanshyam to quit. Ghanshyam was entitled to be paid the remuneration for painting

one room and a kitchen

Case Law 7

De Bernady vs. Harding105

In this case principal wrongfully revoked his agent’s authority before the agent could

complete his duties. It was held by the Court that the agent could recover quantum

meruit for the work he had done and the expenses he had incurred in the course of his

duties.

5. When a contract is divisible: When a contract is divisible and the party not

in default has enjoyed the benefit of the part performance, the party in default

may sue on quantum meruit. But if the contract is not divisible which means

that the contract requires complete performance as a condition of payment, the

party in default cannot claim remuneration on the ground of quantum meruit.

Illustration: Ghanshyam a painter promised to paint Shyam’s car for rupees five

thousand. Ghanshyam painted just half the car and left the work. Hence he was not

104

(1942) 1 All E.R. 220 105

(1853) 8 Ex. 22.

206

entitled for the remuneration because the work was not divisible and the contract

required complete performance

Case Law 8

Cutter vs. Powell106

Powell agreed to pay Cutter, 30 guineas on the completion of a voyage from Jamaica

to Liverpool. Cutter died before the completion of the voyage. Held, C’s widow was

not entitled to claim proportionate payment for the part of the voyage completed as

the contract imposed one indivisible obligation, which had not been performed.

6. When a contract is completely performed but badly: When a contract is

completely performed but badly, the person who performed the contract can

claim the lump sum but the other party can make deductions for bad work.

Illustration: Ramu a cook promised to make food for 20 guests at a party, which was

to be held at Mr Nair’s house for rupees ten thousand. As per the agreement Ramu

cooked food but the food was very bad to taste. There was too much of salt and

pepper in the food as a result the guests left the party without eating much Mr. Nair

had a right to deduct from the remuneration promised to Ramu for the bad

preparation.

Case Law 9

Dakin (H) & Co. Ltd. vs. Lee107

A agreed to repair B’s house for 265 pounds payable on completion in accordance

with a specification. A did the repairs but these were defective. Held A was entitled to

recover 265 pounds less a reduction in respect of the defective work.

106

(1795) 6 T.L.R. 320 107

(1916) 1 K.B. 566

207

10.4 POINTS TO REMEMBER

Definition of Quasi Contract

Difference between Contract and Quasi Contract

Types of Quasi Contracts

Supply of Necessaries

Payment by an Interested Person

Obligation to Pay for Non-Gratuitous Acts

Responsibility of Finder of Goods

Mistake or Coercion

Finder of goods right to sell

When the good found is in a perishable condition

When the owner could not be found with reasonable diligence

When the owner is found but he/she refuses to pay the lawful charges of the finder

When the lawful charges of the finder, in respect of the thing found, amount to two-

thirds of the value of the thing found.

Quantum Meruit

When an agreement or contract is void

When something is done without any intension to do so gratuitously

When there is an express or implied contract to render services but there is no

agreement as to remuneration

When the completion of the contract has been prevented by the act of the other party

to the contract

When a contract is divisible

When a contract is completely performed but badly

208

10.5 QUESTIONS

Match the following

1 Contract a Incompetent person

2 Quasi Contract b Not bound by law to pay

3 Supply of necessaries c Bailee

4 Payment by an interested person d Formed by law

5 Finder of goods e Offer and Acceptance

Answers: 1e, 2d, 3a, 4b, 5c

Practical Problems

1 Sweetie went to the college and found a sunglass lying on a chair in an empty

class-room. She started wearing them. After a week Sita approached her and

claimed that the sunglass were hers and she had lost it in the college premises.

Is Sweetie Liable to return them to Sita?

Answer: Yes, Sweetie is liable to return the sunglass to Sita as she is a finder

of goods and so her position is that of a bailee and not an owner

2 Riki was attending her Physics lecture and after the lecture she found a lunch

box at her adjacent table. She called out to find if someone had left it by

mistake. When no one came to claim the lunch box Riki opened the box and

ate all that was there in it. Later Puja came to Riki and claimed that the lunch

box was hers. Is Riki Liable to compensate for the lucnch she ate to Puja?

Answer: No, as the lunch was perishable and Riki took all the reasonable

measures to trace Puja therefore she was not liable to compensate for the food

she ate.

3 Tracy found a puppy at her door step. She enquired at her neighbourshood if

the puppy belongs to anyone. No one came to claim it. Tarcy kept the puppy

with her and one day when the puppy fell sick she showed him to a veterinary

doctor. She paid the medical fees as well as the cost of medicine. After a

month the owner of the puppy came to collect the puppy. Could Tracy claim

compensation from the owner for the medical treatment?

Answer: Yes, Tracy has all the right to retain the puppy as along as the owner

for all the lawful charges she made on the puppy does not compensate her.

209

4 Mr Srivastava went to buy a shirt for himself. By mistake the shirt he bought

got replaced by another shirt, which seemed more expensive than the one he

had purchased. Is he liable to return the shirt back to the shop?

Answer: Yes, Mr. Srivastava is laible to return the shirt back to the shop

because it was a mistake and he cannot benefit himself from the mistake of the

other party. he is bound to return the shirt.

5 Rustam took an advance payment from Jugnu for the delivery of Pizza and

burger. On the way the delivery boy met with an accident and the pizza and

burger fell on the road. Is Rustam liable to return the advance payment to

Jugnu?

Answer: Yes, Rustam is liable to return the money he took from Jugnu

because he cannot benefit himself at the cost of the other party.

Questions:

1 What is Quasi Contract? What is the difference between Quasi Contract and a

Contract?

2 What are the various types of Quasi Contract? Illustrate with examples.

3 Who is a finder of goods? In what situations does the finder of goods get the

right to sell the good?

4 What is Quantum Meruit? In what conditions does Quantum Meruit arise?

6.5 REFERENCES

! Chadha P.R. & Bagrial A.K. (2005): Business Law, Pragati Publictions, New

Delhi

! Bangia R.K. & Bangia S. (2002): Indian Contract Act, Allahabad Law Agency,

Faridabad

! Singh Avtar (2008): Law of Contract and Specific Relief, Ninth edition, Eastern

Book Company, Lucknow

! Kapoor N.D. (2004): Business Law, Sultan Chand & Sons, Educational

Publishers

! Kuchhal M.C. (2005): Business Law, fourth edition, Vikas Publishing House Pvt.

Ltd.

210

Lesson – 11

Breach of Contract

by

Preeti Singh

This Lesson deals with various

aspects of Breach of contracts:

11.1 What is Breach of Contract?

11.2 Anticipatory Breach of Contract

11.3 Actual Breach of Contract

11.4 Remedies for Breach of Contract

11.5 Rescission of the Contract

11.6 Suit for Damages

11.7 Suit for Specific Performance

11.8 Suit for Injunction

11.9 Suit upon Quantum Meruit

11.1 What is Breach of Contract?

Breach of contract occurs when one of the parties to the contract refuses to perform

his obligation under a contract. Breach of contract may be either partial or total but

the effect is that one of the parties fails to perform his part of the obligation. When

breach of contract takes place then the aggrieved party is discharged from performing

his part of the obligations of the contract. The aggrieved party also has the right to

take action against the party not performing his commitment under the contract.

Breach of contract is of two types. These are anticipatory breach and actual breach.

11.2 ANTICIPATORY BREACH

Anticipatory breach occurs in executory contracts. If before the performance of the

contract becomes due one of the parties decide not to perform the contract it is an

anticipatory breach of contract. The person makes his intention known to the other

211

party that he does not intend to complete the contract and the terms binding him to the

contract will no longer be his liability. The anticipatory breach is created in the

following way:

1. By express repudiation: One of the parties to the contract renounces

his obligations towards the contract before his actual performance is

due.

2. By implied repudiation: One of the parties before his performance is

due creates some impossibility before the time of performance by

some act which makes the performance of the promise impossible to

complete.

Section 39 of the Indian Contract Act states that in the doctrine of anticipatory breach

a party to the contract refuses or makes it impossible to perform his part of the

obligation completely the other party can put an end to the contract, except when by

words or conduct he shows his intention to continue the contract.

Illustration 1: Ramesh promises Pratibha that he would

sell all the garments manufactured by him in the month of

March at a wholesale price and deliver them on the 26th

of April 2008 so that she can sell them on retail basis to

her clients. On 5th

April Ramesh informs Pratibha that he

is not interested in supplying the garments as he has a

better price offer from another party. Ramesh has committed anticipatory breach of

contract by express repudiation.

Illustration 2: Rani makes an agreement with Kaval

that she would make the entire wedding trousseau for

Rs. 1,00,000 and delivered it to her on 15th August as

the wedding date was 1st September 2008. On 1st

August Rani made the clothes ready but sold the entire

order of clothes to Simi for Rs. 1,70,000. Rani has

committed anticipatory breach of contract by implied

repudiation.

212

Case Law1

In Hochster v De la Tour108

A person appointed an employee to accompany him on a

tour at a specified salary for three months from the 1st of June. However, before June

1st the employer told the employee that he was not required to accompany him to the

tour. The employee sued the employer before waiting for June 1st. The employer

stated that since June 1st had not yet arrived there was no breach of contract. The

court held that since the employer had made an anticipatory breach, the employee put

take legal action before June 1st. Therefore, the contract becomes a legal entity from

the moment the agreement is made and not when the performance is due.

11.2.1 Rights of Aggrieved Party

In anticipatory breach the aggrieved party has the following rights:

! The aggrieved party has the right to rescind the contract and to claim damages

for causing problems by not completing the performance agreed by him. He

may not wait for the due date.

! The aggrieved party can wait for the date of performance and treat the contract

as operative till the date of performance and wait for the person to perform.

After the completion of the date he has the right to sued for actual breach of

the contract. However, if before the actual performance some event takes

place which makes the contract impossible without the fault of both the parties

the contract becomes void due to supervening impossibility and the person

will be excuse from performing his role in the agreement. The promissee will

not be able to take any action after that date.

Case Law 2

In Avery v Bowden 109

A person (A) chartered a ship (from B) and promised to load it

within 45 days at a specified port. When the ship arrived (A) told the captain to leave

as he did not have any cargo. The captain however continued to stay there. Before the

agreed 45 days a war broke out and the performance could not take place because it

became illegal. (B) sued (A) in court for breach of contract. The court held that the

contract was discharged by impossibility and not by breach.

108

1853 2E & B678 109

1855 5E & B714

213

11.2.2 Amount of Damages

The damages available to the aggrieved party are the following:

! If the aggrieved party rescinds the contract when the breach occurs, the

damages would be the difference between the price on that date and the

contract price.

! If the aggrieved party waits till the date of the performance, the damages will

be the difference between the price on the due date of the contract and the

price of the contract.

Illustration: Raju promised to sell Meera 50

Samsung televisions as he was a dealer of

televisions in South Delhi. He promised to

deliver the televisions by July 15, 2008 at a

price of Rs. 17,500 each. On 1st July he

informed Meera that he could not supply the

goods to her. What would be the damages

which could be recovered by Meera (a) if she

rescinded the contract on 1st July, (b) if she waited until 15th July when the market

price of televisions rose from Rs. 18,000 as on 1st July to Rs. 18,500 by 15th July

each?

Answer: (a) If Meera rescinded the contract on 1st July she would get the damages of

Rs. 500 x 50 = 25,000 and (b) if she did not rescind the contract until 15th July she

would get 18,500 – 17,500 = Rs. 1,000 x 50 = Rs 50,000.

11.3 ACTUAL BREACH OF CONTRACT

Actual breach of contract is when one of the parties does not perform (a) on the due

date of the performance or (b) while the performance is takes place. This is explained

in the following manner:

! On the due date of the performance: If one of the parties fails to

perform or refuses to perform his role in the contract on the date when it has to

be performed, it is called

actual breach of contract.

214

Illustration: Sanjay promised to sell 1000 ball pens for Rs. 5 each to deliver it to

Inder in two installments on 11th and 14th of August 2008. On 10th August Sanjay

failed to deliver the goods. This is an actual breach of performance on due date.

! While the performance takes place: If one of the parties performs a

part of the agreed role in the contract and either refuses or fails to complete the

rest of the contract. It is called actual breach of contract while the performance

takes place. In other words it is also called actual breach during the course of

performance.

Illustration: Avi agreed to sell 80 computers to Ravi at

Rs. 25,000 each. He promised to supply 40 computers

on each of the following dates i.e. 17th

and 21st August

2008. As per the agreement he delivered 40 computers

on the 17th of August but he stated that he would not be

able to supply the rest of the computers. This is an actual breach of contract during

the course of performance of the contract.

Case Law3

In Cort v Ambergate Railway Company,110

Cort agreed to supply 3,900 tons of

railway chairs at a fixed price. After he delivered 1787 tons of chairs the company

decided not to take any more chairs. The company failed to perform its role in the

contract. This is actual breach of contract by the company.

11.3.1 Consequences of Actual Breach

Section 55 of the Indian Contract Acts states that where there is a fixed time for

performance of the contract and a breach of contract occurs, the contract is voidable at

option of the promissee. Further, the promissee is also entitled to claim compensation

for losses in case of non performance of the agreement at the specified time.

If a fixed time is not specified for the performance of the contract it is not voidable at

the option of the promissee. However, the promissee is entitled to claim compensation

for the loss.

110

1851

215

However, if the performance of a party to the agreement is accepted beyond this

specified date then the promissee cannot get any compensation.

Illustration: Delhi Darbar in Habitat Centre entered into a contract with Manjari to

sing every evening for three hours from 8 to 11’O clock for 1 month. Manjari is

promised Rs. 3,000 per evening for her performance. Manjari works for 2 weeks and

then absents herself for the whole of the next week. What are the options available to

Habitat Centre?

Answer: (a) The restaurant has the right to rescind the contract and claim

compensation for the loss due to Manjari’s absence from the performance because

the restaurant lost its business.

(b) The restaurant has the option to allow Manjari to come and sing after one week

and claim compensation from her for the loss occurred to them by giving a notice to

Manjari of their intention to claim the damages from her.

11.4 REMEDIES FOR BREACH OF CONTRACT

When a breach of contract occurs, the aggrieved party has certain options available to

him/her. The following course of action is available to the aggrieved party for

enforcing his/her rights if breach occurs:

! Rescission of the Contract

! Suit for Damages

! Suit for Specific Performance

! Suit for Injunction

! Suit for Quantum Meruit

216

11.5 RESCISSION OF THE CONTRACT

When there is a breach of contract by one party, the other party has the right to

rescind the contract and also refuse any further performance on the contract. By

rescission of the contract the aggrieved party is also free from discharging his role

under the contract.

The aggrieved party also has the option to sue the party under breach of contract for

damages under Section 75 of the Indian Contract Act. If this option is taken then the

aggrieved party has to file a suit for rescission of the contract. If the court grants the

aggrieved party rescission of the contract then the contract is cancelled. The aggrieved

party may now no longer fulfill his obligations under the contract. He also has the

option to apply for compensation for losses that have occurred to him by breach of the

contract through non completion of the contract by the other party.

Illustration: Babbu promises Banu to deliver 200 Chinese sport shoes on 10th August

2008 for Rs. 600 each. Banu promises to pay for the shoes as soon as the delivery is

given. Babbu does not deliver the shoes. Banu has the right to rescind the contract.

She may not pay Babbu the promised price for the shoes. She also has the right to file

a suit for rescissions of the contract and claim damages for non performance.

Under Section 64, if the aggrieved party treats the agreement as rescinded, he has to

restore any benefits that were received by him under the contract.

Remedies Available to an aggrieved Party

Rescission

of contract

Suit for

damages

Suit for specific

performance

Suit for

injunction

Suit upon

quantum meruit

217

11.6 SUIT FOR DAMAGES

Damages are the monetary compensation for any loss that is suffered by an aggrieved

party due to breach of contract. Since the aggrieved party has been inconvenienced

due to breach of the contract the court decides in his favour and compels the party at

fault to accept responsibility for the loss and compensate the aggrieved party.

The damages depend on the amount of loss occurred due to breach of contract. The

parties who have made an agreement can settle the amount of damages themselves

when such a breach occurs. Sometimes conflicts arise and price settlement is difficult

between the two parties. In this case the court makes an assessment of the losses and

the damages have to be paid to the aggrieved party based on this assessment.

Section 73 lays down the different types of damages that an aggrieved party can

claim. These are the following:

! General or ordinary damages

! Special damages

! Exemplary damages

! Nominal damages

11.6.1 General or Ordinary Damages

General or ordinary damages arise out of breach in the usual course of the non

performance of the contract. The aggrieve party has the right to claim damages for the

natural or direct losses occurred due to breach of the contract. General losses do not

have any provision for damages in case of indirect and remote losses.

Case Law 4

In Hadley v Baxendale 111

, A mill’s main shaft of an internal combustion engine

broke down. The mill owner made a contract with a firm of carriers to take the crank

shaft to the manufacturers as a sample for a new one. The carrier delayed the

delivery of the product to the manufacturer. As a result the mill remained non

operational. The mill owner filed a suit against the carrier company fir the loss of the

profits that he suffered because of delay. He sued but did not get the damages that he

demanded. The reason for this was that the court failed that the mill owner should

have kept some spare parts or tried to get them on rent. Since loss of profit was not

111

1854 9 EXCH 341

218

due to direct or natural consequents of breach by the carriers no damages could be

allowed to the mill owner.

Illustration 1: Ajay promised to pay the money due by him to Abhay on 28th

September 2008 on account of goods delivered to him. Abhay does not pay on the due

date. Ajay had promised other people to pay his debts on the same date. Is Abhay

liable to pay Ajay’s debts?

Answer: Abhay is liable to the extent of the amount he had to pay Ajay with interest

on the date he actually makes the payments. However, he is not required to pay any

damages which do not occur directly in the usually course of things from the breach

of contract.

Illustration 2: Alok promises to deliver 1500 pencils on 16th July 2008 to Amulya. He

does not know anything about the methodology of working of Amulya. On the due

date it begins to rain heavily and he is unable to deliver the pencils. Amulya looses

his contract with the university to supply stationary worth Rs. 3,00,000 because he

could not deliver a part of the agreed goods in time. Alok is not responsible for the

loss of Amulya’s contract.

Illustration 3: Amar makes a contract with Veer to supply him the fabric for making

summer uniforms for the staff. He is unable to supply the fabric on the due date and it

becomes too late to make the uniforms for that year by the time it arrives. Is Amar

liable for the losses of Veer?

Answer: Amar has to give compensation to Veer by calculating the difference

between the contract price and the market price of the fabric at the time of delivery.

He however is not expected to compensate the profit which Veer would have made by

tailoring the uniforms or pay for any expenses for manufacturing the uniform.

11.6.2 Special Damages

Compensation for special losses is called special damages. Compensation is recovered

only in special circumstances and if it is brought to the notice of the defaulting party.

When a party claims special damages it has to prove that the other party to the

contract, knew at the time of making the contract, that there would be a loss in special

circumstances, in case of breach of contract.

219

If special damages are proved as a result of breach of contract and it is communicated

to the other parties then special damages will be awarded.

Illustration 1: Malik agrees to repair the machine of Mr. Sangi so that he would not

suffer any losses in business. He agreed to pay Rs. 5,000 in advance for getting the

machine fixed by 10th of July. Malik repaired to machine but it was not according to

the contract. Malik has to pay the cost of the additional repairs which Mr. Sangi will

have to make to use the machine to full capacity.

Illustration 2: Semitech builders promised Mr. Ahuja to complete the house and give

possession of the house by 1st January 2008 as he was living in rented apartment.

This apartment had to be given back to the landlord by December 2007. The builder

was informed and the agreement was made. However, Unitech builders did not give

their promise. They have to pay a compensation for breach of contract. They also

have to pay the rent of another house in which Mr. Ahuja lives while waiting for the

new house to be ready. In addition the builder will have to pay compensation for

relocating Mr. Ahuja to an apartment as he has to give back the present apartment to

the landlord.

11.6.3 Exemplary damages

Exemplary damages are also called vindictive damages. They are awarded by the

court if a party has suffered mentally or emotionally due to breach of the contract.

The court makes an exception to general principle that damages should be awarded

only for financial loss due to breach of contract.

The law finds it difficult to compensate for mental pressure or suffering or

humiliation of the aggrieved party due to breach of the contract. It usually

compensates for financial losses. In exceptional cases it awards exemplary damages.

There are two important matters in which the court awards exemplary damages. These

are the following:

! Breach of promise to marry another person

! Unjustified refusal of banker to honour a cheque of another person.

Breach of promise to marry another person: If there is a breach of contract to marry

another person although a promise has been made. The aggrieved party can claim

damages from the person who has broken the promise. The reason for this is that the

220

aggrieved party has been emotionally hurt and as also lost his/her reputation in public.

Since it is difficult to measure the financial loss in such a case, the court awards

exemplary damages. 112

Unjustified refusal of banker to honour a cheque of another person: Sometimes a

bank refuses to honour a cheque even though the account holder has sufficient funds

in his/her account. This causes loss of reputation to the account holder. The aggrieved

party can claim damages from the bank. The smaller the amount that is dishonoured

the greater would be damages.

11.6.4 Nominal Damages

Nominal damages are awarded when in a breach of contract the aggrieved party does

not have any losses due to the breach. The courts however treat this seriously so that

such types of breach are not made by the parties. Therefore, they award a small token

as compensation to take note of the offence made by the guilty party. A small

compensation may be charged so that the guilty party so that he recognizes his

mistake.

11.6.5 Rules Regarding of Damages

The rules are a guide for the courts to measure the damages for the aggrieved party.

The following are the types of damages awarded by the court:

(1) Compensation: The courts award compensation and not penalty because the

objective is that the aggrieved party should be compensated and not to prove a party

guilty of punishing him for causing breach. Law does not consider breach of contract

to a crime for punishment.

(2) Limited damages: The court awards compensation to the aggrieved party when

the contract is not performed according to agreement. It does not pay damages for

expectations of the aggrieved party or for incidental or remote causes that are not

connected with the contract.

(3) Damages attributed directly to the contract: Damages are awarded by the court

for losses occurring on due course of the contract. Damages may be general or special

depending on the circumstances of the case.

112

See State of Kerala and another VMA Mathai AIR 2007 SC 1537

221

(4) Stipulation for liquidated damages or penalty: The parties to the contract can

themselves stipulate the damages to be given to the aggrieved party either by way of

liquidated damages or penalty. English law and Indian law defined stipulation of

amount of damages differently.

(5) Damages under sale of goods: In sale of goods there are several problems of

breach of contract the aggrieved party will get the difference between the contract

price and the market price on the date of the breach of the contract as damages.

(6) Expenses of the suit: The expenses of conducting a suit in the court can be

recovered from the party who has created a breach to the contract. However, it is the

courts discretion to award the cost of the suit to the guilty party.

11.6.6 Liquidated Damages and Penalty under English and Indian Law

The liquidated damages are an assessment by the parties to the contract of the amount

that the aggrieved party would suffer in case of breach. If there is a pre-estimate of

damages it is called a stipulation by way of liquidated damages.

When the parties decide on an amount which is very high in proportion to the loss that

would be suffered by the aggrieved party in case of breach of contract it will called a

penalty.

Case Law 5

Dunlop Pneumatic Tyre Company v The New Garage and Motor Company113

In this

case a manufacturer of tyres made several technical rules with a dealer that if he sold

a tyre below the list price he would have to pay a penalty of £5. The dealer made a

breach of contract. The House of Lords declared that they would have to pay

liquidated damages for breach of contract.

1.English Law

English law states that when two parties have agreed on a stipulated amount of

damages, the court should be informed of it. If the court accepts that the stipulation is

by way of liquidated damages then the aggrieved party would get the whole of the

amount agreed between both the parties as damages. The reason for this is that the

parties knew of the contract that had entered into and have themselves assessed the

113

1915 AC 79

222

losses that would occur if one of the parties committed a breach of contract.

Sometimes the court finds that the stipulated amount of liquidated damages is very

high and is like a penalty to the guilty party. In such cases the court will make its own

assessment of the damages and award to the guilty party an amount that is reasonable

to be given to the aggrieved party.

2. Indian Law

The Indian Law provides greater advantage to the aggrieved party in comparison to

the English Law. The damages in case of breach in each case are discussed in the

court and the amount which both the parties to the contract have stipulated as

damages in case of breach, at the time of entering into the contract are also

considered. Yet the court has the option to decide on further damages for the

aggrieved party. According to section 74 there is no distinction between stipulation of

the amount of damages and penalty. If the contract is broken, the aggrieved party is

entitled to get reasonable compensation assessed by the court.

Liquidated damages can be distinguished from special damages. Under liquidated

damages the amount of damages in case of breach is predetermined whereas under

special damages the extent of losses due to breach are determined but the

quantification of damages are not determined. Special damages are determined by

court depending upon the kind of losses of the case.

There are certain exceptions to section 74 of the Act. In these cases whatever amount

has been fixed for payment under breach of contract will have to be paid in full even

though the amount is far and excess of reasonable compensation. These are in the

following situations:

1 When a bail bond has been executed and it is recognizable in the court.

2 When a person appears in the court and a bond is made for performing a

public duty or an act in which the public is interested.

Note:

1. It may be noted that this applies only to those to perform public duty and not

under government authority. If government rates the bond then under Section

74 the damages will have to be paid to the aggrieved party as determined by

the court.

2. Public duty does not involve commercial contracts like supply of stationary or

furniture. It consists of duties relating to work that is important for public.

223

Illustration: Akriti is bound to attend court for public work on 20th of December

2008 or pay a penalty of Rs. 3,000. She decides not to appear on that day in the court.

She is bound to pay the penalty.

Enhanced rate of interest: Section 74 of the Indian Contract Act states that

stipulation for increase interest from the date of breach can be considered as

stipulation by way of penalty. The court can disallow the enhanced rate of interest if it

is exorbitant. The following points may be noted in this regard:

1. Interest can be paid only if there is an express or implied agreement otherwise

it cannot be paid as damages.

2. A stipulation for enhanced rate of interest from the date of default is treated as

penalty if it is too high but if it is reasonable the court allows recovery of the

interest to the aggrieved party.

3. A party may be allowed the payment of compound rate of interest but this is

possible when the interest rate is not enhanced.

Illustration: Amit gives a bond to Sanjit to pay him Rs. 4,000 with interest of 15% per

annum with a stipulation that if there is a breach then the interest will be payable at

45% from the date of default. This is called a stipulation by way of penalty and Sanjit

will be allowed to only recover that amount which the courts consider to be

reasonable.

11.7 SUIT FOR SPECIFIC PERFORMANCE

The court can use its discretion when it is essential to order the party who has made a

breach of a contract to perform what was intended to be done in the contract between

the parties.

Law usually does not insist in performance of the contract that a party has refused to

complete even though the aggrieved party demands justice. The reason for this is that

the court considers compensation as damages to be the right measure for the

aggrieved party. However, in some specific cases courts may order the guilty party to

complete the contract entered into between the parties.

1. When court orders specific performance: In the following cases the court can

grant relief and direct the guilty party in terms of specific performance of the contract:

224

i) Where there is no standard for quantifying the actual damages that are caused

to the aggrieved party by non-performance of the contract.

ii) Where the monetary compensation is not an adequate measure of the loss of

the aggrieved party. In cases of contracts entered into for sale of immovable

property or special rare antique pieces or certain items which mean a lot to the

aggrieved party and it cannot be replaced.

iii) Where a property of the aggrieved party is held by his agent or trustee and the

act is to be done to perform a trust function.

2. Where courts will not allow specific performance: The courts will not allow relief

for specific performance in the following cases.

1. When the court considers monetary compensation to be adequate for breach of

contract.

2. When contracts are made by trustees or agents who have violated their powers

and breach of contract occurs.

3. In contracts of personal nature especially in the case of contract to marry or a

contract to stage a show.

4. In cases where the courts cannot supervise the performance of the contract

because it involves continuous duty to complete the contract.

5. In cases when the court is of the opinion that enforcement of specific

performance is not possible due to the intricacies of the terms of the contract.

11.8 SUIT FOR INJUNCTION

Injunction is an order of the court where a person is prohibited to do a specific act or

action. Sometimes a party to the contract does some action which he has promised

that he would not do; the court has the right to issue an order to prohibit him to do it.

This action is taken by the court when a party is guilty of breach of some negative

term in the contract. Injunction is therefore a negative order of the court that stops a

party from some action. It is in other words a preventive relief to a party at the

discretion of the court. To give an injunction there are certain requirements of the

court. These are the following:

! The contract between the parties should consist of two parts. One agreement

should be affirmative and the other should be negative in nature.

! The negative part of the agreement should be separate from the positive

aspect.

225

! The person applying for injunction should not have failed in completing the

contract.

Illustration: The cricketer promised his club that he would only play for

the particular club for 6 months and not for any other association. After

1 month he joined another club and refused to perform with the club

under contract. Since this is a two part contract the court can refuse

specific performance of contract with the club but at the same time can

also grant injunction to restrain the cricketer not to play elsewhere.

Case Law 6

In Lumley v Wagner114 A person made a contract to sing at a particular

theatre for 3 months and during that time not to sing for anyone else.

The singer made another contract with a new theatre violating the first

contract. The theatre owner filed a suit. (i) The court ordered the singer

not to perform in any other place until the time of the contract is

completed. (ii) However, it did not compel the singer to actually perform

and complete the first contract.

11.8.1 Earnest Money and Deposit

Sometimes, while forming a contract advance payments in the form of security

deposits are given. This deposit can be either an earnest money or a security deposit.

Court draws a distinction between the two terms and the judgements in both cases are

slightly different.

Earnest money: An advance payment made by one party to another is called an

earnest amount. The full payment is usually made later on the completion of the

contract. This advance payment of money is forfeited if the buyer of a product

commits a breach of contract.

Earnest money is viewed by the court as damages if such money has been paid in

advance. It can be forfeited it is a reasonable amount but if loss is higher than the

earnest money then an additional amount has to be paid to the seller.

114

1852 1 DMG 604

226

If a security deposit has been given by a person the courts consider it as a penalty. In

case of breach only a reasonable amount is allowed to be retained by the aggrieved

party. In case the aggrieved party does not have any loss no amount can be retained.

Whatever compensation is decided it cannot exceed the amount of the security

deposit.

Security deposit: An advance payment made by one party to another made as

guarantee for the fulfillment of the contract by the person is a security deposit. Such

an amount cannot be forfeited if there is a breach of contract.

11.9 SUIT UPON QUANTUM MERUIT

Quantum Meruit means ‘as much as earned’. It is a payment for the proportion of

work that is done when work cannot be measured in terms of money. The doctrine of

quantum meruit is legally applied in some cases when there is a breach of contract. It

is like compensation when the performance of the work is not complete. A reasonable

compensation is given to the extent that the performance has been made. Since no

remuneration was fixed for completion of the work to that incomplete stage, some

amount is paid because further performance has been stopped either because there is a

breach of contract or when an agreement is discovered to be void.

Case Law 7

Plinche v Colburl115

In this case the defendants who were publishers engaged the

plaintiff who was an author to write an article for their magazine. As part of the

contract the plaintiff prepared the manuscript and a large number of drawings. After

a considerable amount of work was done the defendants decided to discontinue with

the publication. The plaintiff claimed remuneration for the work completed by them.

The court decided and their favour for compensation under quantum meruit.

In order to apply under quantum meruit there have to be fulfillment of certain

conditions. The contract should be discharged by the other party and not the claimant

of compensation under quantum meruit. Damages are considered to be compensatory

but quantum meruitum is provided as a restitution or reasonable compensation which

is given as remuneration. In a following cases quantum meurit can be applied for:

115

1831 5 C. & P. 58

227

(a) Breach of contract: If a party has completed a part of his performance to the

contract and the other party decides not to complete the contract and work has

to be stopped due to breach of contract, quantum meurit will apply.

(b) Void agreement: When a person in the course of the contract completes some

part of his performance but it is discovered that the agreement is void. He

becomes entitled to some reasonable remuneration.

Case Law 8

In Craven Ellis v Canons Ltd.116

A person was appointed as a managing director

through and agreement between him and other directors of this company. Since, none

of the directors took qualification shares so accordingly they were not entitled to act

as a director. The managing director sued the company for receiving remuneration

under quantum meurit for the work done by him. The court allowed the company to

compensate the managing director under quantum meurit although the agreement to

the appointment was point to be void.

(c) Implied payment: When a party to the contract performs and the other party

enjoys the benefits of the work, he is bound to compensate the other with the

reasonable sum, even though no agreement for payment was made formally.

The party had performed his part of the work without any intention of doing it

gratuitously.

(d) Divisible and non divisible work: Quantum meurit can be paid only when

work is completed. If it is divisible it will be paid for that part of the work that

is completed. If it cannot be divided the party will not be entitled to claim any

compensation.

Case Law 9

In Cutter v Powell117

, A sailor was to be given a lump-sum remuneration for

completing a voyage. He died before completing the voyage. His widow sued the

company. The court held that she would not remuneration because the payment was

to be made only for completion of a particular service.

Illustration 1: A contractor made an agreement with Sonu to construct the ground

floor and the first floor of his house. After completing the ground floor Sonu decided

116

1936 2 K. B. 403 117

1795

228

not to continue with the construction. The contractor demanded remuneration for the

completed work. The court held that since the project was divisible and also it was a

breach of contract by Sonu and not the contractor he should be paid his dues for

completion of the work performed by him under quantum meurit.

Illustration 2: A Contractor made an agreement with Monu who was Sonu’s brother

to complete the first floor of the house. Before completing it he decided to quit and not

complete the work although a sizable amount had been done. The contractor sued for

remuneration. The court cannot be relief to the contractor because the work was not

divisible and half way he left Sonu and Monu in a lurch. No claim can be allowed

because there was no express or implied promise to pay for the work which is half

done.

Points to Remember

Breach of contract

(ii) When one of the parties decides not to complete the performance in the

contract, it is said to be a breach of contract.

(iii) Breach of contract. may be actual breach or anticipatory breach

Remedies for breach of contract

The aggrieved party has the following remedies for a breach of contract:

8 Suit for rescission

9 Suit for damages

10 Suit for specific performance

11 Suit for injunction

12 Suit for quantum meurit.

Suit for rescission

(n) Rescission means cancellation of the contract.

(o) When there is a breach the other party can refuse to perform his contract.

(p) The court provides rescission through specific relief at for resending a

contract.

(q) Rescission is given when contract is voidable.

(r) Rescission is not awarded when due to change of circumstances or due to third

party rights acquired in good faith.

Suit for damages

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• Damage means monetary compensation to aggrieved party.

• The damages that are awarded are ordinary damages, special damages,

nominal damages and exemplary damages.

• Ordinary damages are awarded for actual loss suffered and that which arises

out of usual course of things due to breach.

• Special damages are paid for special and unusual circumstances.

• Exemplary damages are given for compensation of losses and not as

punishment.

• Nominal damages are awarded only to recognize the rights of the aggrieved

party. It is a small monetary loss but it inconveniences the other person.

• The English Law distinguishes between penalty and liquidated damages.

• The Indian law does not find any difference between penalty and liquidated

damages.

• Stipulation of interest at an ordinary rate is liquidated damages and enhanced

rate is penalty.

Suit for specific performance

a) When court directs the party to complete the contract it is called specific

performance. This is a relief granted by court.

Suit for injunction

(a) Injunction is preventive relief where damages cannot bring an adequate relief.

Suit for quantum meurit

(b) Quantum meurit is awarded by the court for the proportion of work completed

before there is a breach of contract or agreement is discovered to be void.

(c) It can be awarded only if the other party to the contract has made a breach and

a sizable amount of work is done and work is stopped without any fault of his.

Objective Type Questions

Match the Following:

(i) Quantum meurit 1. Penalty

(ii) Injunction meurit 2. Liquidated damages

(iii) Enhanced damages 3. based on restitution

(iv) Predetermined expenses 4. Based on refrain

(v) Earnest money 5. Advance payment

(vi) Security deposit 6. Guarantees payment

230

(vii) Nominal damages 7. cancel contract

(viii) Exemplary damages 8. taken cheque

(ix) Rescission 9. based on promise to mainly

(x) Specific performance 10. order to complete performance

Answers: (a) 3, (b) 4, (c) 1, (d) 2, (e) 5, f (6), g (8), h (10), (i) 7, (j) 9.

Questions

! What is anticipatory breach of contract? How would you distinguish it

from actual breach?

! Discuss the different kinds of damages that may be awarded by the

court in case of breach of contract.

! Comment on the following statements (a) Quantum meurit provides

restitution and not compensation (b) Damages are give as

compensation and not punishment. (c) Payment of earnest money may

or not be forfeited but security deposit cannot be forfeited in case of

breach of contract.

! Damages can be distinguished from penalty but under Indian law they

mean the same thing. Explain the interpretation under the laws.

! What action does the court take in case of payment of interest if these

are a breach of contract? Give illustration to explain?

! What is a suit for injunction? Give illustrations to explain the situations

when this can be used as a relief.

! Distinguish between

! Anticipatory breach and actual breach

! Liquidated cheque penalty

! General and special damages

! Suit for injunction and quantum meurit

! Earnest money and security deposit giving illustrations on the following:

Write notes

! Exemplary damages

! Suit for specific rate of interest

! Enhanced rate of interest

! Suit for rescission

231

Practical Problems

! The general manager of the firm appointed Sanjeev as chartered accountant

to represent the firm for financial matters. Subsequently, he found that only

the directors of the firm could appoint him and therefore his appointment

was not valid. Can he recover his salary for the time he has performed his

duties?

Answer: Sanjeev is entitled to receive his remuneration under quantum meruit for the

time period of his work.

! Manav made a contract with Maneeta that he would deliver 150 Nokia

Mobile phones for Rs. 5500 each on 13th August on which date he would

receive his payment as well. Manav did not deliver on the date and Maneeta

had resold the mobile phones to third parties before receiving the delivery of

the phones. As a result she lost her business. Can she recover the amount

from Manav?

Answer: No, she cannot recover the amount because this is not a direct loss. Manav

did not have any knowledge of resale of the phones even before the delivery.

He is not responsible for it. However he can pay her reasonable losses if any

that are directly attributed to the costs of the contract.

! Muttu was employed by Kala for Rs. 80,000 to do the painting of the walls

of her house. Before completing the painting he decided to leave India and

settle in Malaysia as his visa had come. He asked Kala to pay her for the

work he had done. Can he recover the amount?

Answer: Muttu cannot recover the money as the work is not divisible. The contract

was given for lump-sum work and if the contractor decided to quit the job

before completing it he was not entitled to any remuneration.

! Sunny took a loan from Abhinav to buy a house. Abhinav gave him Rs.

15,00,000 at 10% rate of interest. However if the money was not returned in

two years time he would charge him an enhanced rate of 30% interest.

232

Sunny could not return the loan on the promised date. Abhinav charged him

the enhanced interest rate. Is Sunny liable?

Answer: Sunny will have to pay the normal charges of 10%. Since 30% is a very high

charge the court will not accept it and will reduce it to 10%.

! Sukanya made a contract with Ruhi to construct a hostel building in the

university premises. Ruhi completed some work and was paid Rs. 2,00,000.

Subsequently Ruhi found that the contract was void as Government had not

yet given any permission to construct a building without which no

construction could take place. Sukanya asked Ruhi to return the money paid

to her. Is Ruhi entitled to keep the money or will she have to return it?

Answer: Ruhi is entitled to keep the money under the doctrine of Quantum Meruit.

! Jumna was to construct the whole building and then only the people who

wanted to buy it would make the payment to her. Before Jamuna completed

the building she died. Her son asked the people to pay an amount for the

work completed. Is the son entitled to compensation?

Answer: The son cannot claim compensation as the building has not been completed

and it is not a divisible project that payment can be made for the portion of

the building that is complete.

! Seeta promises to work in Geeta’s school for 5 years and in no other school.

After 2 years she joins another school. Can Geeta restrain Sita from joining

another school?

Answer: Geeta can sue for injunction against Sita. The court will restrain Sita from

joining another school but cannot insist on her performance in Geeta’s

school.

! Popli gave a firm of couriers’ 50 envelopes to be delivered in a week’s time.

Due to some problem, the envelopes could not be delivered in time. Popli

demanded to be compensated for the loss in the profits of his business as he

233

could sell the artifacts in the envelope only for two weeks in the festive

season. Will he succeed in receiving compensation?

Answer: Popli can only be compensated if there is a direct loss of the envelopes but

not in delivering late as he is not responsible for the loss in profits. If the

envelope is lost it is directly attributed to the packet and must be replaced.

The profits on the sale of those products are not the responsibility of the

courier.

References:

! Singh A. (2008 ) Law Of Contract , Pages 386 to 472 ( Chapter 9),

Eastern Book Company, Lucknow, India.

! Maheshwari S.N.and Maheshwari S.K.(2007) Business Law, Pages

1.127 to 1.141 Himalaya Publishing House, Mumnbai,

! Kapoor N.D. (2004) Business Law, Pages 125 to 135, Sultan Chand

and Sons, New Delhi,

! Singh A (2008) Law of Contract Pages 386-430,Eastern Book

Company, Lucknow.

! Chadha P.R. (2001) Business Law Pages158-182, Galgotia Publishing

Company, New Delhi.

Websites:

1.http://www.atkinson-

law.com/cases/CasesArticles/Articles/Measure_of_Damages.htm

2. http://www.atkinson-

law.com/cases/CasesArticles/Articles/Breach_of_Contract.htm

3. http://law.freeadvice.com/general_practice/contract_law/breach_contract.htm

4. http://en.wikipedia.org/wiki/Breach_of_contract

234

Lesson – 12

BAILMENT AND PLEDGE

by

Anu Pandey

This Lesson discusses the various aspects of Quasi Contract

12.1 Definition

12.2 Rights and Duties of Bailor and Bailee

12.3 Finder of Goods

12.4 Termination of Bailment

12.5 Pledge

12.6 Rights and Duties of Pawnor and Pawnee

12.7 Pledge by Non-owners

Contracts of Bailment and pledge are special contracts, which are dealt in chapter IX

(section 148 to section 181) of the Indian Contract Act 1872. Not every time property

is bought and sold. Sometimes a property, whose ownership belongs to a certain

person temporarily, goes into the possession of another person. Such a relationship

between two persons is called bailment. The essence of bailment is possession and it

can happen in numerous circumstances.

235

12.1 DEFINITION

According to Section 148 of the Contract Act “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”. Some of the examples of bailment are-

A cloth given to a tailor for stitching, a watch given to a shop for repairing, a friend

lending his bicycle to another friend for riding it and jewelry taken on rent for

wearing it to party.

The person delivering the goods is called the ‘Bailor’ and the person to whom the

goods are delivered is called the ‘Bailee’118

.

Illustration 1

Ram sends his car to the garage for repair. In this case

Ram is the bailor and the garage owner is the bailee.

The garage owner (bailee) has to repair the car and

then hand it over to Ram (bailor).

Illustration 2

Jacky delivers his suit for dry cleaning with the dry

cleaner. Jacky is the bailor and the dry cleaner is the

bailee who has to return the suit to Jacky after dry-

cleaning it.

118

See Srinivasa Iyer vs. New India Ass. Co. Ltd (A.I.R. (1983) S.C. 899). Also see

Atul Mehra Vs. bank of Maharshtra (A.I.R. (2003) P & H 11

236

Illustration 3

Rajni went from Delhi to Shimla by train. On reaching

Shimla she deposited her luggage at the cloakroom.

Rajni is the bailor and the person who is the in charge

of the cloakroom is the bailee.

The following are the essential features of Bailment:

! Movable goods: The goods in bailment are goods as defined in section

2 (7) of the sale of goods Act, 1930, which means every kind of

movable property other than money and actionable claims. Immovable

property like land and buildings are not considered as goods.

Illustration 1: Ranbir lent his car to Jeetendra for a week for rupees 3500. This is a

case of bailment where Ranbir is a bailor and Jeetendra is a bailee. Jeetendra is

liable to pay Ranbir rupees 3500 and also return the car after a week.

Illustration 2: Ghanshyam lent his house on rent to Shambhu for six months for

rupees 10,000 per month rent. This is a valid contract but not a contract of bailment

because the property in this case is an immovable property and immovable property

like land and building are not considered as goods under bailment. Hence this is not

a case of bailment.

! Delivery of goods: Section 149 of the Indian contract act 1872

explains the mode of delivery of goods. It states that there may be two

modes of delivery. Actual delivery and constructive delivery. In actual

delivery the bailor hands over physical possession of goods to the

bailee and in constructive delivery the bailor does not hand over

physical possession of goods but does something which has the same

effect of putting the goods in possession of the bailee.

237

Illustration 1: Sita gives a piece of cloth to her tailor for stitching a dress. This is a

case of actual delivery where the bailor has physically delivered the cloth to the

bailee for stitching purpose and once the purpose has been fulfilled the bailee returns

the cloth to the bailor.

Illustration 2: Jhankar had some problem with her car she went to the mechanic and

handed him the car keys. This is a case of constructive delivery because here the car

(good) is not handed over physically to the bailee but by delivering the car keys to the

mechanic the (mechanic) bailee has been given the possession of the car (good).

! Some purpose: The delivery of goods from bailor to bailee is done to

accomplish some purpose. If goods are delivered by mistake without

any purpose then there is no bailment.

Illustration 1: Mr Rastogi went to the presswala (dhobi) to give his clothes for

ironing. This is a case of bailment where Mr Rastogi is the bailor and presswala is

the bailee and the purpose here is to get the clother ironed.

Illustration 2: Naina went to her friend’s house Sunaina and while leaving the house

she forgot to pick up her purse. After coming home she realized that she had left her

purse on the sofa in Sunanina’s house. This is not bailment because the purse was

kept in Sunaina’s house by mistake.

! Return of goods: After the purpose for which the goods were bailed

to the bailee has been fulfilled the goods have to be returned to the

bailor.

Illustration 1: Som had given his shoes to the cobbler for repairing the shoes. After

the shoes were repaired the cobbler was liable to return the shoes to Som. Similarly

Som too was liable to pay the shoe repairing charges to the cobbler.

238

Illustration 2: Som went to a shoe shop and bought a pair of shoes for himself. This is

not a case of bailment and Som is not liable to return the shoes to the shoe owner

because here Som is a buyer and not a bailee and the shoe owner is a seller and not a

bailor.

Kinds of Bailment

Bailment may be classified according to the benefit derived by the parties. These are

as follows:

1. For the benefit of the bailor: When the delivery of goods by the bailor to the

bailee is done for the exclusive benefit of the bailor and the bailee gets nothing

in return that is consideration does not pass between the bailor and the bailee.

Illustration: Rumu gave a cloth piece to her friend Geeta who was a fashion designer

to stitch a shirt. Geeta after stitching the shirt gave it back to Rumu. In this case

Rumu is the bailor and Geeta is the bailee and Geeta stitches the shirt without taking

anything from Geeta.

2. For the benefit of the bailee: When the delivery of goods by the bailor to the

bailee is done for the exclusive benefit of the bailee and the bailor gets nothing

in return. Hence consideration does not pass between bailor and the bailee.

Illustration: Rumu lent her saree to her friend Geeta for a wedding party. In this case

Rumu is the bailor and Geeta is the bailee and Geeta has to return the saree to Rumu

after the function is over.

3. For mutual benefit of both the bailor and the bailee: When the delivery of

goods by the bailor to the bailee is done for mutual benefit of both the parties.

In this case consideration passes between the bailor and the bailee.

239

Illustration: Rumu gave a cloth piece to the tailor for stitching a shirt for rupees two

hundred. In this case Rumu is the bailor and tailor is the bailee and consideration of

rupees two hundred passes between the bailor and the bailee.

Bailment may also be classified as Gratuitous and Non-Gratuitous Bailment.

1 Gratuitous Bailment: In this case no consideration passes between

the bailor and the bailee. The bailment for the benefit of the bailor and

the bailment for the benefit of the bailee mentioned above are

gratuitous bailment.

Illustration: Lucky was going out of station for two days. She had a dog Romeo whom

she gave to Satish her neighbour for safekeeping. This is a case of gratuitous

bailment.

2 Non-Gratuitous Bailment: In this case consideration passes between

the bailor and the bailee. The bailment for mutual benefit of the bailor

and the bailee is a non-gratuitous bailment.

Illustration: Shyama took a necklace on rent from a jeweler for wearing it

in a party for rupees two hundred. This is a case of non-gratuitous bailment.

12.2 RIGHTS AND DUTIES OF BAILOR AND BAILEE

12.2.1 Duties of a Bailor

(1) To disclose known facts: The bailor should disclose the known faults about the

goods, which he/she has bailed to the bailee. If the bailor does not disclose the defects

then he/she is liable for any damage caused to the bailee due to such defects in the

goods.

240

Illustration: Sangeet went for a horse riding. He took a horse from the stable that was

mad. The horse owner was aware of the horse’s madness but he did not inform

Sangeet about it. Sangeet sat on the horse and the horse threw him off as a result

Sangeet hurt himself. In this case it was the duty of the horse owner to inform Sangeet

about the madness and therefore the owner is liable to compensate Sangeet for the

injury sustained by him.

(2) To incur extraordinary expenses of bailment: The bailee is responsible to bear

ordinary and reasonable expenses of the bailment but for any extraordinary expenses

it is the bailor who is responsible.

Illustration: Rajni use to leave her daughter in a crèche for rupees 100 a day. One

day her daughter became sick and was taken to the hospital by the crèche owner and

the owner paid the medical bills. As this is an extraordinary expense therefore it is the

duty of Rajni to reimburse the owner all the medical expenses.

(3) To indemnify bailee for loss in case of premature termination of gratuitous

bailment: If the gratuitous bailment is terminated by the bailor

before the specified time then any loss the bailee incurs due to such termination shall

not be born by the bailor. However if the loss suffered by the bailee exceeds the

benefit he/she has derived from bailment then in such a case the bailor shall

indemnify the bailee.

Illustration: Deepak’s relatives had come to Delhi on vacation. He had no vehicle so

he borrowed his friend’s car for two days. He had filled up the petrol tank for rupees

two thousand. The very next day his friend came to take the car back. Hence the

friend was liable to pay the petrol cost to Deepak as rupees two thousand was the loss

he incurred due to premature termination of the contract of bailment.

(4) To receive back the goods: once the purpose has been fulfilled for which the

goods were bailed out it becomes the duty of the bailor to receive back his/her goods

from the bailee. He cannot refuse to take back the goods. However if the bailor

refuses to take back the goods then the bailee is entitled to receive compensation for

the expenses he/she incurs in custody of goods.

241

Illustration: Reena had left her cat at her neighbour’s place for two days as she was

going out of station. Once she came back it was her duty to fetch her cat back from

her neighbour’s place.

(5) To indemnify the bailee: If the title of the good is defective and due to

that the bailee suffers a loss then the bailor is responsible to the bailee for the loss

suffered by him/her.

Illustration: Krishna found a watch on the road and picked it up. He sold it to Rani

for rupees hundred. The watch was not in a workable condition so Rani got it

repaired for rupees fifty. Later the real owner of the watch came and claimed back his

watch from Rani. Rani was entilteld to be reimbursed for the loss suffered by her in

purchasing and using the watch from Krishna (the bailor).

12.2.2 Duties of a Bailee

(1) To take reasonable care of the goods: It is the duty of the bailee to take

reasonable care of the goods bailed to him/her by the bailor. According to section 151

of the Indian Contract Act 1872 the bailee is to take care of the goods 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 152 states that if, in spite of

taking all the reasonable care the goods are damaged or destroyed in any way then the

bailee is not liable for the loss, destruction or the deterioration of the goods bailed.

Illustration 1: Roopwati gave her mobile phone for repair to Nikhil at his repair shop.

Nikhil forgot to keep the phone in the drawer and the phone kept lying on the table.

Someone came to the shop and stole the mobile. Later Nikhil found that the mobile

had been stolen. In this case Nikhil is liable to compensate Roopwaiti for the loss as

the loss was due to his negligence.

242

Illustration 2: Roopwati gave her mobile phone for repair to Nikhil at his repair shop.

Nikhil kept it safely in the drawer. Late at night after the shop was closed there was a

short circuit in the streetlights and this led to fire. The shop too caught fire.

Roopwati’s mobile got burnt in the shop. In this case Nikhil (the bailee) took all

reasonable care to protect goods from damage therefore he is not liable for the loss to

Roopwati (the bailee).

Case Law 1

Coldman vs. Hill119

In this case some cattle belonging to A were given for feeding of grass against

payment with B. without any negligence on the part of B the cattle were stolen. B did

not inform the owner or the police or make any effort to recover them, because he

thought it would be useless to do so. It was held by the Court that B was liable for the

loss.

(2) Not to make any unauthorized use of goods: The bailee is not to use the goods

in a manner, which is inconsistent with the terms of the contract. If he/she uses the

goods in an inconsistent manner then he/she is liable for any loss or damage made to

the goods bailed.

Illustration: Ragini gave a piece of cloth to her tailor for stitching a kurti. After two

days Ragini went to a friends wedding and there she saw her tailor wearing her

stitched kurti. This is not within the terms of the contract of bailment therefore the

tailor has to compensate Ragini for using the kurti for using it for personal purpose.

(3) Not to mix goods bailed with his/her own goods: The bailee is to keep the

goods bailed to him/her separately from his/her own goods. If the bailee mixes the

goods with his/her goods-

With Bailor’s consent- in such a case both the bailor and the bailee shall have a

proportionate interest in the mixture produced due to mixing of goods.

Illustration: Ramvir bought hundred kilograms of rice but due to scarcity of space he

requested Shyam to put the rice in his storehouse. Shyam’s storehouse was already

119

(1919) 1 K.B. 443

243

filled with rice. When Ramvir’s rice was kept in the storehouse the rice got mixed with

Shyam’s rice. Whenever Ramvir gets the rice he will get his share of twenty kilos from

the whole bulk.

Without the bailor’s consent and the goods can be separated - In this case the

bailee is liable to bear the expenses of separation as well as the damage caused to the

bailed goods due to such a mixture.

Illustration: Ramvir bought hundred kilograms of wheat but due to scarcity of space

he requested Shyam to put the wheat in his storehouse. Shyam’s storehouse was

already filled with rice. When Ramvir’s wheat was kept in the storehouse the wheat

got mixed with Shyam’s rice. Whenever Ramvir gets the wheat Shyam has to separate

the wheat from the rice and the expense incurred for separating the two will be born

by Shyam.

Without the bailor’s consent and the goods cannot be separated- In this case the

mixture cannot be separated therefore the bailee is liable to compensate the bailor for

the loss of goods.

Illustration: Ramvir bought hundred kilograms of basmati rice but due to scarcity of

space he requested Shyam to put the rice in his storehouse. Shyam’s storehouse was

already filled with rice of another variety. When Ramvir’s rice was kept in the

storehouse the rice got mixed with Shyam’s rice. It was not possible to separate

Ramvir’s rice from Shyam’s rice therefore Shyam would be liable to compensate

Ramvir for the loss of his basmati rice.

(4) To return the goods: The bailee is bound to return the bailed goods to the bailor

once the purpose for which the goods were bailed has been fulfilled.

244

Illustration: Shilpa had given her car to her friend Sikandar to go to Agra from Delhi.

Sikandar took the car to Agra and came back to Delhi the next day. Hence Sikandar is

bound to return the car to Shilpa.

Case law 2

Shaw & Co. vs. Symmons & Sons120

A delivered some books to B to be bound. He pressed for their return, but B neglected

to return them although more than a reasonable time had elapsed. A fire accidentally

broke out on B’s premises, and the books burnt. Held, B was liable for the loss,

although he was not negligent, because of his failure to deliver the books within

reasonable time.

(5) To return any accretion to the goods: If during the period of bailment any profit

or addition in value has accrued from the goods bailed then it is the duty of the bailee

to return such profit or increase in value to the bailor.

Illustration: Mr Sharma’s family was going for a vacation to Goa so they left their

dog Sherly at their neighbor Mr hussain’s house. During that time Sherly gave birth

to six puppies. It was Mr Hussain’s duty to return Sherly and her puppies to Mr

Sharma once his family came back from Goa.

12.2.3 Rights of Bailor

(1) Duties of a Bailee: The duties of a bailee are the rights of a bailor. The bailor can

enforce by suit all the duties of the bailee as his/her rights121

.

(2) Right to terminate the contract: According to section 153 of the Indian

Contract Act the bailor can at anytime terminate the contract of bailment if he/she

finds that the bailee has done an act, which is inconsistent with the terms of the

contract of bailment.

120

(1917) 1 K.B. 799 121

See section 12.22 for duties of a bailee.

245

Illustration: Mrs Nagpal had given her cooking gas to her neighbor Mrs Saxena who

had recently shifted in the neighborhood and did not have a gas to cook. Later Mrs

Nagpal found that Mrs Saxena was using the gas for commercial purpose. She was

making sweets and various delicacies and serving the dishes to a restaurant. Hence

Mrs Nagpal had the right to terminate the contract.

(3) Right to demand return of goods at any time in case of gratuitous bailment:

According to section 159 of the Indian Contract Act in

case the bailor has lent the goods gratuitously to the bailee the bailor has a right to

terminate the contract anytime before the expiry of the period. However if the

termination causes loss to the bailee and the loss is in excess of the benefit derived by

him/her then the bailor has to indemnify the bailee’s loss.

Illustration: Anshita was a poor girl and did not have money to buy law book. Her

classmate Mangla had two law books. She lent one to her friend Anshita for

preparing for the exam. As the book was old and worn out mangla got the book bound

for rupees Twenty. Later Mangla lost her law book and so asked Anshita to return the

law book. However Mangla was liable to pay Anshita rupees twenty for the binding

the book.

(4) Compensation from a wrongdoer: According to section 180 of the Indian

Contract Act if a third person wrongfully deprives the bailee from the rightful use or

possession of bailed goods or does them any injury or damage then the bailor or the

bailee can bring a suit against that person for such deprivation or injury.

Illustration: Keshav had visitors at his house so he took ten blankets for one night on

rent from a shop. Keshav’s cousin put blankets in a bucket of water. The bankets got

wet and so could not be used in the night. The cousin deprived Keshav from using the

blanket and so was to compensate Keshav for the loss.

246

12.2.4 Rights of Bailee

1 Duties of a Bailor: The duties of a bailor are the rights of a bailee. The bailee can

enforce by suit all the duties of the bailor as his/her rights122

.

2 Right to deliver goods to one of several joint bailors: According to section 165 of

the Indian Contract Act if the goods have been bailed by several joint owners, the

bailee has a right to deliver them to, or according to the directions of, one joint owner

without the consent of all, in the absence of any agreement to the contrary.

Illustration: Dinesh took the costume of Ravana on rent for playing the part of

Ravana in Ramlila from the shop, which was owned by three brothers Rinku, Pinku

and Tinku. Rinku had given the costume to Dinesh but after the Ramlila was over

Dinesh went to the shop and returned the costume to Pinku.

3 Right to deliver goods, in good faith, to bailor without title: According to

section 166 of the Indian Contract Act the bailee has a right to deliver the goods, in

good faith, to the bailor without title, without incurring any liability towards the true

owner.

Illustration: Sunita took her mother’s cloth piece to a tailor and asked him to stitch a

cushion cover. Later Sunita’a mother visited the tailor and asked him to return the

stitched cushion cover to her. The tailor refused to hand over the cushion cover to her

and instead returned the cover to Sunita. Although the mother was the owner of the

cloth piece however the tailor had a right to deliver it only to Sunita (the bailor).

4 Right of lien: Lien means the right to retain possession of the property or goods,

which belongs to another person until that person pays the dues or claims. The bailee

can exercise the right to lien only till the goods are in his/her custody. As soon as the

bailee loses the possession of goods he/she loses the right to lien. Liens are of two

types:

122

See section 12.21 for duties of a bailor.

247

Particular lien- According to section 170 of the Indian Contract Act where a bailee

has, in accordance with the purpose of the bailment, rendered any service involving

the exercise of labour or skill in respect of goods bailed, he/she has, in the absence of

a contract to the contrary, a right to retain such goods until he/she receives due

remuneration for the services he/she has rendered in respect of them.

Illustration: Rumpa gave her car to the car service center for servicing. If Rumpa

does not pay the servicing charges then the service center can exercise the right of

particular lien. They car retain the car and keep it in their possession till the

servicing charges are paid by Rumpa.

There are three conditions, which have to be fulfilled to get the right of particular lien:

1 The bailee should have rendered some service to the bailor for the goods bailed and

therefore be entitled for some remuneration for it.

2 The service rendered by the bailee must be one involving the exercise of labour or

skill in respect of the goods bailed, so as to confer an additional value on the article.

3 The services must have been performed in full in accordance with the directions of

the bailor, within the agreed time or a reasonable time.

General Lien-According to section 171 of the Indian Contract Act General lien is a

right to retain the goods of another as a security for a general balance of account. The

bailee can retain the goods bailed to him/her for any amount due to him/her whether

in respect of those goods or any other goods. The bailees who have a right of general

lien are bankers, factors123

, attorneys of high Court and policy brokers (they can retain

the policy of fire or marine insurance for their brokerage).

Illustration: Ghanshyam had taken loan of rupees five lakh from Kantilal by

mortgaging his wife’s jewelry with him. Ghanshyam had paid back ninety percent of

the loan amount but due to some emergency he had to take further loan of rupees two

123

An agent entrusted with possession of goods in the ordinary course of business for

the purpose of sale.

248

lakh.though the jewelry was kept as a security for the first loan however Kantilal

retained jewelry as a security for the subsequent loan.

12.3 FINDER OF GOODS

According to section 71 of the Indian contract Act a person who finds goods

belonging to another and takes them into his/her custody is subject to the same

responsibility as that of a bailee.

The rights of a finder of goods are as follows:

(1) Right of lien: The finder of goods has a right of lien over the goods for his/her

expenses. He /she can retain the goods against the owner until he/she receives the

compensation or expenses but the finder cannot sue the owner for such compensation

or expenses because he/she incurred those expenses voluntarily.

Illustration: Rita found a small puppy that was injured. She took him to a vet and got

his injuries treated. She kept the puppy in her house and after a week the owner of the

puppy came to her house and asked her to return the puppy. Rita claimed for the

expenses she incurred on puppy’s medical treatment, food and bedding. The owner

refused to compensate Rita for the expenses incurred by her so she exercised the right

of lien on the puppy.

(2) Right to sue for reward: The finder can sue for a reward, which the owner has

offered for the return of goods and the finder can also exercise the right of lien till

he/she gets the reward from the owner.

Illustration: Rita found a small puppy but in spite of all her efforts failed to find the

owner of the puppy. Later she found an advertisement in the paper that said that a

puppy was lost and anybody who finds the puppy will be rewarded with a cash prize

of rupees five thousand. Rita contacted the owner and told him about the puppy. The

owner came and found that it was his puppy but he refused to give the promised

reward to Rita. Hence Rita could exercise the right of lien on the puppy.

249

(3) Right of sale: The finder also has a right to sell the goods124

12.4 TERMINATION OF BAILMENT

Termination means the end of a contract or a discharge of a contract. The contract of

bailment can be discharged in the following ways:

(1) On the expiry of the period: When the bailment of good is made for a specific

period and that period expires then the bailment also comes to an end.

Illustration: Mr Gujral took a bike from his neighbor Shrinath for two days as his

bike had gone for repair. He used the bike for two days and then returned the bike to

Shrinath. Thus the contract of bailment came to an end.

(2) On the completion of the task or the achievement of the objective: When

bailment of good is made for a particular purpose and that purpose gets accomplished

then the bailment comes to an end.

Illustration: Jaggu took Manoj’s mobile to make a call. Once the call has been made

the bailment comes to an end and Jaggu has to return the mobile to Manoj.

(3) Inconsistent uses of good by the bailee: When bailment is made and the bailee

does an act, which is inconsistent with the terms of contract then the bailor can

terminate the contract.

Illustration: Rustam borrowed Kavi’s Car to go to Dehradun but instead he took the

car to Kanpur. Hence Kavi terminates the contract due to inconsistent usage of good

borrowed.

(4) Destruction of the subject matter: When the subject matter of the contract

gets destroyed or becomes incapable of use for the purpose of bailment then the

bailment ends.

124

For right to sell see lesson 10 on Quasi Contract

250

Illustration: Mr Arora gave his shirts and trousers for dry-cleaning at the dry

cleaning shop. The same night there was fire in the shop and the shirt and trousers of

Mr Arora got burnt. Hence the contract of bailment came to an end.

(5) Gratuitous Bailment: It can be terminated anytime subject to condition laid

down in section 159 (please see gratuitous bailment in this lesson above)

(6) Death of the bailor/bailee: In case any of the parties to the contract of

bailment expires the contract terminates.

Illustration: Geeta had given her saree to Sangita for doing some embroidery work on

the border of the saree. Sangita met with an accident and died the next day. Hence the

contract of bailment came to an end.

12.5 PLEDGE

According to section 172 of the Indian Contract Act when bailment of goods is done

as security for payment of a debt or performance of a promise it is called pledge. In

case of a contract of pledge the bailor is called the pledger or pawner and the bailee is

called the pledgee or pawnee.

Illustration: Ramnath a farmer took loan of rupees fifty thousand from the

moneylender for his daughter’s wedding and he kept his cow with the moneylender as

a security for payment of debt. In this case Ramnath is the pledger, moneylender is

the pledgee and the cow is the good that has been pledged for the performance of the

promise.

251

Table 12.5.1 shows the difference between Bailment and Pledge

TABLE 12.5.1

Basis of difference Bailment Pledge

Purpose Goods are given for some

purpose to be

accomplished

Goods are given as a

security for the payment of

a debt or for the

performance of a promise.

Parties Bailor is the person who

delivers the goods and

Bailee is the person who

keeps the goods

Pawnor / Pledger is the

person who delivers the

goods as a security and

Pawnee / Pledgee is the

person who keeps the

goods in his/ her custody

till the debt is repaid or the

promise is performed.

Rights In case the Bailor fails to

make the payment to the

Bailee for the work done

then the Bailee can either

retain the goods or sue the

Bailor for his/her charges.

In case the Pawnor fails to

repay the debt, the Pawnee

has the right to sell the

goods pledged with

him/her.

Usage The Bailee has a right to

use the goods if the terms

of bailment so provide.

The Pawnee/ Pledgee has

no right to use the goods

pledged with him/her.

252

Bailment and other similar Relations: A comparison

An agent who has collected money on his principla’s behalf is not a bailee of the

money. In United Commercial Bank Vs. Hem Chandra Sarkar125

. The Honorable

justice Setty made an observation in this respect whereby he clarified the distinction

between bailment and agency. He said, “One important distinguishing feature

between agency and bailment is that the bailee does not represent the bailor. He

merely exercises, with the consent of the bailor (under contract or otherwise) certain

power of the bailor in respect of his property. Secondly, the bailee has no power to

make contracts on bailor’s behalf, nor can ha make the bailor liable, simply as bailee,

for any acts he does.”

A bailment is also different from sale, exchange or barter. In these transactions what

is transferred is not mere possession but also ownership and, therefore, the person

buying is under no obligation to return.

12.6 RIGHTS AND DUTIES OF PAWNOR AND PAWNEE

Rights of a Pawnee/ Pledger

The rights of a Pawnee are as follows:

(1) Right of retainer: According to section 173 the Pawnee has the right to retain the

goods pledged with him /her if the Pawnor / Pledger does not repay the dues or does

not perform the promise. The Pawnee may also retain the goods till the Pawnor pays

the interest due on the debt.

Illustration: Ramnath a farmer took loan of rupees fifty thousand from the

moneylender for his daughter’s wedding and he kept his cow with the moneylender as

a security for payment of debt. Ramnath failed to return the money on time as a result

the moneylender had a right to retain the cow with him till Ramnath paid back the

loan amount.

(2) Right of retainer for subsequent advances: According to section 174 of the

Indian Contract Act if the pawnee lends money to the same pawner after the date of

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(1990) A.I.R S.C. 1329

253

the pledge then the pawnee’s right of retention of goods extends to subsequent

advances.

Illustration: Ramnath a farmer took loan for rupees fifty thousand from the

moneylender for his daughters wedding and he kept his cow with the moneylender as

a security for payment of debt for one year. After a year Ramnath paid back all the

money he had taken to the money- lender and also took a fresh loan of rupees twenty

thousand from him. The moneylender retained the cow as a security for the

subsequent loan.

(3) Right to extraordinary expenses: According to section 175 the Pawnee is

entitled to receive from the pawnor extraordinary expenses incurred by him for the

safe keeping of the goods pledged with him. Though he has no right to retain the

goods for non-payment of such expenses but he/she can sue the Pawnor for the

recovery of such expenses.

Illustration: Ramnath a farmer took loan of rupees fifty thousand from the

moneylender for his daughter’s wedding and he kept his cow with the moneylender.

The cow fell sick and the moneylender had to bear expenses on her medical treatment.

Hence the moneylender had a right to be compensated by Ramnath for the medical

expenses. Though the moneylender did not have the right to retain the cow for

recovery of such expenses however he had the right to sue Ramnath (the pledger) for

recovery of expenses.

(4) Right against true owner, when the Pawnor’s title is defective: According to

section 178-A if the Pawnor has got the possession of goods which he /she has

pledged with the Pawnee under a voidable contract (by fraud, misrepresentation,

undue influence and coercion)126

and the contract has not been rescinded at the time

of pledge, the pawnee acquires a good title to the goods. The pawnee gets a good title

only when he acts in good faith and does not have the knowledge of the Pawnor’s

defect of title.

Illustration: Ramnath a farmer took loan of rupees fifty thousand from the

moneylender for his daughters wedding and he kept his cow with the moneylender as

126

For more information see lesson 5 on free consent.

254

a security for payment of debt. Actually the cow belonged to Ramnath’s elder brother

Shyamnath. The moneylender was ignorant about this. Hence Shyamnath did not have

the right to take the cow back from the moneylender during the period of pledge.

(5) Has a right to recover from the Pawnor any deficiency arising on the sale of

the goods and is liable to the Pawnor to return any surplus, if any, realized on

the sale of goods: In this case if the pawnor fails to repay within the due date then the

pawnee has a right to sell the goods pawned and recover the money from it. In case

the sale proceeds are more than the loan amount then the pawnee is liable to return the

surplus to the pawnor and if the sale proceeds are less than the loan amount then the

pawnee can recover the deficient amount from the pawnor.

Illustration 1: Ramnath a farmer took loan of rupees fifty thousand from the

moneylender for his daughters wedding and he kept his cow with the moneylender as

a security for payment of debt for a year. A year lapsed and Ramnath could not pay

back the debt. Hence the moneylender sold the cow to recover his money. After selling

the cow he got rupees ten thousand which was less than the loan money. Hence the

deficient money could be recovered from Ramnath.

Illustration 2: Ramnath a farmer took loan of rupees ten thousand from the

moneylender for his daughters wedding and he kept his cow with the moneylender as

a security for payment of debt for a year. A year lapsed and Ramnath could not pay

back the debt. Hence the moneylender sold the cow to recover his money. After selling

the cow he got rupees fifteen thousand which was more than the loan amount. Hence

the exceee money was to be returned to Ramnath.

Rights of a Pawnor / Pledger

The rights of a Pawnor are as follows:

(1) Right to get back goods: After returning the debt or after performing the

promise the pawnor is entitled to get back the goods.

255

Illustration: Ramnath a farmer took loan of rupees fifty thousand from the

moneylender for his daughter’s wedding and he kept his cow with the moneylender as

a security for payment of debt for a year. After a year Ramnath returned the money to

the moneylender and took his cow back.

(2) Right to redeem debt: In case the pledger fails to repay the debt or does not

perform the promise within the stipulated time then he/she may still redeem

the goods pledged at any subsequent time before the actual sale of goods take

place however the Pawnor has to pay any expenses which have arisen due to

his / her default.

Illustration: Ramnath a farmer took loan of rupees fifty thousand from the

moneylender for his daughter’s wedding and he kept his cow with the moneylender as

a security for payment of debt for a year. After a year Ramnath could not pay the loan

money as a result the moneylender decided to sell the cow. Just before the day when

the cow was to be sold Ramnath arranged the money and gave it to the moneylender.

However he had to pay extra money for additional days after the expiry of the loan

period.

(3) Right for preservation and maintenance of goods: The Pawnor has a right

to see that his/ her goods are kept safely with the Pawnee that is that the

Pawnee preserves the goods and properly maintains them.

Illustration: Ramnath a farmer took loan of rupees fifty thousand from the

moneylender for his daughter’s wedding and he kept his cow with the moneylender as

a security for payment of debt for a year. Ramnath had a right to see that his cow was

properly kept with the moneylender.

(4) Rights of an ordinary debtor: The Pawnor apart from having all the rights

mentioned above also has the rights of a debtor127

.

127

A debtor is a person who takes money or goods on credit. The person from whom

he /she takes credit is called the creditor.

256

12.7 PLEDGE BY NON-OWNERS

Generally it is only the owner of goods who have the power and authority to pledge

the goods but in some cases even the non-owners can pledge the goods. The cases

where the non-owners can pledge the goods are the following:

1 Mercantile Agents: Where with the consent of the owner a mercantile

agent128

is in possession of goods or the documents of title to such goods then

the agent has a right to pledge the goods in the ordinary course of business.

Illustration: Sudhir was an agent of Yogendra who was a manufacturer of readymade

garments. Yogendra had a shortage of working capital due to bad debts therefore

Sudhir took loan of rupees fifty thousand from Devendra and kept as security hundred

shoes worth rupees thousand each with Devendra for a period of six months.

2 Pledge by seller or buyer in possession after sale: There are two situations

in this. In the first situation the seller is left with possession of goods after sale

has been made. In the second situation the buyer obtains possession of goods

with the consent of seller before the sale has been made. According to section

30 of the sale of goods act 1930 in both the situations the respective

possessors of goods have the right to pledge the goods provided the Pawnee or

the Pledgee acts in good faith and has no notice of the previous sale of goods

to the buyer or of the lien of the seller over the goods.

Illustration 1: Simran bought a television set from a shop but did not take it with her

as she was shifting to a new house and so wanted the seller to send the set after two

days into her new house. Later that day the seller took money on loan from his friend

and pledged the sold television set with him.

Illustration 2: Simran wanted to buy a television set on easy installments. She took the

televison set home and promised the seller to pay the balance in twenty monthly

128

For more information on mercantile agent refer to lesson 14 on contract of agency

257

installments. The very next day Simran took money on loan and pledged the

television set with the creditor.

3 Pledge where Pawnor has limited interest: According to section 179 of the

Indian Contract Act where a person pledges goods in which he / she has

limited interest, the pledge is valid to the extent of that interest. A person

having a lien over the goods or a finder of goods may pledge them to the

extent of his /her interest.

Illustration: Margaret found a wristwatch lying on the road and could not find the

owner of the watch. She took the watch home and because it was not working so got it

repaired for rupees two hundred. After a couple of days she took some money from a

friend on loan and pledged the watch with her. The pledge was valid to the extent of

Margaret’s interest in the watch namely rupees two hundred.

Case Law 3

Thakurdas vs. Mathura Prasad129

A delivers a suit length to B, the tailor, for making a suit and agrees to pay Rs.

1500 as sewing charges. B pledges the suit with C for Rs. 3000. The pledge is

valid to the extent of B’s interest in the suit, namely Rs. 1500. A can recover

the suit only by paying Rs. 1500 to C, the pledgee.

4 Pledge by co-owner in possession: Where the goods belong to more than one

owner then one of the several co-owners of goods who is in possession of

goods with the consent of the other owners has a right to create a valid pledge

of the goods.

Illustration: Two sisters Reena and Susmita were gifted a car by their father. Reena

was once in need of money so she went to a moneylender and took a loan of five lakh

and pledged the car with the creditor with the consent of her sister.

129

(1985) A.I.R. All. 66.

258

5 Pledge by person in possession under voidable contract: According to

section 178-A if a person obtains possession of goods under a voidable

contract, the pledge created by him / her is valid provided:

(1) The contract has not been rescinded before the contract of pledge

(2) The Pawnee acts in good faith and has no knowledge about the defective title

of the Pawnor.

Illustration: Sita purchased a necklace worth rupees one lakh from a jeweler and paid

cash. Later the jeweler found that the cash consisted of fake notes. Meanwhile Sita

went to a moneylender and took a loan of rupees two lakh and pledged the necklace

with him. As the jeweler had not rescinded the contract before the contract of pledge

was entered and the moneylender also was unaware of the fraud and took the

necklace as a security in good faith therefore the contract of pledge was a valid

contract.

12.9 POINTS TO REMEMBER

Bailment

Definition

Essential features of Bailment

Kinds of Bailment

Rights and Duties of a Bailor and a Bailee

Duties of a Bailor

Duties of a Bailee

Rights of Bailor

Rights of Bailee

Mistake or Coercion

Finder of Goods

Right of Lien

259

Right to sue for reward

Right of sale

Termination of Bailment

On the expiry of the period

On the completion of the task or the achievement of the objective

Inconsistent uses of good by the bailee

Destruction of the subject matter

Gratuitous Bailment

Death of the a Bailor / Bailee

Pledge

Difference between Bailment and Pledge

Rights and Duties of a Pawnor and a Pawnee

Pledge by Non-Owners

12.9 QUESTIONS

Match the following:

1. Bailment a Security for payment of debt

2. Goods b Delivery of goods

3. Gratuitous Bailment c Right to retain possession

4. Lien d movable property

5. Pledge e No consideration

Answer: 1b, 2d, 3e, 4c, 5a

Practical problems

260

1 Sadhna gave her mobile phone for repair to a Gopal a mobil mechanic. Gopal

was unable to repair the mobile so he gave the mobile to Aslam another

mobile mechanic. Is this a valid contract of bailment?

Answer: Yes, this is a valid contract of bailment as Sadhna is the bailor, Gopal is the

bailee and Aslam is the sub-bailee.

2 Mr Gupta gave his house on rent to Mr Mukerjee. Is this a contract of

bailment?

Answer: No, this is a not a contract of bailment because in bailment the goods to be

bailed are not immovable property like land and building.

3 Rita borrowed her Vikram’s car to go to the market. The car had faulty brakes

and Vikram was aware of it but he did not disclose it to Rita. Rita while

driving met with an accident. Is Vikram liable?

Answer: Yes, Vikram is liable to compensate Rita for the accident because it was the

duty of Vikram (the bailor) to disclose known faults about the good bailed to the Rita

(the bailee).

4 Jugnu went to a park and found a purse with lots of money in it. Is she the

owner of the purse?

Answer: No, Jugnu is not the owner of the purse. Her position is that of a bailee and

she has to return the purse once the actual owner comes to claim it.

5 Mukul took loan from Pranjal and gave as security his bike. The time for

repayment became due and Mukul could not repay the loan. Pranjal sold the

bike. Was Pranjal’s act of selling the bilke valid?

Answer: Yes, it was the right of Pranjal (the pledgee) to sell the bike because Mukul

(the pledger) made a default in payment.

261

Questions:

1 What is bailment? What are the rights and duties of a bailor and a bailee?

2 What is a pledge? How is pledge different from bailment?

3 What are the various situations where the non-owners can create a valid

pledge?

12.10 REFERENCES

1 Chadha P.R. & Bagrial A.K. (2005): Business Law, Pragati Publictions, New

Delhi

2 Bangia R.K. & Bangia S. (2002): Indian Contract Act, Allahabad Law Agency,

Faridabad

3 Singh Avtar (2008): Law of Contract and Specific Relief, Ninth edition, Eastern

Book Company, Lucknow

12.11 DISCLAIMER

The photos used at various places in this lesson to the best of my knowledge have

been downloaded from free sites, which I believe do not require any prior permission

for use. The sites are duly acknowledged and listed below. However if any

photograph/picture used in this lesson require permission for use then kindly let me

know. I will gladly do the needful and use the picture only after authorization.

Websites from where pictures have been downloaded

http://images.google.com/imgres?imgurl=http://vijay.bhatter.com/uploaded_images/s

wift_red.jpg&imgrefurl=http://vijay.bhatter.com/2006/08/my-new-maruti-suzuki-

swift-vxi.asp&h=280&w=400&sz=28&hl=en&start=6&sig2=dYk-

qU7yH4glilEYMeYt2Q&um=1&usg=__CECdwWRUZ0eh

http://images.google.com/imgres?imgurl=http://www.arxmanstyle.com/wp-

content/uploads/2008/04/dry-cleaning-and-caring-tips-for-your-

garments.jpg&imgrefurl=http://www.arxmanstyle.com/tag/jacket/&h=300&w=300&s

z=51&hl=en&start=34&sig2=58Nh-HX3IPh5CHN00a5bqg&h

http://images.google.com/images?um=1&hl=en&client=safari&rls=en-

us&q=luggage+pictures&btnG=Search+Images

262

Lesson – 13

INDEMNITY AND GUARANTEE

by

Preeti Singh

This Lesson deals with the

following aspects of Indemnity and Guarantee

13.1 What is contract of Indemnity?

13.2 Essentials of Valid Contracts of Indemnity

13.3 Rights of Indemnity Holder

13.4 Rights of Indemnifier

13.5 Commencement of Indemnifier’s Liability

13.6 What is Contract of Guarantee?

13.7 Essentials of Contract of Guarantee

13.8 Distinction between Contracts of

Indemnity & Contracts of Guarantee

13.9 Kinds of Guarantee

13.10 Rights of Surety

13.11 Surety’s Liabilities

13.12 Discharge of Surety

13.1 WHAT IS CONTRACT OF INDEMNITY?

The Indian Contract Act 1872 provides certain special types of contracts. These are

contracts of(1) indemnity,(2) guarantee, (3)bailment and(4) agency. The meaning of

indemnity is to make good the loss that another has suffered or in other words to

compensate the party who has suffered a loss. Section 124 of the Act defines contract

of indemnity “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”.

263

Illustration: Akshay makes the contract to indemnify Neelam

against the consequences of any types of proceedings with

respect to a loan of Rs. 2,00,000 lakhs which Atul may take

against her. This is a contract of indemnity.

In this illustration Akshay is the indemnifier and Neelam is the indemnified. A person

who makes a promise to make good the loss is called the promisor or the indemnifier

and the promisee or the person whose loss is to be recovered is the indemnity holder

or the person who is indemnified. According to this illustration it can be said that the

contract of indemnity is made to protect the promisee from any future losses.

This definition is restrictive as it is limited to the conduct of the promisor or of

another person but it does not cover losses by accidents or events that are not caused

through human conduct. Also, indemnity under Section 124 of the Act covers only

express indemnity and not implied promise of indemnity. According to this the

contracts of insurance would not be within the purview of the contracts of indemnity.

The law makers however did not have any intention to exclude insurance from the

contracts of indemnity. Recently, in a landmark judgement of Gujrat High Court this

issue came up before the court and the court in New India Assurance co Ltd. V State

Trading Corporation of India A.I.R 2007 Fur 517 (Noc)130

observed, “almost all

insurances other than life and personal accident insurance are contracts of indemnity.

The insurer’s promise to indemnify is an absolute one. A suit can be filed

immediately upon failure of performance, irrespective of actual loss. Of the indemnity

holder, incurred liability was absolute, he would be entitled to call upon the

indemnifier to save him from that liability by paying it off.”

The English Law and Indian Law both define indemnity. The English law covers

contracts of indemnity by human conduct as well as losses by accidents or other

events like death, disability, and destruction by fire, floods, earthquakes and cyclones.

The Indian law is narrow in scope when compared to English law but the law courts

in India have followed the English law. The general law on contracts of indemnity in

India covers losses that arise out of accidents and events that are not dependent only

130

Also see State Bank of India V Mala Sahakari Sakkar Kar Khana Ltd. A.I.R. 2007

s.c. 2361

264

on the conduct of human beings. It also covers express and implied promises of

indemnity.131

13.2 ESSENTIALS OF VALID CONTRACTS OF INDEMNITY

The following are the essentials of valid contracts of indemnity:

(a) The contracts of indemnity must be between two parties, the indemnifier and

indemnity holder or indemnified.

(b) A contract of indemnity should contain offer, free consent between parties,

consideration, competency of both parties and legality of object to become a

valid contract.

(c) There should be a promise between two parties whereby one party promises

another to save the other from any losses suffered by him.

(d) The losses may be due to the conduct of the promisor himself or any other

person.

(e) Contracts of indemnity can be express or implied. In an express contract of

promise is made by a person to compensate the other person in express terms

but in an implied contract it is the intention of the promisor to indemnify the

other party from losses.

13.3. RIGHTS OF INDEMNITY HOLDER

Section 125 has provided the rights of the indemnity holder. According to it the

indemnity holder has a right to recover from the indemnifier some of the amounts that

he has paid on behalf him, if he has acted within the scope of his authority:

a) Damages in respect of a promise to indemnify the other in case of a law suit.

b) Costs paid by the indemnity holder to defend a suit that was authorized by the

promisor.

c) Any amount paid for compromising in a suit authorized by the promisor, if the

amount has been authorized by the promisor.

13.4 RIGHTS OF INDEMNIFIER

The Act does not provide any rights for the indemnifier. However, it is taken as a

silent acceptance of the rights of the promisor. Therefore, it is made equivalent to the

rights of a surety under Section 141 of the Indian Contract Act. With this explanation

131

State of Orissa V India Insurance Co. Ltd V Arumugham (2006) 2 CTC 368

(mad)3

265

of the Act the rights of the promisor are the same as that of a surety in a contract of

guarantee.

13.5 COMMENCEMENT OF INDEMNIFIER’S LIABILITY

There are several judgements which have decided upon the liability of the indemnity

holder but the Indian Contract Act of 1872 is silent on the time when the liability of

the indemnifier commences. The liability of the indemnifier begins as soon as he

indemnifies the other person. Some high courts have been of the view that the

indemnifier becomes liable only when the indemnity holder actually suffers of loss.

Some other high courts have held that the indemnifier is liable before the actual loss.

This is considered to be the correct version of indemnity.

Case Law 1

Gajanan Moreshwar v Moreshwar Madan132

In this case of the Bombay high court

came to the conclusion that if the indemnifier is not liable until the loss has occurred

it will be a burden on the indemnity holder. The court held that the indemnifier has to

pay as soon as his liability becomes absolute. If the indemnified has incurred an

absolute liability, he is entitled to ask the indemnifier to pay of his liability.

Case Law 2

Osman Jamal & Sons Ltd. v Gopal Purshottam133

In this case a company acted as a

commission agent for another form and purchased goods on behalf of the firm. The

firm failed to take the goods. The supplier of the goods is entitled to recover from the

firm damages relating to breach of contract. However, before the claim was paid the

company went into liquidation. The court held that the official liquidator was entitled

to recover the damages from the firm though the company had not paid any amount to

the supplier.

13.6 WHAT IS CONTRACT OF GUARANTEE?

A contract of guarantee according to Section 126 of the Indian Contract Act is a

contract to perform the promise or discharge the liability of a third person in case of

default. The contract of guarantee consists of three parties. These are the surety, the

principal debtor and the creditor.

132

AIR 1942 BOMBAY 302 133

1928 I.L.R. 56 CAL 262

266

a. Surety: A surety is a person who gives the guarantee to pay in case of

default.

b. Principal debtor: The person for whom the guarantee has been taken by

the surety is the principal debtors.

c. Creditor: A promise of guarantee is given to the creditor to whom the

payment has to be made.

Illustration 1: Seema gives a loan of Rs. 50,000 to Aditi on the

promise that Atul will repay the loan to Seema if Aditi defaults in

her payment. This is a contract of guarantee.

Seema is the creditor. Aditi is the principal debtor and Atul is the surety or guarantor.

The English law defines guarantee as a promise that is made by one person to another

to be collaterally answerable for a debt in case of default by a third person. The

promise must be made in writing. The Indian law a contract of guarantee can be

implied or inferred by the conduct of the parties. It is not necessary for it to be in a

written form.

13.7 ESSENTIALS OF CONTRACT OF GUARANTEE

Figure 13.7.1 Essential features of valid contract of guarantee

The contract of guarantee can be performed only when certain essential elements of

the contract are fulfilled. The following are the essential requirements of a contract of

guarantee.

a. Valid contract: A contract of guarantee must have all the essentials of the

valid contract like competence of parties, free consent, consideration to make

the contract valid but there are certain exceptions:

a. The principal debtor may not be competent to contract. If he is not

competent the surety will become the principal debtor and will be liable

personally to make the payment.

b. A surety that makes a promise for the benefit of the principal debtor need

not be benefited. Any promise that a surety makes is sufficient

consideration for giving a guarantee.

267

Illustration 1: Bhanu asks Billu to deliver 50 watches to

him on credit. Billu agrees and Braj guarantees the

payment of the goods. Braj states that he would stand

guarantee for the payment in consideration of Billu’s

promise to deliver the 50 watches. This is a sufficient

consideration for Braj his promise.

Illustration 2: Akriti sells 100 pens to Abhimanyu.

Sanjay requests Akriti not to sue Abhimanyu for at

least a year if he cannot pay. He also promises that

in case of default Sanjay would be responsible and

will make the payment to Akriti. Akriti agrees not to

go to court for her payment. This is sufficient consideration for Sanjay’s promise.

Illustration 3: Tunnu promises to deliver his old car to

Munnu at a fixed price. Later Janu without any

consideration agrees to pay for the car if Munnu does not

pay. This is a void agreement.

b. Tripartite agreement: In a contract of guarantee there is the involvement of

three contracts.

a. Contract 1: It is a contract between the principal debtor and the creditor on

the basis of which a guarantee of the debt arises.

b. Contract 2: It is an agreement between the principal debtor and the surety

in which the principal debtor accepts the responsibility to indemnify the

surety if the payment is required to be made by the surety.

c. Contract 3: It has the contract between the creditor and the surety in which

the surety promises to under take the payment of the debt of the principal

debtor in case the principal debtor defaults his payments.

268

c. Consent: Since the contract of guarantee involves the creditor, principal

debtor and the surety, it is necessary that all the three parties have agreed

to the contract.

Illustration: Abu sells 5 air-conditioners to Sara. He later request Sonu to pay if Sara

makes a default in her payment. Sonu cannot become a surety without the consent of

Sara.

d. There should be no misrepresentation of facts: Guarantee should be

obtained after disclosing all the material facts that may affect the degree of

responsibility of the surety. The surety must know all the facts of the case

because if he neglects to do his duty he is responsible for the

consequences. Any guarantee that is obtained by misrepresentation or

concealment of facts by the creditor becomes an invalid contract of

guarantee.

e. Contract may be oral or in writing: A contract of guarantee may be either

oral or written as given in section 126 of the Act. The position as per

English Law is different to that of the Indian Law. Under the English Law

the contract must be in writing but the Indian Law does not specify it.

Hence in India both oral and written contracts are acceptable.

f. There should be a principal debt: There has to be a primary liability of a

person who is other than the surety to the contract of guarantee. The surety

becomes liable only if the principal debtor is unable to discharge his

obligation. If there is no principal debtor, there cannot be a contract of

guarantee. In situations when there is a promise by one of the parties for

compensating another without involving a third party it becomes a contract

of indemnity.

269

Case Law 3

Birkmyr V Dar nell134

In this case the following were distinguished as contracts of

indemnity and contracts of guarantee.

When A person says to a shopkeeper “give your goods to a certain person and I will

pay you” it is a contract of indemnity and when a person goes with another to a shop

and tell the shop keeper that “if my friend does not pay for the goods you are giving

him I will pay for it” it becomes a contract of guarantee.

2. To summarize according to Section 142 of the Act an invalid guarantee is one

which is obtained by the creditor through misrepresentation regarding a

material part of the transaction.

3. Section 143 states that any guarantee in which he creditor maintains silence to

the material facts also makes the contract of guarantee invalid.

4. Under Section 144 when co-surety does not join and it is necessary for him to

give guarantee with the surety the contract of guarantee will not be valid.

5. If there is no consideration between the creditor and the principal debtor, the

surety will be discharged from his liability as the contract will not be valid.

Illustration: Malti employs Meena to make the collections of money on credit sales.

Meena collects Rs. 3,00,000 but does not account for all the receipts. Meena’s friend

accounted for Malti’s misappropriation of funds of her employer. Malti agreed to

retain Meena but expected a guarantee from her friend Atul. Malti did not let Atul

know of Meena’s earlier dishonesty. Atul gave the guarantee. However, this

guarantee cannot be enforced because he does not disclose Meena’s

misappropriation of funds.

Is a contract of a guarantee a contract of uberrimae fidei?

Uberrimae fidei means a contract of absolute good faith. A contract of guarantee

cannot be called a contract of uberrimae fidei. Due to this reason the principal debtor

or the creditor may not disclose material facts to a surety before making a contract. If

134

1704 91 ER 27 1 Salk, 27 & 28

270

a guarantee is given to a bank, the bank may not inform the surety of the matters that

pertain to the credit of the principal debtor.

Section 142 and 143 protect the surety by making a guarantee invalid if it is obtained

by misrepresentation or concealment of material facts.

However, if it is a contract of guarantee concerning insurance in a fidelity guarantee

then all material facts should be disclosed otherwise the surety can rescind the

contract.

13.8 DISTINCTION BETWEEN CONTRACTS OF INDEMNITY &

CONTRACTS OF GUARANTEE

The contracts of indemnity can be distinguished from contracts of guarantee. In a

following matter:

(i) Parties to the contract: Contracts of indemnity comprise of two

parties. These are indemnifier and the indemnity holder whereas

contracts of guarantee are made with three parties. These are the

principal debtor, the creditor and the surety.

(ii) Number of contracts: Contracts of indemnity are between the

indemnifier and the indemnity holder. Only one contract is made

between them. However, contracts of guarantee are made out of free

contracts. One contract is between the principal debtor and creditor.

The second contract is between the surety and the creditor and the third

is between the surety and the principal debtor.

(iii) Nature of liability: The indemnifier is independent and has primary

liability in contracts of indemnity but in contracts of guarantee the

surety has collateral or secondary liability where as the primary

liability is of the principal debtor.

(iv) Purpose of contract: Contracts of indemnity provide security against

losses whereas contracts of guarantee provide security to creditors

against default of the principal debtors.

(v) Request: In an indemnity contract the indemnifier does not have to act

at the request of the indemnity holder. In contracts of guarantee the

surety can act only when the principal debtor requests him to do so.

(vi) Occurrence of liability: In contracts of indemnity liability will arise on

the happening of the contingency but in contracts of guarantee liability

271

will arise when and existing promise of payment of a debt is not

performed.

(vii) Interest in the contract: In indemnity contracts the promisor usually

has his own interest in the contract but the surety does not have any

interest in the transaction when he makes a contract of guarantee.

(viii) Right to suit third parties: The indemnifier does not have any right to

sue a third party in his own name because he does not have any privty

of contract. Only in transactions where there is an assignment in his

favour he may sue third parties in contracts of indemnity. In contracts

of guarantee the surety has the right to sue the principal debtor in his

own made after he discharges his debt.

13.9 KINDS OF GUARANTEE

There are two categories of guarantees. These are called specific guarantees and

continuing guarantees.

1. Specific guarantee

A specific guarantee pertains to a single debt or a single transaction. It is a simple

guarantee or a specific guarantee when the debt is discharged, then the duty is

performed and the contract of guarantee comes to an end. In a specific guarantee if a

new transaction has to be made between two parties a fresh guarantee will have to be

taken as the guarantee on the single debt is completed. Guarantee can be for an

existing debt or for a prospective debt or a future transaction.

Illustration: Purva guarantees the payment of 5 computers to Ali to be delivered to

Khan in March. Ali delivers the computers to Khan and it is paid by him. Purva’s

contract of guarantee ends on the payment. He is not liable for any further contracts

because it is a specific contract pertaining to only five computers. If Khan had not

paid then Purva would be liable to make the payment to Ali.

2. Continuing guarantee

According to Section 129 a continuing guarantee extends to a series of transactions.

The surety is liable for all the transactions as his guarantee extends to all of them until

the guarantee is removed.

272

Illustration 1: Raju was employed as a driver by Mr. Tiwari on the recommendation

of Shiv for collection of credit payments from Delhi. Shiv guaranteed Raju’s honesty

and promised to pay in case of any default in payments collected by him (Raju). This

is a contract of continuing guarantee.

Illustration 2: Alok guaranteed that he would pay Amod Rs. 5,000 for continuously

supplying his friend Asif a special cleaning powder every three months. Amod

supplies Asif with cleaning powder of Rs. 4,000 and 5,000 which Asif pays. Then

Amod supplies cleaning powder of Rs. 6,000 for which Asif does not pay. Alok is

under continuing guarantee and is liable to pay Amod upto Rs. 5,000 under

continuing guarantee contract.

13.9.1 Revocation of a Continuing Guarantee

When a guarantee is cancelled it is called revocation of a guarantee. If guarantee is

cancelled then the surety’s liability is discharged. A continuing guarantee can be

revoked in the following way:

(i) By notice of revocation: A surety can give a notice of revocation to the

creditor. After the notice is given the surety does not have any future liability

but he continues to the liable under Section 130 for any transactions that have

already been entered into by him.

Modes of Revocation of Contining Guarantee

By Death of Surety (Section 131) By Notice of

Revocation

(Section 130)

By Modes of

Discharging Surety

By Novation

(Section 62)

By Variance

in terms of

contract

(Section 133)

By release or

discharging of

principal

debtor

(Section 134)

By

arrangement

(Section 135)

By creditors

act or

omission

(Section 139)

By loss of

security

(Section 141)

Figure 13.9.1 Revocation of continuing guarantee

273

Illustration: Dharam guarantees to Marram an amount of Rs. 50,000 that Moti will

pay his debt in 30 days time. Marram agrees and the contract of guarantee is formed.

Before the debt is cleared Dharam gives a notice of revocation. Moti defaults in

making his payment on the due date. Dharam is liable to pay as it is an existing debt

guaranteed by him.

(ii) By death of surety: In case of a continuing guarantee if the surety dies the

contract is automatically revoked even if no notice of death of surety is given. But,

under Section 131 of the Act the surety is liable for the existing transactions to which

he had given a guarantee before his death.

Illustration: Mulla guarantees the payment to Asraf a book seller of Rs. 500 for any

book that he supplies to Braj from time to time. Asraf supplies to Braj a book of Rs.

200. After this transaction Mulla dies. After the death of Mulla, Asraf again supplies a

book of Rs. 100. Mulla’s representative is liable only to the payment of the book of Rs.

200 to Asraf and not of Rs. 100 because that book was supplied after his death.

(iii) Other reasons: A continuing guarantee can also be revoked in the following

conditions.

(I) When there is a variance in the terms of a contract. (Section 133)

(II) When the principal debtor is discharged or released. (Section 134)

(III) When there is an agreed arrangement with the principal debtor. (Section 135)

(IV) When the creditor is responsible for an act or its omission which impairs the

remedy of a surety. (Section 139)

(V) When there is a loss of security.

274

13.10 RIGHTS OF SURETY

A surety also has certain rights against the principal debtor, the creditor and the co-

sureties. Each of these is explained below:

13.10.1 Rights against the Principal Debtor

The surety has the right of subrogation and the right to claim indemnity from the

principal debtor.

(i) Rights of subrogation: When a surety makes a payment to a creditor on behalf

of the principal debtor in case of default, he acquires the rights of a creditor

against the principal debtor. He can recover the entire amount that he has paid

to the creditor. This is called the right of subrogation.

Section 140 of the Contract Act, states that when a surety has performed the duty or

made a payment on behalf of the principal debtor he acquires the rights of the

creditor. He is entitled to claim all the sums he has rightfully paid to the creditor. He

also gets the benefits of security that were given to the creditor when the contract was

entered into.

(ii) Rights of indemnity: When a contract of guarantee is entered into there is an

implied promise that the principal debtor will indemnify the surety for all the

payments rightfully made by him. If he has made any payments wrongfully he

will not be able to recover any amounts. This has been stated in section 145.

Rights of surety

Rights against to creditor Rights against

the principal

debtor

Rights against the co-sureties

(a) Right to subrogation

(b) Right to indemnity

(a) Right to securities

(b) Right to claim set off

(a) Right to contribution

Figure 13.10.1 Rights of surety

275

Illustration 1: Rahul has to pay Rs. 2,00,000 to Mahesh. Venkat is the surety for the

debt. Mahesh demands the payment from Rahul on the due date. Rahul fails to pay the

amount. Venkat who is the surety is compelled to make the payment on behalf of

Rahul. Venkat has the right to recover the amount from Rahul with all the benefits

promised to Mahesh as he now acquires the right of a creditor.

Illustration 2: Sonu promises to supply 5 computers to Khursheed for Rs. 1,50,000.

Kamal is surety for the amount to be paid by Khursheed on delivery. On the due date

the computers are delivered but Khursheed fails to pay. Kamal who is the surety is

compelled to make the payment. Kamal wrongly begins to defend Khursheed and

incurs certain costs. Kamal incurs an extra expenditure of Rs 8,000. Kamal makes the

payment finally on behalf of Khursheed. He later asks Khursheed to pay him

1,58,000. Since Khursheed incurs an expenditure of Rs. 8,000 wrongfully he cannot

compel the principal debtor to pay him for it. He can only claim Rs 1,50,000

Is surety a favoured debtor?

1. The surety’s liability is secondary. If he becomes insolvent he will not have to

pay for the debts of the principal debtor. However, if the principal debtor

becomes insolvent he will still have to pay to the creditor if became insolvent.

2. The surety becomes discharged from his liabilities if there is a variance in the

contract but the principal debtor has the liability to pay to the creditor if he

defaults.

3. In case securities are offered a surety has the right to demand a share.

However, the principal debtor can not claim a share if his claim is not

satisfied.

4. The surety has to pay for the principal debtor only when there is a default by

the principal debtor. However, the principal debtor will have to pay the

amount either to the creditor on the due date or to the surety in case of default.

13.10.2 Rights against the Creditor

The surety has the following rights against the creditor:

(i) Right to claim securities: According to section 141 of the Act the surety has

the right of subrogation after performing his duty or making a payment to the

creditor. All the rights of the creditor are passed on to the surety. Accordingly

276

the surety gets the right to the benefit of every security, which the creditor has

against the principal debtor even if he has no knowledge of the existence of

such securities. If the creditor loses the security the surety is discharged of his

responsibilities to the extent of the value of his security.

Illustration: Sunny gives Manju Rs 10,000 on the guarantee of Prem. Sunny has a

further security of Manju’s office table which is made of teak and is of the value of

Rs.4000. Sunny cancels the security. Manju becomes insolvent and cannot pay his

dues. Sunny sues Prem on his guarantee. Prem is discharged of his responsibility to

the value of the office teak table.

(ii) Right of set off: If the creditor sues the surety, he can claim set-off or counter

claim, which the debtor had against the creditor.

Illustration: Deepak took a loan from Sohan for Rs. 8,50,000. Samu guaranteed the

loan. Samu also had a claim on Sohan for Rs. 3,00,000. Somu is liable to pay

5,50,000. Somu will also claim the benefit of this set-off although he does not have

any personal claim on Sohan.

(iii) Right to share reduction: If the surety has paid the amount to the creditor on

behalf of the principal debtor and when he has to recover his amount from the debtor,

the debtor becomes insolvent then the surety can claim from the creditor a reduction

in his liability by the amount of dividend that is claimed by the creditor from the

official receiver of the debtor.

Case Law 4

In Hobson V Bass135

J gave a guarantee to B for payment of the goods sold by him to

another person A up to an amount of Rs 1,000. B supplied goods for Rs 2,000. To A. A

became insolvent and B supplied the goods He asked J to pay. J paid him Rs 1000. B

received from the official receiver 25% of Rs 2,000 as dividend in insolvency. It was

held that J was entitled to receive a part of the dividend out of the whole received

that is 50% of Rs 1000. This is Rs. 500

135

1971 6 CRA 772

277

(iv) Right to ask the creditor to terminate debtor’s services: When a person gives a

guarantee for the honest performance of another employee and the employee defaults,

the surety has a right to the demand that the employee is dismissed. Such dismissals

are usually in the case of fidelity contracts for example contracts relating to insurance.

13.10.3 Rights against Co-sureties

When there is more than one surety to guarantee a debt they are called co-sureties. In

case of default all the sureties become liable towards the contribution of the guarantee

amount.

The following are the rights of the surety against co-sureties:

(i) Right to contribution: Under Section 146 of the Indian Contract Act

wherever there are co-sureties for the same amount, they are liable to share an

equal amount of the debt which remains unpaid by the principal debtor. If a

surety pays more than his share he has the right to ask the other sureties to

participate in contributing an equal amount towards the debt.

Illustration: Rohit, Monty and Shiva are sureties to Kajal for Rs. 6,00,000 that is

given as a loan to Randhir. On the date of payment Randhir defaults. Rohit, Monty

and Shiva are liable between themselves to pay Rs. 2,00,000 each to clear the date.

(ii) Bound in different sums: If co-sureties are bound in different sums there

liability will be shared equally, subject to the maximum amount guaranteed by

each of them.

Illustration: Manu, Pappu and Abhi are sureties for Dhara. They enter into a

contract that Manu will pay Rs. 1,00,000, Pappu will pay Rs. 2,00,000 and Abhi will

pay to the extent of Rs. 4,00,000 if Dhara makes a default in payment of an amount of

Rs. 6,00,000 to Prakash. Manu is liable to pay Rs. 1,00,000, Pappu Rs. 2,00,000 and

Abhi Rs. 3,00,000.

278

13.11 SURETY’S LIABILITIES

The surety has several liabilities since he has guaranteed the debt. These are discussed

below:

Co-extensive: The nature and extent of a surety’s liability is co-extensive with that of

the principal according to section 128 of the Indian Contract Act. This means that the

surety has the same liability as the principal debtor. If the principal debtor does not

pay on time, the surety will be required to pay to the creditor.

Illustration: Amit has taken a loan of Rs 1,00,000 from Shamit and Sanjeev has

guaranteed it. If Amit fails to pay the amount to Shamit on the due date, Sanjeev will

have to pay the amount to the creditor. If an interest rate has been fixed, Sanjeev is

also liable to pay that amount.

Reduction in liability: When the principal debtors liability is reduced, the liability of

the surety will also be reduced.

Secondary liability: A surety’s liability is secondary and comes into force only when

the principal debtor defaults in his payment. If the surety himself becomes insolvent

before the principal debtor defaults his payment his will not be liable to pay any

amount guaranteed by him if the principal debtor makes a default later.

Liability restricted to valid contract: If a contract of guarantee is valid the surety will

be liable. If the creditor makes a contract with representation or fraud, then the surety

has the right of treating it as a voidable contract at his option.

Liability when original contract between creditor and principal debtor is void or

voidable: The surety and the creditor have a contract that is independent from the

principal debtor. Sometimes the original contract between the creditor and the

principal debtor is not valid but the surety is still liable for the principal debtor. This is

in the event of the principal debtor being a minor; the surety does not get absolved of

his liability. The surety is liable like a principal debtor.

279

When the contract between the creditor and the principal debtor is voidable the surety

can still be liable. Moreover the liability of the surety continues to exist in the event of

the creditor not making his claim during the period of limitation of 3 years of a debt

the surety is not discharged if the limitation period against the surety exists. But a

surety who guarantees a time barred debt is not liable because according to the

contract of guarantee he is not liable beyond the period of the guarantee contract. If

the principal debtor is discharged from his liability or dies, the surety is discharged

from his liability.

Liability on default of principal debtor: The surety becomes liable immediately on

default of the principal debtor. Before the default the surety does not have to pay as

his liability only begins if the principal debtor does not pay. At the same time, the

principal debtor does not have to send any notice of default to the surety. The creditor

can sue the surety for the amount immediately on default. Procedurally, he is not

required to sue the principal debtor first. He can immediately sue the surety for the

amount owed to him.

13. 12 DISCHARGE OF SURETY

The surety and the so-surety are discharged from their liabilities in the following

circumstances:

(a) Revocation of contract by surety

(b) By act or conduct of creditor

(c) By invalidation of the contract of guarantee

280

Revocation of contract by surety

(i) By notice (ii) By death of surety (iii) By novation

Figure 13.12.1

Modes of Discharge of Surety

By Conduct of the Creditor By Revocation By Invalidation

of Conduct

By Notice

(Section 130)

By Death of

surety

(Section 131)

By Novation

(Section 62)

(a) Right to

contribution

Variance in

terms of

contract (Section 133)

Release or

discharge of

the principal

debtor

(Section 134)

Arrangement

between

principal debtor

and creditor

(Section 135)

Creditor’s act or

omission

impairing surety’s

eventual remedy

(Section 139)

Loss of

security

(Section 141)

Guarantee obtained by

misrepresentation

(Section 142)

Guarantee obtained

by concealment

(Section 143)

Failure of a co-

surety to join surety

(Section 144)

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Revocation of contract by surety

A contract can be revoked by a surety either by (i) giving notice of revocation or (ii)

by death of the surety or (iii) by novation.

(i) By notice: A specific guarantee can be revoked by the surety by giving notice

to the creditor. However, this is possible only before the liability of the surety

accrues. If action has already been taken, it can be revoked. A continuing

guarantee can be revoked for future transactions but the surety cannot be

relived from his liabilities from transactions that have already taken place

(Section 130).

(ii) By death of surety: In the event of death, the surety is not liable to pay for any

transactions entered into by the principal debtor and the creditor after his

death. He is however liable for the past transactions. After his death his

property cannot be attached for any new contracts made by the creditor and

the principal debtor. His liability ceases after his death even though notice is

not given. As already stated in a continuing guarantee the same rule will

apply. (Section 131)

(iii) By novation: When a new contract of guarantee is made and it replaces the

old contract either between the same parties of the contract or a continuation

between at least one of the old parties with a new parties, the old contract is

discharged. The contract of guarantee made originally is also discharged.

(Section 62)

13.12.2 By Act or Conduct of Creditor

The surety is discharged from his liabilities due to a certain act or conduct of the

creditor.

By Act or Conduct of Creditor

(i) Variance in contract terms

(ii) Release of principal debtor

(iii) Compounding by creditor

with principal debtor

(iv) Act or omission impairing

Surety’s eventual remedy

(v) Loss of security

Figure 13.12.2

282

(a) Variance in contract terms: The liability of the surety extends to the terms of

the contract between the three parties i.e., creditor, principal debtor and the

surety. Any variation in terms and conditions must be approved by the parties

concerned. If any changes take place without the consent of the surety, he will

be discharged from his liability after such changes are made (Section 133).

If the contract of guarantee consists of several distinct different duties and

obligations the surety will be discharged from only those duties where there is

a variance in the contract terms.

In a continuing guarantee the surety need not perform his duties subsequent to

the variance in the contract as it will discharge him from his liabilities.

Illustration: Madhwi is a distributor for consumer products. She employs Munish to

sell the goods on commission. Raju is the surety of Munish to Madhwi for giving the

correct amount of money on sell of goods on which the commission becomes due.

After Munish is employed, Madhwi changes the terms of the contract and begins to

pay a salary to Munish on his request without giving any information to Raju. The

surety (Raju) is discharged from his liabilities.

(b) Release of principal debtor: If the principal debtor is released in a contract by

the creditor, the surety is automatically released from his liabilities or by any

act omission of the creditor which has the effect of discharging him from the

principal debtor.

Illustration: Rani makes a contract with Tinu to furnish her office for Rs. 5,00,000

within one month. Rani promised to supply the furnishing material for the office.

Minu guarantees the performance of Tinu. Rani does not supply the furnishing

material. Minu is discharged from her liabilities of a surety.

(c) Compounding by creditor with principal debtor: When the principal

debtor and the creditor make a composition with each other without the

knowledge of the surety. This applies to a situation in which a variation

takes place from the original contract. In such a situation the surety is

discharged from his liability.

283

Illustration: Akhil borrows a sum of Rs. 50,000 from Shobha. Nirma is a surety for

the payment by Akhil. Before the date of payment Akhil and Shobha change the

terms of the contract by agreeing that Akhil may pay Rs. 30,000 instead of the

whole amount. Nirma is discharged from his liability.

(d) Act or omission impairing surety’s eventual remedy: The surety’s

liability is discharged when the creditor acts or omits to act in a certain

way. This action or its omission becomes inconsistent with the rights of

the surety impairing his eventual remedy against the principal debtor,

(section 139). If the creditor does not do his duty required towards the

surety in the contract of guarantee, the surety can be discharged from his

liability.

Illustration: Ahluwalia contracts to build a hotel in Kohima for Rajender & Co.

with specifications and a fixed date of completion. Sugani guarantees the

completion and quality of the work to be done by Ahluwalia. Rajender & Co.

promised to pay Ahluwalia in installments and according to the stages of work

completed. The last installment was to be paid on the completion and inspection of

the hotel by the requisite authorities. Before the work is completed Rajender & Co.

pay the complete amount to Ahluwalia. The contractor stops his work after

receiving the full payment without completing the construction of the hotel. Sugani

is not responsible as surety because Rajender & Co. have paid early and impaired

the surety’s eventual remedy.

(e) Loss of security: The surety is discharged from his liability if the creditor loses

the security given to him by the principal debtor. The surety will be also be

discharged if the creditor parts with his security without the consent. However he

will not be discharged if the security of the creditor is lost due to natural calamities,

or an act of an enemy of a country.

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Invalidation of the Contract of Guarantee

12.2.3 By Invalidation Of the Contract of Guarantee

The surety will be discharged from his liabilities by invalidation of the contract of

guarantee in the following cases:

1. Guarantee obtained by misrepresentation

2. Guarantee obtained by concealment

3. Contract of guarantee without consideration

4. Contract of guarantee where co-surety fails to join a surety

18 Guarantee obtained by misrepresentation: According to section 142 if a

guarantee is received by misrepresentation made by the creditor or with his

knowledge and a major part has been misrepresented, the surety will be

discharged from his liability.

19 Guarantee obtained by concealment: According to section 143 of the contract

Act, if the creditor has remained silent on certain important and material facts

and obtained a guarantee, the surety will be discharged from his liability. The

surety will be relieved from his liability as such a guarantee will be obtained

by concealment

20 Contract of guarantee without consideration: In a contract of guarantee there

must be consideration between the creditor and the principal debtor. If there is

no consideration the surety will be discharged from his liability.

(i) Guarantee by

misrepresentation

(ii) Guarantee by concealment

(iv) Failure of co-surety

to join surety

(iii) Guarantee without

consideration

285

21 Contract of guarantee where co-surety does not join the surety: According to

section 144, in a contract of guarantee involving co-sureties and making it

necessary for the contract to be completed by more than one surety, the

guarantee is invalid if the co-surety does not join the surety in the contract.

Points to Remember

Specific contracts

(iv) Contracts of indemnity and guarantee are special contracts, They have

specific provisions.

Contracts of indemnity and guarantee.

(v) Contracts of indemnity are made to compensate a party that has

suffered a loss.

(vi) Contracts of guarantee are made to perform a promise or discharge the

liability of a third party.

Parties to contracts of indemnity

1. There are two parties to the contract. The indemnifier and the indemnity

holder.

Parties to contract of guarantee

• There are three parties to the contract. The principal debtor, the creditor and

the surety.

Rights of indemnity holder

Indemnifier is the person makes good the loss of the other person. His rights are:

b) To recover damages that he was compelled to pay in a suit.

c) All costs for defending a suit.

d) All sums paid for compromise of a suit.

Liability of Indemnifier

(d) Liability of indemnifier begins as soon as the liability of an indemnity holder

becomes certain and absolute.

Essential features of contract of guarantee

(e) Tripartite agreement.

286

(f) Consent of three parties.

(g) Essentials of valid contract.

(h) Existence of liability.

(i) Guarantee not received by misrepresentation

(j) Guarantee not received by concealment

Types of guarantee

(k) Specific guarantee

(l) Continuing guarantee.

Revocation of continuing guarantee

(m) By notice of revocation.

(n) By death of surety.

(o) By modes of discharging surety: By novation, by variation in terms, by

discharge of principal debtor, by act or omission of creditor and by loss of

security.

Rights of surety

(p) Rights against principal debtor – right of subrogation, right to indemnity.

(q) Rights against creditor – Right to securities, right to claim set off.

(r) Rights against co-sureties – Right to claim contribution.

Discharge of surety

(s) By revocation of contract of guarantee – By notice, by death, by novation.

(t) By conduct of creditor – variance and contract, discharge of principal debtor,

by act or omission impairing surety’s eventual remedy and loss of security.

(u) By invalidation of contract – Guarantee by misrepresentation, concealment,

without consideration and failure of co-surety to join a surety,

Objective Type Questions:

State whether the following are True or False

1. The party who gives a promise of indemnity is the indemnity holder.

2. A person giving guarantee is called the guarantor.

3. The liability of the surety is co-terminus with the debtor.

4. The liability of the surety is primary.

5. A surety is discharged from liability if the principal debtor dies.

287

6. A surety for a minor’s loan is liable.

7. A contract of indemnity should be supported by consideration.

8. A surety has a right over securities that are offered.

9. A continuing guarantee cannot be revoked.

10. A contract of guarantee is a contract of ‘uberrimae fidei’

Answer: 1 (F), 2 (T), 3 (F), 4 (F), 5 (F), 6 (T), 7 (T), 8 (T), 9 (F), 10 (F).

Questions

1. What is a contract of indemnity? How is it different to a contract of guarantee?

2. What are the different types of guarantees? How can a continuing guarantee

be revoked?

3. Discuss the rights of a surety.

4. What are the liabilities of a surety? How can he be discharged of his

liabilities?

5. What are the essentials of a valid contract of guarantee?

6. Discuss the position of the surety against the principal debtor, creditor and co-

sureties.

7. What are the liabilities of surety in relation to (a) minor and (b) expiry of

period of limitation?

8. Explain the statement: “The indemnifier becomes liable as soon as liability of

indemnity holder becomes absolute”.

9. Why is a surety sometimes called a favoured debtor?

10. Write notes on (a) co-sureties have an equal burden and benefit, (b) Right of

subrogation, (c) liability of surety is co-extensive with the debtor.

Practical Problems

1. Madhav asks Mahesh to make a false charge of stealing against Mahima and

to beat her with a stick. Madhav promises to indemnifier Mahesh on the

consequences. Mahesh beats Mahima five times and she bleeds profusely.

288

He is fined by the police and has to pay Rs. 50,000 to Mahima. Can Mahesh

claim the money from Madhav?

Answer: Mahesh cannot claim the amount from Madhav because the agreement is

not lawful.

2. Abhinav, a minor took a loan of Rs. 1,00,000 from his neighbour to visit

Singapore. The loan was guaranteed by Anubhav who was known to both

the parties. Abhinav came back from his trip and refused to return the

money. Can his neighbour claim the money from Anubhav?

Answer: The neighbour has a right to recover the money from Anubhav who is this

surety of the loan. An agreement with a minor is void under the law of

contract. However, in a guarantee agreement collateral to the agreement is

enforceable. The contract is not illegal and does not affect the validity of any

collateral transactions. The guarantee agreement has been signed by people

who are not minors. It is valid. The neighbour can recover the amount from

the surety. The surety, Anubhav cannot however recover the amount from

Abhinav as he is minor.

3. Amitabh takes a loan of Rs. 3,00,000 from Abhishek. It is guaranteed by

Braj. The loan is taken on 1st Jan 2007. The due date of the loan was 5th

April 2007. 18 months have passed after the due date and Amitabh has not

paid the debt. Abhishek does not take any action. What is the position of

Braj? Is he absolved from his liability if the period of limitation expires for

recovering the amount?

Answer: Braj is the surety. He cannot be absolved from his liability because

Abhishek has not taken any action. Even if Abhishek does not taken action

within the period of limitation Braj will not be absolved from his obligation

towards the creditor.

4. Tunnu, Somu and Jhumu act as sureties for Babu for guarantees of different

penalties with a co-operative society. Tunnu is a surety for Rs. 50,000, Somu

289

for Rs. 15,000 and Jhumu for Rs. 19,000. Babu defaults of the amount of Rs.

55,000 what are the liabilities of the different sureties?

Answer: The sureties are actually co-sureties for different sums and they are liable to

pay equally to the maximum extent of their liability. In the above case Somu

pays Rs. 15,000 which is the maximum liability. The balance of Rs. 35,000

will be paid equally by Jhumu and Tunnu. The amount of Rs. 17,500 would

be shared equally between both parities.

5. Arjun is a surety for Shruti who has taken a loan of Rs. 80,000 from Sunita.

It has been decided that if Shruti does not pay the money in four months, she

will pay an interest of 15% per annum on the amount of the loan. Afterwards

unknown to Arjun, Shruti and Sunita decide that rate of interest is too high

and it was reduced to 10%. What is the position of Arjun?

Answer: Arjun is a surety and has made a contract to guarantee Shruti’s loan from

Sunita. Since the terms of the agreement were changed without the

knowledge of Arjun, he is not liable to pay in case of default.

6. Reena guarantees the payment of Sheena upto the extent of Rs. 50,000 on

clothes being supplied by Madhvi in the year 2008. Madhvi supplies a

consignment of Rs. 20,000, Rs. 40,000 and Rs. 60,000. Sheena pays for the

first two consignments but does not pay Rs. 60,000. What is the extent of

liability of Reena who is the surety of Sheena?

Answer: Reena has given a continuing guarantee for the year 2008 upto the extent of

Rs. 50,000 for delivery of garments. She is liable to pay upto an amount of

Rs. 50,000 in case of default.

7. Hingorani became a surety for Mangatram for 5 computers to be delivered to

Hansika of the value of Rs. 1,50,000 payable in 45 days. Mangatram

delivered computers in lots of 5 computers. He delivered 5 computers every

week. Hansika paid for computers received in the first three weeks after that

she did not pay. Does Hingorani have to pay to Mangatram?

290

Answer: This problem is not of continuing guarantee. The language is such that it is

limited to surety for delivery of 5 computers only. Since Mangatram

supplied the computers in various lots Hingorani is not responsible for any

contracts after the first five computers were delivered and paid for. He is

therefore not liable to pay Mangatram.

8. Babli has taken a loan of Rs. 80,000 from Siya. Akhil is surety for the debt.

Siya demands payment on the due date. Babli is unable to pay. Siya

demands the payment from Akhil who is the surety. When he also does not

pay Siya sues him in the court. Akhil defends the suit because of reasonable

grounds to do so and incurs a cost of Rs. 20,000. He is compelled to pay the

amount of debt and the costs to defend the case. Can he recover the amount

from Babli?

Answer: Akhil is the surety and he has incurred costs genuinely by defending the

case. He can recover the principal amount and the costs that he had to pay from the

principal debtor that is Babli.

References

i. Bangia R.K. (2002) Indian Contract Act Allahabad Law Agency, Delhi, Tenth

Edition pages 310-343

ii. Aggarwal S. K and Singhal K. (2006) Indian Business Laws, Second Edition

pages 213-235. Galgotia Publications, New Delhi,

iii. Tulsian P. C. (2003) Business Law, Second Edition pages 12.1-12.23.Tata

Megraw Hill Publishing Company Ltd., New Delhi,

iv. Tuteja S. K. (2004) Problems in Mercantile Law,Eight Edition pages 73-

83.Sultan Chand & Sons, New Delhi

291

Websites

a. http://www.hba.org.my/articles/bhag_singh/2002/guaranteeing.htm

b. http://en.wikipedia.org/wiki/Indemnity

c. http://books.google.com/books?id=2eu20I_FDmEC&pg=RA1-

PR16&lpg=RA1-

PR16&dq=contract+of+indemnity+and+guarantee&source=web&ots

=kVNxTdhHW2&sig=WQyvgMfyUAJs7-

LYMeM60xpYzL8&hl=en&sa=X&oi=book_result&resnum=7&ct=re

sult

d. http://business.timesonline.co.uk/tol/business/law/reports/article30708

07.ece

292

Lesson – 14

CONTRACT OF AGENCY

by

Anu Pandey

This Lesson discusses the various aspects of Contract of Agency

14.1 Definition

14.2 Creation of Agency

14.3 Agent’s Authority

14.4 Sub-Agent & Substituted Agent

14.5 Rights and Duties of an Agent

14.6 Rights and Duties of a Principal

14.7 Termination of Agency

The term agency has been referred in previous lessons136

. It is important to know what

exactly is agency? Agency is a relationship between two people where one is called

the principal and the other is called the agent.

14.1 DEFINITION

According to Section 182 of the Indian Contract Act 1872 “an agent is a person

employed to do any act for another or to represent another in dealings with third

persons. The person for whom such act is done, or who is so represented, is called the

“principal”.

136

Minor and person with unsound mind can be an agent (Lesson 4, Capacity of

parties), formation of agency does not require consideration (Lesson 3, Consideration)

293

Illustration: Sukrita a resident of Delhi wanted to buy a house in Shimla so she

approached a property dealer and asked him to purchase a house for her. The

property dealer bought a house from Mr Nagendra in Shimla according to the budget

and the other specifications given by Sukrita. In this case Sukrita is the principal, the

property dealer is the agent and Mr Nagendra is the third party.

Who can be a principal?

The principal should have the contractual capacity therefore the following two

conditions must be fulfilled:

1 The person should be of the age of majority137

according to the law to which

he/she is subject to

2 The person should be of sound mind138

Who can be an agent?

One can become an agent even without having the contractual capacity therefore even

a minor or a person of unsound mind can become an agent. Whether the agent has the

contractual capacity or does not have the contractual capacity it is the principal who

would be held liable to the third party for the acts of the agent. However it is the

agent with contractual capacity who would be responsible to the principal for his/her

acts and not the agent without contractual capacity therefore it is in the interest of the

principal to appoint only those agents who have the contractual capacity.

Illustration 1: Badruddin a tailor sent his trainee Ramzan who was twenty one-year

old to his customer Neeta to deliver a kurti. On the way Ramzan lost the Kurti. Hence

it is Badruddin who is responsible to compensate Neeta for her lost Kurti and not

Ramzan however Ramzan is responsible to Badruddin for losing the kurti thus

Badruddin if he wants can deduct from Ramzan’s salary the cost of the Kurti or can

take any other action to penalize Ramzan for his irresponsibility.

137

Person above the age of 18 is a major 138

Person who is a lunatic, a drunkard, intoxicated or an idiot (for more details refer

to the lesson on capacity of parties, lesson 4)

294

Illustration 2: Badruddin a tailor sent his trainee Ramzan who was thirteen-year old

to his customer Neeta to deliver a kurti. On the way Ramzan lost the Kurti. Hence it is

Badruddin who is responsible to compensate Neeta for her lost Kurti and not

Ramzan. As Ramzan is a minor therefore he is not responsible to Badruddin for losing

the kurti as a result Badruddin cannot penalize Ramzan for losing the Kurti.

How is an agent different from a servant?

The difference is given in the Table 14.1

Basis of Distinction Agent Servant

Relations with third party Agent creates legal

relationship between the

principal and the third

party

Servant does not create

legal relationship between

his/her employer and the

third party

Authority Agent is not under direct

supervision and control of

the principal. He / she can

exercise discretion to a

large extent

Servant acts under direct

supervision and control of

the employer. He / she

cannot exercise discretion

Line of command Agent can work for several

principal at the same time

Servant generally works

for only one employer

Interconnection Agent cannot be

considered a servant

Servant can for some

purposes act as an agent of

his/her employer

Case Law-1

Laxmi Narayan Ramgopal & Sons Ltd. Vs. Hyderabad Govt139

.

Lakshmi Narayan Ramgopal and Sons was appointed under an agreement of 1920 to

manage the business of Ram Gopal Mills & Co., subject to the contract and

supervision of the Director, of the latter co. The remuneration paid for the services

was to be taxed. The question for consideration was whether Lakshmi Narayan

139

(1954) A.I.R. S.C. 364

295

Company’s status was of a servant or an agent. It was found that the company in

question was in the position of an agent and not of a servant. Here the remuneration

was taxable as it arose in the course of the agency. In this case the Supreme Court of

India made a vital observation that an agent as such is not a servant but a servant is

generally for some purposes his master’s agent, the extent of agency depending upon

the duties or position of the servant.

Characteristics of Agency

Certain essential elements of Agency are given below:

1 Agreement between principal and agent: It is important that there be an

agreement as agency depends on agreement and not necessarily on contract. A

contract cannot be formed with minor because an agreement with a minor is

void but an agreement of agency with minor is possible because between the

principal and the third person any person may be appointed as an agent

whether it be a minor or a person of unsound mind.

Illustration: Rustam a shoe manufacturer appointed Kapil as his agent to sell shoes.

Kapil was just fifteen-year old therefore the agreement between Kapil and Rustam is

a void agreement as a result it cannot become a contract. However the agreement

between them can be treated as a contract of agency because in an agency the agent

can be a minor.

2 Intention of the agent to act on behalf of the principal: it is important that

the person (agent) intends to act on behalf of another (principal) only then

agency may arise.

Illustration: Prabhu a builder appointed Sooga as his agent to sell houses. The

agreement between them can become a contract of agency only when Sooga gives his

consent to Prabhu to become his agent.

296

Case Law-2

Krishna Vs. Ganapathi140

It was held by the Court that it is only when one acts as a representative of the

other in business dealings so as to create contractual relations between that

other and third persons, that he is an agent and there is an agency.

3 Whatever the principal can do personally he/she can do it through his/her

agent: The agent can perform all those activities which the principal is liable

to perform however the agent cannot perform acts which are personal in

character or are annexed to public office such as marriage and duty of a

magistrate.

Illustration: Ramlal was going to get married so he appointed Shambhu his cousin

brother as his agent to look after his business and all other personal and business

affairs. Shambhu had the right to run the business on behalf of Ramlal but he did not

have the right to marry on behalf of Ramlal.

4 He who does an act through another does it by himself/ herself: The acts

of an agent are the acts of the principal. The principal is liable to the third

party for the acts done by the agent.

Illustration: Radheylal a creditor appointed Ramu as his agent to recover payments

from his debtors. Ramu was sent by Radheylal to recover rupees fifty thousand from

Sangeeta a debtor. Ramu took rupees fifty thousand from Sangeeta and ran away with

it. Hence Radheylal cannot ask Sangeeta to pay the money again. However if Ramu is

a major then Radheylal can take legal action against him.

5 No consideration required for agency: According to section 185 of the

Indian Contract Act no consideration is necessary to create an agency. The

fact that the principal has agreed to be represented by the agent is a sufficient

detriment to the principal to support the contract of agency.

Illustration: Sangeeta was having a headache so she asked her son to go to the

market and get a tablet of disprin. In this case the relation between the mother and

140

(1955) A.I.R, Mad. 648.

297

son is that of a principal and agent and for getting a tablet of disprin Sangeeta gave

nothing in cash or kind to her son. Thus there is a contract of agency without any

consideration.

14.2 CREATION OF AGENCY

Agency can be created in any of the following manner:

The agent gets authority from the principal. The authority can be given in two

ways. Either it can be expressly given or the authority can be implied. Section

187 of the Indian Contract Act defines express and implied authority as under:

1 Express authority: An authority is said to be express when it is given by words

spoken or written. The authority enables the agent to bind the principal by acts

done within the scope of his/her authority. The written contract of agency is the

power of attorney wherein one person empowers the other to represent him/her, or

act in his/her stead for certain purposes.

Illustration: Phulki was a garment trader in Delhi. She used to buy her garments

from Jodhpur. Once it was not possible for her to go to Jodhpur so she asked her

salesman Farhan to go and buy the merchandise from Jodhpur.

2 Implied authority: An implied authority arises from the conduct, situation or

relationship of the parties. It is inferred from the circumstances of the case. The

agency arises when the principal conducts himself / herself towards the person

alleged to be the agent to the third parties in such a manner, as if the principal had

conceded to the appointment of that person as agent. This form of agency can be

formed in any of the following manner

(a) Agency in Emergency: According to section 189 of the Indian Contract Act an

agent has authority in an emergency, to do all such acts for the purpose of

protecting his / her principal from loss as would be done by a person of

ordinary prudence in his /her own case, under similar circumstances. The

agent while protecting the principal from loss may exceed his / her authority

298

thus giving rise to agency of necessity provided (1) He / She was not in a

position to communicate with the principal (2) Had taken all reasonable care

and necessary steps to protect the interests of the principal. And (3) had acted

bona fide.

Illustration: Salman was a tea merchant who used to export tea. He had kept Balram

as his agent whose duty was to take export orders and then deliver the tea from the

storehouse. One day the storehouse caught fire and Balram poured water to

extinguish the fire. Though this was not a part of the duty assigned to him but as an

agent it was his implied duty to protect his principal from loss.

(b) Agency by Necessity: Sometimes in certain urgent circumstances the law

confers an authority on a person to act as an agent for the benefit of another,

there being no opportunity of communicating with that other. Such agency is

called agency of necessity. The following are some cases of agency by

necessity:

1 Person entrusted with another’s property: when a person is entrusted

with some property of another, which he/she has to protect or preserve.

In such case although the person who is entrusted with the property has

no express authority to do the act necessary to preserve it, yet because

of the necessity such an authority is implied.

Illustration: Ranbir wanted to sell his car but was not very good at dealing with

purchase and sale so he entrusted this job to his friend Jeetendra and gave the car in

his possession. One day in the night a thief tried to steal the car and Ranbir tried to

catch hold the thief and while doing that he got hurt.

2 Husband and wife: Wife is considered to be the agent of her husband.

A husband is bound to supply necessaries of life to his wife and if he

makes no adequate provision for her maintenance, she is entitled to

299

pledge his credit for necessaries141

. The husband can escape liability if

he can prove the following:

(1) He has expressly forbidden his wife to pledge his credit.

(2) The goods purchased by his wife are not necessary goods.

(3) He has expressly told the salesman not to give credit to his wife.

Illustration 1: Ram and Sita were husband and wife who were staying together. Ram

was the breadwinner and used to run the house. He had expressly told his wife Sita

not to buy anything from the shop on his credit therefore if Sita buys necessaries on

his credit then Ram is not liable to pay for the goods purchased.

Illustration 2: Ram and Sita were husband and wife who were staying together and

Ram was the breadwinner who used to provide all the necessities of life to his wife.

One day his wife bought a gold necklace from a jeweler on Ram’s credit. As gold

jewelry was not a necessity therefore Sita cannot buy it on Ram’s credit and Ram is

not liable to pay for it.

Illustration 3: Ram and Sita were husband and wife who were staying together and

Ram was the breadwinner who used to provide all the necessities of life to his wife.

He had told the shopkeepers of that locality not to give anything to Sita on credit. Sita

purchased a necessary good from one of the shopkeeper on Ram’s credit. Thus Ram is

not liable to pay for it.

Wife and husband living separately: If a woman’s husband has deserted her and they

are both living separately she still has the authority to pledge her husband’s credit for

necessaries. The wife enjoys this right only if her husband does not provide for

maintenance. If the wife is living separately out of her own will and without any valid

justification then she cannot be treated as the agent of her husband and the husband is

not liable for her necessaries.

141

Necessaries are goods and services which are commensurate with the couples

(husband and wife) joint style of living

300

Illustration 1: Ram and Sita were husband and wife who were staying separately

because Ram had abandoned Sita and he was not even providing maintenance to her.

Sita had a right to buy necessary goods on Ram’s credit and therefore Ram was liable

to pay for the goods purchased by Sita.

Illustration 2: Ram and Sita were husband and wife who were staying separately from

each other. It was Sita’s decision to live separately because she wanted to stay at her

mother’s place. Sita was not entitled to buy necessary goods on her husband’s credit

because Ram did not abandon her.

3 Agency by Estoppel: At times the principal by his / her conduct creates

an impression in the mind of a third person that the agent has an

authority to act on his/her behalf. In such case the principal is liable

towards the third person for the acts done by the agent, on the ground

of the application of the law of estoppel. The basis of the action is what

appears to the third person to be an authority, i.e. apparent or

ostensible authority conferred on the agent.

Illustration: Pankaj had come from America and for few days came to stay with his

friend Rajinder in Bikaner. Rajinder went with Pankaj to the market and got lunch

packed from a nearby restaurant. While he was getting the lunch packed he told the

restaurant owner that Pankaj was like a brother to him. After a couple of days Pankaj

moved out from Rajinder’s house and started staying somewhere else. One day he

went to the same restaurant and got the lunch packed and the restaurant owner did

not charge him anything as he thought that Pankaj was taking the lunch on Rajinder’s

behalf. Later he charged Rajinder for the price of the lunch.

4 Agency by Holding out: Such an agency is based on the “doctrine of

holding out” which is a part of the law of estoppel. In this case also the

alleged principal is bound by the acts of the supposed agent, if he / she

has induced third persons to believe that they are done with his/her

authority. But, unlike an “agency by estoppel” “agency by holding

out” requires some affirmative or positive act or conduct by the

principal to establish agency subsequently.

301

Illustration: Rajni went to the sweetshop and purchased sweets in the meantime her

neighbour’s eight-year old daughter Harshita happened to visit the place. Rajni out of

affection for Harshita asked the shop owner to serve two hot gulabjammuns to

Harshita. Rajni paid for the gulabjamuns. One day again Harshita visited the sweet

shop and the owner served hot gulabjamuns and mistaking her for Rajni’s daughter

did not ask for the money. Later he recovered the price of gulabjamuns from Rajni.

3 Agency by Ratification: Sometimes a person may act as an agent of someone and

does an act on his/her behalf for which he/she did not have the authority and that

someone binds himself / herself for the acts done by the agent then it is called

agency created by ratification.

Illustration 1: Som had a car, which he wanted to sell. He was not at home when a

buyer came to see the car. Som’s son Rahul showed the car to him and without asking

his father finalized the deal for rupees fifty thousand. After coming home Som gave

his consent to the deal as a result agency was created by ratification.

Illustration 2: Som had a car, which he wanted to sell. He was not at home when a

buyer Mr Nath came to see the car. Som’s son Rahul showed the car to him and

without asking his father finalized the deal for rupees fifty thousand. After coming

home Som did not approve of what his son had done and the agreement between the

buyer and Rahul was revoked and contract of agency was never formed.

Case Law-3

Bolton vs. Lambert142

In this case the managing director of a company, purporting to act as agent on

company’s behalf, but without its authority, accepted an offer made by Lambert, the

defendant, for the purchase of some sugar works belonging to them. Lambert

subsequently withdrew the offer but the company ratified the managing director’s

acceptance. Held, Lambert was bound. The ratification, related back to the time of

managing director’s acceptance, and so the withdrawal of the offer was inoperative.

142

(1889) 41 Ch. D. 295

302

Some of the essential elements of Ratification are as follows:

(a) The principal must be in existence at the time of the contract: It is

very important that the principal is in existence at the time when

original contract is made because rights and obligations cannot be

attached to a non-existent person. Thus contracts entered into by

promoters of a company before the company is incorporated cannot be

ratified by it after it comes into existence.

Illustration: A promoter of a company (to be incorporated) purchased a land on

company’s behalf. He purchased the land only by paying half the amount and

promised that the company would pay the balance once it is formed. At the time of the

contract the company was not in existence therefore the promoter cannot be

considered as the agent of the company and company is not bound to pay the balance

once it comes into existence (incorporated).

(b) The agent must purport to act as agent for a principal who is in

contemplation: The agent must expressly contract with the third party

as an agent of the principal. The principal must be named or must be

identifiable.

Illustration: Dr Sanjeev went to a property dealer to buy a house. The property dealer

showed him a house and Dr Sanjeev liked it and showed his willingness to buy it

however the property dealer did not disclose the identity of the owner of the house.

Hence contract of agency could not be formed.

(c) The principal must have the contractual capacity both at the time

of the contract and at the time of ratification: The principal must

have the contractual capacity both at the time of original contract and

at the time of ratification.

Illustration: Sapna was suffering from mental sickness and was declared mentally

unsound by the doctors. She went to a property dealer and asked him to sell her

house. The property dealer on her behalf finalized a deal with a buyer. The property

dealer cannot act as an agent of Sapna because Sapna is of unsound mind so she is

incapable to become principal.

303

Case law-4

Grover & Grover Vs. Mathews143

It was held by the Court that a person cannot ratify a contract of insurance made by an

unauthorized agent on his behalf after he has become aware that the event insured

against has in fact occurred, because he could not himself insure in such

circumstances.

(d) Ratification must be with full knowledge of facts: The principal

must have full knowledge of all the material facts of the contract,

which he /she is to ratify or the principal must give an unqualified

acceptance where he/she intends to ratify the contract whatever be the

facts.

Illustration: Gunia’s mother wanted a new saree to wear in a party. Gunia who was a

minor went to a showroom and bought a saree on credit. She showed the saree to her

mother and told her the price but the mother did not approve the transaction. Hence

Gunia’s mother did not ratify the agreement of agency and so agreement between

Gunia and the shopkeeper was revoked.

(e) Ratification must be done within reasonable time of the act that is

to be ratified: Ratification to be effective must be made within a

reasonable time after the original contract has been made. If the time

has been expressly fixed for the performance of the contract then

ratification must be made within that time.

Illustration: Saroj promised to sell his brother’s house to Mr. Kripashankar and

informed her brother about the deal. Her brother asked her to give him sometime to

think. He gave his approval after four months. The agreement between Saroj and Mr.

Kripashankar had already lapsed because the contract of agency was not ratified

within a reasonable time.

143

(1910) 2 K.B. 401

304

(f) The act to be ratified must be lawful and not void or illegal or

ultra vires in case of a company: It is important that the object and

the consideration of the agreement entered into by the agent and the

third party be lawful. The principal cannot ratify an unlawful

agreement.

Illustration: Somnath had a fight with his neighbour and he was very upset about it.

His friend Shyam came to know of his problem and on his behalf hired some goons to

bash up Somnath’s neighbour. Somnath could not ratify the agreement between

Shyam and the goons because the object of the agreement was unlawful.

(g) The whole transaction must be ratified: Ratification must be of the

whole transaction. The principal cannot ratify a part of the transaction

and reject the rest of it. He/she cannot accept the benefits and reject the

burdens. Either he/she rejects the whole transaction or accepts (ratifies)

the whole transaction.

Illustration: Roopwati used to sell cosmetics and bags. She hired an agent Neelam to

sell the same in some other locality. Neelam had an agreement with Shalu a buyer

who was ready to buy cosmetics and bags if she was given a discount of forty percent.

Neelam agreed to sell the articles at a discount of forty percent after getting the

approval from Roopwati. Roopwati gave her approval to sell only the cosmetics at the

discounted rate and not the bags. The agreement was not ratified because Roopwati

accepted only one part of the transaction and not the other part.

(h) Ratification must not injure the third party: Ratification cannot be

effective where its effect is to subject a third person to damages, or

terminate any right or interest of a third person.

Illustration: Mr. Singla a sweet shop owner had prepared lots of sweets during

diwali. After diwali lots of sweets were left unsold and some of them had become stale

and unhygienic to eat. Mohan had a party at his house and ordered sweets from Mr

Singla’s shop. Kishan a helper at the shop took Mohan’s order and agreed to send the

required number of sweets. He was sending the stale sweets. Mr Singla was not to

ratify the agreement because it was injurious to Mohan the third party.

305

(i) Ratification is tantamount to prior authority: ratification relates

back to the date when the act (contract) was done by the agent which

means that agency comes into existence from the moment the agent

first acted and not from the time when the principal ratified the act

(contract).

Illustration: Jagan entered into a contract to buy a car from Pawan on behalf of his

brother Chandan on 1st February 2008. Pawan was at that time in Agra and was not

aware of the contract. He returned on 20th

February 2008. After coming he ratified

the contract of agency entered into by his brother Jagan. Though Pawan came to

know of the agreement on the 20th

February but he ratified the contract from 1st

February 2008.

14.3 AGENT’S AUTHORITY

Authority of an agent means his/her capacity to bind the principal to third parties. The

agent can bind the principal only when he/she acts within the scope of his/her

authority (Section 226). The types of authorities are as follows:

Actual Authority: Actual authority is the acts, which have been assigned to the

agent by the principal either expressly (in words spoken or written) or

impliedly (inferred by circumstances of the case or the ordinary course of

dealings) and thereby bind the principal to third party.

Illustration: Reenu a garment manufacturer in Punjab appointed Mr. Yadav as her

agent to look after her business in the southern states of India. She gave him the

freedom to take decisions only in case of selling the goods for any other case he was

suppose to consult Reenu before taking decision.

Ostensible or Apparent Authority: When an agent is employed for a particular

business, persons dealing with him/her can presume that he/she has authority

to do all such acts as are necessary or incidental to such business. Such

authority is called Ostensible / apparent Authority. If the act of an agent is in

306

excess of his/her actual authority, but within the scope of his/her ostensible

authority, the principal will be bound by the act of the agent.

Illustration: Reenu a garment manufacturer in Punjab appointed Mr. Yadav as her

agent to look after her business in the southern states of India. She gave him the

freedom to take decisions only in case of selling the goods and for any other matter he

was suppose to consult Reenu before taking decision. For selling the goods Mr. Yadav

had to take a shop on rent and he took the decision of renting a shop without

consulting Reenu. Though renting of a shop was not the actual authority given to Mr

yadav by Reenu but renting was incidental to selling the goods that was within his

actual authority.

Case law-5

Watteau Vs. Fenwick144

It was held that if it is the usual practice of hotel managers to purchase liquors

and cigarettes, then purchases of this nature shall be deemed within the scope

of the manager’s apparent authority and the principal will be bound by such

purchases, notwithstanding limitations, as between the principal and agent, put

upon that authority.

Authority in emergency: In an emergency an agent has the authority to do all

such acts for the purpose of protecting his/her principal from loss as would be

done by a person of ordinary prudence in his/her own case under similar

circumstances

Illustration: Jaspinder a garment manufacturer in Punjab appointed Mr. Yadav as

her agent to look after her business in the southern states of India. She gave him the

freedom to take decisions only in case of selling the goods and for any other case he

was suppose to consult her before taking decision. However few days later Jaspinder

had a heart attack and she was bed ridden. Mr Yadav had no other option but to take

decisions on all matters which had to do with the running of the business without

consulting Jaspinder.

144

(1893) 1 Q.B. 346

307

14.4 SUB-AGENT & SUBSTITUTED AGENT

When the principal appoints a particular agent to act on his/her behalf, he/she relies

upon the agent’s skill, integrity and competence therefore according to section 190 the

agent is not entitled to delegate his/her authority to another person. However section

190 also provides that an agent may appoint a sub-agent and delegate the work to

him/her in any of the following circumstances:

(i) There is a custom of trade to that effect.

Illustration: Mr Bal a businessman had appointed a lawyer Mr Ramchandani to fight

a case against Mr Maheshwari. Mr Ramchandani being a very busy lawyer asked his

assistant Mr Shekhran to handle the case on hi behalf.

(ii) The nature of work is such that a sub-agent is necessary.

Illustration: Mr Rastogi a resident of Meghalaya wanted to buy a house in

Jamshedpur. He contacted John a property dealer residing in Meghalaya to buy the

house for him. John was not very familiar with Jamshedpur therefore he contacted his

friend Bansal who was a property dealer in Jamshedpur to buy the house for Mr

Rastogi.

(iii) Where the principal is aware of the intension of the agent to appoint a

sub-agent and does not object to it.

Illustration: Ramvir was a seller of ladies garments. His business was expanding and

it was becoming difficult for him to manage the business all by himself therefore he

asked Shyam his brother to look into the business. As Shyam did not have knowledge

about ladies garments so he told Ramvir that he would like to involve his wife Asha in

running the business.

308

(iv) Where unforeseen emergencies arise rendering appointment of sub-

agent necessary.

Illustration: Rukmani had a beauty parlor running in five countries. She was

managing only the Indian parlor. Four different agents appointed by her were

managing the other four parlors. One of the agents named Julie in Hong Kong met

with an accident and so was unable to work. She appointed a sub-agent Anna for

managing the parlor till she was fit again to run the parlor.

(v) Where the act to be done is purely ministerial not involving confidence

or use of discretion.

Illustration: Narain Tiwari was a very renowned Chartered Accountant. He used to

audit the accounts of many business houses. He had kept four chartered accountants

as agents to look after the audit and accounts of business houses in the four regions

(northern, southern, western and eastern) of India. The agent in the north got too

much of work to handle therefore after informing Mr Tiwari he appointed a sub-agent

Mr Jogi to look after all the clerical and routine work involved with his job

assignment.

(vi) Where power of the agent to delegate can be inferred from the conduct

of both the principal and the agent.

Illustration: Sandhya was running a catering business. As her business was

expanding and she was finding it difficult to manage she appointed Naina her sister to

help her in running the business. Naina was managing the catering orders for South

Indian food and Sandhya for North Indian food. One day Naina received an order for

Italian food, which she was unable to cater so she appointed Angelina a proficient

cook of Italian food for catering orders for Italian food.

309

(vii) Where the principal permits appointment of a sub-agent.

Illustration: Ram Narain a builder appointed an agent Sukhwinder to look after his

construction work in Nepal. Sukhwinder could not understand the Nepalese language

therefore he took permission from Ram Narain to appoint a Nepalese national as an

agent to help him in the construction work.

Sub-agent

According to section 191 a “sub-agent” is a person employed by and acting under the

control of, the original agent in the business of agency. He is the agent of the original

agent.

Case law-6

Calico printers Association vs. Barclays Bank145

It was held that in the eye of law there is no privity of contract between the principal

and the sub-agent and therefore, in general, the principal cannot claim against the sub-

agent for negligence.

The sub-agent may have two positions:

1 Sub-agent’s position when he / she is properly appointed (Section 192)

As the principal permits appointment of a sub-agent therefore he /she is bound

by the acts of the sub-agent and is responsible to the third party.

The agent is responsible to the principal for the acts of the sub-agent.

The sub-agent is responsible for his/her acts to the agent, but not to the

principal, except in case of fraud or willful wrong.

145

(1931) 145 L.T. 51.

310

2 Sub-agent’s position when he/she is not properly appointed (Section 193)

As the sub-agent is appointed without the consent of the principal therefore

he/she is not responsible for the acts of the sub-agent to the third parties.

The agent is responsible for the acts of the sub-agent to the principal as well as

to the third parties.

The sub-agent is responsible for his/her acts to the agent and not to the

principal.

Substituted Agent / Co-agent

According to section 194 of the Indian Contract Act a co-agent or a substituted agent

is a person who is named by the agent, on an express or implied authority from the

principal, to act for the principal. He 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. He is the agent of

the principal, though the agent names him, at the request of the principal.

Illustration: Ramnath a businessman due to old age was unable to travel. He

appointed an agent Seekunder to look after his business in the north of India. His

business had expanded to the south as well therefore after consulting Seekunder and

on his recommendation he appointed another agent Mr Narain to look after his

business in the south. In this case Seekunder is the agent and Mr narain is the sub-

agent. Both Seekunder and Mr Narain are responsible to Ramnath and Ramnath is

liable for both of their acts to the third party.

311

Difference between Sub-agent and Substituted agent

Basis of distinction Sub-agent Substituted agent

Line of command Sub-agent is under direct

control of the agent.

Substituted agent is under

direct control of the

principal.

Privity of Contract There is no privity of

contract between the sub-

agent and the principal

There is a privity of

contract between the

substituted agent and the

principal.

Responsibility The sub-agent is

responsible for his/her acts

only to the agent and the

agent is responsible for all

the acs of the sub-agent to

the principal

The substituted agent is

responsible for his/her acts

only to the principal

Liability to third party If the sub-agent is properly

appointed then for all

his/her acts the principal is

liable to the third party. If

the sub-agent is not

properly appointed then

for all his/her acts the

agent is liable to the third

party

For all the acts of the

substituted agent the

principal is liable to the

third party

312

Position of principal and agent in relation to third parties:

The position of the principal and his/her agent as regards contracts made by the agent

with third parties are discussed below:

Named Principal: In this case the principal’s existence and name is

disclosed by the agent to the third party while making a contract therefore the

principal is liable for the acts of the agent to the third party provided the agent’s acts

are done within the scope of his/her authority and in the course of his/her employment

as an agent. If the agent exceeds his/her authority then the principal is bound by that

part of the work, which is within the agent’s authority and which can be separated

from the part, which is beyond his/her authority. The principal also has the power to

repudiate the whole transaction if what the agent has done beyond the scope of

authority cannot be separated from what he/she has done within the authority. The

principal is liable for the fraud and misrepresentations made by the agent in the course

of business. However if the agent commits such misrepresentations and frauds and

they do not fall within his/her authority then the principal cannot be held liable.

Illustration: Sunita wanted to buy a house and for that she contacted Prabhu a

property dealer. Prabhu on behalf of Sunita bought a house from Rajneesh. Sunita did

not pay the whole amount. She promised to pay the balance within a month’s time. A

month lapsed and Sunita did not pay the amount to Rajneesh. Rajneesh sued Sunita

for the balance.

Unnamed Principal: In this case the agent discloses the existence of the

principal but conceals the principal’s name from the third party while entering into a

contract. The principal is liable to the third party, unless there is a trade custom or a

term, express or implied, to the effect, which makes the agent personally liable. If the

third party contracts knowing that there is a principal although his/her identity is not

disclosed then he/she cannot sue the agent. However if the agent does not disclose the

existence of the principal then he/she is liable to the third party.

313

Illustration: Sunita wanted to buy a house and for that she contacted Prabhu a

property dealer. Prabhu on behalf of Sunita bought a house from Rajneesh but did not

disclose her name to Rajneesh. Sunita did not make the full payment. She promised to

pay the balance within a month’s time. A month lapsed and Sunita did not pay the

amount to Rajneesh. Rajneesh sued Sunita for the balance. Even though Sunita’s

name was unknown to Rajneesh, Rajneesh could still sue her for non-payment.

Undisclosed Principal: In this case the agent does not disclose the existence as

well as the name of the principal to the third party. The agent gives an impression to

the third party that he /she is contracting in an independent capacity. This gives rise to

the doctrine of undisclosed principle. The agent is personally liable to the third party

and the third party can sue the agent. However if the third party comes to know of the

existence of the principal then he/she can either sue the principal or sue the agent or

sue both of them.

Illustration: Sunita wanted to buy a house and for that she contacted Prabhu a

property dealer. Prabhu bought the house from Rajneesh without telling him that he

is the agent of Sunita and Sunita is the actual buyer. The identity of the principal was

not disclosed to Rajneesh. Sunita did not pay the full amount. She however promised

to pay the balance within a month’s time. A month lapsed and Sunita did not pay the

amount. Rajneesh sued Prabhu for non-payment.

Case Law-7

T.R Chettiar Vs. M.K. Chettiar146

It was held by the Court that the liability of the principal and agent is joint and

several. In such a case if the third party elects to sue the agent and the claim remains

partially unsatisfied, he may afterwards sue the principal for the balance.

146

(1970) A.I.R Mad. 337

314

Pretended Agent: If an agent represents himself/herself as an authorized

agent of a person and induces the third party to enter into a contract then he/she alone

is liable to the third party and the third party has the right to sue only the agent.

However if the alleged principal ratifies the agent’s acts then contract of agency

comes into existence and the principal will become liable to the third party for all the

acts done by the agent. In case this does not happen then the pretended agent may also

be sued for fraud by the aggrieved party (third party).

Illustration 1: Sunita mentioned one day to her friend Prabhu that she wants to buy a

house. Prabhu on his own made a deal and bought a house from Rajneesh for Sunita.

After buying the house he told Sunita. Sunita ratified the deal.

Illustration 2: Sunita mentioned one day to her friend Prabhu that she wants to buy a

house. Prabhu on his own made a deal with a seller and bought a house from

Rajneesh on Sunita. After buying the house he told Sunita. Sunita did not ratify the

deal. Hence Prabhu was liable for any loss Rajneesh would have incurred due to this

deal.

Personal Liability of the Agent: Generally it is the principal who is liable to the

third party for all the acts done by the agent on his/her behalf however the agent is

personally liable in the following cases:

1 When the contract expressly provides that it will be the agent alone who

would be responsible to the third party for all his/her acts.

Illustration: Romita hired an agent Raghuveer to run her business. She had made it

clear to Raghuveer that whatever transactions Raghveer makes with the third party

he alone would be liable for his acts.

315

2 In case the agent acts for a foreign principal then also he/she is personally

liable. The agent can exclude his/her personal liability by express provision to

this effect in the contract. If he/she does that then the agent is not personally

liable.

Illustration: Nainika residing in the United Kingdom wanted to buy a house in

Calcutta. She asked her friend Ram to buy a house for her. Ram bought the house.

Hence he would be liable to the third party.

3 When the agent acts for a principal who is incompetent to enter into a contract

(minor and a person of unsound mind) then he / she is personally liable to the

third party.

Illustration: Nikita a twenty-four year old girl was mentally challenged. Her brother

Raghuveer bought a house on her behalf from Somnath. Although the house belongs

to Nikita (the principal) but as she is mentally challenged it will be her brother (the

agent) who would be liable to the third party.

4 In case the agent signs a contract in his / her own name without disclosing that

he/she is an agent then also he /she is personally liable to the third party147

.

5 When the agent acts for an undisclosed principal148

.

147

See pretended agent in this lesson 148

See undisclosed principal in this lesson

316

14.5 RIGHTS AND DUTIES OF AN AGENT

Duties of an agent

The agent has the following duties towards the principal:

(1) Duty to follow principal’s directions or customs: According to Section 211

of the Indian Contract Act the first duty of every agent is to act within the

scope of the authority conferred upon him/her and performs the agency

according to the directions given by the principal. When the agent acts

otherwise and loss is sustained the agent must make it good to the principal

and if any profit accrues then the agent must account for it.

Illustration: Ram asked his sister Lochina to book rail tickets in second class AC from

Delhi to Assam. Lochina couldn’t get reservation in second class AC so she booked

tickets in First class AC. Ram had not asked her to book tickets in first class AC

therefore Sulochna had the option to either pay the extra money on the ticket from her

pocket or cancel the ticket and bear the loss of cancellation herself.

Case Law-8

Lilley Vs. Doubleday149

In this case the principal instructed the agent to warehouse the goods at a particular

place and the agent warehoused them at a different warehouse which was equally

safe, and the goods were destroyed by fire without negligence, it was held that the

agent was liable for the loss because any departure from the instructions makes the

agent absolutely liable.

(2) Duty to carry out the work with reasonable skill and diligence. According

to Section 212 of the Indian Contract Act the agent must carry the work of

agency with reasonable diligence and to the best of his/her skill.

149

(1881) 7 QBD 510

317

Illustration: Jyotsna asked her friend to help her buy a second hand car. Her friend

without doing much research bought a second hand car without test drive and without

checking the parts of the car. After the purchase the car did not start. Hence Jyotsna

could sue her friend for not working with reasonable diligence and to the best of his

ability while selecting the car.

(3) Duty to render accounts: According to Section 213 of the Indian Contract

Act it is the duty of an agent to keep proper accounts of his/her principal’s

money or property and render them to him /her on demand, or periodically if

so provided in the agreement.

Illustration: Joseph had a business, which was running all over India. He appointed

an agent to look after his business in the eastern part of India. It was the agent’s duty

to keep proper accounts and hand over the money whenever Joseph demanded.

(4) Duty to communicate: According to section 214 in case of any difficulty the

agent should communicate with his/her principal and seek instructions from

him/her before taking any steps in facing the difficulty or emergency.

Illustration: Jyotna wanted to buy a laptop. She asked her brother to buy one for her.

She had given him a budget of rupees fifty thousand. Her brother went to buy the

laptop but couldn’t find any laptop as per his liking within the budget. He liked a

laptop, which was worth rupees seventy thousand. As this was a difficult situation so

he rang up Jyotsna and asked her if he could buy the laptop for seventy thousand.

Jyotna permitted him to buy the laptop. Hence Jyotna is liable to pay her brother the

extra money incurred on the purchase.

(5) Duty not to deal on his/her own account: According to Section 215 and 216

the agent must not deal on his /her own account that means that he must buy

or sell goods only on behalf of his/her principal. If the agent violates this rule

then the principal may repudiate the transaction and can also claim from the

agent any benefit, which may have resulted to the agent from the transaction.

318

Illustration: Sonpari had hired an agent to sell purses. The agent was to sell purses

on Sonpari’s behalf. However the agent started selling the purse as her own and

taking the share of profit, which actually belonged to Sonpari. Hence the agent is

liable to return any such monetary profit she made on the transaction to Sonpari.

(6) Duty not to make any profit out of his/her agency except his/her

remuneration: According to section 217 and 218 an agent must not make any

secret profit out of the agency. The agent must pay to his/her principal all

money, which he/she may have received on principal’s account.

Illustration: Jamshed had asked his nephew Rahim to help him sell carpets. Rahim

was selling carpets at a price higher than what Jamshed had quoted. He was keeping

the excess profit with him. In this case Rahim was cheating Jamshed therefore

Jamshed could repudiate the contract and sue Rahim for the profit he made secretly.

(7) Duty on termination of agency by principal’s death or insanity: According

to section 209 when an agency is terminated by the death of the principal or

due to his/her mind becoming unsound, the agent must on behalf of the legal

representatives of the principal take all reasonable steps for the protection and

preservation of the interests entrusted to him/her.

Illustration: Shyamnath had his brother helping him in his firm. Shyamnath got an

attack of paralysis and was bed ridden. It was now the duty of his brother to take all

possible steps to protect and preserve the interests entrusted to him by Shyamnath.

(8) Duty not to delegate authority: According to section 190 subject to certain

exceptions150

an agent cannot delegate his/her authority to another person.

He/she has to perform all the work himself / herself.

150

For exceptions please see delegation of authority by agent in Section 14.4, page 10

319

Illustration: Rakesh asked his friend Sonu to escort his mother from the railway

station. Sonu asked his brother Monu to get Rakesh’s mother from the station. Sonu

did not have a right to delegate his work to Monu.

Rights of an agent:

The agent has the following rights against the principal:

(1) Right of retainer: According to section 217 of the Indian Contract Act the

agent has the right to retain out of sums received on account of the principal

for the money due to himself/ herself in respect of his /her remuneration or

advances made or expenses properly incurred by him in conducting the

business of agency.

Illustration: Rakesh a publisher hired an agent Paul to sell books. Paul was to take a

commission of five percent on every sale. Paul had a right to deduct his commission

from the total sales he made before handing over the proceeds to Rakesh.

(2) Right to receive remuneration: According to section 219 and 220 the agent

is entitled to receive his/her agreed remuneration and if nothing is agreed, to a

reasonable remuneration, unless he/she agrees to act gratuitously. In the

absence of any special contract the right to claim remuneration arises only

when the agent has done what he/she had undertaken to do. The agent can

claim remuneration once the work has been completed even though the

contract is not executed on account of breach either by the principal or the

third party.

Illustration: Rakesh a publisher hired an agent Paul to sell books. Nothing was

decided about the terms of remuneration to be given to Paul. Paul was able to sell

fifty books and he returned all the proceeds he had made by selling books to Rakesh.

However Paul had a right to claim a reasonable amount of remuneration from

Rakesh.

320

(3) Right of lien: According to section 221 of the Indian Contract Act an agent

has the right to retain goods, papers and other property, whether movable or

immovable, of the principal received by him/her until the amount due to

himself/herself for commission, disbursements and services in respect of the

same has been paid or accounted for to him / her. The lien is a particular lien

but by a special contract the agent may have a general lien151

.

Illustration: Rakesh a publisher hired an agent Paul to sell books. Nothing was

decided about the terms of remuneration to be given to Paul. Paul was able to sell

fifty books and he returned all the proceeds he had made by selling books to Rakesh.

Rakesh did not pay any remuneration / commission to Paul. Paul had a right to retain

the unsold books till his remuneration was paid.

(4) Right to be indemnified: According to section 222 of the Indian Contract Act

an agent has all the right to be indemnified against the consequences of all

lawful acts done by him/her in exercise of the authority conferred upon

him/her. The agent also has a right to be indemnified against the consequences

of acts done in good faith. Though it turns out to be injurious to the rights of

the third persons (section 223).

Illustration: Ramsingh wanted to sell his scooter. He did not have time so he asked

his brother Vishal to sell the scooter. Vishal sold the scooter to Mr. Goswami for

rupees ten thousand. Mr Goswami was not satisfied with the deal and he wanted to

cancel the deal. Vishal did not cancel the deal so Mr Goswami sued Vishal for giving

him a defective scooter. It was the duty of Ramsingh to indemnify his brother’s act.

(5) Right to compensation: According to section 225 the agent has the right to be

compensated for injuries sustained by him/her due to the principal’s neglect or

want of skill.

151

For difference between particular and general lien see lesson 12 on Bailment and

Pledge.

321

Illustration: Sangram used to manufacture crackers. Sumeet had taken agency of

selling crackers for Sangram. The crackers, which Sumeet took to his shop from

Sangram were not properly packed. On the way Sumeet lit a cigarette and one of

cracker caught fire. Sumeet received burn injuries. Hence it was Sangram’s duty to

compensate Sumeet for his injuries.

(6) Right of stoppage of goods in transit: An agent has a right to stop the goods

in transit to the principal if he/she has bought goods either with his/her own

money or by incurring a personal liability for the price and the principal has

become insolvent.

Illustration: Somnath had taken agency to sell readymade garments from Aloknath.

He used to also buy raw material for making readymade garments on behalf of

Somnath. Aloknath had already made a delivery of raw material by truck to Somnath

when he heard that Somnath had turned insolvent. Aloknath stopped the goods in

transit after hearing the insolvency of Somnath.

14.6 RIGHTS AND DUTIES OF PRINCIPAL

Duties of a principal

The duties of a principal towards his/her agent are the rights of the agent

against the principal. The rights of the agent have already been discussed

above.

Rights of a principal

The principal can enforce all the duties of the agent, which are indirectly the

rights of the principal. However if the agent fails in his/her duty towards the

principal, the principal has the following remedies against the agent.

(1) To recover damages: If the principal suffers loss due to disregard by the

agent of the directions by the principal, or by not following the custom of

trade in the absence of directions by the principal, or where the principal

322

suffers due to lack of requisite skill, care, or diligence on the part of the agent,

he/she can recover damages accruing as a result from the agent.

Illustration: Ramsingh asked his brother Rakesh to sell his mobile. Rakesh took the

mobile and put it in his shirt pocket. That day was holi and Rakesh played holi

without removing the mobile from his pocket. The mobile got damaged. Hence Rakesh

was liable to compensate his brother for the damage.

(2) To obtain an account of secret profits and recover them and resist a claim

for remuneration: If the agent makes secret profit out of business of agency,

the principal has a right to recover them from the agent. The principal can also

forfeit his/her right to any commission in respect of the transaction.

Illustration: Joginder had taken agency of selling Nokia mobile phones. He was

selling phones at a price higher than what he had quoted to Nokia. Hence he was

liable to return the secret profits he had made.

(3) To resist agent’s claim for indemnity against liability incurred: If the

principal can prove that the agent has acted as principal himself/herself and

not merely as agent, he/she can resist the agent’s claim for indemnity against

liability incurred by him/her in such a transaction.

Illustration: Rumani sold Tulsi’s car without asking her to Sridevi. The car brakes

were defective hence Sridevi met with an accident while driving the car. Sridevi sued

Rumani for selling her a defective car. As Tulsi had not asked Rumani to act as her

agent therefore she will not indemnify Rumani against the liability.

323

14.7 TERMINATION OF AGENCY

An agency can be terminated or can be brought to an end by any of the following

ways:

1 By act of the parties

2 By operation of law

Agency can be terminated by the act of the parties in the following ways:

(1) By Revocation of Agent’s authority: According to section 203 the principal can

revoke the authority of the agent at any time before the agent has exercised his/her

authority so as to bind the principal, unless the agency is irrevocable (agency cannot

be terminated).

Illustration: Aslam took the agency of selling dolls, which Bonney used to make.

Aslam took twenty dolls but before he could sell any dolls Bonney terminated the

agency.

(2) By Agreement: An agency can be terminated at any time by mutual agreement

between the principal and the agent.

Illustration: Aslam took the agency of selling dolls, which Bonney used to make.

Aslam took twenty dolls and was able to sell only two dolls. Bonney wanted to cancel

the agency. He approached Aslam and after paying his share of remuneration for

selling two dolls both of them mutually agreed to terminate the agency.

(3) By Renunciation by the agent: An agency can be terminated by an express

renunciation by the agent because a person cannot be compelled to continue as agent

against his/her will. According to section 206 the agent must give a reasonable notice

of renunciation to the principal otherwise he/she will be liable to compensate the

principal for any damage resulting thereby. If the agency is for a fixed period and the

agent renounces it without sufficient cause before the expiry of the period, he/she will

have to compensate the principal for the resulting loss, if any.

324

Illustration: Aslam took the agency of selling dolls, which Bonney used to make.

Aslam took twenty dolls and was able to sell only two dolls. After sometime Aslam

wanted to cancel the agency. He approached Bonney and told him that he would not

like to continue with the agency after a month. This was taken as a reasonable notice

and the agency was duly terminated with mutual consent after a month.

Agency can also be terminated by operation of law in the following circumstances:

(1) By the completion of the business of agency: According to section 201 an

agency automatically terminates when the purpose for which agency was created is

fulfilled.

(2) By expiry of time: If the agency is for a fixed term, the expiration of the term puts

an end to the agency, even though the business of the agency may not have been

completed.

(3) Death and insanity of the principal or the agent: According to section 201 an

agency is terminated automatically on the death or insanity of the principal or the

agent. After coming to know about the principal’s death or insanity although the

agency terminates but the agent must take all reasonable steps for the protection of the

interests of the principal.

(4) By insolvency of the principal: According to section 201 of the Indian Contract

Act agency terminates when the principal becomes insolvent. The section is silent on

the point whether agency terminates or not when the Agent becomes insolvent.

(5) By destruction of the subject matter: when the agency is created to deal with a

subject matter and when that subject matter gets destroyed the agency automatically

terminates.

(6) By dissolution of a company: When the principal or the agent is an incorporated

company, the agency automatically terminates after the company gets dissolved.

(7) Principal or the agent becoming an alien enemy: If the principal and agent are

nationals of two different countries and a war breaks out between the two countries

the agency gets terminated. If they still continue the agency then they would be called

alien enemies and their relationship of agency will be called unlawful.

325

Irrevocable Agency:

When the authority given to an agent cannot be revoked its called irrevocable agency.

An agency becomes irrevocable in the following circumstances:

(1) Where the agency is coupled with interest: According to section 202 if the

agent has himself / herself an interest in the subject matter of agency, the agency is

said to be coupled with interest. Such an agency is created with the object of

protecting or securing any interest of the agent. It cannot be applied to a case where

an agent’s interest arises after the creation of agency.

Illustration: Vipin had given loan of rupees ten thousand to Sekunder. Sekunder was

unable to pay the loan so in consideration he appointed Vipin as his agent to collect

rents due from his tenants for adjusting the loan amount. In this case the agent Vipin

has an interest in the subject matter of agency (collection of rent). Hence agency

becomes irrevocable.

(2) Where the revocation of agency would cause a personal loss to the agent:

Where the agent has in pursuing his/her authority contracted a personal liability, the

agency becomes irrevocable and the principal cannot revoke the agent’s authority

unilaterally.

Illustration: Narain asked his brother Sindh to buy a sofa set for his new house. He

promised to pay the money later. Sindh bought the sofa set and paid the money from

his account. Hence Narain cannot revoke the agency.

(3) When the authority has been partly exercised by the agent: According to

section 204 the principal cannot revoke the authority after the agent has partly

exercised his/her authority, so far as regards such acts and obligations as arise from

acts already done in agency.

Illustration: Sukhmani asked Govind her neighbour to prepare five dishes for the

dinner, which was being hosted at her place. Govind purchased all the ingredients

needed for the preparation and started preparing the dishes. Sukhmani cannot revoke

the contract of agency because the authority has already been partly exercised by

Govind.

326

14.8 POINTS TO REMEMBER

Definition of Agency

Difference between Agent and Servant

Characteristics of Agency

Agreement between principal and agent

Intention of the agent to act on behalf of the principal

Whatever the principal can do personally he/she can do it through his/her agent

He who does an act through another does it by himself/ herself

No consideration required for agency

Creation of Agency

Express authority

Implied authority

Agency by ratification

Implied Authority

Agency in Emergency

Agency by Necessity

a. Person entrusted with another’s property

b. Husband and wife

Agency by Estoppel

Agency by Holding out

Elements of Ratification

The principal must be in existence at the time of the contract

The agent must purport to act as agent for a principal who is in contemplation

327

The principal must have the contractual capacity both at the time of the contract and

at the time of ratification

Ratification must be with full knowledge of facts

Ratification must be done within reasonable time of the act that is to be ratified

The act to be ratified must be lawful and not void or illegal or ultra vires in case of a

company

The whole transaction must be ratified

Ratification must not injure the third party

Ratification is tantamount to prior authority

Agent’s Authority

Actual Authority

Ostensible / Apparent Authority

Authority in Emergency

Delegation of work to a Sub-Agent

There is a custom of trade to that effect

The nature of work is such that a sub-agent is necessary

Where the principal is aware of the intension of the agent to appoint a sub-agent and

does not object to it

Where unforeseen emergencies arise rendering appointment of sub-agent necessary

Where the act to be done is purely ministerial not involving confidence or use of

discretion

Where power of the agent to delegate can be inferred from the conduct of both the

principal and the agent

Where the principal permits appointment of a sub-agent

Position of a Sub-agent

When Sub-agent is properly appointed

When Sub-agent is not properly appointed

328

Substituted Agent / Co-agent

Relation between Substituted agent, Sub-agent and the principal

Difference between Sub-agent and Substituted agent

Position of a Principal and an agent in relation to third parties

Named Principal

Unnamed Principal

Undisclosed Principal

Pretended Principal

Personal liability of the Agent

Rights and Duties of an Agent

Duty to follow principal’s directions or customs

Duty to carry out the work with reasonable skill and diligence

Duty to render accounts

Duty to communicate

Duty not to deal on his/her own account

Duty not to make any profit out of his/her agency except his/her remuneration

Duty on termination of agency by principal’s death or insanity

Duty not to delegate authority

Rights of an Agent

Right of retainer

Right to receive remuneration

Right of lien

Right to be indemnified

Right to compensation

329

Right of stoppage of goods in transit

Rights of a principal

To recover damages

To obtain an account of secret profits and recover them and resist a claim for

remuneration

To resist agent’s claim for indemnity against liability incurred

Termination of Agency

By act of the parties

By operation of law

By act of the parties

By revocation of Agent’s authority

By agreement

By renunciation by the agent

By operation of law

By the completion of the business of agency

By expiry of time

By death and insanity of the principal or the agent

By insolvency of the principal

By destruction of the subject matter

By dissolution of a company

By Principal or the agent becoming an alien enemy

Irrevocable Agency

Where the agency is coupled with interest

330

Where the revocation of agency would cause a personal loss to the agent:

When the authority has been partly exercised by the agent

14.9 QUESTIONS

Match the following

1 Agent a Employee

2 Servant b Responsible to the Principal

3 Express authority c Agency in emergency

4 Implied authority d Tantamount to prior authority

5 Agency by Ratification e Authority given in words

Answers: 1b, 2a, 3e, 4c, 5d

Practical Problems

1 Sugna asked her twelve-year old son to go to the market and get two kilos of

rice on her credit. The son goes to the market and buys the rice from the

market. Can the son be called an agent?

Answer: Yes, Sugna is the principal, and her son the agent and the shopkeeper

from whom the rice was purchased is the third party to whom Sugna is liable.

2 Shyamnath asked Julie his daughter to deposit the electricity bill. Julie forgot

about the bill and the date of payment expired. Shyamnath received a letter

from the Jal Board imposing a penalty of rupees one thousand for nonpayment

of bill. Is Shyamnath’s daughter liable to the Jal Board for nonpayment of the

bill?

Answer: No, Shyamnath’s daughter is not liable. The liability to pay the bill

lies with Shyamnath.

3 Joginder a trader of shoes gave hundred shoes to Hanumanthapa to sell.

Joginder agreed to give ten percent commission on every shoe sold by

Hanumanthapa. Hanumanthappa was not able to sell even a single pair of

shoes. He asked Joginder to pay some remuneration for making the effort

to sell shoes.

Answer: No, this is a contract of agency and no consideration is required

in forming a contract of agency.

331

4 Mr Srivastava gave rupees one thousand and asked Kishan to go to the

market and buy a shirt for him. Kishan gave the money to Raghu his

brother and sent him to buy the shirt. Raghu lost the money on the way to

the market. Is Raghu responsible for losing the money to Mr Shrivastava?

Answer: No, Raghu is not responsible to Mr. Shrivastava because Raghu

is a sub-agent appointed by Kishan. It is only Kishan who is answerable

for the loss of money to Mr. Shrivastava.

5 Sapna asked Rajini to look after her business in Bhopal. Soon after Sapna died

in a road accident. ? Does the agreement between Sapna and Rajini terminate?

Answer: Yes, after the death of Sapna the contract of agency terminates.

However it is Rajini’s duty to take all reasonable steps to protect and preserve

the interest of Sapna.

Questions:

1 What is Agency? How is agency created?

2 What is ratification? What are the various elements of ratification?

3 What is the difference between Sub-agent and Substituted agent?

4 What are the rights and duties of an Agent and Principal?

14.9 REFERENCES

! Chadha P.R. & Bagrial A.K. (2005): Business Law, Pragati Publictions, New

Delhi

! Bangia R.K. & Bangia S. (2002): Indian Contract Act, Allahabad Law Agency,

Faridabad

! Singh Avtar (2008): Law of Contract and Specific Relief, Ninth edition, Eastern

Book Company, Lucknow

! Kapoor N.D. (2004): Business Law, Sultan Chand & Sons, Educational

Publishers

! Kuchhal M.C. (2005): Business Law, fourth edition, Vikas Publishing House Pvt.

Ltd.

332

Part II

Sale of Goods Act-1930

Lesson 15- AN INTRODUCTION TO THE SALE

OF GOODS ACT

Lesson 16- CONDITIONS AND WARRANTIES

Lesson 17- TRANSFER OF PROPERTY

Lesson 18- PERFORMANCE OF CONTRACT OF

SALE

Lesson 19- REMEDIES

333

Lesson - 15

AN INTRODUCTION TO THE SALE OF GOODS ACT

by

Reena Marwah

This lesson discusses the following aspects of the Sale

of Goods Act:

15.1 Introduction

15.2 Sale and Contract of Sale

15.3 Difference between ‘Sale’ and ‘Agreement to Sell’.

15.4 Hire Purchase Agreement And Sale: A Comparison

15.5 Types of Goods

15.6 Destruction of Goods

15.7 Price of Goods

15.8 Earnest Money and Advance Payment or Security

Deposit

15.9 Stipulations regarding Time

15.10 Document of the Title

15.1 INTRODUCTION

In 1930, transactions relating to sale and purchase of goods became the purview of a

separate Act called the ‘Indian sale of Goods Act”. This Act came into force with

effect from July 1, 1930. Before 1930, this was a part of the Indian Contract Act. The

sale of goods is a common transaction of all commercial contracts. Earlier the legal

provisions relating to the contract of sale were contained in Sections 76 to 123 of the

Indian Contract Act, 1872. However, as a result of the developments of modern

commerce, certain amendments were required in these provisions. To suit these

developments, in modern trade and commerce, Sections 76 to 123 of the Indian

Contract Act were repealed. And a new Act, known as THE SALE OF GOODS ACT,

334

1930 was enacted for the exclusive contracts dealing with the sale of only movable

goods. This Act does not deal with the sale of immovable property. In September

1963, another change took place, as the word ‘Indian’ was removed. The Sale of

Goods Act containing 36 sections extends to all of India except State of Jammu and

Kashmir.

15.2 SALE AND CONTRACT OF SALE

To explain a contract of sale, the distinction between sale and contract of sale must be

explained.

15.2.1 What is a Sale?

A sale consists of a transaction between two parties, i.e. the buyer and the seller.

In each transaction, the following happens:

• There is a sale of movable goods.

• Between two parties, a buyer and a seller.

For example: A housewife buys a box of juice.

A chemical company buys a truckload of salt.

An office goer buys a car.

The three examples show the sale of goods. The goods sold are a box of juice, a

truckload of salt and a car. The buyer in these illustrations is the housewife, the

chemical company and the office goer. The seller is the person or company or

shopkeeper who sells the goods. All the illustrations show that in a Sale or Purchase,

transfer of ownership of goods takes place.

Thus, the scope of the Act is:

• To deal with sale of goods and not mortgages.

• The Act deals with goods, not with actionable claims and money.

15.2.2 What is a Contract of Sale?

335

According to Section 4(1) of the Sale of Goods Act 1930, “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.”

Thus, a contract of sale is a contract by which the ownership of movable goods is

transferred from the buyer to the seller.

The above definition brings out the following elements of contract of sale. These are:

• It is a contract as specified in Indian contract Act 1872.

• Existence of two parties: A buyer and a seller.

• Goods for exchange between two parties.

• Transfer or agreement to transfer property.

• Price as mutually determined.

These points are discussed below:-

! A contract: A sale or agreement to sell is in accordance with all the essential

elements of a valid contract. Money is the essence of any transaction.

Illustration 1: Sonu wanted to sell hashish to Monu . Is that a valid contract of sale ?

Answer : An agreement to sell drugs is not a part of the Act. Why? Because it is an

unlawful activity.

Illustration 2: Ram agrees with Shyam that he will sell a washing machine to Shyam,

a month later on payment of cash. This is an agreement to sell and both Ram and

Shyam are bound to it. When the washing machine will be transferred to Shyam, it

will become a sale.

Illustration 3: Sita pays Seema an advance amount of Rs.1,00,000 for purchase of a

car. The car will be delivered to Sita a month later. This is an agreement to sell.

In a contract of sale, the following are important:

20 There is an offer and an acceptance.

21 There is a delivery and payment, which can be immediate, in installments or at a

later date.

336

22 The contract may be in writing or by word of mouth or implied.

2. Two parties: A seller and a buyer. Buyer is a person who buys or agrees to

buy goods. Seller is a person who sells agrees to sell goods. The Act does not permit

the buyer and seller to be the same person.

Case Law 1:

State of Gujarat Vs Ramanlal152

: A partnership firm was dissolved and the surplus

assets including some stock were divided among the partners in specie. The Sale tax

officer was interested in taxing this as a sale. The court held that the property

distributed among the partners was their own. They could not sell this property to

themselves. Not being a sale, there could be no levying of sales tax.

Exception to the rule : A part owner may sell to another part owner.

When a person’s goods are sold in execution of a decree, he may himself buy them

back from the trustee. King Vs England 153

(3) Goods: It is important, that there are ‘some goods’ for a valid sale or

agreement to sell’.

Illustration: Akash agreed to sell to Bhasker his wheat crop which is grown in his

(Akash’s) field. They agreed that upon the payment of the price, Bhakser may cut the

crop and take it away. It is a valid contract of sale as the growing crop is included in

the term’goods’, and can be validly sold.

‘Goods’ means every kind of movable property other than actionable claims and

money and includes stock and shares, growing crops, grass and things attached toor

forming part of the land, which are agreed to be severed before sale or under the

contract of sale [Section 2(7)]. It may be noted that the contract relating to actionable

claims, immovable property and services are not covered by this Act.

20 ‘Actionable claims’ is a claim, which can be enforced through law, e.g. a debt

due from one person to another is an actionable claim.

152

[1965] AIR Guj 60 153

[1864] 4 B&S 782.

337

21 They ‘money’ here means the legal tender (i.e. currency of the country). Rare

coins can be treated as goods and sold.

Case Law 2:

Kuresell Vs Timber Operators & Contractors Ltd 154

: Some trees were sold so that

they could be cut out and separated from the land and then taken away by the buyer.

The court held that it was sale of goods.

(4) Transfer or agreement to transfer property. The word ‘general property

means ownership of goods’. Special property menas. Possession of goods for

example: Manu pledges a scooter to Ram for a loan of Rs.20,000. In this case, Manu

has general property or ownership of the scooter, while Ram has special property or

right to the extent of Rs.20,000 in the scooter.

Thus, for the contract of sale, the seller must transfer or agree a transfer the ownership

of the goods to the buyer. A mere transfer of possession of goods is not a sale.

Illustration : Meena keeps some of her jewellery in Kirin’s locker. Kirin cannot

become the owner of the jewellery, as no sale has taken place. In this case, there is no

sale or purchase.

(5) Price or Consideration. In every sale there must be a price, which is the

money consideration for a sale of goods. [Section 2(10). If the consideration is in the

form of ONLY GOODS, it is a barter and not a sale. However, the sale of Goods Act

1930 does recognize a sale where part money and part goods are paid155

.

154

[1927] 1 K.B. 298 155

For a detailed understanding refer to the lesson on consideration, under the Indian

Contract Act.

338

Illustration : Mona agrees to sell a saree to Geeta for Rs.500. Geeta makes a

payment to Mona of Rs.300 and the balance she pays in the form of a lipstick. This is

a valid sale.

The illustration shows that the entire payment for the transaction has been made.

Case Law 3:

Aldridge Vs Johnsons156

: 52 bullocks valued at 6 pounds each were exchanged for

100 quarters of barleys at 2 pounds per quarter and the balance in cash. The court

held that it was a sale of goods.

15.3 Difference between ‘Sale’ and ‘Agreement to Sell’.

As stated earlier, the ‘contract of sale’ includes both a sale and an agreement to sell

Section 4(1) of the Sale of Goods Act.

S.No. Differences Sale Agreement to Sell

1. Type of Contract The contract is

complete

The contract is to be

completed.

2. Transfer of Rights The Buyer becomes

the owner

The buyer gets a ‘jus in

personam’ i.e. (a right against

the person)

3. Transfer of Property Creates jus in rem

(Right against

Property).

He can get the

property anytime.

Buyer only gets jus in

4. Transfer of Risk The risk of danger or

loss passes with

property to the buyer.

Risk of loss or damage has to

be borne by the seller.

5. Rights of seller in

case of breach of

contract by buyer

Seller can sue the

buyer for the price

even if goods are in

possession of seller

Seller can sue the buyer for

damages breach of contract

not for recovery of goods

156

[1857] 7 E and B 885

339

6. Rights of buyer in

case of breach of

contract by seller

Buyer can sue seller

for damages and sue

the third party

Buyer can sue the seller or

damages only

7. Right of Resale Seller cannot resell

the goods even if he

has there possession

Seller can sell to another

buyer, but the first buyer can

sue the seller for damages.

8. Insolvency of Seller

and its effects

Buyer can recover his

goods

Buyer can only claim a

proportional amount

depending on the payment

that he has made for purchase

of the goods.

9. Insolvency of buyer

and its effects

He can get delivery of

the goods through his

legal representative

Seller can refuse to sell the

goods until the entire price

has buyer paid.

15.4 Hire Purchase Agreement And Sale: A Comparison

A Sale is different from a Hire Purchase Agreement. A hire purchase agreement is an

agreement under which the owner delivers his goods on hire basis to a person called

‘hirer’, to be used by him. Also, the hirer has the option to purchase the goods by

paying the agreed amount in instalments. The term ‘hire purchase agreement’ is

defined in Section 2(c) of the Hire Purchase Act, 1972, which reads as under:

“Hire purchase agreement means an agreement under which goods are let on

hire and under which the hirer has an option to purchase them in accordance

with the terms of the agreement, and includes an agreement under which:

o possession of goods is delivered by the owner thereof to a person on

condition that such person pays the agreed amount in periodical

instalments, and

o the property in the goods is to pass to such person on the payment of

the last of such instalments, and

o such person has a right to terminate the agreement at any time before

the property so posses.”

The above shows that in a hire purchase agreement, the owner delivers his goods to a

person (i.e., hirer) for his use, and the hirer agrees to pay the fixed amount by

periodical instalments. It is agreed that after the payment of all the instalments, the

340

ownership of the goods will be transferred to the hirer. The hirer has the following

two options:

! He may purchase the goods after paying all the instalments.

! He may return the goods at any time and stop further payment of the instalments.

The instalments already paid are treated as the hire charges for the use of goods

hired.

Illustration: Amar, a shopkeeper, delivered his new cycle to Krishan. They agreed

that Krishan will pay Rs.50 on the first day on every month for ten consecutive

months. After making all payments regularly for ten months, he (Krishan) will become

the owner of the cycle. It was also agreed that Krishan may return the cycle at any

time and stop the payment of further instalments. This is a hire purchase agreement.

The nature of Hire Purchase Agreement is described below:

15.4.1 Hire Purchase Agreement

The hire purchaser agrees to pay a fixed number of installments, which are treated as

hire charges by the owner of the goods.

When the last payment is made by the hire purchaser, it is only then that he gets the

ownership of the goods. If this hire purchaser is unable to pay any installments even

one, the seller can take back the ownership and possession of the goods.

The hire purchaser can only recover the goods once he makes the entire payment.

Illustration: Ankush takes a computer from M/s Electronics on hire purchase. It is

agreed that Ankush will pay Rs.1,000 for 2 years (24 installments) to M/s Electronics.

At the time of payment of the last instalment of Rs.1,000. Ankush defaults and cannot

pay. M/s Electronics takes back the computer and the money paid by Ankush is

treated as hire charges for the period he used the computer.

15.4.2 Sale through Installments

Here, all the elements of sale are included. The difference is that the total price is not

paid in one lump sum but in installments. In the case of consumer goods like washing

machines, cars, electronic equipment, this mode of sale is gaining popularity as the

buyer does not have to make the entire payment at one time.

341

Illustration: Sheela bought a camera from a shopkeeper. It was agreed that she

would pay for the camera in 10 monthly interest free installments of Rs.1,000 each as

the cost of the camera was Rs.10,000. The ownership of the camera was transferred

to Sheela at the time of the contract.

15.4.3 Similarity between Sale and Hire Purchase Agreement

In both a sale and a hire purchase agreement the purpose is that the property in goods

passes from the seller to the buyer.

Following are the legal provisions relating to hire-purchase agreement, as contained

in the Hire Purchase Act, 1972.

! The hire purchase agreement must be in writing and signed by all the concerned

parties. If any one these two requirements is not fulfilled, the hire-purchase

agreement shall be void. [Section 3(1)].

! The number of instalments and amount of each instalment should be specified and

written in the hire-purchase agreement. [Section 4 (d)].

! The hirer may end the hire-purchase agreement at any time, before the final

payment falls due.

! The owner may also terminate the hire purchase agreement in any of the following

circumstances [Section 18]:

o Where the hirer makes more than one default in the payment of the hirer.

o Where the hirer does any act, with regard to the goods, which is inconsistent with

any of the terms of the agreement.

o Where the hirer does not follow any express condition, which provides that, on

breach thereof, the owner may terminate the agreement.

In the cases (b) and (c) mentioned above, the owner is also required to

give the hirer a notice in writing.

! On the termination by the owner, he may keep the hire charges which have

already been paid to him. However, if any charges are due, the owner may recover

the arrears. He may also apply to court for the recovery of the possession of the

goods. [Section 19, 21 & 22].

15.4.4 Similarity between Hire Purchase Agreement and Sale

The property in goods passes from owner to buyer /hire purchaser at a future date.

This happens in both a sale and a hire purchase.

342

15.4.5 Difference between Sale and Hire Purchase Agreement

S.No. Points of

Difference

Sale Hire Purchase

Agreement

1. Governing Law Sale of Goods Act, 1930 Hire Purchase Act, 1972

2. Type of contract It is contract of sale. It is an agreement to sell.

3. Possession of

goods

Possession of goods need

not be transferred

immediately.

Possession of goods is

transferred immediately.

4. Status of

ownership of

goods

Ownership of goods is

transferred immediately.

Is when ownership of

goods is transferred on the

payment of the last

instalment.

5. Right to end the

contract

The buyer has no right to

end the contract of sale.

The hirer has right to end

the agreement at any time

before the ownership is

transferred.

6. Right to repossess

the goods

The seller has no right to

repossess the goods. He

can sue for the price.

The seller has a right to

repossess the goods if the

hire-purchaser defaults.

7. Transfer of good

title to third party

The buyer can transfer a

good title to third party

because ownership of

goods has been

transferred.

The hirer purchaser cannot

transfer a good title to third

party because ownership of

goods has not been

transferred.

8. Written or

otherwise

A contract of sale need

not necessarily be in

writing.

The Hire Purchase

Agreement should be in

writing.

9. Benefits The benefits of implied

conditions and warranties

are available.

The benefits of implied

conditions and warranties

are not available.

10. Levy of Sales tax In case of sale of taxable In case of hire of even

343

goods, sales tax is levied. taxable goods, sales tax is

not livied.

11. Payment Vs Hire

Charges

The payment made by the

buyer is treated as

payment towards the price

of goods

The payment made by the

hire purchases is treated as

hire charges for the use of

goods till the option to

purchase the goods

exercised.

In Hire Purchase Agreement the person taking the goods can, if he desires bring the

agreement to an end before the ownership of goods is transferred. In the case where

the person taking the goods cannot bring the agreement to an end, the said agreement

would be a contract of sale even if the price is paid in instalments.

Case Law 4:

Helby v. Malthews157

:

A let a piano to B on hire, on the following terms that:

• If B regularly pays 36 monthly instalments, the piano shall become his property

• B can terminate the hire at any time and return the piano to A, and need not pay

any more.

After paying a few instalments, B pledged the piano with C. A brought a legal action

against C to recover the piano. It was held that A could recover piano from C. The

court observed that B had no right to pledge the piano because he was not its owner.

He had the possession only under a hire purchase agreement. In this case, B had the

option to buy the piano by paying all the 36 instalments. However, he was not under

any legal obligation to purchase the piano.

15.4.6 Difference between Sale and Contract for Work and Labor.

Under a contract for work and labor, the main objective of the contract is the service

that is provided, even though it may ultimately result in the delivery of goods.

It is the goods which lave been contracted and not an allied.

157

(1893) AC 471

344

Illustration:

i) Painting of a building. To paint a building it requires special experience and

skill.

ii) Painting of a portrait. This work is considered as a work of art and also

requires extensive creativity.

iii) Flower decoration of a hall. This involves considerable labour and creative

skills.

Service, like the delivery of the goods contracts for skill and labour are not included

in the sale of Goods Act.

Case Law 5:

Day Vs Yates158

: A agreed to print and deliver to B five hundred copies of

manuscript which B entrusted to A for that purpose. It was agreed that A will also use

his own ink and paper. It is a contract for work and skill, and not for the sale of

goods. In this case, though A used his own ink and papers, but the substance of the

contract was the skill and experience of the printer. It is to be noted that the use of ink

and papers by A was only ancillary to the main contract of printing the manuscript.

Case Law 6:

Lee Vs Friffin159

: A lady contracted with a dentist to make for her two sets of false

teeth. The contract was held to be one for sale of goods, although it involved lot of

technical work also. The false teeth required both the use of a special material and

work and skill for proper fitting of the teeth.

15.5 TYPES OF GOODS

The goods are the subject matter of any contract. They can be classified as follows:

20 Existing Goods

158

[1856] 1 H & N 73. 159

[1861] 30 LJ QB 252

345

These may be of three types:

20.7 Specific Goods

20.8 Ascertained Goods

20.9 Unascertained Goods

21 Future Goods

22 Contingent Goods

We now explain each one.

1) Existing Goods: When the goods are in position of the seller at time the

contract is entered into, they are called existing goods. This means that the goods to

be sold are in the control of the seller (Section 6(1) has stated: “ The goods which

form the subject of a contract of sale may be either existing goods, owned or

possessed by the seller, or future goods.”

As stated above existing goods may be specific, Ascertained or Unascertained.

According to Section 2(14) “Specific goods means goods identified and agreed upon

at the time of contract sale is made.”

Illustration: A contract to sell a Nokia cell phone of a particular model is a specific

good. In this case, the sale is for a specific good, as the phone has been identified.

An ascertained good is when a part of the goods that are available in bulk quantity are

specially meant for sale.

346

Illustration: Sheela owns 20 Maruti Cars. Uma enters into a contract with Sheela to

buy one car out of those 20 cars, after the contract one car is kept to be given to Uma

and this car then will be an ascertained good.

Unascertained good, these types of good are not specifically agreed upon at the time

of entering into the contract.

Illustration: 100 leather jackets are lying in the godown, out of this lot of 100 jackets

10 jackets are to be bought by Bhawana, this is a contract for sale of unascertained

goods by the leather jacket manufacturer.

2) Future Goods: Section 2(6) has defined future goods as “Future Goods means

goods to be manufactured or produced or acquired by the seller after the making of

the contract of the sale” Future goods therefore are neither in existence nor in

possession of the seller at the time when the contract of sale is entered into.

Illustration: Rama agrees to sell to Urmilla, the entire crop of sugarcane to be

grown at her farm in Uttar Pradesh for an amount of Rs.2,00,000. Such type of

agreement is not a sale but an agreement to sell future goods.

3) Contingent Goods: Section 6(2) has defined ‘contingent goods’ as the goods

“the acquisition of which by the seller depends upon a contingency which may or may

not happen”. Such goods are therefore dependent upon an event or occurrence which

may or may not happen.

Illustration: Ravi agreed to sell 100 cotton shirts he was importing from China

provided his ship arrived safely at in time. In this example the cotton shirts are

contingent goods as there sale is dependent upon the safe and timely arrival of the

ship.

15.6 DESTRUCTION OF GOODS

347

When goods have perished or have deteriorated to an extent that they can not be put

to the use they were meant for they are considered to be destroyed. The causes

include: a) physical destruction of good, b) damage of good, for example perishing of

vegetable or spoiling of juices etc., c) loss of goods by theft, and d) acquisition of

goods by the government.

15.6.1 Effect of Destruction of Goods before contract of sale is made

In such a situation the contract is void ab-initio, because the contract is impossible to

be performed.

Illustration : Seema sold a container to Savita which was on its way from Thailand to

India, at the time of the contract the ship had already sunk. The contract of sale is

void, even though both Seema and Savita were not aware of it.

In this context, it is important to consider the following:

• The good must be specific good.

• When the subject matter has entirely been destroyed, the contract is void.

However, where the contract is divisible the parties will be bound to honour

that part of the contract, which can be fulfilled.

Case Law 7:

DESTRUCTION OF GOODS

Destruction of

Goods before

contract of Sale

Destruction of

Goods after

agreement of Sale

Destruction of

future goods

348

Barrow Lane & Ballard Ltd. Vs. Phillips & Co.160

: A agreed to sell to B a parcel of

700 bags of groundnut lying at a particular place. It was discovered later that at the

date of the contract, there were only 591 bags in the parcel, 109 bags having been

stolen before the contract was made. The court held that the contract was not

divisible because the buyer wanted to buy a specific quantity, and to ask him to take

less would be compelling him to do what he had not contracted for. The contract is

void.

c) The seller should not have the information of the destruction of the goods.

In such a situation the seller would liable to pay compensation to the buyer, when the

buyer is unaware. However, if the buyer has the information regarding the

destruction of the goods and he still enters into a contract, the seller would not be held

liable for any compensation.

d) The goods must have been destroyed before the contract was entered into.

15.6.2 Effect of Destruction of Goods after agreement of Sale

When an agreement is made for the sale of some specific goods but the goods are

destroyed before the final sale, the contract of sale becomes void and both sides are

not liable. Here, the following points are important:

i. They must be an agreement to sell and not an actual sale

ii. They must not be any fault of either party, i.e. the buyer or the seller

iii. The goods must be specific goods, and

iv. If only the part of goods have been destroyed and contract is indivisible

than the whole contract is void. However, in case the contract is divisible

than the part of the contract which applies to the goods that are in usable

condition can be implemented.

Illustration 1: Chander agreed to sell to Ramesh 100 bags of cement lying in his

godown. In fact, that cement had already been destroyed by leakage of water and has

160

[1929] KB 574

349

been converted into stone. But this fact was not known to the seller (A), In this case,

the contract of sale is valid.

Illustration 2: Arun sold to Manish a speicific cargo of goods which was on its way

from America to Bombay. The ship conveying the goods had been sunk before the day

of the barging. The parties were not aware of this fact. In this case, the contract of

sale is void. It will be interesting to know, that the contract will also be void where

only a part of the goods are perished which make the rest of the goods useless for the

buyer.

Case Law 8:

Appleby Vs. Myers161

: A agreed to erect a machinery on the premises of M, where

the price was agreed to be paid on completion of the work. While the work was in

progress, a fire broke out, and whatever machinery was erected by then, got

destroyed. The court held that the contract was indivisible because price was to be

paid on completion of the work, and hence void. Thus A could not recover the price of

the work already done before the fire.

15.6.3 Effect of Destruction of future goods

When the goods are future goods because they have not been acquired by the seller

then the destruction of such goods will result in the contract becoming void. When

specific goods perished then Section 8 will apply to the contract.

Case Law 9:

Howell Vs Coupland162

: C agreed to sell H 200 tonnes of regent potatoes to be

grown on C’s land. C cultivated sufficient land to grow more than 200 tonnes of

potatoes, but a disease attacked the crop with the result that he got only about 10

tonnes from the land. The court held that the contract could be avoided.

161

[1867] L.R. 2 C.P. 651 162

[1876] 1 QBD 258

350

15.7 PRICE OF GOODS

Section 2(10) of the Act defines price as the money consideration for the sale of

goods. Thus price has to be in terms of money.

The price may be fixed in following ways:

a) The price may be fixed in contract [Section 9], this is the usual way of

fixing the price.

• the way the prices fixed may have been agreed upon in the contract of sale

[Section 9(1)].

• The price may be decided by course of dealings between the parties [Section

9(1)].

• When the price is not fixed by any of above ways. [Section 9 (2)]. When the

price is not being fixed through the agreement of both the parties then a

reasonable price is taken as the price of the contract, depending upon the

prevailing circumstances of the case.

Illustration: Amita Orders Bhawna to Supply 100 pounds to her without discussing

the exchange rate of the pound in terms of the Rupee. Here Bhawna would pay Amita

according to the prevailing market exchange rate for the pound.

• Price to be fixed by third party [Section 10(1)]. When a third party is brought

in to fix the price and such third party is not able to do so, then the situation

will be handled depending on the reasons for which the third party has not

been able to fix the price. The contract can be avoided when the third party is

not willing to fix the price or is unable for any reason to fix the price.

However, where the third party is stopped from valuing the goods due to the

fault of the buyer or the seller then the one who is in fault will be liable to pay

damages to the other party. The party that is not at fault has the right to sue the

other for damages

Illustration: Vikram agrees to sell 50 tonnes of steel to Ramesh at a price to be fixed

by Amar and to be delivered in 4 equal instalments. Ramesh receives a delivery of 20

tonnes of steel. State the legal position (a) if Amar refuses to value the goods and fix

351

the price, (b) if Amar is prevented from fixing the price by the fault of Vikram, (c) if

Amar is prevented for fixing the price by the fault of Ramesh.

Solution:

Case (a): The agreement to sell becomes void. But Ramesh must pay a reasonable

price for 20 tonnes of steel.

Case (b): The agreement to sell becomes void. But Ramesh must pay a reasonable

price for 20 tonnes of steel. However, Ramesh may maintain a suit for damages

against Vikram.

Case (c): The agreement to sell becomes void. But Ramesh must pay a reasonable

price for 20 tonnes of steel. However, Vikram may maintain a suit for damages

against Ramesh.

15.8 EARNEST MONEY AND ADVANCE PAYMENT OR SECURITY

DEPOSIT

Earnest money implies a payment as security. When the total price is to be paid the

earnest money is adjusted against the total price to be paid. When the transaction or

contract is not or can not be undertaken because of the buyers fault the other party can

forfeit the earnest money and keep it. However, a security deposit is different

because it is not part of the total value of the contract. This security amount cannot be

forfeited when the contract is completed as it is not a part of the purchase price.

Illustration : A student deposits Rs.10,000 as a security deposit with an educational

institution for a one year diploma course. After completion of the diploma course, the

student is entitled to receive the security deposit of Rs.10,000.

Case Law 10:

Shree Hanuman Cotton Mills Vs. Tata Air Craft Ltd.163

: A contracted with B to

purchase from his aeroscrap for Rs. 1.00 lac and paid Rs.25,000 as earnest money,

being 25% of the purchase price. One of the conditions of the contract was that if A

163

[1970] AIR SC 1986

352

failed to pay the balance, contract would cancelled and earnest money would be

forfeited. A defaulted in paying the balance and in consequence, B forfeited the

deposit. A filed a suit for recovery of the deposit. The court held that the deposit was

intended as earnest money, and the seller was entitled to forfeit it.

Case Law 11:

Maula Bux Vs. Union of India164

: A contracted to supply potatoes, eggs, and fish,

etc. to Military Headquarters. He deposited Rs.18,500 as a security for due

performance of the contract. A committed defaults in making regular and full

supplies. The government rescinded the contract and forfeited the deposit. The court

held that the amount was a ‘security deposit’ and the government was not entitled to

forfeit the same.

15.9 STIPULATIONS REGARDING TIME

A contract of sale of goods may include a time schedule for two elements of the

contract. a) payment of price and b) the delivery of goods. Although, the element of

time of payment is important, a delay in payment cannot give the seller the right to

terminate the contract. Section 11 lays down the provision in relations to importance

of the time factor in undertaking the contact. In this context, the terms of the contract

would be important. The view adopted by courts is that time is an important element

with respect to the delivery of goods in commercial contract.

15.10 DOCUMENT OF THE TITLE

A right over a document of title symbolizes the rights over goods. Section 2(4) has

defined the documents of title as follows:

164

[1969] SCC 544

353

“Documents of title to goods” includes bill of lading, dock-warrant, warehouse

keeper’s certificate, wharfinger’s certificate, railway receipt, [multi-modal, transport

document,] warrant or order for the delivery of goods and any other document used in

the ordinary course of business as proof of the possession or control of goods or

authorizing or purporting to authorize, either by endorsement or by delivery, the

possessor of the document to transfer or receive goods thereby represented”.

Illustration: Amit agreed to buy a new motor cycle from Sanjay, a dealer, for

Rs.20,000. Amit paid the price and the motor cycle was got registered in his name.

Sanjay delivered the registration book (title of the motor cycle) to Amit. This is a valid

contract of sale as the ownership of the motor cycle has been transferred to the buyer

(Amit).

Note: Sometimes, the ownership is agreed to be transferred at some future date. In

such cases, there is an ‘agreement to sell’. And legally, an ‘agreement to sell’ is

included in the definition of ‘contract of sale’.

Thus the document of title is the proof that the goods are in the possession of the

issuing authority and in titles the document holder to receive the goods mentioned in

the document or further transfer them.

Points to remember

Introduction

• The Sale of Goods Act was passed in 1930

• It extends to the whole of India except the State of Jammu and Kashmir.

The sale of goods implies both a sale and an agreement to sell.

All the elements of the contract Act hold true in a contract of sale.

Other essential elements are :

1. A buyer and a Seller

2. Goods

3. Transfer of property

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4. Price

Differences between Sale and Agreement to sell are based on the following :

! Nature of contract

! Transfer of ownership

! Transfer of risk

! Rghts of seller

! Rights of buyer

! Effect of insolvency of seller

! Effect of insolvency of buyer

A hire purchase agreement and a contract of sale are different in many respects.

Differences relate to possession of goods, the nature and type of contract, the right to

repossess the goods, the method of stating the contract, payment of hire charges and

levy of sales tax.

A contract of work and labor is different from a contract of sale.

In a contract of sale there is delivery of some goods ; however in a contract for work

and labor the rendering of service and exercise of skill is the essence.

Meaning and types of goods

Goods includes every kind of movable property other than actionable claims and

money and includes:

! Stocks and shares

! Grass and items attached to the land including trees and crops etc.

Effect of destruction of goods

! In case of contract of sale, the effect of destruction can result in the

contract becoming void if the contract is impossible to be performed.

! In the case of an agreement to sell, the agreement becomes void if

specific goods are agreed upon, if there is no fault of the buyer or the

seller, and the goods have not passed to the buyer.

There are different ways of determining the price of goods

The price may be fixed by contract

(i) It may be left to be fixed in an agreed manner

(ii) It may be determined during the course of dealings between the two parties.

State which of the following is true or false, giving reasons.

355

• A contract of sale can be absolute or conditional

• A person can buy the goods from himself

• The object of a contract of sale must be the transfer of ownership of oods from

one party to another.

• A contract of sale is different from any other contract.

• A contract of sale has to be in writing.

• In a sale, the transfer of risk of loss of goods passes to the buyer as soon as the

sale is made.

• A sale of goods contract is not an executed contract.

• The higher purchase agreements are governed by the sale of goods act.

• Sales tax is not levied in the case of higher purchase agreement.

• Old rare coins, shares and goodwill are examples of goods.

Answers: 1.T; 2.F; 3.T; 4.F; 5.F; 6.T; 7.F; 8.F; 9.T; 10.T.

Questions

• When does an agreement to sell become a sale? What are the essential

elements of a valid contract of sale?

• Distinguish between a sale and an agreement to sell. Give examples.

• What are the differences between sale and higher purchase agreement?

• ‘A contract for work and labour can never be a sale’. Explain.

• Goods can mean both existing and future goods in a contract of sale. Explain.

• Discuss and explain the effect of destruction of goods in a contract of sale.

• Define the term price. What are the different ways of price fixation?

Practical Problems

• Amita agrees to buy ten leather bags from Bhavna’s shop. Bhavna has many

shops of leather bags and many bags in each shop. Is this a sale or an

agreement to sell?

Answer: This is an agreement to sell because the exact goods have not been

identified or ascertained.

356

• Anil enters into a contract for sale for the entire crop of cotton that would be

produced on his farm. Is this a sale or an agreement to sell?

Answer: This is an agreement to sell because the subject matter of the contract is

future goods.

3. Seema enters into a contract with Shalu for the sale of ten cloth pieces out

of 100 cloth pieces lying in her house. Unknown to Seema all the pieces

get destroyed and she refuses to deliver. Can Shalu recover the goods?

Answer: Yes. According to section 7, Seema must deliver the 10 pieces or pay

damages to Shalu for breach of contract.

4. Arushi agreed to sell a dog to Megha on the condition that Megha will

keep it for 2 weeks and can return the dog if she finds it difficult to

manage it. However, the dog dies on the tenth day, without any fault of the

seller or buyer. What will be the position of the two parties?

Answer: According to section 8, the agreement to sell has become void and Megha

is not liable to pay for the dog.

5. Rajiv gave a piece of cloth to his tailor to stitch a shirt for him. The tailor

got the buttons and the collar material for the shirt. Can this be called a

contract of sale?

Answer: No. This is only a contract of work and labour and not a contract of sale

because the essence of the contract is the skill in stitching.

6. Madhu agreed to sell 10 silver coins for Rs. 4,000/- to Shreya. Can this be

termed as a contract of sale.

Answer: Yes. This is a contract of sale. This is because old rare coins can be the

subject matter of sale.

7. Namita agreed to exchange with Meher 50 kgs of rice valued at Rs. 60 per

kg for 100 kg of wheat. (valued at Rs. 40 per kg and pay the difference in

cash). Can this be termed as a contract of sale.

Answer: Yes, since there is no provision in law to prevent the consideration from

being partly in money and partly in kind or goods.

References :

Books :

Chadha P.R. , Bagrial Ashok K. ,Business Law,pragati Publications, New Delhi, 2005

Tulsian P.C. Business Law Tata McGraw Hill, New Delhi, 2007

Aggarwal Rohini, Studnts Guide to mercantile and Commercial lawas, Taxmann

Allied Services, 2004.

Websites:

! www.helplinelaw.com

! www.consumer-law.lawyers.com

357

Lesson -16

CONDITIONS AND WARRANTIES

by

Reena Marwah

This lesson discusses the following aspects of

Conditions and Warranties as provided in the Sale of

Goods Act:

16.1 Introduction

16.2 Conditions and Warranties

16.3 Types of Conditions and Implied Warranties

16.4 Meaning and Exception to the Doctrine of Caveat

Emptor

16.1 INTRODUCTION

The Sale of Goods Act, identifies the terms, ‘Conditions’ and ‘Warranties’ as being of

prime significance in a contract of sale. Both the terms imply a promise that is made

by the seller. However, the difference between Conditions and Warranties arises due

to the nature of the promise that is made in each case. In the case of ‘Condition’ the

impact is on the very essence of the contract; whereas, in the case of ‘Warranty’, the

promise is in the nature of a collateral to the main purpose of the contract. It is thus

evident that if there is a breach of either a condition or a warranty, the effects will be

different.

Illustration 1: Sita bought a wet grinder from an electric shop. The purpose for

which the grinder was to be used was made known to the seller. The grinder was unfit

for the purpose. In this case there is a breach of an expressed condition by the electric

shop and Sita is entitled to return the grinder and be refunded the money paid.

Illustration 2: Varuna bought a Sofa-cum-bed from a furniture shop. There was an

implied warranty that the piece of furniture could be used both as a sofa and as a bed.

358

However, when it was used as a bed, it broke. In this situation there was an implied

warranty and Varuna can claim compensation for the price paid for the Sofa cum

Bed.

Stipulations, which may be either a condition or a warranty, become a part of the

contract of sale. It should be noted here that a mere recommendation by the seller for

the purchase of certain items to a prospective buyer, does not give any right of action

to the buyer against the seller. This is because a mere expression of opinion by the

seller does not become a part of the contract.

16.2 CONDITIONS AND WARRANTIES

Both Conditions and Warranties are important elements of every contract.

16.2.1 Conditions

The term ‘condition’ may be defined as a representation made by the seller, which is

so important that, its non-fulfilment defeats the very purpose of the buyer. As a matter

of fact, it is a stipulation, which forms the basis of a contract of sale, i.e., which is

essential to the main purpose of the contract.

According to Section 12(2) - A Condition is a stipulation essential to the main

purpose of the contract, the breach of which, gives rise to a right to treat the contract

as repudiated.

This implies that a condition forms the essence of a contract of sale. Any breach will

therefore will result in damages to the buyer and will give him the right to bring an

end to the contract of sale. The goods can be returned and the buyer has the right to

get his money back.

Case Law 1:

Baldry v. Marshall165

: Baldry consulted the car dealer, and told him that he wanted

to purchase a car for the purpose of touring. The Car dealer Mr. Marshall suggested

that a Bugati car would be fit for the purpose. Baldry bought the car as he believed

the car dealer. However the car was found to be unsuitable for touring purposes. The

Court ruled that the suitability of the car for the purpose of touring was a condition

165

(1925) 1 KB 260

359

because that was the very purpose for which Baldry has purchased it. Thus, Baldry

could return the car to the dealer and receive the refund for the same.

16.2.2 Warranties

The term ‘warranty’ may be defined as a representation made by the seller. The non-

fulfillment of a warranty does not defeat the very purpose of the buyer. In fact, it is a

stipulation, which is not essential to the main purpose of the contract of sale, i.e., it is

only subsidiary or collateral to the main purpose.

According to Section 12(3) - 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

the right to reject the goods and to terminate the contract. Therefore, a Warranty does

affect the contract in some way but it is not as important as condition, which results in

bringing the contract to an end. If there is a breach of warranty the buyer cannot end

the contract but he does have the right to claim damages for the loss he suffered

because of the breach

Illustration: Malti goes to a cosmetic shop to buy an eyeliner. The shopkeeper states

that the eyeliner was waterproof and would not get washed off, unless it was removed

with cotton. However, later on when Malti used the eyeliner she found that it was not

waterproof. Here a breach of warranty took place and Malti is entitled to claim

damages only.

16.2.3 Distinction between Conditions and Warranties

Basis of Distinction Conditions Warranties

1. Essential vs. Collateral It is a stipulation, which

is very important for the

purpose of the contract.

It is in the nature of a

collateral only

2. In the case of

Breach/Condition/Warranty

The party can bring the

contract to an end.

The party can only claim

damages.

3. Basic difference A breach of condition can

also be considered as a

breach of warranty

A breach of warranty

cannot be considered as a

breach of condition.

360

Case Law 2:

Wallis Sons and Wells v. Pratt166

: A sold some quantity of seeds to B which were

described as ‘Common English Sanfoin’. One of the terms of the contract was that

“the seller gives no warranty express or implied as to growth, description or any

other matter”. Later on, it was found that the seeds delivered to B were not ‘Common

English Sanfoin’ but ‘Gain Sanfoin’, which was different and of inferior quality. B

accepted the goods believing it to be ‘Common English Sanfoin’. B resold the seeds to

C, who recovered damages from B because of the inferior quality. As B has accepted

the goods, his only remedy was to bring an action for damages against A. As such he

sued A for damages. The seller (A) contended that the condition was reduced to

warranty as the buyer (B) had accepted the goods. And he is not liable because the

liability for warranty is expressly excluded in the contract. The Court rejected the

contention of the seller (A), and the buyer (B) was allowed to recover damages from

him (A). The Court observed that the condition is converted into warranty only for the

purpose of remedy.

Thus, where the condition is changed to warranty, the buyer can recover damages for

the breach of a condition, even if the liability for warranty is expressly excluded in the

contract.

16.2.4 When a Condition can be treated as a Warranty

According to Section 13 – A breach of a Condition can also be considered as a breach

of Warranty in the following cases:

! Where the buyer on his own waives a condition that is an essence of the contract.

In such a situation, the buyer cannot insist on the conditions being a part of the

contract of sale.

! Where the buyer chooses to treat the breach of condition as a breach of warranty

only and thereby only claims damages, but does not end the contract.

166

[1911] AC 294

361

! Where the buyer has already accepted the goods, whole or in part. In such a

situation, the contract cannot be terminated. The buyer can only claim damages,

when he finds that some conditions have remained unfulfilled.

16.3 TYPES OF CONDITIONS AND IMPLIED WARRANTIES

There are certain standards that need to be followed by every seller as part of his

obligations. The law presumes that there are some implied conditions and warranties

in every contract of sale. These pertain to the nature of the good, its quality and

rightful ownership. There are both express conditions and warranties as well as

implied conditions and warranties.

16.3.1 Express Conditions and Warranties

These are always clearly stated in the contract of sale.

Illustration : Sonia buy a Nokia Cellphone , model No.1500. Here the Model No. is

an express condition. If the Nokia Dealer gives a warranty for one year and that is

stated in the sale document then the Warranty for one year is considered as an

Express Warranty.

16.3.2. Implied Conditions and Warranties: Such Conditions and Warranties are

implied by law in every contract of sale of goods. Unless these are specifically

excluded from the terms of the contract, there are several kinds of implied conditions

and implied warranties.

16.3.3 Implied Conditions: These relate to the following :

! Title (Section 14 A),

! Sale by Description (Section 15),

! Sale by Sample (Section 17),

! Sale by Sample and Description (Section 15),

! Condition for fitness and quality [Section 16 (i)],

! Condition to as to merchantability [Section 16(2)],

! Condition as to wholesomeness, and

! Condition implied by custom.

362

(i) Implied Condition as to title (Section 14 A): In the case of a sale, it is implied

that the seller has the right to sell the goods as he is the rightful owner/authorized

agent. In the case of an agreement to sell, the seller has the right to sell the goods at

the time of sale. This term ensures that the buyer can terminate the contract if the

seller does not have the rightful ownership or authority to sell the goods.

Illustration 1: Mona bought a second hand Stereo from Shyam, a dealer. After a few

months the police took the Stereo away as it was a stolen one. Mona has the right to

recover the entire price of the Stereo from Shyam because Shyam did not have the

right to sell the Stereos.

Illustration 2: Vivek buys a stolen watch from Suresh without knowing this fact. By

the time Vivek realizes that the watch he bought was a stolen one, Suresh

compensated the true owner of the watch for the theft and paid him the required

amount to get the legal ownership of the watch. Now, Vivek cannot terminate the

contract on the ground of breach of implied condition.

Case Law 3:

Rowland v. Divall167

: Rowland bought a second hand car from Divall, a car dealer.

After a few months, the police took the car away as it was a stolen one. The Court

observed that it was a breach of condition as to title as Rowland had no right to sell

the car. It was held that Divall could recover full price of the car from Rowland.

Case Law 4:

Niblett v. Confectioners’ Material Co.168

: Niblett, brought 3000 tins of condensed

milk from Confectioners’ Material Co. Out of the entire lot, only 1000 tins were

labeled as ‘Nissly Brand’. Naveen, another manufacturer of the milk under the brand

name of ‘Nestle’, claimed that this was an infringement of his trademark.

Consequently, Niblett had to remove all labels from the tins and was forced to sell

them at a loss. The Court held that the seller had breached the implied condition that

he had a right to sell.

167

[1923] 2 KB 500 168

[1921] 3 KB 387

363

16.3.3.1 Implied Condition in a sale by description: Where there is a contract of

sale of goods by description, there is an implied condition that the goods shall

correspond with the description.

When a descriptive word or phrase is used in a contract of sale to describe the

product, it creates an implied condition that the goods will be like the description. For

example, a sale of ‘seedless pears’ signifies that the fruit will have no seeds. If it turns

out to be a fruit with seeds, the buyer reserves the right to reject the contract.

Case Law 5:

Moore & Co. v. Landaver & Co.169

: A sold to B, 3000 tins of Australian fruits,

which were agreed to be packed in cases each containing 30 tins. A delivered the

substantial portion of the fruits in cases containing 24 tins. It was held that the

method of packing was a part of the description. Therefore, B was entitled to reject all

the goods.

Thus, once it is proved that the sale is by description, than the goods must correspond

with the description. If they do not correspond, the buyer may reject them and the

seller cannot take the defense by saying that they will serve the buyer’s purpose.

Case Law 6:

Andrews Bros. V. Singer & Co.170

: Singer contracted to supply ‘new Singer Cars’

to Andrews. However, one of the cars supplied under the contract was not at all new

and had already run a considerable mileage. The Court observed that it was a breach

of condition on the part of the seller and Andrews could return the car to Singer.

Meaning of the term ‘sale by description’. It is interesting to note that the term ‘sale

by description’ has not been defined in the Sale of Goods Act, 1930. Some common

sense conclusions can however be drawn so as to understand what amounts to a

description in a sale. Such a description may be expressly spoken or written in words.

It can be found in the given documents or technical specifications supplied along with

the product. Goods described by a particular trade name as commonly used to denote

certain characteristics must have those characteristics. For example, the term

Darjeeling Tea implies that the tea must meet the standards of being from Darjeeling.

169

[1982] 2 KB 519 CA 170

[1934] 1 KB 17

364

At times, the description about packing of goods is also considered as a description

essential to be adhered for sale.

16.3.3.2 Implied Condition in sale by sample: Where a sample of the ordered

product is provided to the buyer, and the parties treat the sample as of a standard

quality for the sale, there is a condition that the goods will conform to the sample.

Such sale is termed as a ‘sale by sample’.

In the case of a contract for sale by sample, there is an implied condition:

! that the bulk shall correspond with the sample in quality;

! that the buyer shall have the opportunity of comparing the bulk with the sample;

! that the goods shall be free from any defect, rendering them un merchantable,

which would not be apparent from reasonable examination of the samples.

Case Law 7:

E & S Ruben Ltd. V. Fair Bros.171

: Ruben agreed to buy some rubber material from

Fair Bros. The sample of the rubber was shown to Ruben. On receiving the material,

Ruben found that the measurement of the rubber material was different from that of

the sample. The Court observed that the measurement of the rubber was part of its

quality. It was held that the goods did not correspond to the sample.

Case Law 8:

Lorymer v. Smith172

: Two parcels of wheat were sold by sample. The buyer went to

examine the bulk a week later. One parcel was shown to him but the seller refused to

show the other parcel, which apparently was not there in the warehouse. In this case,

the buyer was not given reasonable opportunity to test the bulk with the sample. The

Court held that the buyer was entitled to reject the contract of sale.

16.3.3.3 Implied Condition in a sale by sample as well as description: When the

sale is by sample as well as by description, it is not sufficient that the bulk of the

goods correspond with the sample if the goods do not also correspond with the

description. Thus the bulk of goods should correspond with both, the sample as well

as description.

171

[1946] 1 KB 254 172]

[1822] 1 B&C 1

365

Case Law 9:

Azemar v. Carella173

: Azemar agreed to sell Carella some cotton, which was

described as ‘Long Staple Cotton’. The sample was also shown to Carella. Azemar

delivered the cotton which was exactly as the quality of the sample. Later, Carella

discovered that it was not ‘Long Staple Cotton’, but only ‘Western Madras Cotton’.

The Court held that the buyer could reject the goods as they did not correspond with

the description given by the seller although they did correspond with the sample.

16.3.3.4 Implied Condition as to Fitness or Quality: Usually, there is no implied

condition that the goods supplied by the seller should be fit for the particular purpose

of the buyer. The rule ‘Caveat emptor’ applies instead. This means that while

purchasing the goods, it is the responsibility of the buyer to check that the goods he is

buying are fit for his purpose. However, in the following situations, the responsibility

as to fitness of goods is on the seller:

! the buyer makes known to the seller the particular purpose for which the goods

are required,

! the buyer relies on the expertise and judgment of the seller, and

! the seller’s business is to deliver and supply such goods whether he is the

manufacturer or producer or not.

It is important that the specific purpose for which the goods can or are to used should

be made known to the seller.

Illustration: Sheela ordered paper for packaging of paintings. The paper was

accordingly supplied. However, the buyer did not find that the paper was strong

enough for packing paintings and wanted to return the paper to the supplier. Can

Sheela return the paper?

Answer : Sheela cannot return the paper because she did not specify that she had

required the paper for packaging of expensive paintings.

Although, the purpose of the use for which the goods are meant should be expressly

stated by the buyer, there can be situations when it is implied that the seller was aware

about the purpose for which the buyer bought the goods.

173

[1867] 2 CP 431

366

Illustration: Suman went to Ajanta Chemist, and asked for a hot water bottle from

him. Ajanta Chemist gave a bottle to her telling that it was meant for hot water, but

not boiling water. After a few days, while using that bottle, Suman got injured as the

bottle burst. It was found that the bottle was not fit to be used as hot water bottle. The

Court observed that the buyer’s purpose was clear when she asked for a hot water

bottle. Thus the implied condition that the product should be fit for the purpose of

buyer was not met in this case.

When a buyer relies upon the skill and judgment of the seller there is an implied

condition that the goods should be fit for that purpose.

Case Law 10:

Dr. Baretto v. T.T. Pruce174

: Mr. Pruce bought a set of false teeth from Dr. Baretto

a dentist. But the set was not fit for Mr. Pruce’s mouth, so he rejected the set of teeth

and claimed the refund of price. It was held that Mr. Pruce was entitled to do so as

the only purpose for which he wanted the set of teeth was not fulfilled.

16.3.3.5 Implied Condition as to Merchantability: Where goods are bought by

description from a seller who deals in goods of that description (whether he is the

manufacturer or producer or not), there is an implied condition that the goods shall be

of merchantable quality.

The condition of merchantability is applicable in the following circumstances:

1. The goods are sold to the buyer by description.

2. The seller actually sells such goods.

Illustration: Raman, the owner of a stationery shop sells a house to Reena. Here, no

condition of Merchantability applies because Raman is not a property dealer. Reena

should be aware that Raman could not be held liable in case the property purchased

by her is not a valid sale.

Case Law 11:

174

[1939] AIR Nag. 19

367

Morelli v. Fitch & Gibbons175

: Morelli bought from a dealer Fitch & Gibbons a

bottle of wine. While opening its cork in the normal manner, the bottle broke off and

injured Mr. Morelli’s hands. Morelli was entitled to claim damages because the bottle

was not of merchantable quality.

It a buyer examines the goods before purchasing them and the defects are evident then

the condition of Merchantability does not apply to the extent of such defects.

However, if some defects are noticed later as they were not evident but latent then the

condition of Merchantability would apply even if the buyer had inspected the goods

properly.

Important:-

1. The implied condition as to merchantable quality applies to goods whether or

not the goods are sold under a patent or trade name.

2. The implied condition as to merchantable quality applies to goods whether or

not the buyer relies on the skill and judgement of the seller.

16.3.3.6 Implied Condition as to wholesomeness: The condition of fitness of

merchantability in case of good products requires that the goods should be

wholesome, i.e., fit for the purpose of consumption. This condition is a part of the

condition as to merchantability. It is applicable in cases of eatables, i.e., foodstuffs

and other goods, which are used for human consumption. As per this condition, goods

sold must be fit for human consumption.

Case Law 12:

Frost v. Aylesbury Dairy Col Ltd.176

: Frost bought milk from Aylesbury a dairy

owner. The milk was contaminated with germs of typhoid fever. Frost’s wife on taking

the milk became infected and died of it. The Dairy owner was held liable and had to

pay damages as he had breached the condition of wholesomeness.

16.3.3.7 Implied Condition implied by Custom [Section 16(3)]: An implied

condition as to quality or fitness for a particular purpose may be attached by the usage

of trade. In commercial exchanges evidence of custom is attached in the case of

incidences in written contracts in matters of which they are silent.

175

[1928] 2 KB 636 176

[1905] 1 KB 608

368

Case Law 13:

Grant v. Australian Knitting Mills177

: Grant bought underwear from the Knitting

Mills. He examined them before the purchase. Later on, it turned out that the

underwear were harmful for his skin because of presence of hidden sulphites in the

underwear. These could not have been revealed by ordinary examination. The Court

held that the implied condition of merchantability is applicable in this case.

16.3.4 Implied Warranties [Section 14(b), 14(c), and 16(3)]: Whenever a product is

sold it is assumed that there are certain Warranties that are given by the seller. It is a

warranty which the law implies into the contract of sale. It can be stated that it is the

stipulation which has not been included in the contract of sale in express words.

However, the law presumes that the parties have included it into their contract. It can

also be noted that an implied warranty is read into every contract of sale unless they

are expressly excluded by the express agreement of the parties. These may also be

excluded by the course of dealings between the parties or by usage of trade [Section

62]. It may be noted that sometimes there is conflict between the express and implied

warranties. In such cases, the express terms shall prevail and the implied terms shall

not be considered.

16.3.4.1 Warranty as to Quiet Possession [Section 14(b)]: There is an implied

warranty that the buyer shall have and enjoy quiet possession of the goods. The

breach of this warranty gives buyer a right to claim damages from the seller.

Case Law 14:

177

AIR 1936 PC 34, 40

369

Mason v. Burmingham178

: Burmingham sold a second hand radio to Mason who

spent Rs.100 on the repairs of this radio. This radio was seized by the police as it was

a stolen one. Mason filed a suit against Burmingham including the cost of repairs. It

was held that Mason was entitled to recover the same.

Case Law 15:

Rowland v. Divall179

: Rowland purchased a motor car from Divall. The car was a

stolen property and Rowland had to restore it to the true owner. Rowland was held

entitled to recover the whole of the price paid despite the fact that he had used the car

for some months.

16.3.4.2 Warranty as to Non-Existence of Encumbrances [Section 14(c)]: There is

an implied warranty that the goods are free from any charge or encumbrance in favour

of any third person if the buyer is not aware of such charge or encumbrance. The

breach of this warranty gives the buyer a right to claim damages from the seller.

Illustration : Ramesh borrowed Rs.5000 from Shankar and hypothecated his radio

with Shankar as a security. Later on Ramesh sold his radio to Subodh who bought the

same in good faith. Here, Subodh can claim damages from Ramesh because his

possession is disturbed since the radio had been kept with Shankar.

16.3.4.3 Warranty as to Quality or Fitness for a Particular Purpose which may

be Annexed by the Usage of Trade [Section 16(3)]: This relates to the quality or

fitness for a particular purpose which may be attached by the usage of trade.

Illustration: Mohan buys 100 shares through a share broker later he requests for

those shares to be registered in his name. However, the shares are received by him

without registration and marked as ‘bad delivery’. Mohan can claim the damages

from the broker, because in accordance with the trade usage it is the responsibility of

178

[1949] 2 KB 545 179

[1923] 2 KB 500

370

the broker to ensure that there is no loss caused as a result of ‘bad deliveries’ of the

shares purchased through him.

16.3.4.4 Warranty to Disclose Dangerous Nature of Goods: In case of goods of

dangerous nature the seller must disclose or warn the buyer of the probable danger. If

the seller fails to do so, the buyer may make him liable for breach of implied

warranty.

Case Law 16:

Clarke v. Army and Navy Cooperative Society Ltd.180

: Clarke purchased a tin of

disinfectant powder which required that it be opened with special care. Clarke’s wife

while opening the tin was injured as the powder flew into her eyes. Held, the seller

was liable for the injury sustained by Clarke’s wife because of breach of warranty.

16.3.5 Change of a Condition into Warranty: If there is breach of a condition by a

seller the buyer can opt to reject and return the goods to the seller. In the case there is

a breach of Warranty by the seller the buyer can claim damages. When a breach of

condition is treated as breach of warranty than the main implication is the availability

of the kind remedies that the buyer can resort to. In the following situations, breach

of condition is treated as a breach of warranty.

a) Option of the buyer: This happens when the buyer instead of putting

an end to the contract, accepts the goods in return for damages from

the seller.

b) When the circumstances are such that the goods sold cannot be

returned. This takes please when the buyer has already accepted the

goods. According to Section 42 of the Act, the buyer is deemed to have

180

[1903] 1 KB 155

371

accepted the goods when he informs the seller of his acceptance, or the

buyer continues to retain them for a long time without any such

indication to the seller.

16.4 Meaning and Exception to the Doctrine of Caveat Emptor:

The doctrine of Caveat Emptor has been important in the context of the buyer,

because the buyer must carefully examine the goods that he purchases.

16.4.1 Meaning of the Doctrine of Caveat Emptor [Section 16]: The term ‘Caveat

Emptor’ means ‘let the buyer beware.’ The doctrine of caveat emptor has been given

in the first paragraph of Section 16 and runs as follows “Subject to the provisions of

this Act and 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”.

This implies that it is not part of the seller’s duty to show the defects of the goods

which he offers for sale, rather it is the duty of the buyer to ensure himself about the

quality as well as the suitability of goods.

The buyer must take care of his own purpose while purchasing the goods, i.e., it is his

duty to purchase the goods of his requirement. As such, the buyer must take care

while purchasing the goods. In case, the buyer makes a wrong choice of the goods, he

cannot blame the seller if the goods turn out to be defective or do not serve his

purpose. The seller is not supposed to know the particular purpose for which the

buyer is purchasing the goods.

Case Law 17:

Ward v. Hobbs181

: Hobbs sold certain pigs to Ward through an auction. The pigs

were sold with “all faults and errors of description”, i.e., no warranty was given by

the seller in respect of any fault of description. Hobbs bought the pigs. The pigs were

ill, and all of them, except one, died. Moreover they infected the other pigs of the

buyer. The Court observed that there was no implied warranty that the pigs were of

good health. It was Hobbs’s duty to check whether the pigs were healthy or otherwise.

Thus Hobbs could not recover damages from Ward.

181

[1878] 4 App. Cas. 13

372

16.4.2 Exceptions to the Doctrine of Caveat Emptor: The doctrine of caveat

emptor is subject to the following exceptions, as given below.

16.4.2.1 Misrepresentation by the Seller: Where the seller makes a

misrepresentation and the buyer relies on that representation.

Illustration : Sita bought a house form Sunder who showed Sita the documents of the

house. He represented himself as the rightful owner when the house did not actually

belong to him. Sita believing the documents made the initial payment for the purchase

of the house.

In this case, there is a misrepresentation by Sunder and Sita has the right to be

refunded the payment that she made to Sunder. She can cancel the Contract.

16.4.2.2 Concealment of Latent Defect: Where the seller deliberately conceals a

defect, which could not be discovered on a reasonable examination.

Illustration : Bhavna bought a bottle of glue from a stationery shop. The shopkeeper

did not disclose the fact that the glue was defective. When Bhavna used the glue, she

discovered that it was defective and could not be used for sticking the stamps. Here

Bhavna can return the bottle of glue to the shopkeeper because the defect was not

visible.

16.4.2.3 Sale by Description [Section 15]: Where the goods are sold by description

and the goods supplied by the seller are not as per the description.

Illustration : Munna bought a Television from a Elctronics dealer. The dealer

informed Munna yhat although the Tv a few years old it was in an excellent condition.

Later, Munna found that the Television set did not work properly. He was entitled to

reject the TV and recover his money. This was a contract of sale by description and th

dealer had described the TV to be in an excellent condition whereas it was not.

16.4.2.4 Sale by Sample [Section 17]: Where the goods are sold by sample and the

goods supplied by the seller are not as per the sample.

Illustration : Anu agreed to sell to Bunty asome oil described as foreign refined

groundnut oil and a sample of the oil was given to Bunty. When the oil was supplied,

Bunty found that the oil was not of the same quality. Bunty rejected the oil supplied by

Anu.

Here bunty can reject the oil as the oil had been sold by Sample.

373

16.4.2.5 Sale by Sample as well as Description [Section 15]: Where the goods are

sold by sample as well as description and the goods supplied are not as per the sample

as well as description.

Illustration : Tina entered into a contract with Shina to supply 50 leather jackets.

Tina showed one sample of the jacket made of Sheep leather. Here the sale was to be

both by sample and by description. However, when the 50 jackets were delivered to

Shina, Shina rejected them because the leather was not of the quality that had been

showed in the sample and the stitching was also improper.

Shina has the right to reject the leather jackets supplied by Tina as the jackets had

been sold by sample as well as description.

16.4.2.6 Implied Conditions as to Quality or Fitness [Section 16(1)]: Where the

seller or a manufacturer is a dealer of the type of goods sold by him and the buyer has

disclosed the purpose for which goods are required and relied upon the seller’s skill or

judgement. Here if it is the routine business of the seller to supply certain goods then

there will be an implied condition that the goods will be fit for the purpose.

Illustration: In the case Priest v. Last, as has been discussed earlier the purpose of

purchasing the hot water bottle was communicated to the seller and so it was held

that the seller was liable. The hot water bottle had been bought for the purpose of

using it with hot water and the purpose had not been served.

16.4.2.7 Merchantable Quality [Section 16(2)]: This means that if the goods are

bought for resale then they must be in a position of being marketed under the

description by which they are sold. It also implies that if the buyer buys the goods for

use than their quality must be such that they can be used for the purpose they were

bought. Where the goods are bought by description from a seller who deals in goods

of that description (Whether he is the manufacturer or producer or not), there is an

implied condition that goods shall be of merchantable quality.

Case Law 18:

Jones v. Bowden182

: A sold certain drugs by auction, to B. In case of sale by auction,

it was a trade usage to declare any ‘sea damage’ in the goods. In this case, the goods

were sold without such declaration. Subsequently, the goods were found to be sea

182

[1813] 4 T, 847

374

damaged. It was held that the sale without such declaration meant that the goods

were free from any sea damage. And thus, B could reject the drugs and claim the

refund of the price.

16.4.3 Relevance of Caveat Emptor: The doctrine of Caveat Emptor was

considered very significant and relevant in historical times, when trade was conducted

on a small scale or the sale was a barter deal and the buyer had every opportunity to

examine the goods before buying. However, in modern times, when the pace of sale

and purchase as well as the methods adopted in trade are highly advanced and when

laws protecting the consumer have been enacted, the doctrine is of less importance. In

addition, consumers are aware of their rights and thus in fact, the rule of caveat

emptor should be replaced by the rule of ‘caveat vendor’ (Let the seller beware).

Points to remember

Introduction

1. A stipulation in a contract of sale of goods may be a Condition or a Warranty.

2. A Condition is a stipulation, which is the essence of the main purpose of the

contract and gives the aggrieved party the right to end the contract.

3. Warranty is a stipulation that is collateral to the main purpose of the contract

and the breach of warranty results in the aggrieved party having a right to

claim damages only.

Express and Implied Conditions and Warranties.

In a contract of sale of goods, Conditions and Warranties expressed or implied.

1. Implied Conditions can be related to:

a. Title, Sale by Description, Sale by Sample, Sale by Description and

Sample, Quality, Fitness, Merchantable Quality, Wholesomeness,

Implied by Custom.

2. Implied Warranties can be with respect to following

a. Quiet Possession, Freedom from Encumbrances, and Disclosure of

dangerous nature of goods.

Caveat Emptor, the Doctrine (Section 16):

! Caveat Emptor means ‘Let the buyer beware’.

! There are several exceptions to the Doctrine of Caveat Emptor. These are in

case of:

o Misrepresentation by the Seller, Concealment of Latent Defect, Sale by

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Description, Sale by Sample, Sale by Sample as well as Description,

Fitness for a Particular Purpose, Merchantable Quality.

QUESTIONS

Short answer type questions.

1. Define a Condition and write a case law to explain.

2. What is a Warranty? Show how it gives rise to claim for damages.

3. When can a Condition can be treated as Warranty?

4. What is meant by Condition as to Merchantable Quality?

5. What are the conditions to be satisfied in the condition of Fitness?

6. Explain the meaning of sale by sample as well as by description.

7. What is condition as to wholesomeness?

8. Which implied warranty results in presuming that when the goods are sold

they are delivered free of any problems?

9. Explain the term quiet possession.

10. Why is it important for the seller to disclose whether the goods are dangerous

at the time of sale?

11. What is the meaning of Caveat Emptor?

12. Give three exceptions to the Doctrine of Caveat Emptor.

Long Answer Questions

1. Define the term ‘warranty’. What are the kinds of implied warranties under the

provisions of the Sale of Goods Act, 1930?

376

2. What do you understand by an implied condition? Sate the Conditions implied

in a contract of sale of goods.

3. When can a condition be treated as warranty under the Sale of Goods Acts,

1930?

4. Explain the doctrine of caveat emptor and explain the exceptions to this

doctrine.

5. When does the doctrine of ‘caveat emptor’ not apply to the sale of goods?

6. Distinguish between ‘condition’ and ‘warranty’ in a contract of sale. What are

implied conditions in a contract of sale?

7. Distinguish between:

a. Condition and Warranty

b. Condition as to fitness of goods for buyer’s purpose and condition

as to wholesomeness.

8. Write short notes on the following:

a. Caveat emptor or Caveat Vendor

b. Condition of fitness

c. Warranty as to quiet possession

Practical Problems

1. A teacher ordered some bakery products from a baker and they were duly

delivered to her. After consuming it her children fell sick. Can she sue the

baker for damages?

Answer: Yes, the goods are not of merchantable quality [Section 16(2)]. Therefore

she can claim damages.

2. Rani knew that she was allergic to ‘paracetamol’ medicine. However, she did

not tell the doctor about it and developed an allergy after the medicine was

prescribed to her by the doctor. Is the doctor liable for breach of implied

condition?

Answer: No. The doctor is not liable for breach of implied condition as Rani

should have told the doctor about her allergy to medicines.

3. Sonia contracts to sell Rama a piece of silk. Rama thinks that it is Chinese

Silk. Sonia is aware that Rama believes so but she knows that it is not

Chinese Silk. Sonia does not correct Rama’s impression. Rama later

discovers that it is not Chinese Silk and wants to repudiate the contract.

Can she do so?

Answer: No, Rama cannot repudiate the contract; the rule of caveat emptor would

apply here.

377

4. Aman sells a cow to Bhawani. When Bhawani goes with the cow he is

arrested by the police in the charge of keeping stolen property as it belongs

to Sunil. Can Bhawani sue Aman and on what basis, what damages can

Bhawani recover?

Answer: Yes, Bhawani can sue Aman and also recover the loss suffered by him,

which is the direct and natural consequence of the breach of implied

condition.

5. Anirudh agreed to sell Vikram some oil described as ‘foreign refined rape

seed oil’ warranted only eaual to sample. The oil supplied though

corresponded with the sample was adulterated with hemp oil. The buyer,

Vikram rejected the same. Is he so entitled?

Answer: Yes, Vikram can reject the oil. Here goods have been sold by the sample

as well as description. Although the goods correspond to sample but they

do not correspond to the description ‘foreign refined rape seed oil’.

6. Anjali purchases a television from Sam on Sam’s plea that though it is old,

it is in an excellent condition. Anjali finds later on that the television set

does not work at all, Can she reject the set and recover her money?

Answer: This is a contract of sale by description. Sam described the T.V. to be in

excellent condition whereas it was not. Thus Anjali can reject the T.V. set

and recover her money.

References:

Books:

! Chadha P.R., Bagrial Ashok K., Business Law, Pragati Publications, New

Delhi, 2005.

! Tulsian P.C. Business Law Tata McGraw Hill, New Delhi, 2007.

Websites:

! www.helplinelaw.com

! www.consumer-law.lawyers.com

********

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Lesson -17

TRANSFER OF PROPERTY

by

Reena Marwah

This lesson discusses the following aspects of the

Transfer of Property that are comprised in the Sale

of Goods Act:

17.1 An Introduction

17.2 Importance of Transfer of Ownership

17.3 Rules regarding Transfer of Property

17.4 Transfer of Title

17.1 AN INTRODUCTION

An essential part of the Sale of Goods Act is the Transfer of Property, which passes

from seller to the buyer. Possession is different from ownership, and these must be

distinguished.

Whereas a person may be the righteous owner of goods, he may not have the goods in

his/her possession. An agent, for example is not the owner of the goods, he is in

possession of, on behalf of the seller. When there is a passing or transfer of property

in the form of goods, the element of risk also passes. The essential aspect is the

‘ownership’ of the goods. This is because several rights and liabilities of the

transacting parties are directly connected with the issue of ownership. Usually, a

contract of Sale takes place over a period of a few hours, a few days or even a few

months. During such time there can be events which result in the entire contract of

sale being affected. The goods may be damaged or destroyed or lost in transit or

confiscated etc. It is in such circumstances that the questions relating to the passing of

property arise. These questions are discussed below:

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17.2 IMPORTANCE OF TRANSFER OF OWNERSHIP

The questions of what is the exact time when the property is stated to have passed

from the seller to the buyer, when the risk in the goods is stated to be passed and who

is capable of transferring property in goods will be answered in this lesson. The

following factors make it necessary to decide the actual time when the property in the

goods pass from the seller to the buyer. These factors are:

A. Risk passes with property

B. Action against third parties

C. Seller’s right for price

D. Effect of insolvency of the seller or the buyer

17.2.1 Risk passes with the property

The usual rule is that in the absence of specialized terms, the risk follows the

property. Till goods are property of the seller, the risk remains with him. When goods

become property of the buyer, he must bear any loss arising from their destruction or

injury.

Section 26 of the Act provides that, “Unless otherwise agreed, the goods remain at the

seller’s risk until the property therein is transferred to the buyer, but when the

property therein is transferred to the buyer, the goods are at the buyer’s risk whether

delivery has been made or not.”

Illustration 1: Amar bids Rs.4000 for a wall clock at a sale by auction. After the bid,

the wall clock is broken by an accident. If the accident happens before the hammer

falls, the loss falls on the seller. If afterwards, it falls on Amar. Here property in the

picture passes to Amar when the sale is complete, i.e., when Amar’s offer is accepted,

the acceptance being communicated by the fall of hammer.

380

Illustration 2: Bhanu offers and Anil accepts Rs.50,000 for 10 sheds of wood standing

on Anil’s premises. The wood to be allowed to remain at Anil’s place till a certain

date and not to be taken away till paid for. Before payment, and while the firewood is

at Anil’s premise, it is accidentally destroyed by fire. Here Bhanu must bear the loss

because the property in the goods has already been passed to him with the acceptance

of Bhanu’s offer by Anil. It does not make any difference that payment and delivery

are both postponed.

Illustration 3: Sunil contracts with Bindu to sell a van for Rs.2,00,000. Bindu is to

collect van from Sunil’s premises within a month, on making full payment for the

same. They also agree that any loss arising to the van till it is in possession of Sunil

will be borne by Sunil. After 5 days of the contract, van gets burnt. Here irrespective

of the fact that the property in the goods has already passed to Bindu, Sunil shall bear

the loss.

Case Law 1:

Demby Hamilton & Co. Ltd. V. Barden183

: S contract to sell 30 tins of apple juice to

B. S accordingly crushed the apples, and put their juice in casks pending delivery. B

was late in taking delivery and some juice went bad. The Court held that B bore the

risk of deterioration, which was due to his delay in taking the delivery.

17.2.2 Action against third parties

It is only after passing of property to the buyer that he can exercise proprietary rights

over the goods. For example, if after the sale, the seller refuses to deliver the goods,

the buyer can bring an action against him for forcing the delivery, and if the seller has

already resold those goods to a third person, he can also recover them from such third

person in certain circumstances. Moreover, if the goods are damaged or destroyed due

to act of a third person, the owner of the goods can take an action against him. Thus

ownership of the goods fixes the rights of a person to have the goods as against the

whole world.

183

[1949] 1 All. E.R. 435

381

17.2.3 Seller’s right for price

The seller becomes entitled to recover the price of the goods from the buyer only after

the property of the goods has been transferred to the buyer.

17.2.4 Effect of insolvency of the seller or the buyer

On insolvency of a person, the Receiver or Official Assignee takes the possession of

the property belonging to the insolvent. Here the decision as to ownership of the

goods is very important. If the seller becomes insolvent, and the property, in the

goods has already been passed to the buyer, buyer becomes insolvent, and the

property in the goods is yet to pass to him, his Official Assignee cannot take over the

possession of the goods.

17.3 RULES REGARDING TRANSFER OF PROPERTY

Sections 18 to 24 of the Sale of Goods Act explain the rules regarding transfer of

ownership in goods. These rules are as follows:

! Goods must be ascertained. Section 18 provides that where there is a

contract for the sale of unascertained goods, no property in goods is

transferred to the buyer unless and until the goods are ascertained (Section

18).

! Intention of the parties. Section 19 provides that where there is a contract for

the sale of specific or ascertained goods, the property in them passes to the

buyer at the time when the parties, intend it to pass. For determining intention

of the parties, regard shall be had to the terms of the contract, conduct of the

parties and the circumstances of the case.

Case Law 2:

Appleby vs. Myers184

: S offered to sell to B a certain machine for Rs.5,000. B refused

to buy it unless certain work was done on it. S asked B to get the work done himself

and deduct the expenses from the cost of the machine. To this B agreed and took the

machine to a repair shop. While being repaired the machine was destroyed without

any fault of the repairman. The property in the machine did not pass to the B from S.

184

[1867] L.R.2 C.P. 65

382

The time when the ownership passes from the seller to the buyer will depend upon the

category goods that are being dealt with. In this context the goods can be classified as

follows:

1. Specific or Ascertained goods.

2. Goods that are not ascertained.

3. Goods sent on approval or on return basis.

In each of these cases the rules will be different. Discussion on specific goods which

mean goods that are identified and agreed upon at the time when a contract of sale is

entered into are the following:

17.3.1 Transfer of ownership in the sale of specific goods

When the contract for sale of specific goods is entered into there are three main

conditions that will apply.

(a) The sale must be of specific goods, i.e. the identified goods at the time of sale.

(b) The goods must be in a state that they can be delivered; and

(c) The contract of sale must be unconditional and not be restricted by any

conditions.

Illustration 1: Hardeep sold his old Scooter to Vivek and agreed to deliver the

Scooter after getting it painted. Here the ownership of the Scooter is not transferred

to Vivek at the time of contract because the subject matter of the contract is not in

deliverable state.

Illustration 2: Sanjay sold his old Tempo to Amit for Rs.10,000 on the condition that

he can take the delivery of the Tempo on making full payment. In this case, the

property in the car will not pass to the buyer until he makes full payment.

17.3.2 Passing of property delayed beyond the date of the contract

(i) When goods are not in a deliverable state

If the goods are not in a deliverable state, and contract is for the sale of specific

goods, the property does not pass until the seller brings them in a deliverable state and

the buyer has notice thereof. Two conditions are to be fulfilled if the goods are not in

383

a deliverable state: (1) the seller has done his act of putting the goods are not in a

deliverable state; and (2) the buyer has knowledge thereof (Section 21).

The seller might be required to do certain acts to put the goods into a deliverable state

like packing, filling in containers etc. No property in goods passes unless such act is

done and buyer knows about it.

Case Law 3:

Rugg Vs. Minett185

: A sold The entire quantity of oil in a cistern to B. As per the

terms of the contract, the oil was to be filled in the casks by A and then the buyer was

to take them away. Some of the casks were filled by A in B’s presence but before they

were removed by B and the remainder could be filled up, the entire quantity of oil was

destroyed in a fire. It was held that the buyer was to bear the loss of oil, which was

filled in casks and the seller was to bear the loss of the remainder.

(ii) When the price of goods is to be ascertained by weighing of measuring. Where

there is a contract for the sale of specific goods in a deliverable state, but the seller is

bound to weigh, measure, test or do some act or thing with reference to goods for the

purpose of ascertaining the price, the property in goods does not pass to the buyer

until that act or thing is done and the buyer has notice thereof (Section 22).

Case Law 4:

Turley vs. Bates186

: T sold to B a heap of fireclay at a certain price per ton. B was to

load the clay on his carts and take it away at his own expense. The clay was to be

weighed at a certain weighing machine, which the carts were to pass on their way

from T’s ground to B’s place. It was held that ownership of clay passed to B on

completion of the bargain and nothing remained to be done by T.

17.3.2.1 Ownership is transferred when the parties intend to pass it.

Section 19 of the Act reads as – “Where there is a contract for the sale of specific or

ascertained goods, the property in them is transferred to the buyer at such time as the

parties to the contract intend it to be transferred”. According to this provision it is

only when the parties so decide that property will actually pass. In this context, the

intention of the parties can be known taking into consideration the following:

! The term of the contract

! The conduct of the parties

! The circumstances

185

[1809] 11 East 210 186

[1863] 2 H. C.174

384

Illustration: Seema sells a television set to Rama. It is decided that the property in

terms of the television set will pass after the payment of the last installment. In this

case the ownership will pass to Rama only after the last installment has been paid by

her and not at the time of signing of contract.

17.3.2.2 When transfer of Ownership takes place at the time of contract.

Section 20 of the Act in this context states the following, “Where there is an

unconditional contract for the sale of specific goods in a deliverable state, the

property in the goods passes to the buyer when the contract is made, and it is

immaterial whether the time of payment of the price or the time of delivery of the

goods, or both, is postponed.”

This implies that at the time of contract of sale the goods will be transferred if the sale

is of specific goods, the contract is unconditional and the goods are in such a state that

the buyer can take delivery of them.

Illustration 1: Amar sold his old car to Biswajit and agreed to deliver the car after

getting it painted. Here the ownership of the car is not transferred to Biswajit at the

time of contract because the subject matter of the contract is not in deliverable state.

Illustration 2: Anthony sold his old car to Bhasker for Rs.10,000 on the condition that

he can take the delivery of the car on making full payment. In this case, the property

in the car will not pass to the buyer until he makes full payment.

Case Law 5:

Provincial Automobile Co. Ltd. v The State187

- A, a car dealer had many cars in his

showroom. Out of these cars, he sold one car to B. But the car sold to B was not

identified and separated from the other cars at the time of contract of sale. Here the

ownership of the car is not transferred at the time of sale, because it is not specified

by that time.

187

[1952] STC 147

385

17.3.2.3 Cases where property in specific goods does not pass at the time of sale.

The general rule that ownership of specific goods transfers at the time of contract is

subject to the above conditions. But in the following cases, the property in the specific

goods does not pass at the time of contract, but at a later time.

(a) Specific goods to be put into a deliverable state [Section 21].

Where there is a contract for the sale of specific goods and the seller is bound to do

something to the goods for the purpose of putting them into a deliverable state, the

property does not pass until things is done and the buyer has notice thereof.

Here the word ‘something’ signifies anything necessary to put the goods in

deliverable state. It may be packing, polishing, or filling them into containers, etc.

The words ‘buyer has notice thereof’ do not cast an obligation on the seller to inform

the buyer. They mean that the buyer have knowledge thereof, i.e., comes to know of it

somehow.

Case Law 6:

Rugg v Mineet188

- The entire contents of a cistern of turpentine oil were sold. It was

agreed that the oil was to be filled into casks by the seller and then the buyer was to

take them away. Some of the casks were filled in the presence of the buyer, but before

the remainder could be filled, a fire broke out and the entire quantity of oil was put

into casks because in all these casks the property had passed to him, and the seller

must bear loss of the remainder.

(b) Goods to be weighed or measured for ascertainment of their price [Section

22].

Where there is a contract for the sale of specific goods in a deliverable state, but the

seller is bound to weigh, measure, test or do some other act or thing with reference to

the goods for the purpose of ascertaining the price, the property does not pass until

such act or thing is done and the buyer has notice thereof.

188

[1809] East Privy Council 210

386

Case Law 7:

Zagury v Furnell189

- In this contract 289 bales of goatskin containing 60 pieces in

each bale were sold. It was the duty of the seller to count them before sale. Before the

counting was completed, they were destroyed by fire. The Court held that the loss fell

on the seller as the property in the goods had not passed to the buyer.

However, when nothing is left to be done on the part of the seller to ascertain the

price, but buyer does not pick up the goods from the seller’s place because he wants

to do some act for his satisfaction, section 22 does not apply. The property in the

goods passes to the buyer as soon as the seller completes his part of the job.

Illustration: Somesh sells to Bhawna a bag containing 10 Kg. Rice. After taking the

bag in her hand, Bhawna feels that the weight of the bag is less than 10 Kg. She

requests Somesh to weigh the rice again. In the meantime, a truck hits Somesh’s shop,

and the rice falls in a nearby drain. Here Bhawna will suffer the loss because the

property in the goods had passed to her when the Somesh had given her the rice bag.

(c) When goods are delivered on approval [Section 24].

When goods are delivered to the buyer on approval of “on sale or return” or other

similar terms, the property therein passes to the buyer –

1. When he signifies his approval or acceptance to the seller or does any other

act adopting the transaction. The buyer may accept the goods and let the seller

know of his decision.

2. If he does not signify his approval or acceptance to the seller but retains the

goods without giving notice of rejection, then, if a time has been fixed for the

return of the good, on the expiration of such time, and, if no time has been

fixed, on the expiration of a reasonable time. This will be known as implied

acceptance.

The essence of the rule is that in the event where the sale is on approval, the

ownership passes to the buyer either by acceptance or failure to return the goods.

189

[1809] Camp 240, 11 Royal Reports 704

387

Illustration: Ameta delivered a bag to Tanu on ‘sale or approval’ basis. Later, Tanu

informed Ameta that she had kept the bag. Here, there is an express approval of the

bag and the ownership is passed to Tanu on her approval.

Case Law 8:

Elphic v Barnes190

- S delivered a horse to B on the terms of ‘sale or return within 8

days’. The horse died on the third day without any fault on the part of B. The Court

held that the S was to bear the loss as the horse was still the property of S.

In the above case, if B informs his acceptance of the horse on the 2nd

day, and the

horse dies on the 3rd

day of the transaction, B will be liable for the loss, because the

property in the horse will transfer to him as soon as he will intimate his acceptance to

the seller.

However, if B does not intimate anything to S, and keeps the horse even after the

expiry of 8 days, the property shall deemed to be passed to him.

The words ‘any other act adopting the transaction’ means an act in the nature of an

exercise of right of ownership of the goods such as a sale to a third person, or

pledging the goods with a pledgee, or using the goods for his own purpose, etc.

Case Law 9:

Kirkham v Attenborough191

- K delivered some jewellery to X on return, X pawned

the jewellery with A, a pawnbroker. The Court held that the X’s action amounts to an

acceptance of the transaction of sale. Thus K could not proceed against A for the

price, he has to recover the price from X only.

17.3.3 Transfer of ownership in the sale of unascertained or future goods.

Section 18 of the Act reads as – “Where there is a contract for the sale of

unascertained goods, no property in the goods is transferred to the buyer unless and

until the goods are ascertained”.

Thus until the goods are ascertained, there are no goods on which the contract can

operate. How then are the goods to be ascertained? The goods can be ascertained in

various ways. These relate to the valid appropriation of the goods and are discussed

below.

190

[1880] 5 C.P.D. 321 191

[1897] 1 Q.B. 201 C.A.

388

17.3.3.1 A valid appropriation of goods is required.

When the contract is for the sale of unascertained goods, the goods can be defined by

the description only, e.g., Fair Bengal Cotton, Calcutta Silk, Java Sugar, etc. Suppose

that the contract is for the sale of 100 bales of Fair Bengal Cotton out of 10000 such

bales lying with the seller. If the seller set aside 100 bales of the cotton in his own

warehouse, it does not amount to ascertainment of goods because he is at liberty to

change his mind and send these bales to some other purchase. What is required for the

transfer of property to the buyer is unconditional appropriation of the bales to the

contract. The seller giving notice to the buyer that the bales are ready for delivery and

the buyer assenting to appropriation by saying that he will take delivery thereof

usually does this.

In the context of appropriation, section 23 of the Act provides that, “Where there is a

contract for the sale of unascertained or future goods by description and goods of that

description in deliverable state are unconditionally appropriated to the contract, either

by the seller with the assent of the buyer or by the buyer. Such assent may be

expressed or implied, and may be given either before or after the appropriation is

made.”

Case Law 10:

Weiner vs Smith192

- A delivered some jewellery to B on sale for case only or return

basis. It was stated in the contract that the jewellery would remain A’s property until

the price was paid. Before the payment of the price, B pledged the jewellery with C. It

was held that at the time of the pledge, the ownership was not transferred to B. Thus,

the pledge was not valid and A could recover the jewellery from C.

192

[1905] 2 K.B. 172

389

17.3.3.2 Essentials of a valid appropriation

An analysis of above provision reveals following essentials of a valid appropriation:

1. The goods should confirm to the description and quality stated in the contract.

Case Law 10:

Vigers Brothers v Sanderson Brothers193

- There was a contract for two parcels of

‘Swan Laths’ of specified length, and it was provided that the property should pass on

shipment, and that if any dispute arose, the buyer was not to reject the goods but the

dispute was to be referred to arbitration. However, the goods supplied by the seller

were not of the contract description. The Court held that no question of passing the

property arose. The buyer could reject the goods in spite of the given clause.

1. The goods must be in a deliverable state.

2. The goods must be unconditionally appropriated. The goods are said to be

unconditionally appropriated when the seller does not reserve the right of

disposal of the goods until certain conditions (like payment of the price) are

fulfilled.

Case Law 11:

Loeschman v Williams194

- A agreed to sell certain goods to B on the condition that

the buyer must pay the price before the delivery of goods. In this case the seller has

reserved the right of disposal of goods until the condition of payment of the prices is

fulfilled.

4. The appropriation must be:

1. by seller with the assent of the buyer, or

2. by buyer with the assent of the seller.

5. The assent may be express or implied.

6. The assent may be given either before or after the appropriation.

193

[1901] 1 K.B. 608 194

[1815] 5 Camp. 181

390

17.3.3.3 Ways of making appropriation

It may be inferred from the above that the property in unascertained goods passes

only when they are ascertained, and the goods are considered to be ascertained when

they are properly appropriated. The goods may be appropriated in any of the

following ways;

1. By separating the contracted goods from the other with the consent of the

buyer.

2. By putting the contracted quantity in suitable receptacles, i.e., by putting the

goods into boxes, gunny bags, in case of liquids, by putting them into bottles,

etc., with the consent of the buyer.

3. By delivering the contracted goods to the carrier or other bailee for the

purpose of transmission to the buyer and without reserving the right of

disposal. [Section 23(2)].

Case Law 12:

Emp. v Kuverji Kavasji195

- A contract to sell B certain quantity of liquor out of a big

cask containing a much larger quantity. The required quantity is not separated or

bottled. The property in the liquor does not pass to the purchaser.

17.4 TRANSFER Of TITLE

17.4.1 No one can transfer better title than he himself possess.

As a general rule, no man can sell goods and give a good title to them unless he is the

owner, or someone having the authority or consent of the owner. If a person other

than the true owner sells the goods, he cannot transfer to the buyer a title better than

that of his. The maxim ‘nemo dat quod non habet’ applies here which means that ‘no

one can transfer a better title than that he himself possess.

195

[1941] 43 Bombay L.R. 95

391

Illustration: Anand sells goods acquired by theft to Bhanu. Chetan, that real owner

of the goods, finds them in Bhanu’s possession. Since Anand was not the real owner

and had no title to the goods, Bhanu would also not acquire any title to the goods.

Hence Bhanu would be liable to return the goods to Chetan, the real owner.

A person, however innocent, who buys goods from one who is not the owner, obtains

no property in them whatever.

Illustration: Amar finds a ring belonging to another and thereafter sells it to Keshav

who purchases it for value and without notice that Amar is not the owner. The true

ownere can recover it from Keshav, for Amar having no title could pass none to the

latter.

The above rules protects the owner’s property so that the owner alone can pass the

title. However, this rule is very harsh against the innocent transferee of the goods in

case of sale by the persons having defective title. Sections 27 to 30 of the Act

enumerate certain exceptions where this rule does not apply.

# Exceptions to the rule

17.4.2.1 Unauthorized sale by a mercantile agent [Section 27]

‘Mercantile agent’ means an agent who has the authority either to sell the goods, or to

consign the goods for the purpose of sale, or to buy the goods or to raise money on the

security of the goods. A mercantile agent can transfer a valid title if the following

conditions are satisfied:

(1) He is in possession of the goods or documents of title of the goods (i.e., proof

of possession), with the consent of the owner,

(2) The sale is made by him while acting in the ordinary course of his business,

and

(3) The buyer acts in good faith believing that he has authority to make the sale.

Such a rule is valid even if the agent has no actual authority to sell.

392

Case Law 13:

Folkes v King196

- F entrusted his car to a mercantile agent for sale at a stated price

and not below that. The agent sold it to S, a bona fide purchase, below the reserve

price and misappropriated the proceeds. S resold the car to K. Subsequently, F sued

K to recover the car back from him. The Court held that S obtained a good title to the

car from the mercantile agent because he was possessing the car with the F’s consent

for the purpose of sale. Thus he conveyed a good title to K, and therefore F was not

entitled to recover the car from K.

17.4.2.2 Transfer of title by Estoppel [Section 27]

Estoppel is the prevention of a claim of law. Thus, when a person makes another

believe that a particular thing or fact is true and afterwards then , he cannot be

allowed to deny the truth of that thing or fact.

Thus, a buyer will get a good title to the goods sold by a non-owner if “…..the owner

of the goods is by his conduct precluded from denying the seller’s authority to

sell….”. Thus where a true owner by his conduct, or act, or omission causes the buyer

to believe that the seller has authority to sell the goods and induces the buyer to buy

them, he cannot afterwards set up the seller’s want of title or authority to sell. The

buyer in such a case gets a better title than that of the seller.

Illustration: Om comes to Suresh’s house where Badal is already sitting. Suresh has a

golden fountain pen belonging to Om in his pocket. Om does not want Badal to know

that pen belongs to him. On enquiry from Badal, he says that pen belongs to Suresh,

and leaves from there. Later on Suresh sells that pen to Badal. Here Badal will get

good title because Om, by his conduct, is stopped from denying Suresh’s authority to

sell.

196

[1923] 1 K.B. 282 (CA)

393

17.4.2.3 Sale by a joint owner [Section 28]

Ordinarily a co-owner can transfer his share only, but a sale by one of the several joint

owners can pass a good title to the buyer, if the following conditions are met:

(a) The co-owner is in sole possession of the goods by permission of his co-

owners.

(b) The purchaser acts in good faith, i.e. with honesty.

(c) The purchaser had no notice at the time of the contract of sale that the seller

had no authority to sell.

Illustration – Anu and Bani were the joint owners of a truck. Anu had the possession

of the truck with the consent of Bani. A sold the truck to Chunu who bought it in good

faith. In this case Chunu will get the title of the truck.

This is because as stated above, the co-owner has the permission to possess the truck

and the purchaser acts in good faith.

17.4.2.4 Sale by a person in possession under a voidable contract [Section 29]

A person possessing the goods under a voidable contract can transfer a valid title if

following conditions are satisfied:

1. The possession must have been obtained under a voidable contract and not

under a void contract.

2. The voidable contract must not have been rescinded (i.e., put to an edn) by the

time of sale.

3. The buyer must have acted in good faith, and without the notice of the seller’s

defective title.

Illustration: Bindu threatens Shekar to kill him if he does not sell his car to Bindu for

Rs.1,000. Se sells his car to Bindu. This is a contract made by coercion, which is

voidable at the option of Shekar. But before the Shekar avoids the contract. Bindu

sells this car to Tarun for Rs.15,000. Tarun is ignorant of the fact that this car is

bought by using coercion by Bindu. Tarun would get a good title to the car.

17.4.2.5 Sale by a seller in possession of goods after sale [Section 30(1)]

At times, the seller continues to be in possession of goods even after sale. In such a

case if he sells these goods again to another person, the second buyer gets a goods

title, provided:

394

1. the seller is in possession of goods as a seller and not as a bailee, and

2. the second buyer acts in good faith and without any notice of the previous

sale.

Illustration 1: Amar sold a radio to Batla for Rs.1,000, where delivery was to be made

after a week. In the meantime, Amar sold the radio to Chaman who acted in good

faith. Chaman has got a good title to the radio set.

Illustration 2: Abhishek sold a radio Bittoo for Rs.1,000 he packed and gave it to

Bittoo. Bittoo requested him to keep it in his shop for two hours since he had to do

some shopping. In the meantime, another buyer came who was ready to buy it for

Rs.1,200. Abhishek sold the radio to him. In this case, the second buyer would not

acquire a better title because Abhishek possessed the radio not as a seller, but as a

bailee of Bittoo’s goods.

17.4.2.6 Sale by a buyer in possession of goods before sale [Section 30(2)]

At times, a buyer obtains possession of goods where the seller still has some rights

over the goods. In such a situation, if the buyer sells these goods to another person

(i.e. second buyer), he can pass a good title to him provided:

the first buyer must have obtained possession of the goods under ‘an

agreement to sell’, and not under ‘an option to buy’ as is done under a hire

purchase agreement, and

the second buyer acts in good faith and without notice of any lien or other

right of the original seller in respect of those goods.

Case Law 15:

Marten v Whale197

- A agrees to buy a car from B if his solicitor approves. In the

meantime he takes possession of the car and sell it to C, where C acts in good faith

and do not know about the pending finalization of the sale of car. The Court held that

C, the bona fide buyer, got a good title in this case.

197

[1917] 2 K.B. 480

395

Illustration: Dinesh gives a sewing machine to Subodh on hire purchase, with the

conditin that the property in the machine would pass to Subodh after paying the price

in five installments. After having paid two installments. Subodh sells it to Preeti, who

acts in good faith. Here Preeti would not get a good title because Subodh has neither

bought nor agreed to buy the machine. He is having the machine under an option to

buy it.

17.4.2.7 Resale by an unpaid seller [Section 54(3)]

Where an unpaid seller who has exercised his right of lien or stoppage in transit

resells the goods, the buyer acquires a good title thereto as against the original buyer,

notwithstanding that no notice of the resale has been given to the original buyer.

Illustration: Medha sells a car to Priya. Priya pays Rs.10,000 in advance. The rest

of the Rs.90,000 is to be paid within two days, and delivery is to be made after

receiving full payment by Medha. For a month Priya does not turn up to pay the

balance money to Medha. Medha resells the car to Tara. Tara would get a good title to

the car.

This is because Priya did not fulfill her duty of making the full payment for the car

and Medha remained unpaid for a month, when she was supposed to receive the

payment in two days.

17.4.2.8 Exceptions provided under other Acts

In addition to above exceptions in the Sale of Goods Act, under the provision ‘Subject

to the provisions of any other law for the time being in force’ (in Section 27), the

following exceptions may be mentioned:

Sale by a finder of goods (Section 169 of the Indian Contract Act). If a finder

cannot trace the owner, or if owner refuses to pay the lawful charges of the

finder, the finder can resell when the thing is perishable or when his lawful

charges for finding the owner amount to two-thirds of value of goods.

Illustration: Amar finds a ring and after making reasonable efforts to discover the

owner, sells it to Govind, who buys without knowledge that Amar was merely a finder.

The true owner may recover the ring from Govind.

396

Pawnee (Section 176 of the Indian Contract Act). The pawnee may under

certain circumstances sell the thing pledged to him on giving the pawnor

reasonable notice of the sale.

Sale by Official receiver or assignee. In case of insolvency of an individual,

his official receiver or any liquidator of a company can confer a good title on

the buyer.

Execution sales. Under order 21 of Civil Procedure Code, officers of Court

can sell goods and convey title to the buyer inspite of the fact that they are not

the owners.

Illustration 1: Delivery by Aanand of goods on sale or return to Balakrishna, upon the

condition that they are to remain the property of Aanand until paid for. Balakrishna

sells them to Chakradhar, without paying Aanand for them. Chakradhar buys in good

faith and without notice of Aanand’s title. Aanand can recover the goods or their

value from Chakradhar.

Illustration 2: Sale of a horse at a public auction. Unknown to the auctioneer and the

buyer, the horse had been stolen. The buyer obtains no title against the true owner.

Points to remember

Introduction

• The term property in goods, means the ownership of goods.

• Possession implies the custody of goods.

• The issue of ownership is important because many rights and liabilities of the

parties are related to the transfer of ownership.

Importance of Transfer of Ownership

It is important to know the exact time when the transfer of ownership of goods takes

place from the seller to the buyer.

5. The risk passes with the ownership.

6. The ownership of goods fixes the rights of the person.

397

7. The seller is entitled to recover the price of goods from buyer, only after the

property has been transferred to buyer.

8. If there is insolvency of either the seller or the buyer, than whether the official

receiver can take over the goods or not depends on whether the ownership has

been transferred or not.

Rules regarding Transfer of Property

! Sections 18 to 24 of the Sale of Goods Act deals with the rules regarding the

transfer of ownership. The rules are applicable depending on whether there is

sale of specific goods or sale of unascertained goods or of sale of goods on

approval.

Transfer of Title

! As a general rule no individual can sell goods and provide a good title

to them, unless that individual is the owner or has the authority or

permission of the owner. This implies that the owner alone can pass

the title.

! Sections 27 to 30 of the Act give the exceptions to the Rule. These

are: Unauthorized sale by an agent, transfer of title by estoppel, sale

by a joint owner, or by a person in possession under a voidable

contract. The exceptions are: when a sale is made by a buyer or seller

in possession of goods, before or after the sale and the case when there

is a resale by a unpaid seller.

QUESTIONS

Short answer type questions.

• Comment and explain:

o A seller of goods cannot transfer a better title of goods than he

possess himself.

o Delivery amounts to acceptance by the buyer.

o The seller of goods is not under compulsion to disclose defects of

the goods that he is selling.

o Sale on approval is different from sale of specific goods.

• Distinguish between:

o Ascertained and Unascertained goods.

o Specific and Unascertained.

o Part delivery and installment delivery.

398

• Explain the term: Risk Prima facie passes with ownership.

• Explain the exceptions to the above given rule.

Long Answer Questions

• Explain the importance of the determination of the time of transfer of

ownership of property.

• What are the conditions and when does the property pass from the seller to the

buyer?

• What are the circumstances which the property passess after the signing of the

contract?

• Explain the exception to the rule that no one can transfer a title better than he

himself possesses.

• Explain in details with the help of an example transfer of title by estoppel.

Practical Problems

• Seema sends a saree parcel by courier to Rama. The parcel is lost in transit.

Can Rama recover the price?

Answer: Rama can recover the price of the saree as the delivery to the courier

company is delivery to the buyer.

• Mr. Chary from Hyderabad places an order with Mr. Singh of Delhi for the

supply of books. The train sends the carton of books and its arrival in

Hyderabad is informed to Mr. Chary. However, before Mr. Chary could

take the delivery of the books, they are destroyed. Can Mr. Singh recover

the money?

Answer: Mr. Singh can recover the money for the books, as the same have been

dispatched and the property had transferred to Mr. Chary.

3. Ravi agreed to sell 100 bags of rice to Ram, out of the 300 bags that were

with him. However, the entire stock of 300 bags was destroyed in the fire.

Ravi had separated 100 bags for Ram and kept them ready for delivery.

Who will bear the loss?

Answer: In this case, Ram will bear the loss as the goods had been ascertained.

4. Sheela sells Seema’s cycle in her presence. Seema does not object at that

time. Can she object later?

399

Answer: Seema cannot object later and sale is valid (title by estoppel).

5. Shyam takes a vacuum cleaner from a shopkeeper and promises to return it

after 3 days or pay for it. However, he fails to return it after 3 days. Can

the Shopkeer recover the price of the vacuum cleaner?

Answer: Yes, Shopkeeperr can recover the price from Shyam as the vacuum cleaner

had not been returned in 3 days time to the shopkeeper.

*******

References:

Books:

! Chadha P.R., Bagrial Ashok K., Business Law, Pragati Publications, New

Delhi, 2005.

! Tulsian P.C. Business Law Tata McGraw Hill, New Delhi, 2007.

Websites:

! www.dolr.nic.in

! www.commonlii.org

! www.indiavisitinformation.com

! www.netlasman.co.in

********

400

Lesson -18

PERFORMANCE OF CONTRACT OF SALE

by

Reena Marwah

This lesson discusses the following aspects of the Sale

of Goods Act:

18.1 Introduction

18.2 Seller's duty to deliver the Goods

18.3 Modes of effective delivery of Goods

18.4 Rules regarding effective delivery of Goods

18.5 Buyer's duty to accept the Goods and pay the Price

18.6 Buyer's right of examination

18.7 Liability of the buyer for refusing to take delivery

of the goods

18.8 Contract involving Sea transit

18.9 C.I.F. Contracts

18.10 F.O.B. Contracts

18.11 Ex-Ship Contracts

18.12 Comparison between C.I.F., F.O.B. and Ex-Ship

Contracts

18.1 INTRODUCTION

The term 'performance of the contract of sale' may be defined as the performance of

the respective duties of the seller and the buyer as per the terms of the contract. Thus,

the performance of the contract of sale comprises two parts, namely:

Seller's duty to deliver the goods.

Buyer's duty to accept the goods and pay the price.

401

It is important to note that the delivery of the goods and the payment of their price are

concurrent conditions, i.e., both these conditions should be performed at the same

time. This provision is included in Section 32 of the Sale of Goods Act, which

provides that the seller should be ready and willing to deliver the goods to the buyer,

in exchange for the actual possession of the goods. However, the parties may also

agree otherwise, i.e., they may enter into an agreement as to when the goods are to be

delivered, and as to when the price is to be paid.

Illustration: Amita agreed to deliver certain goods to Bunty. The price was to be paid

by Bunty on the delivery of the goods. In this case, Amita need not deliver the goods,

unless Bunty is ready and willing to pay the price of the goods on delivery. In fact

Bunty need not pay for goods, unless Amita is ready and willing to deliver them on the

payment of the price. This is because each of the parties in the transaction must be

willing to perfor their respective part of the sale .

Thus, each party should be ready and willing to perform his or her part of the promise

before one can call upon the other to act on his or her promise.

18.2 SELLER'S DUTY TO DELIVER THE GOODS

The seller should be willing to deliver the goods to the buyer as per the terms of the

contract. The term 'delivery of goods' may be defined as the voluntary and lawful

transfer of the possession of goods from one person to another. In the case of sale of

goods, the delivery should be voluntary and it should have the effect of putting the

goods in the possession of the buyer. Thus, where a person steals the goods of another

or takes the goods by force or misrepresentation or any unlawful manner, there is no

delivery of goods to such person.

402

18.3 MODES OF EFFECTIVE DELIVERY OF GOODS

The delivery of the goods may be made by doing anything, which results in putting

the goods in the possession of the buyer or his authorized agent. It may be noted that

the parties (i.e., the seller and the buyer) may agree to treat any act as amounting to

delivery. The different modes of effective delivery may be discussed under the

following heads:

Actual Delivery: The term 'actual delivery' may be defined as the delivery

where the goods are handed over by the seller to the buyer or his authorized

agent. Thus, when the goods are physically put in possession of the buyer,

the delivery is said to be actual.

Illustration: Harnam sold to Billoo 20 tins of oil and delivered the same to him. In

this case, there is actual delivery of oil from Harnam to Billoo.

2. Symbolic delivery: The term 'symbolic delivery' may be defined as the

delivery by doing some act, which has the effect of putting the goods in possession of

the buyer. In other words, when the goods are not physically delivered to the buyer

but are delivered by merely indicating or giving a signal, the delivery is said to be

symbolic, e.g., the delivery of the keys of the godown in which the goods are kept, the

transfer of documents of title to the goods (e.g., railway receipts, bill of lading,

delivery orders, title deeds, etc.) are the Illustrations of symbolic delivery. Such type

403

of delivery is made when the goods are bulky or when it is not possible to actually

deliver them.

Illustration: Anu sold to Bhaskar all the table fans lying in his godown. Anu also

handed over the keys of his godown to Bhaskar so that he could get the fans from the

godown. In this case, there is a symbolic delivery of table fans from Anu to Bhaskar.

3. Constructive delivery: The term 'constructive delivery' may be defined as the

delivery when a third person, in possession of the goods, acknowledges to hold the

goods on behalf of the buyers. Sometimes, at the time of sale, the goods are in

possession of a third person (i.e., a bailee, such as godown keeper, delivery agent etc.)

who informs the buyer that he holds the goods on buyer's behalf. In such cases, the

delivery of goods is said to be a constructive delivery, e.g., where a warehouseman or

a carrier, who holds the goods as bailee for the seller, agrees and accepts holding the

goods as a bailee for the buyer. It is also called a delivery by the attornment.

Illustration: Anshu sold to Bablo 50 bags of rice, which were in possession of Chunu,

a warehouse incharge. Anshu ordered Chunu to transfer the rice to Bablo.

Accordingly, Chunu transferred the rice, in his books, in Bablo's name. In this case,

there is constructive delivery of goods from Anshu to Bablo.

18.4 RULES REGARDING EFFECTIVE DELIVERY OF GOODS

The rules regarding the delivery of goods are provided in Sections 33 to 38 of the Sale

of Goods Act, which are given as under:

1. Possession of goods: The delivery of the goods may be made in any of the modes

discussed above. However, whichever method is used, it must have the effect of

putting the goods in the possession of the buyer or his authorized agent. [Section 33].

Thus, the delivery of goods should be such which enables the buyer to exercise his

control over the goods.

Illustration: Dravid sold 100 bags of wheat to Esh and delivered the same to

railways for handing over to the buyer (Esh). Dravid also took the railway receipt in

Esh's name and sent the same to him to enable him to take the delivery of the wheat

on its arrival at the destination. In this case, there is an effective delivery of wheat to

Esh.

404

2. Demand for delivery of goods: As stated earlier, it is seller's duty to be ready and

willing to deliver the goods to the buyer. However, the seller is not bound to deliver

the goods unless the buyer makes a demand for the delivery of the goods [Section 35].

It is thus important that the buyer must make a demand to the seller for the delivery of

the goods to him. It is only then the seller becomes liable to deliver the goods to the

buyer. If the buyer does not make a demand for the delivery, he has no reason to act

against the seller, i.e., the seller cannot be held liable for delay in the delivery of

goods. Sometimes as per the contract, the goods, to be delivered, are to be obtained

later by the seller. In such cases also, it is the buyer's duty to make a demand for the

delivery of the goods. However, the seller should intimate to the buyer that he has

obtained the goods. The buyer's responsibility arises on receiving the information

about the goods from the seller. It may be noted that the buyer should make a demand

for the delivery of the goods at a reasonable hour [Section 36 (4)] (i.e., during the

working hours for conducting a particular business). The parties may, however, agree

otherwise, i.e., it may be agreed that the seller shall deliver the goods without any

demand by the buyer.

3. Place of delivery of goods: The place for the delivery of goods may be clearly

stated in the contract itself. If the place is so specified, the goods must be delivered at

such place during the business hours and on a working day. In case no place is

specified in the contract, then the following rules, contained in Section 36(1), shall

apply:

(a) If there is a sale, the goods sold are to be delivered at the place where

they are, at the time of sale;

(b) If there is only an agreement to sell, the goods are to be delivered at

the place where they are, at the time of agreement to sell;

(c) If at the time of agreement to sell, the goods are not in existence they

are to be delivered at a place where they are manufactured or produced.

4. Time for delivery of goods: The time for the delivery of goods may also be

written in the contract itself. When the time is so specified, the delivery is to be made

by the seller within the specified time. Where no time is mentioned in the contract

then the delivery of goods must be made within a reasonable time [Section 36(2)].

The term 'reasonable time' can be different for different cases depending upon the

specific facts and circumstances of each particular case.

405

Case Law 1:

Philips Vs Blair & Martin198

: A sold to B some quantity of spirit made from

molasses. One-third of the quantity sold was delivered to B. And B pressed for the

delivery of the remainder spirit also. However, the seller delayed it and in the

meantime, an Act of Parliament was passed which prohibited the distillation of spirit

from molasses and cancelled all the contracts for the sale of such spirit. It was held

the seller was liable to pay damages to the buyer as he had failed to deliver the goods

sold within a reasonable time.

Sometimes, the contract of sale uses words such as 'directly', without loss of time', or

'forthwith'. In such cases, quick and immediate delivery is expected.

It may, however, be noted that where the buyer accepts the delivery after the passing

of reasonable time, without any problem, or without reserving the right to sue, then he

would be deemed to have waived his right to claim compensation. [Hind Techno

Machines (P) Ltd., Vs Jaipur Wire Industries (P) Ltd. (1988) 2 Raj LR 56].

5. Time for the demand of actual delivery: The buyer must demand the delivery

of goods at a reasonable hour. It is the responsibility of the seller to deliver them at a

reasonable hour. Thus, the demand or tender of delivery must be made at a reasonable

hour. The term 'reasonable hour' is a question of fact [Section 36(4)]. It is different

for different cases depending upon the working hours of a particular business.

6. Goods in the possession of a third party: Sometimes, at the time of sale, the

goods are in the possession of a third party. In such cases, the effective delivery takes

place when such person acknowledges to the buyer, that he holds the goods on his

(buyer's) behalf [Section 36(3)]. It may be noted that effective delivery to take place,

the third person must inform the buyer that he holds the goods on his behalf.

Illustration: Akash sold certain goods to Bharat, which was lying in Chunnu's

warehouse. In this case, the delivery of goods will take place as soon as Chunnu

informs the buyer (Bharat) that he holds the goods on his behalf.

198

[1801] 4 Paton, Scotch AC 256

406

However, where the goods are sold by the transfer of documents of title, e.g., railway

documents, bill of lading, etc., then the acknowledgement of the third party having the

possession of the goods (e.g., carrier, etc.) is not required. In such cases, the effective

delivery of goods takes place on the transfer of documents of title.

7. Expenses of delivery of goods: The expenses of putting the goods into a

deliverable state are borne by the seller. Also, expenses of receiving the goods are

borne by the buyer. However, the seller and the buyer may also agree otherwise,

depending on the circumstances. [Section 36(5)].

8. Part delivery of goods: Sometimes, during the process of delivering the whole

lot of goods, the seller makes only a part of the delivery. This is usually done when a

huge quantity of goods is to be delivered. In such cases, the following rules, as

contained in Section 34, shall apply:

Where the part delivery is made in progress of the whole delivery, then it is

treated as a delivery of the whole. Here, the ownership of the whole quantity is

transferred to the buyer.

Where the part delivery is made under the contract, to keep it separate from

the whole, then it is not treated as a delivery of the whole. In this case, then

the ownership of the whole quantity is not transferred to the buyer.

Case Law 2:

Hammond Vs Anderson199

: A sold certain goods to B, which were lying in his (A's)

warehouse. A ordered his warehouse-keeper to deliver those goods to B. B weighed

all the goods and took away a part of them. It was held that this amounted to a

delivery of the whole of the goods. In this case, A's act of ordering his warehouseman

to deliver the goods to the buyer, and buyer's act of weighing all the goods shows that

the delivery of the whole of the goods was contemplated by the parties.

199

. [1803] 1 B & P.N.R. 69, R.R. 763

407

Case Law 3:

Bunney Vs Poyntz200

: A sold a stack of hay, grown on his land, to B. B asked for A’s

permission to cut and remove a part of the stack which was granted by A. Afterwards.

B cut that part of the stack and took away the same. It was held that this did not

amount to the delivery of the whole stack of the hay as the intention of the parties was

to separate the part from the residue.

Illustration: A sold 100 quintals of wheat to B, lying in his (A's) godown.

Afterwards, B sold 50 quintals of wheat to C, and requested A to deliver these 50

quintals of wheat to C. Accordingly; A delivered the 50 quintals of wheat to C. In this

case, the part delivery of the wheat cannot be treated as the delivery of whole wheat

sold. The intention of separating the wheat is clear from B's act of selling and

delivering 50 quintals of wheat to C.

Thus, the effects of part delivery of the goods are important for knowing whether the

ownership of the whole goods or only a part of it is transferred to the buyer. It is also

important for the purpose of knowing whether the seller can exercise his rights of

'lien' and of 'stoppage in transit' on the whole goods or only on part of it.

9. Delivery of wrong quantity: The term 'wrong delivery' may include short

supply or excess supply or delivery of goods than the agreed quantity. It also includes

the delivery of agreed quality goods mixed with a lesser quality. The rules dealing

with the effect of delivery of wrong quantity may be discussed under the following

heads:

(a) Short delivery: Sometimes, the seller delivers a less quantity of goods than he

contracted to sell. In such cases, the buyer may reject the goods. Sometimes, the

buyer may also accept the short quantity. In such a case, i.e. if the buyer accepts it, he

shall have to pay at the contract price for the goods actually delivered to him [Section

37(1)]. However, in such a case, the buyer may claim damages for short delivery of

the goods.

Illustration: Bhawna agreed to sell and deliver to Bittoo, 100 bags of wheat at the

rate of Rs.400 per bag. But Bhawna delivered only 80 bags to Bittoo, who accepted

200

[1833] 4 B. & Ad. 568; R.R. 309.

408

these 80 bags of wheat. In this case, Bittoo shall have to pay for 80 bags of wheat at

the rate of Rs.400 per bag. However, he may claim the damages from Bhawana for

the remaining 20 bags of wheat.

(b) Excess delivery: Sometimes, the seller delivers a larger (i.e., excess)

quantity of goods than he was to sell. In such cases, the buyer may accept the

contracted quantity of goods, or accept or reject the whole quantity. Thus, the buyer

may exercise any of the following options (Section 37 (2)]:

(i) He may accept the contract quantity and reject the excess.

(ii) He may accept the whole of the goods and then he shall have to pay for

all the goods at the contract rate.

(iii) He may reject the entire quantity of goods.

Illustration 1: Kirin agreed to sell and deliver to Mayank 500 cycles at the rate of

Rs.450 per piece. However, Kirin delivered 520 cycles to Mayank, who accepted 500

cycles and rejected the 20, which were delivered in excess of the required quantity. In

this case, Mayank is justified in doing so. Kirin cannot compel him to accept the 20

cycles also. This is because Mayank is not bound to accept more than what he had

ordere and this is a case of excess delivery.

Illustration 2: Ravi agreed to sell 100 H.M.T. watches to Rajesh at the rate of Rs.500

per piece. Ravi delivered 110 watches to Rajesh, who accepted all the watches. In this

case, Rajesh is liable to pay for all the 110 watches at the rate of Rs.500 per piece.If

the buyer accepts the excess quantity that has been delivered to him, then he shall be

liable to pay for the excess quantity that he has kept.

It may be noted that in case of excess delivery, the buyer is free to exercise any of the

above options. He cannot be compelled to accept the contract quantity and reject the

excess. However, if the excess is so small as to be negligible, the buyer may not reject

the goods. This is based on the maximum 'de minimis non curatlex', i.e., the law does

not take account of trifles. On the same principle, the buyer may also not be allowed

to reject the goods in case of negligible deficiency.

409

Case Law 4:

Shipton Anderson & Co. Vs. Weil Bros. & Co. Ltd.201

: A contracted to supply

4950 tons of wheat to B. But A delivered 4950 tons and 55 lb. However, the seller (A)

made no attempt to charge the buyer (B) with excess quantity. B rejected whole

quantity of wheat. A filed a suit against B for the same. It was held that the buyer (B)

was not entitled to reject the whole quantity of wheat. In this case, the excess delivery

of 55 lb. was so trivial as to be wholly insignificant.

On the same principle, the buyer could not refuse to take delivery of the goods, where

out of the agreed quantity of 16,000 kg. of rice, there was a shortage of 522 kg. only.

It was held to be a slight deficiency, which fell within the 'de minimis non curatlex'

rule. [Suresh K. Rajendra K. Vs. K. Assan Koya & Sons AIR 1990 AP 20].

In the case of short delivery or excess delivery of goods, the buyer may reject the

whole quantity of goods. It may, however, be noted that if the buyer does so, the

contract is not treated as cancelled. The seller still has the right to tender again the

contract quantity of goods, and the buyer is bound to accept the same. [Vilas Udyog

Ltd. Vs. Prag Vanaspati Products, AIR 1975 Gujrat 112].

Illustration: Rajeev agreed to sell and delivery to Rathi 100 tins of coconut oil at

the rate of Rs.500 per tin. However, Rajeev delivered 125 tins. Rathi rejected the

entire quantity of coconut oil. Immediately thereafter, Rajeev delivered the 100 tins of

coconut oil of the contract quality. Rathi again rejected the same on the ground that

he had already cancelled the contract by rejecting the tins. In this case, Rathi is not

justified in rejecting the tins, at the second time as the contract was not cancelled by

Rathi’s earlier rejection of the tins on the ground of excess quantity.

(c) Mixed delivery: Sometimes, the seller delivers the goods mixed with the goods

of a different description. In such cases, the buyer may accept the contracted goods or

reject the whole quantity of goods. Thus, the buyer may exercise any of the following

options [Section 37 (3)].

(i) He may accept the goods, which are in accordance with the contract

and reject the rest.

201

[1912] 106 LT 372.

410

(ii) He may reject the whole.

Illustration: Rita agreed to sell and deliver to Rajni 100 tins of 'Dalda' ghee at the

rate of Rs.350 per tin. Rita delivered 80 tins of 'Dalda' ghee and 20 tins of 'Rath'

ghee. In this case, Rajni may accept 80 tins of 'Dalda' ghee and reject 20 tins of 'Rath'

ghee. If ' Rajni ' does so then she will have to pay for 80 tins of 'Dalda' ghee at the

rate of Rs.350 per tin. Or she may reject the whole quantity of ghee. This is

regarding the rule of wrong delivery of goods. Rita had agreed to deliver Dalda ghee

and not any other brand of ghee to Rajni.

The above rules, regarding the delivery of wrong quantity of goods, are subject to any

usage of trade, special agreement, or course or course of dealing between the parties

[Section 37 (4)]. Thus, where such usage or special agreement, etc. provides that the

goods shall be accepted or rejected in whole, then the above rules shall not apply.

10. Delivery of goods by installments: As a matter of fact, the delivery of goods by

installments is not considered as a goods delivery. And the buyer is not bound to

accept the goods delivered to him by installments, unless other wise agreed [Section

38(1)].

Illustration: Ranju bought from Girish 100 tons of coal to be delivered in January.

However, Girish delivered 50 tons of coal in January and agreed to deliver the

remaining 50 tons in February. In this case, as the contract did not provide the

delivery by installments, Ranju is not bound to accept the coal delivered by

installments. She may reject the coal delivered to her.

By mutual consent, the parties may agree that the goods shall be delivered and

accepted by installments. Thus, the delivery of goods by installments may be made

and demanded only if the contract of sale provides for the same. The contract to make

delivery by installments may be express or implied. Where the seller starts delivering

the goods by installments and the buyer accepts the same without any objection, then

he should accept the remaining installments also as he has impliedly consented to

delivery by installments.

411

Case Law 5:

Richardson Vs. Dunn202

: A contracted to sell to B 200 tons of coal. A shipped only

152 tons, and informed B about the same. But B made no reply. It was held that the

buyer (B) merely consented to delivery of coal by installments.

Sometimes, there is a contract for delivering the goods by installments, and for each

installment of goods the payment is to be paid separately. In such cases, the following

problems may arise:

The seller may fail to deliver an installment, or he may deliver defective goods

in one or more installments. Or

The buyer may refuse to take the delivery of an installment, or he may refuse

to pay for an installment.

In such cases, it is a question of fact whether the whole contract is treated as

cancelled, or only one installment is cancelled for which the party may claim

compensation, and the rest is to be performed [Section 38 (2)]. In this context, the

following points are important in order to consider whether the whole contract may be

rejected or not:

The extent of breach as a ratio of the entire contract. This implies, the ratio of

defective or unpaid installments to the whole contract. If the circumstances

show that there is a breach of a major portion of the contract, then the whole

contract may be cancelled.

Degree of probability of breach of the contract being repeated. If the

circumstances show that similar defaults shall be repeated in future also, the

whole contract may be cancelled.

Case Law 6:

Maple Flock Co. Ltd. Vs. Universal Furniture Pdts. (Wembley) Ltd.203

: A

contracted to sell to B 100 tons of flock by 20 installments. The first fifteen

installments were satisfactorily delivered. But the sixteenth installment was defective.

However, the subsequent four installments were again satisfactory. The buyer (B)

wanted to repudiate the whole contract could not be rejected. In this case, the

circumstances of the case showed that there was no possibility of the default being

repeated.

202

[1841] 2 Q.B. 218. 203

[ 1943] 1 K.B. 148.

412

11. Delivery to a carrier or wharfinger: Where in a contract of sale, the sold

goods are delivered to a carrier for the purpose of transmission to the buyer, the

delivery of goods to the carrier for the purpose of transmission to the buyer. Similarly,

where the sold goods are delivered to a wharfinger204

for the purpose of safe custody,

the delivery of goods to the wharfinger is also treated as delivery to the buyer [Section

39(1)]. However, where it is agreed that the goods are to be delivered at a particular

place (e.g., at the buyer's factory) then the delivery of goods to a carrier does not

amount to a delivery to the buyer. [Jagdish Pd. v. Produce Exchange Corpn. AIR

1946 Cal. 245]205

.

It may, however be noted that the seller's duty is not over only by delivering

the goods to the carries or wharfinger. The seller is further required the perform the

following duties:

To make a reasonable contract with the carrier or wharfinger: The seller has

to make a reasonable contract, with the carrier or wharfinger for the safe

transmission or custody of the goods. This will have to take into consideration

the nature of the goods and other circumstances of the case. If the seller fails

to make a contract, the buyer may refuse to treat the delivery to himself. Or he

may hold the seller liable for damages [Section 39 (2)].

To give notice to the buyer to enable him to insure the goods: Sometimes, the

goods are to be sent by a route involving sea or land transit, and it is usual to

insure the goods. Here, the seller must give to the buyer such notice as will

enable him to insure the goods during their sea or land transit. If the seller fails

to do so, the goods shall be at his risk during the transit. However, these duties

can be excluded by a contract which specifies the liability.[Section 39(3)].

Case Law 7:

Thomas Young and Sons v. Hobson and Partners206

: A sold 14 electric machines

to B. A agreed to send the goods (electric machine) to B by rail. A delivered the goods

to the Railway Company for the purpose of transmission to the buyer (B). However,

the goods were delivered to the Railway Company "at owner's risk" and not "at

Railway Company's risk". There was no difference in freight in both the cases. The

only difference was that before accepting "at Railway Company's risk", the Railway

204

A person who takes care of the wharf, is called a wharfinger. A wharf is a place

where the goods are stored before shipment or after unloading from the ship. 205

See also Fertilizer Corpn. of India v. Tata Iron & Steel Co. Ltd. AIR 1965 Punjab

148. 206

[1949] 65 TLR 365.

413

Company would have carefully inspected their packing and ensured that the machines

were properly secured in the wagons. Being "at owner's risk", the Railway Company

did not take much care in handling them. The machines were lying loose in the

wagons, and the shunting of train damaged them. It was held that the buyer could

reject the machines and would not be liable to pay the price. The reason for the same

is that, the seller had failed to make a reasonable contract with the railway company

for safe transmission of the machines. In this case, the nature of the goods (i.e.,

machines) required the seller to deliver them "at Railway Company's risk".

Case Law 8:

Cooke v. Ludlow207

: A, a buyer, living in Bristol, ordered certain goods

from B, a seller of London. According to the contract, the goods were to

be sent by any conveyance from London to Bristol. B sent the goods to a

wharf, where he was informed that the goods would be sent to Bristol by

the ship named 'Commerce'. Accordingly, B notified the buyer A that the

goods would be sent by the ship 'Commerce'. However, the ship

'Commerce' was fully laden, as such the goods were sent by another ship.

However, the seller did not know this fact. The ship conveying the buyer's

goods was lost in the sea. It was held that the buyer A was liable to pay

the price of the goods, as the seller B had given a reasonable notice to

the buyer. In this case, the seller has discharged his duty by giving a

notice to the buyer that the goods are being sent by ship 'Commerce', as

he never knew about the change of ship.

12. Deterioration of goods during transit: Sometimes, the seller agrees to deliver the

goods, at his own risk, at a place other than that where the goods are lying at the time

of contract of sale. In such cases, the buyer shall bear the loss of deterioration of

goods, which is incidental or could take place in transit. [Section 40].

207

[1806] 2 B & P.N.R. 119.

414

18.5 BUYER'S DUTY TO ACCEPT THE GOODS AND PAY THE PRICE

The duty of a buyer, in the performance of the contract of sale, is to accept the

goods and pay the price. When the seller delivers the goods, according to the contract,

then it becomes the buyer's duty to accept them and pay the price. When the goods are

accepted and paid for, the contract of sale is completed.

The term 'acceptance of goods' may be defined as the final assent of the buyer

that he has accepted the goods. It needs to be understood that when the buyer receives

the goods and takes possession of them, it does not mean that he has accepted the

goods. Acceptance is when the buyer after receiving the goods, has sufficient

opportunity of examining them as well. [Section 41]. Thus, in the following

circumstances, the buyer is considered to have accepted the goods:

When the buyer informs the seller that he has accepted the goods.

When the buyer does any act, which is inconsistent with the ownership

of the seller, i.e., when the buyer uses the goods as an owner, e.g.,

where he mortgages or resells the goods, or makes changes in the

goods. However, merely dealing with the documents of title does not

amount to acceptance. [Chao v. British Traders & Shippers Ltd. (1954)

1 All ER 779]

When after the expiry of a reasonable time, the buyer keeps the goods

without informing the seller that he has rejected the goods and thus

fails to return the goods within a reasonable time.

Illustration: Amar sold certain quantity of rice to Bal Kishan, and shipped the same

for the purpose of transmission to Bal Kishan. On the arrival of the ship, Bal Kishan

took delivery of the rice, and on the same day resold a part of the rice to Chaman.

After three days, Bal Kishan discovered that the rice was not in accordance with the

contract, and he gave a notice to the seller Amar that he has rejected the rice. This

notice of rejection was given within a reasonable time. It was held that the buyer Bal

Kishan had accepted the rice and the notice of rejection was ineffective. In this case,

the buyer has accepted the rice, as he had resold a part of the same.

18.6 BUYER'S RIGHT OF EXAMINATION

The opportunity of examining the goods is given to the buyer to enable him to

ensure that the goods are in accordance with the contract and thus the buyer should

415

examine the goods carefully. In fact, the buyer is not considered to have accepted the

goods unless and until such an opportunity is given to him. Sometimes, the buyer

seeks an opportunity of examining the goods. Here then, the seller is expected to give

such an opportunity. If the seller refuses to allow this opportunity, the buyer may

reject the goods [Section 41]. Where the buyer rightfully rejects the goods, it becomes

his duty to inform the seller of his decision. Then the buyer is not bound to return the

goods to the seller. It is the duty of the seller to take back the goods at his own

expenses [Section 43]. However, in case the buyer fails to inform the seller about the

rejection of the goods and if he fails to return them within a reasonable time it can be

assumed that the goods have been accepted.

18.7 LIABILITY OF THE BUYER FOR REFUSING TO TAKE DELIVERY OF

THE GOODS

Sometimes, the seller is ready and willing to deliver the goods, and requests the buyer

to take the delivery. However, the buyer defaults and does not take the delivery of the

goods within a reasonable time. In such cases, the buyer is liable to the seller for the

following [Section 44]:

Any loss which arises due to buyer's neglect or refusal to take delivery of the

goods, and

Reasonable charges for keeping the custody of the goods.

Where the neglect or refusal of the buyer amounts to the cancellation of the contract,

the seller may also claim damages for breach of contract.

18.8 CONTRACTS INVOLVING SEA TRANSIT

Sometimes, the goods are to be delivered to the buyer through sea routes. In all such

cases, the parties may enter into certain contracts, which are meant for the delivery of

the goods through sea routes. Following are the three important forms of contracts of

sale which involve the carriage of goods by sea:

1. C.I.F., 2. F.O.B, 3. Ex-Ship.

Under these contracts, the parties may vary or add some other terms in the usual terms

of such contracts.

416

18.9 C.I.F CONTRACTS

The term 'C.I.F.' implies 'cost, insurance and freight' and such a contract is for the sale

of goods at a price, which includes the cost of goods, insurance and freight charges.

Thus, in such contracts, the charges of insurance during transit and the freight charges

are paid by the buyer. Where the buyer orders the goods from a seller, residing in

another country, under a C.I.F. contract, the seller will insure the goods and deliver

them to a shipping company for shipping to the buyer. It is important that the

insurance policy regarding the goods and the bill of lading also be delivered to the

buyer along with the invoice of the goods. In C.I.F. contracts, the seller is bound to

perform the following duties:

To give the invoice of the goods sold.

To ship the goods at the port of shipment.

To get a contract of affreightment with the shipping company under which the

goods will be delivered at a destination decided under the contract, for the

transportation of the goods and obtain a bill of lading.

To insure the goods and obtain an insurance policy. The insurance should be

arranged in a manner that would suit buyer.

To deliver all these shipping documents (i.e., the invoice, bill of lading and the

policy of insurance) to the buyer within a reasonable time. These documents

should be delivered to the buyer at the place decided under the contract.

Thus, the essential part of a C.I.F. contract is that the seller must offer to

deliver the shipping documents to the buyer. If the seller fails to deliver these

documents within a reasonable time, then he is guilty of breach of contract.208

However, when the documentation is complete in all aspects of the contract,

then it is the duty of the buyer to take the documents and pay the price without

waiting for the arrival of the goods have been lost.209

Under the following circumstances the buyer may refuse to take the shipping

documents:

208

N. Swami Chetti V. Soundarajan AIR 1958 Madras 43. 209

Mohanlal Kashinath v. K. Premji & Co. (1928) 30 Bom. L.R. 415; AIR 1928

Bombay 170.

417

o When the documents are invalid, e.g., that the bill of lading is not

correctly written.

o When the goods are of a different quality than stated in the contract.

o When the quantity is different from that written in the contract

Sometimes, the buyer accepts the documents and also makes the payment for the

goods. Later, on the arrival of the goods, he finds that the goods are not in accordance

with the contract. In such cases, the buyer can reject the goods and recover back the

price.

Illustration: Nawal, a trader of Bombay, purchased 100 bags of almonds from Chary

of Cochin, under a C.I.F. contract. Chary insured 100 bags of almonds and delivered

them to a shipping company for the purpose of transmission to Nawal at Bombay and

obtained a bill of lading in the name of Nawal. Chary sent all the shipping documents

(i.e., invoice of cashew nuts, insurance policy and bill of lading) to his agent in

Bombay for the purpose of delivering them to Nawal and receive the payment from

him. Accordingly, B's agent delivered the shipping documents to Nawal who paid the

price in terms of the contract. On receipt of the almonds at Bombay, Nawal found that

these were of inferior quality. In this case, Nawal may reject the almonds and claim

the refund of the price.

The important points regarding the C.I.F. contracts, may be summed up as under:

Transfer of ownership: In case of C.I.F. contracts, the ownership of the goods

is transferred to the buyer when the shipping documents are delivered to the

buyer and he receives them by paying price of the goods.210

On the buyer's

refusal to take the shipping documents, the seller can claim the damages for

the breach of contract, and not the price of the goods.211

However, the parties

may change the terms of a C.I.F. contract, and in that case, the ownership will

be transferred to the buyer when it is meant to be transferred.212

Protection of parties' interest: The C.I.F. contract takes into consideration the

interest of both, the seller and the buyer. It protects the seller in a way that the

210

The Miramichi (1915) p. 71; T.R. Smith & Co. v T.D.B. & Co. (1940) 2 All

England Reporter 60. 211

Stein F. & Co. v Country Tailoring Co. 115 LT 215; see also AIR 1937 Lahore

566. 212

Mahabir Commercial Co. Ltd. v. Cit AIR 1973 SC 430

418

goods continue to be in his ownership until the buyer pays for the goods and

obtains the documents. It also protects the buyer in a way that he is required to

pay the price only when the documents are delivered to him. These documents

enable the buyer to obtain the goods as soon as they arrive at the final

destination. If the goods are lost during sea transit, neither party will be put to

loss. The reason for the same is that the goods being insured, the owner of the

goods (whether the seller or the buyer as the case may be) can claim the loss

from the insurance company.

Nature of contract : The C.I.F. contract is at times, described as a contract for

the sale of the documents as the buyer has to pay the price and receive the

documents without waiting for the arrival of the goods. However, this does not

mean that a C.I.F. contract is a sale of document and not of goods. In fact, a

C.I.F. contract is a sale contract, to be performed by the delivery of

documents, which are meant for the goods. Thus, a C.I.F. contract implies the

transfer of actual goods in the normal course of business, and in case the

goods are lost, the buyer gets his rights on the basis of the documents that

have been prepared i.e., insurance policy and bill of lading. A C.I.F. contract

may, therefore, be described as a contract for the sale of goods through

documents. Chalmer, an authority on the subject has observed in this context:

"a C.I.F. contract is a contract for the sale of insured goods, lost or not lost."

o F.O.B. CONTRACTS

The term 'F.O.B.' means 'free on board' and is a contract for the sale of goods where,

for the purpose of transmission to the buyer, the seller has to load the goods on the

ship at his own cost. Once the goods are loaded on board the ship, they are at buyer's

419

risk, and he is responsible for freight, insurance and subsequent expenses. In a F.O.B.

contract, the seller has to perform the following duties:

To load the sold goods safely on the ship as stated by the buyer.

To undertake to pay the expenses of loading the goods.

To enter into a contract with the shipping company or ship owners for the

transportation of goods and obtain a bill of lading. Such a contract should be

made in the best interest of the buyer and the seller.

To convey the bill of lading to the buyer.

To give notice of shipment to the buyer so that he can get the goods insured

for the sea transit.

On the performance of the above duties, the contractual liability of the seller ends,

and the delivery of goods from the seller to the buyer is complete. Then, the buyer is

bound to pay the price of the goods when the shipping documents are presented to

him even if the goods have been lost by that time213

. This is substantiated as the

Supreme Court has also held that the buyer is liable to pay the full price of the goods

on delivery of dispatch documents even though the goods arrived were short by a few

items. [Marwar Tent Factory v. Union of India, AIR 1990 SC 1753].

It is also the buyer's duty to name a ship upon which the goods are to be delivered. If

the buyer fails to name a ship, he is guilty of breach of contract, and the seller can file

a suit against him for the recovery of the damages. However, in such a case, the seller

cannot file a suit for the recovery of the price of the goods. [Colley v. Overseas

Export (1921) 3 K.B. 302].

The important points in connection with F.O.B. contracts are summed up as under:

Transfer of ownership: In case of F.O.B. contracts, the ownership of the goods

is transferred to the buyer as soon as the goods are loaded on board the ship.

The ownership of is so transferred even if the goods are not specific or

ascertained. However, the ownership of the goods will not be transferred to

the buyer, if, by the shipping documents, the seller has reserved his right of

disposal. Thus, if seller does not reserve his right of disposal, the goods are at

buyer's risk after they are loaded on the ship.

213

Stock v. Inglis (1889) 12 QBD 564; affirmed 10 App Cas 263.

420

Illustration: Anthony of Goa, purchased certain goods from Biswajit of Kolkata,

under a F.O.B. contract. Biswajit delivered the goods to a shipping company for the

purpose of transmission to Anthony at Goa, and obtained a bill of lading in the name

of Anthony. The goods were loaded on a ship named by the buyer Anthony, and

Biswajit paid the expenses for loading the goods. Biswajit sent the bill of lading to his

agent in Goa for the purpose of delivering them to Anthony. The ship carrying the

goods was sunk. However, Biswajit's agent presented the bill of loading to Anthony

and demanded the price of the goods. But Anthony refused to pay the price on the

ground that the ship carrying the goods had already been sunk. In this case, Anthony

is liable to pay the price of the goods as the ownership of the same was transferred to

him as soon as the goods were loaded on a ship named by him.

Insurance of Goods: In most cases, insurance of the goods is required. In such

cases, the seller should give to the buyer such notice as will enable him to

insure the goods the goods. If the seller fails to give such notice, the goods

shall be at his risk during the transit [Section 25(3)]. In some situations, the

buyer has enough information about the shipment of the goods so as to enable

him to insure them, then he cannot insist on a particular notice from the seller,

i.e., in such cases, the goods shall be at the risk of the buyer, even if no notice

is given by the seller, i.e. in such a case, the goods shall be at the risk of the

buyer, even if no notice is given by the seller.

Note: In F.O.B. contracts, the buyer cannot unilaterally ask for the delivery of the

goods before they are loaded as per the terms of the contract.

18.11 EX-SHIP CONTRACTS

An Ex-Ship Contract is a contract for the sale of goods in which the seller has to

deliver the goods to the buyer at the port of destination. The freight charges are to be

borne by the seller. It may be noted that during the voyage (sea route) the goods are at

the risk of the seller. Thus, to protect his own interest, the seller may insure the goods,

if he so wishes, at his own expenses. In an Ex-Ship Contract, the seller has to perform

the following duties:

421

To deliver the goods to the buyer at the port of destination, i.e., to make the

goods physically available at the port of destination to enable the buyer to take

their delivery.

To pay the freight charges.

To hand over the proper delivery orders to the buyer to enable him to obtain

the delivery of the goods from the ship owner.

On the performance of the above duties, the contractual liability of the seller ends.

Thereafter, the buyer becomes bound to pay the price of the goods.

The important points in connection with Ex-Ship contracts may be summed up as

under:

(a) Transfer of ownership: In case of Ex-ship contracts, the ownership of the

goods is transferred to the buyer only when the goods are actually delivered at

the port of destination to enable the buyer to take their delivery.

(b) Insurance of goods: In Ex-ship contracts, the seller is not bound to insure the

goods on behalf of the buyer. Since the goods are at seller's risk during sea

transit, he may insure the goods for his own assurance.

(c) The Contract, whether C.I.F. or Ex-ship: In case of sea transit, whether a

particular contract is C.I.F. contract or an Ex-ship contract, does not depend

merely upon the word (i.e., C.I.F. or Ex-ship) used by the parties in their

contract. But it depends upon the essence of the contract, i.e., upon the effect

of the contract, e.g., a contract referred as C.I.F. contract may not be so if by

the other terms of the contract the goods are actually to be delivered at the port

of destination. [The Prachim (1918) AC 157 PC].

Illustration: Amar and Bhandari entered into a contract for the sale of 'rye' by Amar

to Bhandari. The contract was expressed to be on C.I.F. terms. According to the terms

of the contract, the goods were to be delivered by Amar at a port called Antwerp, and

the price was payable on the presentation of delivery orders to Bhandari. A shipped

the goods. However, the ship carrying the goods was sunk. Bhandari brought an

action against Amar for the refund of the price paid by him. It was held that Bhandari

was entitled to the refund of the price. In this case, though the contract was expressed

to be a C.I.F. contract, but in fact it was not so. The contract was an Ex-ship contract

as the goods were to be delivered to Bhandari, the buyer, at his port. And the

ownership of the goods would have been transferred to Bhandari only on the delivery

422

of the goods at the port. Thus, at the time of loss of the goods, the seller was their

owner and not the buyer.

o COMPARISON BETWEEN C.I.F, F.O.B. AND EX-SHIP

CONTRACTS

The following table gives the comparison between C.I.F., F.O.B and Ex-ship

contracts:

S.No. C.I.F. Contract F.O.B. Contract Ex-ship Contract

1. In such a contract, the

price of the goods

includes the cost of the

goods, insurance and

freight charges.

In this contract, the

price of the goods does

not include the

insurance and freight

charges.

In this case also, the

final price of the goods

does not include the

insurance and freight

charges.

2. In C.I.F. the ownership

of the goods is

transferred to the buyer

when the shipping

documents are delivered

to the buyer, and he

receives them by paying

the price of the goods

In F.O.B. the ownership

of the goods is

transferred to the buyer

as soon as the goods are

loaded on the ship

named by the buyer.

In the Ex-ship contract,

the ownership of the

goods is transferred to

the buyer only when the

goods are actually

delivered at the port of

destination so that the

buyer can take their

delivery.

3. In this case, the

insurance of the goods

sold is compulsory. And

the seller is bound to

insure the goods.

In the F.O.B. contract,

the insurance of the

goods sold is not

compulsory. The buyer

may insure the goods to

protect his interest as

during transit by sea the

goods are at his risk.

In the Ex-ship contract

also, the insurance of

the goods sold is not

compulsory. The seller

may insure the goods to

protect his interest as

during the sea transit the

goods are at his risk.

4. In the C.I.F. contract,

the seller's duty is to

deliver the goods to a

shipping company for

the purpose of being

delivered to the buyer.

In F.O.B. contract, the

seller's duty is to load

the goods in a ship

decided by the buyer.

In the Ex-ship contract,

the seller's duty is to

deliver the goods at the

port of destination to

enable the buyer to take

their delivery.

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Points to remember

Introduction

• The Performance of Contract of Sale implies the delivery of goods by the

seller and acceptance of the delivery of goods and payment for them by

the buyer as per the terms of the contract.

Delivery of goods and Rules regarding delivery.

• Delivery means transfer of possession from one person to another. This

may be actual delivery, symbolic delivery or constructive delivery.

Rules regarding delivery:

Possession of goods

Demand for delivery of goods

Place of delivery of goods

Time for delivery of goods

Time for the demand of actual delivery

Goods in the possession of a third party

Expenses of delivery of goods

Part delivery of goods

Delivery of wrong quantity

Delivery of goods by instalments

Delivery to a carrier or wharfinger

Deterioration of goods during transit

Buyer: Duties, Rights and Liabilities:

! The buyer has the right to examine the goods and to make sure that

they are in accordance with the contract.

! The buyer is not bound to return the reject goods.

! The buyer is deemed to have the accepted goods, if he does not act

otherwise or after the lapse of reasonable time.

! The buyer is liable for refusing delivery of goods, when the seller has

done everything according to the contract.

Contract involving passage by sea.

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There are three forms of Contract of Sale which involve the carriage of goods by sea:

C.I.F., which is Cost Insurance Freight.

F.O.B.. This is Free On Board contract.

Ex-Ship Contract, in this the seller has to deliver the goods to the

buyer at the port of destination and the transport charges are to be

borne by the seller.

Questions

1. State the respective duties of the seller and buyer in the performance of

contract of sale.

2. What do you mean by the term 'delivery of goods' in a contract of sale? State

the modes of effective delivery of goods and the legal rules relating thereto.

3. "Delivery of goods and payment of their price are the concurrent conditions"-

Explain with Illustrations.

4. "It is the duty of the seller to deliver the goods and of the buyer to accept and

pay for them" – elucidate.

5. State the buyer's duty to accept the goods and pay the price. What is the

liability of the buyer if he refuses to take delivery of the goods?

6. What options are open to the buyer if the seller makes (a) part delivery, (b)

short delivery, (c) excess delivery, and (d) mixed delivery, of goods?

7. State the legal provisions relating to delivery to the carrier or wharfinger.

8. Explain with Illustrations the C.I.F., F.O.B. and Ex-ship contracts, and state

the comparison between the three.

9. "C.I.F. contract is not a contract for sale of goods, but a contract for the sale of

documents relating to the goods" – comment and state the duties of a seller

and a buyer in such a contract.

10. Write short notes on legal provisions relating to (a) part delivery, (b) short

delivery, (c) excess delivery, and (d) acceptance of goods.

425

Practical Problems

X company of Bombay orders some goods from an Engineering

organization in Italy. The Italian Co. sends the specific items and also

some other mechanical equipment, which was not ordered by buyer.

What should X company of Bombay do?

Answer: X Company may either reject the whole or accept the whole or accept

only the goods ordered by them and reject the rest. [Section 37(3)].

A sells certain kitchen fitments to B. The goods were delivered to one

employee of B and they remained in his godown for one month. Has B

accepted the goods?

Answer: Yes, since the goods had been delivered to B and he kept them beyond

a reasonable time, he is suppose to have accepted them. (Section 42)].

X contracts with Y to purchase 50 tonnes of grape pulp in canned

containers. Y acts likewise and takes out grape pulp and puts them in

containers. X delays to take the delivery of goods on account of slack

demand in that market. The goods go putrid and are thrown by Y. Is X

liable to pay damages to Y?

Answer: The buyer should bear the cost of damages as the delivery has been

delayed due to his fault. (Sec. 44 and Sec. 26)].

Ramesh sold to Mahesh 1000 tons of meat of a specified quality to be

shipped 125 tons monthly in equal weekly installments. After about

half the meat was delivered and paid for, Mahesh discovered that it

was not of contract quality. He refused to take further deliveries. Can

he do so?

Answer: Yes, See section 38, the facts of this case are similar to the case of

Robert A. Munro v. Meyer [1930] 2 K.B. 312].

R enters into a contract to sell 500 liters of palm oil to M in the month

of January 2001. He sends only 250 liters of palm oil and insists upon

the price to be paid to him of this lot after which he would dispatch the

other lot. Decide the case.

426

Answer: R cannot insist on payment of the price of palm oil supplied by him

unless he has delivered the whole quantity of palm oil to Mr. M.

References:

Books :

o P.P.S. Gogna; A text book of Mercantile Law, S.Chand & Co. 1999.

o Tulsian P.C.; Business Law, Tata McGraw Hill, New Delhi, 2007.

Websites:

! www.helplinelaw.com

! www.consumer-law.lawyers.com

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Lesson -19

REMEDIES

by

Reena Marwah

This lesson discusses the following aspects of the Sale

of Goods Act:

19.1 Introduction

19.2 An Unpaid Seller

19.3 Rights of an Unpaid Seller

19.4 Buyer’s remedies when there is a breach of contract

by the seller.

19.1 INTRODUCTION

The Sale of Goods Act 1930 provides the remedies available to both the seller and the

buyer in different possible circumstances. When a buyer and seller has entered into a

contract each party is to perform the promise i.e. made to the other. If one of the

parties does not perform one or more of a promise made then there is a breach of

contract and the other party can have remedy against the breach.

19.2. AN UNPAID SELLER

The definition of ‘unpaid seller’ is provided in section 45 of the Sale of Goods Act

and it runs as follows “the seller of the goods deemed to be an unpaid seller is:

when the whole of the price has not been paid

when a bill of exchange or other negotiable instrument has been

received as conditional payment and the condition on which it was

received has not been fulfilled by reason of the dishonor of the

instrument or otherwise.”

428

Thus, a seller who has received only a part of the payment is an unpaid seller.

However, a seller is not an unpaid seller if the buyer has tendered (i.e.) offered to pay

the price, and the seller has refused to accept the payment. In such a case, the seller

will lose the rights of an unpaid seller.

Illustration: Seema sold certain goods to Bindu for Rs.10,000. Bindu made the

payment by cheque. Seema presented the cheque to the banker for the payment but it

got dishonoured as there was not enough money in the bank account of Bindu. Seema

can return the cheque to Bindu and claim the payment as Seema is in the position of

an ‘unpaid seller’.

The seller must not refuse to accept the payment when tendered. If the price has been

offered by the buyer but the seller wrongfully refuse to accept it, the seller is not

considered as an‘unpaid seller’.

Illustration: Suresh sold certain quantity of jute to Jatin for Rs.5000. Jatin paid

Rs.2500 and failed to pay the balance. In this case, Suresh is in position of an ‘unpaid

seller’. The cost of the jute is Rs. 5,000 and till Jatin makes the entire payment,

Suresh can claim the payment due to him

Where the price has been paid to the seller by bill of exchange, cheque or promissory

note, etc., the seller is not an unpaid seller’. However if such bill of exchange, cheque,

etc. is dishonoured, the seller becomes an ‘unpaid seller’.

o THE RIGHTS OF AN ‘UNPAID SELLER’

The rights of an‘unpaid seller’ can be studied under two main heads:

a) Rights against the goods and b) Rights against the buyer.

429

# RIGHTS OF AN ‘UNPAID SELLER’ AGAINST THE

GOODS:

In some circumstances after the sale of goods the seller continues to have the

possession of the sold goods. At such times, an unpaid seller has certain rights against

the goods. These can be further studied under two heads;

a) Where the property of goods has passed to the buyer; and

b) Where the property of goods has not passed to the buyer.

• Where the property of goods has passed to the buyer

When the property in goods has passed to the buyer there are three rights of an unpaid

seller. These are:

Right of Lien,

Right of stoppage in transit

Right of Re-sale

These are discussed in detail below:

o Right of Lien

The Right of Lien means, the right to keep the possession of the goods until the

charges or the price has been paid. This right is available to the unpaid seller where

the goods have been transferred to the buyer. This is because lien depends on

possession. Even if the seller has handed over the documents of title to the buyer, the

lien is not affected. According to Section 47, the unpaid seller can exercise lien, only

when the following conditions are satisfied:

o where the goods have been sold without stipulation as to credit; or

o where the goods have been sold on credit but the term of credit has

expired; or

o when the buyer has become insolvent.

This Section implies that the unpaid seller can exercise his lien over the goods, even if

he is in possession of such goods only as an agent for the buyer. It is to be noted that

the right of lien will be only for the price of the goods and not for any other charges.

430

If in such case where the unpaid seller has made only a part of the delivery of goods

he has the right of lien on the rest of the goods, unless such a part delivery has been

made under an agreement to waive the lien [Section 48].

If under the contract the delivery of goods is to be made in installments the seller

cannot stop the delivery of the rest of the installments in case the buyer defaults in

making the payment for one installment. However, the seller can stop the delivery

when the buyer becomes insolvent or the default by the buyer actually implies a

cancellation of entire contract.

Termination of Lien: The unpaid seller loses the right of lien as soon he fails to have

the possession of goods. Under Section 49 of the Sale of Goods Act the unpaid seller

of goods can lose his lien when he delivers it to a carrier or delivers to the buyer or by

a waiver or when the buyer makes the payment. These are explained below:

Delivery to Carrier: When the unpaid seller delivers the goods to

carrier so that they may be taken to the buyer, the right of lien is lost.

However, this should be done without the seller reserving the right of

disposal. If the seller reserves the right of disposal then the seller will

consider the carrier as his agent and the latter will have to act under the

supervision of the seller.

Case Law 1:

Valpy vs. Gibson 214

: The goods sold were delivered to the buyer’s shipping agents,

who had put them on board a ship. However, the goods were returned to the sellers

for repacking. While they were still with the sellers for this purpose, the buyer became

insolvent and the sellers claimed to retain the goods in the exercise of right of lien

214

[(1847) 4C.B. 837]

431

because they were unpaid. However it was held that they could not do so as they lost

their lien by delivery of goods to the shipping agent.

Case Law 2:

Jain Mills & Elec. Store v. State of Orissa, 215

: A sold 100 bags of cement to B and

delivered them to the Railways for the purpose of transmission to the buyer B. A

obtained the railway receipt in B’s name and sent the same to B to enable him to

obtain the delivery of the goods from the Railways. While the bags of cement were in

transit, the buyer (B) became insolvent, and the seller (A) was still unpaid. In this

case, the seller’s right of lien is lost as the goods are delivered to the carrier

(Railways). However, he still has the right of stoppage in transit

Delivery to the Buyer: The unpaid seller loses the right of lien when

the buyer or buyer’s agent obtains the possession of the goods in a

legal manner. However, the lien continues in case the buyer takes

possession of the goods without the permission of the seller.

By Waiver of Lien: There can be an express or implied waiver of lien.

When in a contract of sale it is specifically written the seller does not

have the right to retain possession until the payment of price, it is an

express waiver. An implied waiver is when goods are sold on credit or

if there is a sub-sale or if the seller uses the goods for himself or

refuses to deliver them.

Payment by the buyer: The seller will not be an unpaid seller when the

buyer makes the payment for the goods. Here the seller cannot term

himself as an unpaid seller by refusing to accept the payment for the

goods by the buyer.

215

AIR 1991, Orissa 117.

432

o Right of Stoppage in Transit

As stated earlier the lien is lost in the case where the seller no longer has the

possession of goods. However, in certain situations an unpaid seller can have the right

to continue with the possession of goods as long as they have not been delivered to

the buyer and may also have the right over them till the buyer have made the

payment. The seller has the right of stopping the goods and taking their possession

from the carrier by exercising the right of stoppage in transit. This right of stoppage in

transit is for goods only and for this right to be used by the seller, the following three

conditions must be satisfied:

The seller must be unpaid;

The buyer must be insolvent; and

The seller must have parted with the possession of goods and the buyer

must not have acquired it, i.e., goods should be in transit (Section 50).

The right of stoppage in transit is against goods only. The last requirement is a

question of fact but it is sometimes difficult to ascertain because much depends upon

the capacity in which the carrier holds the goods. If the carrier holds goods as agent of

the seller, goods are under seller’s lien. If he holds them as agent of the buyer, there is

no transit because the buyer has acquired possession. It is only when the middleman

holds the goods in his own name as a carrier that the goods are in transit. Transit does

not mean that the goods should be actually moving.

Illustration: Amar of Ahmedabad sold certain goods to Vikas of Delhi and delivered

the goods to Chauhan, a common carrier for the purpose of transmission to Vikas.

Before the goods could reach him, Vikas became insolvent. In this case Amar can stop

the goods in transit by giving a notice to Chauhan.

Duration of Transit (Section 51):

The goods are stopped to be in transit in the following cases:

433

o When they are delivered to a carrier or to other agent for the purpose

of delivery to the buyer, until the buyer or his agent takes the delivery

of them from such carrier or other bailee [Section 51(1)].

o If the buyer rejects the goods and the carrier or other bailee continues

to possess them, the transit continues, even if the seller has refused to

receive them back [Section 51(4)].

o When goods are delivered to a ship chartered by the buyer, it depends

on the circumstances of the case whether the goods are in the

possession of the master as a carrier or as agent of the buyer. When the

seller knows that he is delivering the goods to someone as a carrier,

who is receiving them in the character, he delivers them with an

implied right of stopping them so long as they remain in the possession

of the carrier as a mere carrier [Section 51(4)].

o When part delivery has been made, the remainder of the goods may be

stopped in transit unless delivery of part of goods shows an intention to

give up the possession of the whole of the goods [Section 51(7)].

When Transit comes to an End?

Transit comes to an end and the seller loses the right to stop the goods in

transit in the following cases:

1. Delivery to the buyer: When goods are delivered to the buyer or his agent,

transit comes to an end [Section 51(1)]. Where the buyer does not accept

the goods, the transit does not end even if the goods have reached the place

of destination.

2. Interception by the buyer: If the buyer or his agent in that behalf obtains

delivery of goods before their arrival at the appointed destination, the

transit comes to an end. [Section 51(2)]. The buyer or his agent may take

delivery with or without consent of the carrier; However as far as the

seller’s right of stoppage is concerned that comes to an end.

3. Acknowledgment to the buyer: If after arrival of the goods at the appointed

destination, the carrier or other bailee acknowledges to the buyer or his

agent that he is now holding the goods on his behalf, the transit period

ends. It is immaterial that the goods are still with the carrier or the buyer

has indicated a further destination [Section 51(3)]. However, there must be

a very clear acknowledgement to put an end to the original contract of

434

carriage. (It should be noted that where the goods have to be carried by

more than one carrier as part of the original contract, the transit

continues till the goods arrive at their ultimate destination).

4. Delivery on ship chartered by buyer: Where the goods are delivered to a

ship chartered by the buyer, and if the circumstances show that the carrier

is acting as an agent of the buyer, then the transit comes to an end as soon

as the goods are loaded on board the ship [Section 51(5)].

5. Wrongful denial to deliver: Where the carrier or other bailee wrongfully

refuses to deliver the goods to the buyer or his agent in that behalf, the

transit is deemed to be at an end [Section 51(6)]. However, if that has been

done rightfully, the transit may not end (e.g., on refusal by buyer to pay

freight charges when their payment is a precondition to delivery).

6. When part delivery of goods is made to the buyer or his agent: If part

delivery shows an agreement to give up possession of the whole of the

goods, transit comes to an end. However, in general, delivery of a part is

not equivalent to delivery of the whole and the seller can stop the

remainder of the goods [Section 51(7)].

7. How stoppage in transit can be undertaken: An unpaid seller can exercise

the right of stoppage in transit either:

a. By taking the possession of goods; or

b. By giving due notice of his claim to the carrier or other bailee in

whose possession the goods are. Such notice may be given either to

the person in actual possession of goods or his principal [Section

52(1)].

In case the notice is given to the principal, then to be effective and

workable, it must be given at such time and in such circumstances that the

principal, by the exercise of reasonable carefulness, may communicate it to his

servant or agent to prevent a delivery to the buyer.

When enough notice is given by the seller to the carrier to stop the

goods, the carrier should re-deliver the goods or deliver them according to the

seller’s directions. The seller must pay the charges for re-delivery.

435

Differences between Right of Lien and Right of Stoppage in Transit

Right of Lien Right of Stoppage in Transit

1. This right can be exercised

when the goods are in actual

possession of the seller

This can be enforced so long as the goods

are in the possession of the intermediary or

carrier or agent between the seller and the

buyer.

2. This can be exercised even

when the buyer has the capacity

to pay but does not pay.

This takes place when the buyer becomes

insolvent.

3. This comes to an end as soon as

the goods are no longer in the

possession of the seller.

This comes to an end as soon as the goods

are delivered to the buyer.

4. This right comes to an end when

the goods are no longer in the

possession of the seller.

This starts when the right of lien ends, and

continues to hold till the delivery of goods

to the buyer.

5. This right is exercised to retain

possession of goods.

This right is to regain (take back) the

possession of the goods.

In case of sub-sale or pledge by buyer on unpaid seller’s right of lien

and stoppage in transit. The unpaid seller’s right of lien or stoppage in

transit is not affected by sale or disposal of goods by the buyer.

However, in the following circumstances, the unpaid seller’s right of

lien and stoppage in transit cease to hold:

A. Seller’s consent: Where the buyer sells or disposes of goods with the

consent of the seller, the seller is bound by it. However, a mere

acknowledgement of the receipt of information from the seller’s end is

not considered sufficient unless the circumstances show that the seller

intended to give up all rights against the goods [Section 53(1)].

B. Transfer of documents of title: When the seller has issued documents

of title to the goods to the buyer and the buyer has sold or pledged the

goods by transferring the documents of title, then in case of sale, the

seller’s right of lien and stoppage in transit cannot be exercised.

However, if the final sale was by way of pledge or other mortgage for

value, the rights of unpaid seller become subject to the pledge.

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However, it is necessary that the transferee should act in good faith and

for consideration (Section 53).

If there is a transfer in the form of a pledge, the unpaid seller may

require the pledgee to have the amount secured by the pledge fulfilled

as far as possible, out of any other goods or securities of the buyer with

the pledgee and available against the buyer [Section 53(2)]. Where a

pledge takes place, the seller may exercise his rights by paying off the

pledgee. If the pledgee possesses other securities against the one who

has pledged, the unpaid seller can require him to satisfy his claim as

far as possible, out of other securities. Where the pledgee needs to sell

the goods, he has to hand over the surplus sale proceeds, if any, to the

unpaid seller.

Illustration: Amarender sold 200 tons of iron to Vikram. Amarender handed over the

iron to a shipping company and sent the bills of lading to Vikram, who then obtained

a loan from his friend Chauhan and pledged with him the bill of lading as security

against which the loan would be repaid. While the goods were in transit, Vikram

became insolvent and Amarender became the unpaid seller. In this case, the right of

stoppage by Amarender will depend on the right of Chauhan, who is the pledgee. In

fact, Chauhan will continue to have charge of the goods as the loan has to be

recovered by him. In this illustration, assume that along with the bill of lading Vikram

also pledges some securities with Chauhan. In such a situation, then Amarender can

ask Chauhan to make good the amount due to him by selling the securities and then

make Amarender liable for the balance amount.

19.3.1.1.3 Right of Re-sale

After discussing the right of lien and the right of stoppage in transit, the third

important right is the right of resale. Section 54 indicates that the unpaid seller has the

right of resale. When the seller uses his right of lien or stoppage in transit, the contract

continues to remain in force and the buyer can claim delivery of goods by paying for

the goods. The seller is not expected to wait indefinitely for the buyer to make the

payment. However, just because the seller is unpaid, the property in the goods cannot

pass to the unpaid seller again. The buyer has the rights to the property the buyer has

the option to pay the price and take delivery of goods at any time. Thus, under section

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54, the seller has been given a limited right to resell the goods in certain

circumstances.

The seller has the right to resell the goods under the following circumstances.

! Where the goods are of perishable and will lose value in a short time. When

the goods are of perishable nature, the unpaid seller can resell the goods, in

such a situation where buyer fails to pay the price within a reasonable time.

The term perishable implies not only physical deterioration but also

commercially un-saleable. In case of perishable goods, the unpaid seller need

not give any notice of resale.

! Where the unpaid seller has used his right of lien or of stoppage in transit

and gives notice to the buyer of his decision to resell the goods. Where the

unpaid seller who has exercised right of lien or stoppage in transit gives notice

to the buyer of his intention to resell, the unpaid seller may, if the buyer does

not pay or tender the price within a reasonable time, resell the goods.

In this case, (i.e. in the event of a resale) the unpaid seller can recover

the difference of price between the price due from the buyer and that

received by the resale. Any profit arising on resale belongs to the seller

because the resale is actually due to a breach of contract by the buyer.

The law does not permit the buyer to benefit as a result of his own

default. In case where no prior notice has been given, the seller cannot

claim the damages from the original buyer.

Notice of Resale

Unless the goods are of perishable nature, the seller is expected to give

a reasonable notice of resale to the buyer of his intention to resell the

goods. What is reasonable notice is a question of fact depending upon

the nature of goods, the distance between the parties and other

circumstances of the case. The notice has been made compulsory for

two reasons:

The first reason is to allow the buyer to have an opportunity of

fulfilling the contract by paying the price before such resale even at the

last moment. Secondly, in case the buyer does not have the capacity or

means to repay or does not pay, he can have the opportunity to see and

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confirm that on such resale the goods fetch a reasonable or good price.

In case the resale is not properly conducted, the seller cannot keep any

surplus or be entitled to sue the buyer if there is a deficiency. Here it

must be understood that this does not prevent the subsequent buyer

from getting a good title to the goods.

If the notice of resale is not given, Section 54(2) also provides that, the

unpaid seller shall not be entitled to recover the damages for breach

and he has also to hand over the profit, if any, made on the resale to the

buyer.

Moreover, Section 54(3) also further provides that where an unpaid

seller who has exercised the right of lien or stoppage in transit resells

the goods, the buyer acquires a goods title thereto as against the

original buyer notwithstanding that no notice of resale has been given

to the original buyer.

! Where the seller expressly reserves his right of resale. The seller can also

resell goods when he has expressly reserved the right of resale in case where

the buyer does not fulfill his part of the contract or pays the due amount. In

such cases he is not required to give any notice to the buyer of his decision to

resell. If the seller sells the goods, the original contract comes to an end but

the seller can still claim damages from the buyer.

In all the above cases where the seller resells the goods whether with or

without notice, the buyer from him gets a good title thereto as against the

original buyer. This is because the original buyer being in default, is not

entitled to the possession of goods, and therefore cannot sue to recover the

goods or their value.

19.3.1.2 Rights of an Unpaid Seller where the Ownership of the Goods has not

passed to the Buyer.

Where the property in goods has not passed to the buyer, the unpaid seller has, in

addition to his other remedies, a right of withholding delivery. This right is similar to

and goes along with the unpaid seller’s right of lien and stoppage in transit where the

property has passed to the buyer [Section 46(2)].

Seller has the right to hold back delivery of the goods until the price is

paid even though the sale was on credit.

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19.3.2 RIGHTS AGAINST THE BUYER

In addition to the rights, which he has against the goods, unpaid seller has the

following remedies against the buyer. There rights are called rights in parsonam as

these are available against the buyer personally:

19.3.2.1 Suit for price. Where under a contract of sale the property in goods has

passed to the buyer and the buyer wrongfully neglects or refuses to pay for the goods

according to the terms of the contract, seller may sue him for the price of the goods

[Section 55(1)]. However sometimes, under a contract of sale the price is payable on a

certain day whether the goods are delivered or not. In such cases if the buyer

wrongfully neglects or refuses to pay the price, the seller may sue him for the price

although the property in the goods may not have passed to the buyer and the goods

may not have been appropriated to the contract [Section 55(2)].

Illustration: Rama sold 100 grams of silver to Shyama for Rs.2, 000/- The payment

was to be made within two months of the sale. Shyam was unable to pay the price

within the agreed period of two months. Here Rama can file a suit against Syama for

the recovery of the price of silver.

19.3.2.2 Suit for damages for non-acceptance of the goods. Sometimes the seller is

ready and comes forward to deliver the goods to the buyer. However the buyer

wrongfully neglects or refuses to accepts the goods and pay for them. In this case, the

seller may sue the buyer for damages for non-acceptance. Before the seller becomes

entitled to sue for damages, there must be either a wrongful neglect or refusal on the

part of the buyer to accept and pay for the goods (Section 56). Damages are decided

in accordance with the principles laid down in Sections 73 and 74 of the Indian

Contract Act. The following rules are applicable under such a case:

o Where there is a ready market for the goods, the

extent of damages is prima facie to be

ascertained by the difference between the

contract price and the market price at the date of

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the breach. The term available market means

that goods can be sold freely because there is

existing demand.

o Where the goods do not have a ready market,

the measure of damages will be the estimated

loss directly and naturally arising, in the

ordinary course of events, from the breach of

contract. Therefore, the measure of damages

will depend upon the facts are presented in each

case.

Case Law 3:

Thompson Ltd. v. Robinson 216

: R contracted to buy a ‘Vanguard’ car from T Ltd.

who was a car dealer. R refused to accept delivery. It was held that T Ltd. was

entitled to damages for the loss of their bargain i.e. the profit they would have made

as they had sold one car less than they otherwise would have sold.

In case the seller is ready and willing to deliver the goods and requests the buyer to

take delivery which the buyer does not do within a reasonable time, the seller may

recover from the buyer (i) any loss occasioned by the buyer’s refusal or neglect to

take delivery; and (ii) a reasonable charges for the case and custody of the goods.

19.3.2.3 Suit for damages for repudiation of contract before the due date of delivery

of goods. If the buyer cancels the contract before the due date of delivery of goods,

the seller has before him two alternatives; he may immediately accept the breach and

bring an action for damages or he may wait till the date of delivery. If he accepts the

breach immediately, the contract is thereby cancelled and damages will be determined

according to the price prevailing on the day of breach and the contract price. If the

seller waits till the date of delivery, the contract is open for both the parties and the

buyer has the option of performing the contract and also taking advantage of any

additional circumstances that take place which would justify him in declining to

complete the contract. (Section 60).

216

(1955) 22 W.L.R.185

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Illustration: Hira agreed to sell to Mira 20 bags of jute at the rate of Rs. 100 per

bag. According to the contract the jute was delivered on 1st January 2007. However,

before this date, Mira informed Hira that she will not accept any jute from Hira.

Since Mira refused, Hira sold the bags of jute to Jira at the rate of Rs. 90 prer bag; as

this was the prevailing market price.In this case, Hira can file a suit against Mira for

the recovery of damages of Rs. 10 per bag, as Hira had to suffer a loss to that extent.

19.3.2.4 Suit for interest and special damages. There is nothing in the Sale of Goods

Act that can affect the right of the seller to recover interest or special damages in the

situation where the law permits that interest or special damages may be recoverable.

The Court may award interest at such rate as it thinks fit on the amount of the price to

the seller in a suit filed by him for the amount of the price – from the date of the

tender of the goods or from the date on which the price was payable. If the seller

delivers or sends the goods to the buyer and the buyer wrongfully refuses to accept

and pay for them, Court may award interest on the price. If the price is payable on a

certain day irrespective of delivery, interest will be calculated from that day, and if

the goods are sold on credit, interest will be calculated from the date of expiry of the

credit period (Section 61).

19.4 BUYER’S REMEDIES AGAINST SELLER

If the seller is guilty of default, the buyer has the following remedies against the

seller:

19.4.1 Suit for damages for non-delivery of goods. In case the seller refuses to

deliver the goods to the buyer, the buyer has the right to sue the seller for damages for

non-delivery. The wrongful neglect or refusal to deliver the goods may arise in the

following cases:

(i) Where the buyer has prepaid the price partly or wholly and the goods are not

delivered; or (ii) Where the seller has unjustifiably delayed the delivery of goods. If

the goods are readily available in the market, the buyer is entitled to claim damages;

these being the difference between the contract price and market price on the day of

breach of contract. The buyer is in any case entitled to refund of the price, if already

paid, in case of non-delivery. Where the buyer purchased goods for resale and the

profit of sub-sale but also the damages he has paid to his buyer. In case there is no

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market for goods, the buyer may be allowed reimbursement for loss of profit, which

may be calculated according to the price at which he contracted to resell the goods.

The buyer is of course under a duty to lessen his loss by taking practical steps at the

earliest possible. (Section 57).

19.4.2 Suit for specific performance. Where there is a contract for the sale of specific

or ascertained goods and seller refuses to deliver them the Court may require him to

deliver the goods in terms of the contract although he may be willing to pay damages

instead of goods. The Court (subject to certain condition) allows this remedy. First,

the contract must be for the sale for specific goods and secondly, the power of the

Court to order specific performance is subject to provisions of the Specific Relief Act

of 1963. It empowers the Court to order specific performance (at its judgment) where

just payment of damages would not be an adequate remedy. Specific performance will

be granted if goods are of special value or are unique e.g., a miniature painting or

valuable antique etc. (Section 58).

19.4.3 Suit for breach of warranty. In the event of a breach of warranty or where the

buyer chooses or is forced to treat the breach of condition as a breach of warranty, the

buyer cannot reject the goods. He can set up the breach of warranty in extinction or

diminution of the price payable by him an dif the loss suffered by him is more than

the price, he may sue for damages (Section 59).

Therefore, in case of breach of warranty the buyer has two remedies: (i) he may

deduct from the price payable the loss suffered by him; or (ii) he may file a suit for

damages where the loss is more than the price.

If he has already paid the price, his only remedy is to bring an action for damages

suffered by him due to the breach of warranty. The measure of damages for breach of

warranty is the estimated loss directly and naturally resulting, in the ordinary course

of events, from the breach of warranty.

19.4.4 Repudiation of contract before the due date. Where the seller repudiates the

contract before the date of delivery, the buyer can (i) treat the contract as rescinded

and bring an action for damages; or (ii) wait till the actual date of delivery. If the

buyer chooses the first remedy, damages shall be assessed on the basis of the price

prevailing on that date and contract price. In case of second alternative, the contract

remains open for the benefit of both the parties. Not only the seller may subsequently

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choose to perform the contract but also damages will be assessed according to the

price prevailing on the day stipulated for delivery. If the buyer accepts repudiation of

contract as immediate breach, he must minimize the loss caused thereby. If the seller

cancels the contract the buyer is not required to wait till the due date. He can buy the

goods immediately from the market and wait if the prices are rising and thereby claim

damages for increased price on the due date. The buyer must act in a reasonable way

to mitigate the effects of breach (Section 60).

19.4.5 Interest by way of damages. Sometimes, the buyer has already made the

payment but the seller fails to deliver the goods. In such a case where the

consideration for the payment has failed, the buyer can recover the money paid for the

goods. He can also claim interest or special damages in any case where by law,

interest or special damages may be recoverable.

According to Section 61, in the absence of a contract that states otherwise, the Court

may permit interest to be charged at such rate as it thinks reasonable on the amount of

the price – to the buyer in a suit by him for the refund of the price in a case of breach

of contract on the part of the seller – from the date on which the payment was made.

Points to remember

Introduction

• There can be breach of contract either by the seller or by the buyer. Thus,

the main aspects covered in the lesson include (a) rights of the unpaid

seller; and (b) rights of the buyer, in case there is a breach by the seller.

Rights of the unpaid seller against goods.

The rights of an unpaid seller against goods will be different depending upon the

whether the property in goods has passed or not. Where the property has passed the

unpaid seller has the following three rights. These are:

! Right of Lien.

! Right of Stoppage in Transit

! Right of Re-sale.

Where the property of goods has not passed, the unpaid seller will have one right, i.e.

to withhold the delivery of the goods.

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Unpaid Seller’s Rights against the Buyer.

The unpaid seller has the following rights against the buyer. These are:

! Suit for Price

! Suit for Damages

! Cancellation of the Contract

! Suit for Interest

Remedies for the Buyer against the Seller.

In case, the seller has defaulted, the buyer will have the following remedies against

the seller:

1. Suit for Damages for non-delivery of goods.

2. Suit for Specific performance

3. Suit for Damages where there is a breach of warranty

4. Where the Contract is Cancelled before the due date by the Seller

5. Right of buyer to recover interest by way of damages

Questions

11. When can a seller of goods be deemed to be an unpaid seller? What are his

rights against the (a) goods; and (b) the buyer personally?

12. Explain the nature of right of lien. When can the unpaid seller exercise the

right of lien? Under what circumstances is the lien terminated?

13. Discuss the rules regarding the duration of transit. When does it comes to end?

14. What are the conditions required to be fulfilled for the exercise of the right of

stoppage in transit?

15. Can an unpaid seller exercise his right of lien or stoppage in transit on the

goods transferred by way of sale or other disposition by the buyer?

16. ‘The right of stoppage in transit is an extension of an unpaid seller’s right to

lien.’ Comment.

17. Distinguish between unpaid seller’s right of lien and right of stoppage in

transit. When can he resell the goods?

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18. What are the remedies available to the buyer in case of breach of a contract of

sale by the seller?

Practical Problems

Azad sells and consigns certain goods to Vikram for cash and sends

the Railway Receipt to him. Bhasker becomes insolvent and while the

goods are in transit he assigns the Railway Receipt to Madan, who

does not know that Bhasker is insolvent. Azad wants to exercise the

rights of stoppage in transit. Can he do so?

Answer: No he cannot do so. The unpaid seller’s right is defeated – Section

53(i)

Asharam sells and consigns certain goods to Kishor. Kishor assigns

bill of lading for these goods to Hardeep to secure the sum of

Rs.10,000 due from him to Hardeep. Kishore becomes insolvent. Can

Asharam stop the goods in transit?

Answer: Yes, he can stop the goods in transit, subject to right of Hardeep –

Section 53.

Imran of Agra orders Hansraj of Delhi to supply certain goods. The

stationmaster of Agra informs Imran about the arrival of goods but

before Imran could receive the goods, he is declared insolvent. Hansraj

wants to exercise his right of stoppage in transit. Can he do so?

Answer: No. The right of stoppage cannot be exercised as the transit has ended –

Section 51.

Mahesh sells and consigns certain goods to Naresh. Mahesh being still

unpaid, Naresh becomes insolvent while the goods are in transit.

Naresh assigns the bill of lading for cash to Arvind who knows that

Naresh is insolvent while the goods are in transit. Naresh assigns the

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bill of lading for cash to Arvind who knows that N is insolvent. Can

Mahesh stop the goods in transit?

Answer: Yes, he can stop the goods in transit as Arvind has not acted in good

faith.

Ramaswamy sold a quantity of rice to Shekhar, who made the payment

by cheque which was dishonored on presentation. Ramaswamy gave a

delivery order to Shekhar for the rice and Shekher resold it to Chetan

who acted in good faith and for consideration, by endorsing the

delivery order to Chetan. Ramaswamy refuses to deliver goods to

Chetan on the plea of non-payment of price. Advise Chetan.

Answer: In this case, Chetan can get the goods from Ramaswamy on

presentation of delivery order – Section 53.

References:

Books :

o P.P.S. Gogna; A text book of Mercantile Law, S.Chand & Co. 1999.

o Tulsian P.C.; Business Law, Tata McGraw Hill, New Delhi, 2007.

Websites:

! www.helplinelaw.com

! www.consumer-law.lawyers.com

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Part III The Negotiable Instruments

Act-1881

Lesson 20- Negotiable Instruments Act-1881

Lesson 21- Holder and Holder in Due Course

Lesson 22- Negotiation and Endorsement

Lesson 23- Crossing and Dishonour of Cheques

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Lesson – 20

Kinds and Characteristics of Negotiable Instruments

By

Deepti Singh

This lesson discusses the following aspects of Negotiable

Instruments:

20.1 Introduction

20.2 Meaning and definition of Negotiable Instruments

20.3 Characteristics of Negotiable Instruments

20.4 Presumptions about Negotiable Instruments

20.5 Relevant Provisions of RBI Act, 1934

20.6 Kinds of Negotiable Instruments

20.7 Promissory Note

20.8 Bill of Exchange

20.9 Cheque

20.10 Distinction between promissory note and bill of exchange

20.11 Distinction between bill of exchange and cheque

20.1 INTRODUCTION

The earliest foundation of trade was set when man realized the need for goods and

services, which he could not produce on his own. He felt the desire to possess the

things available with someone else and that let to idea of exchanging goods and

services. This exchange of goods and services is known as trade. In the past, goods

were exchanged on a one-to-one basis with the intent that the value of the goods

traded was of relatively equal value. This was known as barter system. Prior to the

establishment of currencies, barter was the most accepted form of commerce whereby

people exchanged goods and services as a consideration for trade. This had several

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limitations among which equality of value was most predominant which was

overcome by the introduction of money as a medium of exchange. With the

introduction of money as a medium of exchange all the goods and services were

valued in terms of money and traders materialized their transactions through payment

of money. As the volume and scale of transactions increased, money couldn’t remain

the only medium of exchange and need for supplements of money was felt as it

became both inconvenient and risky to carry out all transactions in cash. This led to

the emergence of a third category of medium of exchange such as bills of exchange,

cheques, bank drafts, hundis etc. collectively grouped as negotiable instruments. A

negotiable instrument is a written document, which entitles a person to a certain sum

of money, which can be transferred from one person to another by delivery or by

endorsement and delivery. The introduction of negotiable instruments made business

transactions much easier. It is no longer required to execute each and every

transaction in cash. The Negotiable Instruments Act, 1881 seeks to regulate the

dealings in such instruments, it aims to legalise the system under which negotiable

instruments pass from hand to hand in negotiation like ordinary goods.

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20.2 MEANING AND DEFINITION OF NEGOTIABLE INSTRUMENT

The meaning and definition of negotiable instruments are discussed below with

reference to some eminent jurists.

20.2.1 Meaning

The word “ negotiable” means transferable from one person to another by mere

delivery or by endorsement and delivery in return for consideration and “ instrument”

means a written document creating a right in favor of some person which may be a

duty for another. Therefore a ‘negotiable instrument’ is

a) a written document

b) signed by the maker or drawer of the instrument

c) that contains an unconditional promise or order to pay

d) a fixed amount of money ( with or without interest which may be a specified

amount or at a specified rate)

e) payable on demand or at a specified exact future date

f) to a specific person or to order or to its bearer

Illustration: Ganesh a rice dealer sells rice worth Rs. 40,000 to Shyam on

four months and to ensure that Shyam makes the paymen, Ganesh may

write an order addressed to Shaym that he is to pay after four months,

for value of goods received by him, Rs.40,000/- to Ganesh or anyone

holding the order and presenting it before him (Shyam) for payment. This

written document has to be signed by Shyam to show his acceptance of

the order. Now, Ganesh can hold the document with him for four months

and on the due date can collect the money from Shyam.

Therefore, a negotiable instrument must fulfill the following conditions:

a) The document must be freely transferable either by delivery (when it is

payable to the bearer of the document) or by endorsement and

delivery (when the document is payable to order).

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Illustration: If we continue with the previous illustration only, where the

instrument was with Ganesh for receiving payment from Shyam. Ganesh

can use the same to carry on other business transactions. For instance,

after a month, if required; he can borrow money from Ajeet for a period

of three months and pass on this document to Ajeet. He has to write on

the back of the document an instruction to Shyam to pay money toAjeet,

and sign it. Now Ajeet becomes the owner of this document and he can

claim money from Shyam on the due date. Ajeet, if required, can further

pass on the document to Ghanshyam after instructing and signing on the

back of the document. This passing on process may continue further till

the final payment is made.

b) The transferee taking the instrument in good faith and for consideration gets

a good title to the same even if the title of the transferor is defective.

Illustration: Kartik writes a negotiable instrument in favour of Chariter,

but before the due date it is stolen by Shakti who passes it to Geeta for

consideration by endorsing it to her (he forges Chariter’s signatures on

the document), Geeta accepts the document in good faith and for value.

Now on due date Geeta holds a good title to the instrument even if

Shakti’s title is defective.

c) The party holding the instrument should be entitled to maintain a suit thereon

in case the instrument gets dishonored while in his custody.

Illustration: Tinu writes a negotiable instrument in favor of Jai and later

doesn’t pay him on due date, Jai can sue Tinu in court of law for payment.

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20.2.2. Definition of Negotiable Instrument

The term negotiable instrument is not adequately defined in the Negotiable

Instruments Act. Some of the definitions given below throw light on various aspects

of a negotiable instrument.

Justice Willis: “A negotiable instrument is the one the property in which is

acquired by anyone who takes it bona fide and for value notwithstanding any

defect of title in the person from whom he took it.”217

Section.13 of the Negotiable Instrument Act states that a Negotiable Instrument

means a promissory note, bill of exchange or cheque payable either to order or to

bearer.

Though the act states these three as negotiable instruments, some other instruments

are also acceptable as a custom of trade or under some other acts like hundis, share

warrants, drafts, bearer bonds etc.

20.3 CHARACTERSTICS OF NEGOTIABLE INSTRUMENTS

The characteristics of negotiable instruments may be described as follows:

217

See Willis, William, 1835-1911 book “The Law of Negotiable Securities”, 5th

edition page 5, published by Stevens & Haynes, London

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1 Writing and Signed by Its Maker: A negotiable instrument being an

instrument must be in writing and signed by its maker. Therefore an oral

promise to pay certain sum at a future date with out any written document is

not enforceable in the eyes of law. Similarly if the maker does not sign the

instrument, it is not a valid negotiable instrument.

2 Unconditional: A negotiable instrument contains an unconditional promise or

order to pay some money. Therefore if payment of money is conditional to the

completion of some condition then it is not a valid negotiable instrument.

Illustration: If Ajay writes a negotiable instrument to pay Rs. 5000 to Garjun subject to the condition that Garjun stands first in the exam, then it is not a valid negotiable instrument as it is not unconditional.

3 Fixed Sum of Money: A negotiable instrument is a promise to pay a fixed

sum of money only, which may include interest at a fixed rate. Any promise to

pay an uncertain sum will not make a valid negotiable instrument.

Illustration: Sharda makes a negotiable instrument in favor of Alok, to

pay whatever dues she has to pay him; in this case, it is not a valid

instrument as the amount payable is not mentioned.

4 Transferable: A negotiable instrument is transferable easily from one person

to another any number of times. The instrument is freely transferable either by

delivery when it is payable to the bearer of the document or by endorsement

and delivery when the document is payable to order. Transferability is an

essential feature of negotiable instruments but all transferable instruments are

not negotiable instruments.

5 Absolute And Good Title: The transferee of a negotiable instrument who

receives it in good faith and for value gets the instrument free from all defects.

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He gets an absolute and good title irrespective of any defect in the title of the

transferor.

Illustration: Jack gets a negotiable instrument drawn in his favor by

Gaurav by way of using coercion and later endorses it in favor of Chetan

for value and Chetan accepts the same in good faith. Here, though the

title of Jack is defective but Chetan gets a good title to the instrument

and can receive payment from Gaurav.

6 Right to Recovery: The transferee has a right to recovery i.e. he can sue on

the instrument in his own name to enforce his rights. Moreover he need not give

any notice of transfer to the party liable on the instrument.

Illustration: Padma receives a negotiable instrument drawn in her favor

from Rajesh, she endorses it to Jatin who further endorses it in favor of

Hiten. Rajesh refuses to pay Hiten stating that Padma did not inform him

about endorsements. Hiten can sue Rajesh for recovery in his own name.

There is no obligation to inform Rajesh.

7 The operations regarding the negotiable instruments are based on certain

presumptions, unless the contrary is proved. These presumptions are discussed

below.

20.4 PRESUMPTIONS ABOUT NEGOTIABLE INSTRUMENTS

Section 118 and 119 of the negotiable Instrument Act provide the following

presumptions, which are applicable to all negotiable instruments unless something to

the contrary is proved.

1 Consideration: It is presumed that every negotiable instrument has

been made or drawn or accepted or endorsed or negotiated or transferred

for consideration. This holds both for the original parties as well as for

subsequent parties.

2 Date: In case a negotiable instrument bears a date, it is presumed that

it was drawn on the date which appears on it.

455

3 Time of Acceptance: In case of a Bill of Exchange, it is presumed that

it was accepted within a reasonable time after its date and before its

maturity.

4 Time of Transfer: It is presumed that every transfer of a negotiable

instrument was made before its date of maturity.

5 Order of Endorsements: It is presumed that the endorsements

appearing on a negotiable instrument have been made in the order in

which they appear on the instrument.

6 Stamp: Unless the contrary is proved, it is presumed that a lost

negotiable instrument was duly stamped.

7 Holder in Due Course: It is presumed that every holder of the

instrument is a ‘holder in due course’.218

20.5 RELEVANT PROVISIONS OF RESERVE BANK OF INDIA ACT 1934

At this stage it is essential to understand the importance of R.B.I Act,

particularly section 31 of the Act, which clearly proves the supremacy of

the Central Government over the issue of national currency. The said

section states that:

(1) No person in India other than the Bank, or, as expressly authorised by Reserve

Bank of India Act the Central Government shall draw, accept, make or issue any bill

of exchange, hundi, promissory note or engagement for the payment of money

payable to bearer on demand, or borrow, owe or take up any sum or sums of money

on the bills, hundis or notes payable to bearer on demand of any such person.

Provided that cheques or drafts, including hundis payable to bearer on demand or

otherwise, may be drawn on a person's account with a banker, shroff or agent.

218

In case of a dispute, the party liable for payment has to prove that the person

holding the instrument is not a holder in due course. If it is proved that the instrument

was obtained from its lawful owner by means of fraud or offence or for unlawful

consideration then the holder has to prove that he is a holder in due course i.e. he

received it in good faith, for some value and before its maturity date.

456

• This means that a bill of exchange or hundi cannot originally be made payable

to ‘bearer on demand’. It may be a ‘time’ bill payable to bearer or order; as a

‘demand’ bill payable to order. However, a cheque payable to bearer on

demand can be drawn on person’s account with a banker.

(2) Notwithstanding anything contained in the Negotiable Instrument Act, 1881 (26

of 1881), no person in India other than the Bank or, as expressly authorised by the

Reserve Bank of India Act, the Central Government shall make or issue any

promissory note expressed to be payable to the bearer of the instrument.

• A promissory note cannot be originally made payable to bearer.

The above provisions do not apply to an order instrument which becomes payable

to bearer by an endorsement in blank.

20.6 KINDS OF NEGOTIABLE INSTRUMENTS

There are many kinds of negotiable instruments but the Act has considered only

three namely a promissory note, bill of exchange and cheque. Apart from these

three, any document which fulfills the requirements of a negotiable instrument is

recognized by the custom or usage or some other Act as negotiable instrument.

These include hundis, treasury bills, banker’s drafts and pay orders, share warrants,

dividend warrants, bearer debentures, Government Promissory Notes are considered

as negotiable instruments as a usage or custom of trade or Companies Act. Further,

Sec 137 of Transfer of Property Act also recognizes the negotiability of instruments

‘by law or custom’. 219

20.7 PROMISSORY NOTE

A promissory note is an unconditional promise in writing made by one person

(maker) to another person( payee), signed by the maker, engaging to pay, on demand

219

Certain documents like postal orders, money orders deposit receipts, share

certificates, debenture certificates do not come under the category of negotiable

instruments as they are not transferable by delivery or endorsement and delivery.

However the documents like railway receipt, dock warrants and bill of landing come

under the category of quasi-negotiable instruments as they are transferable by delivery

or endorsement and delivery but the transferee doesn’t get a title better than the

transferor which happens in case of negotiable instruments.

457

or at a fixed or determinable future time, a sum certain in money to, or to the order of,

a specified person or to the bearer.

Illustration 1: Suppose Rahul takes a loan of Rupees Twenty Thousand

from his friend Hardik. Rahul can make a document stating that he will

pay the money to Hardik or the bearer on demand. Or Rahul can mention

in the document that he would like to pay the amount after three months.

This document, once signed by Rahul, duly stamped and handed over to

Hardik, becomes a negotiable instrument. Now Hardik can personally

present it before Rahul for payment or give this document to some other

person to collect money on his behalf. He can endorse it in somebody

else’s name who in turn can endorse it further till the final payment is

made by Rahul to whosoever presents it before him. This type of a

document is called a Promissory Note.

Illustration 2: Mithit purchased 100 meters of cloth worth Rs.40,000

from his supplier Vineet, he could not pay the amount immediately so he

made a document stating that he will pay Rs.40,000 after 2 months to

Vineet or the bearer on demand. He signed and stamped the document.

This document becomes a promissory note. After 2 months Mithit is

under the obligation to pay the amount mentioned on the promissory note

(Rs.40,000) to Vineet or to anybody authorized by Vineet through

endorsement on the promissory note.

Section 4 of the Negotiable Instruments Act, 1881 defines a promissory note as

‘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 to the order of a certain person or to the bearer of the instrument’.

Note:- Bank notes and currency notes do not come under the category of promissory

notes (as they are expressly excluded from the definition). Further, the words ‘or to

458

the bearer’ are redundant by virtue of the provisions of sec.31 of RBI Act, the same

has been discussed in 20.5 above.

20.7.1 Parties to a Promissory Note

The following is a specimen of a valid promissory note.

Rs. 30,000/- New

Delhi

September 25,

2008

On demand, I promise to pay Roshan Lal, s/o Ram Lal of Hissar or order a sum of

Rs 30,000/- (Rupees Thirty Thousand only), for value received.

To , Roshan Lal sd/-

Address……..

Stamp

Mandeep

There are primarily two parties involved in a promissory note. They are-

i. The Maker or Drawer – the person who makes the note and promises to pay the

amount stated therein. In the above specimen, Mandeep is the maker or drawer.

ii. The Payee – the person to whom the amount is payable. In the above specimen it is

Roshan Lal.

a. The Endorser – the person who endorses the note in favour of another person. In

the above specimen if Roshan Lal endorses it in favour of Ranjeet and Ranjeet also

endorses it in favour of Jaiveer, then Roshan Lal and Ranjeet both are endorsers.

b. The Endorsee – the person in whose favour the note is negotiated by endorsement.

In the above, it is Ranjeet and then Jaiveer.

459

20.7.2 Features of Primissory Note

The features of a promissory note are discussed below:

1. A promissory note must be in writing, duly signed by its maker and properly

stamped as per Indian Stamp Act, 1899 and each stamp must be duly cancelled.

Therefore an oral promise may be a valid contract but cannot be considered a valid

promissory note. Writing may be in ink or pencil or a typewritten note. Similarly

mere writing in own hand is not sufficient, the signature of the maker must be there, if

the maker is illiterate then his thumb impression must be there to constitute a valid

promissory note. It must be noted that an agent of a trading firm can sign a

promissory note on its behalf.

Illustration: Shyam writes on a paper

“Mohan I promise to pay you Rs. 3000”.

Does this constitute a valid promissory note?

Ans. No, because shyam has not signed the note.

2 It must contain an undertaking or express and clear promise to pay. Mere

acknowledgement of indebtedness will not constitute a promissory note. Therefore an

IOU document is not a promissory note.220

220 An IOU is an informal acknowledgement of a small debt, usually between friends, co-workers or

family members. The name IOU comes from the literal phonetic spelling of "I Owe You." An IOU is

not the same as a formal promissory note or other financial contract. There are rarely any witnesses to

the drafting of an IOU, and the repayment obligations may or may not be spelled out directly.

Enforcing an informal IOU in court may prove to be difficult, since the document may not be notarized

or even acknowledged by the debtor. An IOU is considered an acknowledgement of a debt, but the sum

total may be so negligible that legal collection actions would be counterproductive.

460

Illustration: Rohan draws the following note

14/10/2008 Haridwar

I am bound to pay Rs. 8000 to Karim which I received from him.

To karim sd/- Rohan

Stamp

Is it a valid promissory note?

Ans. No, because there is no express promise to pay. It is an

acknowledgement of debt.

A receipt mentioning terms and conditions on which money has been borrowed will

not be a promissory note. It would be treated as an acknowledgement of debt. If the

receipt is accompanied with a promise to pay, it is a promissory note. The main

element in determining whether an instrument is a promissory note or not, is the

intention of parties in drawing up that instrument as a promissory note. A receipt even

if coupled with a promise to pay was held not to be a promissory note as it was not

intended to be a promissory note.221

Case Law 1:

:In Surjit Singh v. Ram Rattan the instrument read- “I have received a sum of Rs.

9,000 from R.R.Shrma. This amount will be repaid on demand. I have received this

amount in cash.” It was held to be a promissory note as there was a clear promise to

pay.222

3 The promise must be definite and unconditional. If the promise is uncertain or

conditional to the happening of an uncertain event then the instrument is invalid.

Illustration: Amit writes a promissory note “I promise to pay Ramu Rs.

40,000 on Girish’s death, provided Girish leaves me enough amount to pay

to Ramu in his will.” Is this a promissory note?

221

Akbar Khan v. Attar Singh, A.I.R. (1936),PC 171 222

A..IR (1975), Gau. 15

461

Ans. No, as the promise is contingent upon the happening of an uncertain

event, Girish leaving enough money for Amit. It cannot be a valid

promissory note.

However, if the promise to pay is subject to a condition which according to ordinary

experience of mankind is bound to happen, then it doesn’t render the instrument

invalid. Moreover a note promising to pay at a particular place or after a specified

time is not conditional and hence valid.

In the above illustration if Amit writes a promissory note “I promise to pay

Ramu Rs. 40,000 at India Gate, Delhi on Girish’s death,” then it is a valid

instrument.

4 It must contain a promise to pay in terms of legal tender money only. If the

instrument promises to pay something other than or in addition to money, it will not

be a valid promissory note. The following notes signed by Harish are not valid

promissory notes

• ‘I promise to pay to Jatin Rs. 20,000 and deliver my Santro car to him on next 23rd

January.

• I promise to pay to Jatin in form of 40 Shares of a XY Ltd. company and 20 units

of a Mutual Fund.

• I promise to deliver 20 crates of soft drink to Jatin.

• I promise to deliver an air ticket to France to Jatin.

5 The sum payable mentioned must be certain or capable of being made certain. It

means that the sum payable may be in figures or may be such that it can be calculated.

It must not be capable of contingent additions and subtractions. However, sec 5 para 3

of the act states, where the determination of the amount is to be based on some

interest calculation or an exchange rate or that the payment would be in instalments,

the promissory note would be valid.

Illustration 1: the following notes are invalid in this respect:

• I promise to pay to Karan Rs.9,000, after deducting any amount

which he may owe to me till 31st January next.

462

• I promise to pay to Kartik RS.9,000 and any fine and financial

charges according to rules.

Illustration 2: Cheenu signed a note stating, ‘I promise to pay Shalu

Rs.10,000 in 10 monthly instalments of Rs. 100 each on the first of every

month. If I default in payment of any instalment on the due date, the

whole balance unpaid shall become due.’ Is this a valid promissory note in

the current context?

Ans. Yes, it is valid as there is no uncertainty regarding the amount

payable.

Illustration 3: Kartik sign a note, ‘I promise to pay to Tanvi Rs. 20,000

along with simple interest @ 12% per annum.’ Is this a valid promissory

note?

Ans. Yes, interest calculation does not make the amount uncertain.

6 The parties to a promissory note, i.e. the maker and the payee must be certain.

They must be identified in the instrument itself, the parties may be identified by name

or by designation e.g. manager of a bank or director of a company. If the payee is

misnamed or designated by description only, in such case, the note is valid if the

payee can be ascertained by evidence.223

If there are joint makers of a note, their nature of liability should be clear-joint or

several or both. However, if they bind them alternatively for e.g. a note signed by two

persons as: Dinesh or Pankaj, then this is not allowed and only the first signatory i.e.

Dinesh shall be liable.

7 A promissory note may be payable on demand or after a certain date. For example,

if it is written ‘three months after date I promise to pay Saroj or order a sum of rupees

Ten Thousand only’ it is a promissory note. Payable on demand means payable

immediately or forthwith.

223

Willis v. Barret,(1816) 2 stark 29.

463

8 There may be other formalities like number, place, consideration etc. are usually

found in an instrument although they are not essential in law. The omission of such

information does not invalidate the instrument.

20.8 BILL OF EXCHANGE

A bill of exchange is an order in writing directing a person to pay a sum of money to a

specified person.

Section 5 of the Negotiable Instruments Act, 1881 defines a bill of exchange as ‘an

instrument in writing containing an unconditional order, signed by the maker,

directing a certain person to pay a certain sum of money only to or to the order of a

certain person, or to the bearer of the instrument’.

Illustration: Suppose Rishit has given a loan of Rupees Thirty Thousand

to Govind, which Govind has to pay back to Rishit. Now, Rishit also has to

give some money to Sanjeev. In this case, Rishit can make a document

directing Govind to make payment up to Rupees Thirty Thousand to

Sanjeev on demand or after expiry of a specified period. This document

is called a Bill of Exchange, which can be transferred to some other

person’s name by Sanjeev.

Acceptance of a bill of exchange by the drawee must be in writing only, it may be by

simply putting up signatures on the bill or writing words such as ‘accepted’ on the bill

and signing the bill.

20.8.1 Parties to a Bill of Exchange

The following is a specimen of a bill of exchange:

Rs.50,000 Jaipur, October 21, 2008

Three months after date, pay to Girish or order the sum of Rs. Fifty thousand only,

for value received.

To Tarun Accepted

sd/-

stamp

Maneet

464

15, West avenue, Punjabi Bagh, New Delhi Tarun

The above bill is drawn by Maneet, who is ordering Tarun to pay Rs. 50,000 to Girish

(to whom he is indebted for the same amount) in lieu of goods delivered by Maneet to

Tarun.

There are three parties involved in a bill of exchange. They are:

i. The Drawer – The person who makes the order for making payment. He is the

maker of the bill. In the above specimen it is Maneet.

ii. The Drawee – The person to whom the order to pay is made. He is generally a

debtor of the drawer and when he accepts the bill he becomes the ‘acceptor’ and is

liable on it. It is Tarun in the given specimen, to whom the bill of exchange is

addressed.

iii. The Payee – The person to whom the payment is to be made. In the given

specimen it is Girish.

iv. Drawee in case of need-When in the bill or any endorsement thereon the name of

any person is given in addition to the drawee to be referred to in case of need, such

person is called drawee in case of need. Drawee in case of need is resorted to only

when the bill is dishonored by non-acceptance or non-payment.

20.8.2 Features of a Bill of Exchange

Although a bill of exchange and a promissory note are different in form, the essential

requirements are more or less the same.

1 A bill must be in writing, duly signed by its drawer, accepted by its drawee and

properly stamped as per Indian Stamp Act.

2 It must contain an express order to pay. The only difference between a promissory

note and a bill of exchange is that the maker of a note pays the payee personally,

rather than ordering a third party to do so. Moreover, a mere request or reminder to

pay money is not bill of exchange

Illustration 1: A bill of exchange states ‘ Mr. Raj please pay to Gita or

order Rs. 9,000 and oblige. Is it a valid bill of exchange?

Ans. Yes it is valid as there is an order to pay made in a polite language.

465

Illustration 2: A bill of exchange states ‘Mr. Raj please let Gita have Rs.

9,000 and oblige. Is it a valid bill of exchange?

Ans. No, it is not a bill of exchange as it contains only a request not an

order to pay.

3 The order must be definite and unconditional.

4 It must contain an order to pay in terms of legal tender money only.

5 The order must be to pay a definite sum of money.

6 The parties to a bill must be certain.

7 The formalities relating to number, date, place and consideration, though usually

found on a bill are not necessary in law and hence their omission does not

have any effect on its validity.

• Note- A bill of exchange can be originally be drawn as ‘payable to the bearer’

but then it cannot be simultaneously be made ‘payable on demand’ to comply

with Sec.31 of R.B.I Act, 1934. Hence, there can be no bill payable to bearer

on demand. But there can be a bill payable on demand to a payee.

• A bill which is not expressly made to be payable on demand is entitled to

three days of grace with respect to date of maturity.

Illustration: A Bill of Exchange dated 12th July 2008 was payable 2

moths after date, it would mature for payment on 14th September

2008.

20.9 CHEQUE

Cheque is a very common form of negotiable instrument. Anybody who has a savings

bank account or current account in a bank, can issue a cheque in his/her own name or

in favour of others, thereby directing the bank to pay the specified amount to the

person named in the cheque. Therefore, a cheque may be regarded as a bill of

exchange; the only difference is that the bank is always the drawee in case of a

cheque and it is always payable on demand. Actually, a cheque is an order by the

account holder of the bank directing his banker to pay on demand, the specified

amount, to or to the order of the person named therein or to the bearer.

466

The Negotiable Instruments Act, 1881 defines a cheque as ‘a bill of exchange drawn

on a specified banker and not expressed to be payable otherwise than on demand

and it includes the electronic image of a truncated cheque and a cheque in

electronic form.’

• A cheque in electronic form means a cheque which contains the exact mirror

image of a paper cheque, and is generated , written and signed in a secure

system ensuring the minimum safety standards with the use of digital

signature (with or without biometric signature) and asymmetric crypto

system;

• A truncated cheque means a cheque which is truncated during the course of a

clearing cycle, either by the clearing house or by the bank whether paying or

receiving payment, immediately on generation of an electronic image for

transmission , substituting the further physical movement of cheque in

writing.

• For the purpose of this section. The expression “clearing house” means the

clearing house managed by the Reserve Bank of India or a clearing house

recognized as such by the RBI.

20.9.1 Parties to a cheque

v. The Drawer – The person who draws the cheque. He is the maker of the

cheque. In the specimen it is Mrs. Singh.

ii. The Drawee – The banker on whom the cheque is drawn and who is directed

by the maker to make the payment of the amount mentioned on the cheque. In the

specimen cheque it is BSBO bank.

iii. The Payee – The person to whom the payment is to be made. In the specimen

cheque it is Mr. Rishit

The drawer can be the payee also if he draws a cheque payable to self.

467

20.9.2 Features of a cheque

1 A cheque must be in writing and duly signed by the drawer.

2 It contains contains an unconditional order.

3 It is issued on a specified banker only.

4 The amount specified is always certain and must be clearly mentioned both in

figures and in words

5 The payee is always certain.

6 It is always payable on demand.

7 The cheque must bear a date otherwise it is invalid and shall not be honored by

the bank.

20.9.2 Revocable mandate - A cheque is a revocable mandate or authority to the

drawer’s bankers to pay money and the authority may be revoked any time until

presentation clearance by the bank by countermanding payment.224

Illustration: Puneet had drawn a cheque in favour of his friend Jasmeet

as a gift on his birthday. Puneet can revoke this cheque or issue stop

pament orders for that cheque at any time before it is presented for

payment by Jasmeet and the cheque would not be cleared by the banker.

• Drawer's liability not discharged by non-payment - If the payee does

not present the cheque within the stipulated time, the drawer is not

224

It must be noted that a cheque that is issued against consideration received is a

binding and any revocation of such cheque can be challenged for payment in the

court.

468

discharged from liability, unless drawer has sustained damages by non-

presentation of the cheque.

• Drawn on balance - The cheques are presumed to be drawn on the

balance in the hands of the banker. However, the drawer can draw a

cheque on credit, if the banker has allowed credit to the drawer.

20.9.3 Types of Cheque

Broadly speaking, cheques are of four types.

• Open cheque, and

• Crossed cheque.

• Bearer cheque

• Order cheque

Let us know details about these cheques.

• Open cheque: A cheque is called ‘Open’ when it is possible to get cash over

the counter at the bank. The holder of an open cheque can do the following:

i. Receive its payment over the counter at the bank,

ii. Deposit the cheque in his own account

iii. Pass it to some one else by signing on the back of a cheque.

• Crossed cheque: Since open cheque is subject to risk of theft, it is dangerous

to issue such cheques. This risk can be avoided by issuing another type of

cheque called ‘Crossed cheque’. The payment of such cheque is not made over

the counter at the bank. It is only credited to the bank account of the payee. A

cheque can be crossed by drawing two transverse parallel lines across the

cheque, with or without the writing ‘Account payee’ or ‘Not Negotiable’.

• Bearer cheque: A cheque which is payable to any person who presents it for

payment at the bank counter is called ‘Bearer cheque’. A bearer cheque can be

transferred by mere delivery and requires no endorsement. It must never be

crossed.

• Order cheque: An order cheque is one which is payable to a particular

person. In such a cheque the word ‘bearer’ may be cut out or cancelled and the

word ‘order’ may be written. The payee can transfer an order cheque to

someone else by signing his or her name on the back of it. Following is a

specimen of an order cheque whereby mrs. Singh issued an order cheque in

favour of Mr. rishit or his order, he can endorse this cheque to anyone by

signing his name on the back of the cheque.

469

There is another categorization of cheques which is discussed below:

• Ante-dated cheques:- Cheque in which the drawer mentions the date

earlier to the date of presenting if for payment. For example, a cheque

issued on 20th March 2008 may bear a date 5th March 2008.

• Stale Cheque:- A cheque which is issued today must be presented before

at bank for payment within a stipulated period. After expiry of that period,

no payment will be made and it is then called ‘stale cheque’.

• Mutilated Cheque:- In case a cheque is torn into two or more pieces and

presented for payment, such a cheque is called a mutilated cheque. The

bank will not make payment against such a cheque without getting

confirmation of the drawer. But if a cheque is torn at the corners and no

material fact is erased or cancelled, the bank may make payment against

such a cheque.

• Post-dated Cheque:- Cheque on which drawer mentions a date which is

subsequent to the date on which it is presented, is called post-dated

cheque. For example, if a cheque presented on 3rd

April 2008 bears a date

of 25th May 2008, it is a post-dated cheque. The bank will make payment

only on or after 25th May 2008.

470

20.10 DISTINCTION BETWEEN PROMISSORY NOTE AND BILL OF

EXCHANGE

The following are the points of distinction between a promissory note and a bill of

exchange:

POINT OF

DISTINCTION

PROMISSORY NOTE BILL OF EXCHANGE

Parties In case of a promissory note

there are two parties namely the

maker and the payee.

In case of a bill, there are three

parties: the drawer, the drawee

and the payee.

Promise and

order

A note contains an

unconditional promise to pay.

A bill contains an unconditional

order to pay.

Liability of

maker

Liability of maker of a note is

absolute and primary

The liability of the drawer of a bill

is secondary and conditional to

dishonor by drawee.

Payable to the

maker

A note cannot be made payable

to the maker himself

In case of a bill the drawer and the

payee can be one and the same

person.

Acceptance A note does not require any

acceptance of the maker before

it is presented for payment

A bill generally requires the

acceptance of the drawee before it

is presented for payment.

Payable to

bearer

A note can never be made

‘payable to bearer’

A bill can be made payable to

bearer but in no case there can be

a bill ‘payable to bearer on

demand’.

Notice of

dishonor

There is no need of a notice of

dishonor to the maker in case of

a note as he, himself has

dishonored it.

In case of a bill, the notice of

dishonor must be given by the

holder to all the prior parties who

are liable to pay the money.

Protest for

dishonor

No protest is required in case of

dishonor of a foreign note.

Foreign bills must be protested for

dishonor when such protest is

required by law of the place where

they are drawn

471

20.11 DISTINCTION BETWEEN A BILL OF EXCHANGE AND A CHEQUE

The distinction between a bill of exchange and a cheque is given below:

POINT OF

DISTINCTION

BILL OF EXCHANGE CHEQUE

Drawee A bill can be drawn on any

person including a banker.

A cheque is always drawn on a

banker who is a custodian of the

drawer’s money.

Payable on

Demand

A bill may be payable on

demand or after the expiry of

a certain period.

A cheque is always payable on

demand.

Grace period A bill which is not expressly

made to be payable on

demand is entitled to three

days of grace with respect to

date of maturity.

A cheque is always payable on

demand and hence there is no such

grace period.

Acceptance A bill may be required to be

accepted before payment can

be demanded from the

drawee.

A cheque does not require any such

acceptance as the drawee is the

banker of the drawer only and hence

his agent.

Payable to

Bearer on

Demand

A bill cannot be made

payable to bearer on demand.

A cheque can be made payable to

bearer on demand.

Stamp A bill requires a stamp to be

affixed on it.

A cheque does not require any

stamp.

Protest for

Dishonor

A bill may be noted or

protested for dishonor.

A cheque is not required to be noted

or protested for dishonor.

Crossing There is no provision of

crossing in case of a bill.

A cheque can be crossed and in that

case payment can be received only

through a bank account.

Countermanding

Payment

Payment cannot be

countermanded in case of bill

of exchange.

The drawer of a cheque can request

stop payment and hence payment

can be countermanded.

It must be noted that ‘all cheques are bills of exchange but all bills of exchange are

not cheques’.

472

20.12 Points to remember

Introduction

• The negotiable instruments Act was passed in 1881.

• It aims to legalise the system under which negotiable instruments pass from

hand to hand.

Meaning and Definition

• A Negotiable Instrument means a promissory note, bill of exchange or

cheque payable either to order or to bearer.

• It must be freely transferable either by delivery (when it is payable to the

bearer of the document) or by endorsement and delivery (when the

document is payable to order).

• The transferee taking the instrument in good faith and for consideration

gets a good title to the same even if the title of the transferor is defective.

• The party holding the instrument should be entitled to maintain a suit

thereon in case the instrument gets dishonored while in his custody.

Characterstics Of Negotiable Instruments

• Writing and Signed by Its Maker

• Unconditional

• Fixed Sum of Money

• Transferable

• Absolute And Good Title

• Right to Recovery

Presumptions about Negotiable Instruments

• Consideration

• Date

• Time of Acceptance

• Time of Transfer

• Order of Endorsements

• Stamp

• Holder in Due Course

Relevant Provisions of RBI Act 1934

• A bill of exchange or hundi cannot originally be made payable to ‘bearer on

demand’.

• A promissory note cannot be originally made payable to bearer.

Kinds of Negotiable Instruments

473

• Promissory note

• Bill of exchange

• Cheque

Promissory Note

• An unconditional promise in writing made by one person (maker) to another

person( payee)

• Signed by the maker

• Stamped

• Promise to pay

• On demand or at a fixed or determinable future time

• A sum certain in money

• Pay in terms of legal tender money only

• To, or to the order of, a specified person or to the bearer.

• The parties i.e. the maker and the payee must be certain.

Bill Of Exchange

• An order in writing directing a person to pay a sum of money to a specified

person.

• Duly signed by its drawer

• Accepted by its drawee

• Properly stamped

• Express order to pay

• Definite sum of money

• Definite and unconditional order

• Parties to a bill must be certain

Cheque

• A bill of exchange drawn on a specified banker and not expressed to be

payable otherwise than on demand

• Includes the electronic image of a truncated cheque

• Includes a cheque in electronic form

• issued on a specified banker only

• The amount specified is always certain and must be clearly mentioned

• The payee is always certain.

• Must bear a date

• Types -Open cheque, Crossed cheque, Bearer cheque, Order chequ

474

20.13 Questions

Objective type questions

State whether the following are true or false;

9. A negotiable instrument is transferable from one person to another by mere

delivery or by endorsement and delivery in return for consideration.

10. A negotiable instrument does not pass a title better than that of the transferor.

11. There can be no bearer promissory note.

12. There can be a bill of exchange payable to bearer on demand.

13. There can be a cheque payable to bearer on demand.

14. A bank cannot be the drawee of a bill of exchange.

15. There are only three types of negotiable instruments.

16. The amount of a promissory note should be fixed.

17. Calculation of interest renders the amount uncertain.

18. The status of the maker of promissory note and bill of exchange is same in

terms of liability of payment.

Answers

1.T; 2.F; 3.T; 4.F; 5.T; 6.E; 7.F; 8.T; 9.F; 10.F.

Questions

1. What is a negotiable instrument? Explain its important characteristics.

2. What are the various presumptions as to a negotiable instrument?

3. What is a promissory note? What are the various parties to it?

4. Can an acknowledgement of debt be considered a promissory note? Explain

with illustration.

5. Why promissory notes and bills of exchange are called negotiable

instruments?

6. What are the essential features of a cheque?

7. How is a promissory note different from a bill of exchange?

8. How is a cheque different from a bill of exchange?

475

9. What are various types of cheques?

Practical problems

1. A bill is drawn, payable at 19, The Groove, Gurgaon but does not contain the

name of the drawee. Bharti who resides at the mentioned address accepts the

bill. Is it a valid bill?

Answer: Yes, when Bharti accepts the bill, she hold out by acceptance that she is

the person to whom the bill is directed and hence would be liable on the bill.(Gray

v. Milner (1819) 2 Taunt 739)

2. Pawan owed Rs. 10000 to Gunjan, he wrote a pronote in favor of Gunjan,

signed and stamped it but did not mention the amount on it. Gunjan wrote Rs.

18000 as the amount to be recovered. Can Gunjan recover Rs. 18000 from

Pawan? Suppose Gunjan transferred the note in favor of Dheeraj a holder in

due course, can Dheeraj recover Rs. 18000 on it?

Answer: Gunjan cannot recover RS. 18000 as he had committed a fraud but

Dheeraj can recover Rs. 18000 as he is a holder in due course and hence gets a

title better than that of gunjan.

3. Tinku receives a negotiable instrument drawn in his favor from Rajesh, he

endorses it to Jatin who further endorses it in favor of Pinku. Rajesh refuses to

pay Pinku stating that Tinku did not inform him about endorsements. Can

Pinku can sue Rajesh for recovery in his own name.

Answer: Yes, he can as there is no obligation to inform Rajesh regarding any

endorsement of the instrument.

4. .Ajay drew a bill on jai in favor of Manu. The bill was payable on demand.

When Manu sought to present the bill for acceptance/payment, he realized that

there was no such person as Jai at the given address. Is this a valid bill? To

whom should Manu go for recovery?

Answer: No, this bill is not valid as one of the parties to bill (the drawee) is not

certain. Manu should go to Ajay for payment.

476

5. A bill of exchange dated 1st Jan 2008 was payable 3 months after due date.

When would the bill mature for payment? If it is a bill payable on demand,

then what is the date of maturity?

Answer: the bill becomes payable on 3rd

April 2008 as three days grace period is

available for a time bill. If it is payable on demand then it becomes payable on the

day it is presented for payment.

References

Books:

N.D.Kapoor(2006,) “ Business law”, Sultan Chand & Sons, New Delhi.

P.R.Chandra(2007), “Business Law”, Galgotia Publishing Company, New Delhi.

M.C.Kucchal(2003),”Mercantile law”, Vikas Publishing House(P) Ltd., New Delhi.

Avtar Singh(2004), “The Principles of Mercantile Law”, Eastern Book Company,

Lucknow.

Websites:

www.netlawman.co.in

www.legallight.in

477

Lesson- 21

Holder and Holder in Due Course

by

Preeti Singh

This lesson provides the differences between holder and holder

in due course and their privileges.

21.1 Holder

21.2 Holder in Due Course

21.3 Distinction between Holder and Holder in Due Course

21.4 Privileges of a Holder and Due Course

21.1 HOLDER

Section 8 of Negotiable Instruments Act, defines a holder as “any person entitled in

his own name to the possession thereof and to receive or recover the amount due

thereon from the parties thereto”. The person whose name is in the bill of exchange /

promissory note / cheque or to whose order, the specific amount on it is payable is the

payee. The payee therefore is the original party to the negotiable instrument. Under

the Bills of Exchange Act 1882 it is essential to have possession of the instrument but

under the Indian Law it is not necessary to posses it but he should have an entitlement

to the possession of the instrument even if he does not have actual possession of it.

This means that he requires dejure and not defacto possession of the instrument. He

has two options:

To be entitled to keep in his possession the instrument and to receive the

money specified on it. In this case he has the rights of being a holder of the

instrument.

To negotiate the instrument to another person to whom he has to pay money in

discharge of his liability. In this case the rights of the holder will be

478

transferred to the person on whose name the instrument has been negotiated

and endorsed.

In order to be a holder two conditions must be satisfied. These are the following:

He must be entitled to the possession of the instrument in his own name.

He must be entitled to receive or recover the amount due thereon from the

parties liable thereto.

21.1.1 He must be entitled to the Possession of the Instrument in His Own Name

(i) Identity of holder: A holder should identify himself with a legal or a valid title.

Entitlement to possession of an instrument is not a sufficient proof of identity. If it is a

bearer instrument the holder must be the person who is the original payee or the

person to whom the instrument has been endorsed.

(ii) Possession by gift or inheritance: A person who has in his possession an

instrument because of receiving a gift or by inheritance becomes a holder due to

operation of law. He is entitled to posses the instrument in his own name.

(iii) Possession as assignee: In case of an assignment an assignee of a bill /

promissory note does not become a holder unless it has been endorsed in his favour or

it is payable to order. However, the assignee has a right to sue on the instrument.

(iv) Identity by English and Indian Law: According to the English Law an endorsee

who is making a collection on behalf on another can become a holder. Whereas

according to a Indian Law it is not allowed.

(v) Possession by forging instrument: A person who finds a lost instrument or a thief

who forges the instrument cannot acquire legal title thereto and he is not entitled to

have possession of this instrument in his own name. A person who claims to be a

trustee or a guardian in whose favour instrument is drawn in placed of the beneficiary

does not have the right to be a holder because he is not entitled to possess the

instrument in his name.

Illustration: Raju finds a promissory note and forges it by putting his signature. He

does not become entitled to the rights of a holder as he is a thief and he cannot

acquire legal title to it. Therefore he cannot claim any funds on it.

479

21.1.2 He must be entitled to Receive or Recover the Amount Due Thereon from

the Parties Liable Thereto

(i) Clear title: The person should be legally and lawfully entitled to receive or recover

money. The instrument should have a clear title. Only in that condition will he be able

to give a valid discharge to the payer. If the instrument is under a legal process and

the right to recover money is not possible because of legal problems, the person

cannot be called a holder.

(ii) Title in case of losses and natural calamities: In case of a fire, earthquake, storm

or any form of destruction the negotiable instrument is lost or destroyed, the

entitlement to the instrument will be that of the holder who was entitled to the

instrument. A person who finds this instrument and wrongfully decides to keep it

cannot be a holder.

(iii) Title of agent: This rule also applies to an agent who holds an instrument for his

principal. He cannot be called a holder even though he may have the powers to

receive payment on behalf of the lawfully entitled holder. A person who is an

employee or an agent can receive a negotiable instrument on behalf of his employer

but he cannot sue in his own name for the instrument. Therefore he cannot be a holder

of the instrument.

Illustration: Latika receives a cheque from Karan for Rs 23000/-. She is entitled to

recover the money as payee. When she wants to recover the amount she found that

there was a dispute and it was under legal consideration in the court. Only after it

was cleared would it be possible for her to receive the money.

In such a state her legal entitlement is questionable and she cannot be called a

holder.

A holder has a premium position in the case of negotiable instruments. Only he has

the right to become a holder in due course. According to Sections 46 and 48, the

holder possesses the right to negotiate the instrument further to another person and

under Section 78 to give a valid discharge to the acceptor of the instrument.

480

21.2 HOLDER IN DUE COURSE

A negotiable instrument has the benefit of easy transferability. According to Section 9

of the Negotiable Instrument Act, a holder in due course is a person who possesses

for some consideration the bill of exchange, promissory note or cheque if payable to

bearer or the payee or the endorsee in good faith and without any reason to believe

that there is any defective title in the instrument in his possession. If the following

conditions are satisfied the person will become the holder in due course:

(i) He must be a holder: A holder in due course must be entitled to the possession of

a negotiable instrument in his own name and under legal title and should be able to

recover the amounts from the parties legally. In other words the holder in due course

should actually have the qualities of a holder of the instrument.

(ii) Lawful consideration: The holder in due course should have obtained the

negotiable instrument by some consideration for acquiring it. The consideration may

not be completely adequate but it must be lawful fulfilling the conditions under

Section 2 (d) of the Indian Contract Act. This means that if he has received the

instrument as a gift or donation and there is no consideration attached to it, he cannot

be called a holder in due course even though he is a holder of the instrument.

(iii) Acquisition before maturity: The date of acquiring the negotiable instrument is

important for a person to become a holder in due course. If it is obtained before the

maturity date by a person he is entitled to become holder in due course. If however,

he receives it on the date of maturity or after the payment has been attained, then the

possessor of the instrument cannot become a holder in due course. The justification

for it is that on an over due instrument the possession in taken with the defects that are

attached to it. However, if acquisition is of an accommodation bill it can be acquired

after the date of maturity with all the benefits of being a holder in due course. A

cheque however should be taken only within six months because legally after that

date the validity of the cheque expires.

(iv) Technically complete instrument: A negotiable instrument should be complete in

all respects. It should be clear without any changes through overwriting or cutting. In

case of alterations the drawer should have signed the instrument. If the instrument is

not technically sound the person who receives it cannot become a holder in due

course.

481

Case Law 1

In Arab Bank Ltd. v Ross225

The payee of the promissory note was identified as F and

F. N. & Co. The endorser omitted the words and company and endorsed it as F and

F. N. This was a technical flaw. The endorser could not become a holder in due

course because the endorser and the payee were different on the instrument.

(v) Received in good faith: To become a holder in due course the person should have

received the instrument in good faith. If he has received a defective title or a stolen

instrument but is not aware of it, he gets a valid title. However, he has to enquire

about the title of the instrument and be sure of its legality before accepting it. In other

words, he has to prove that he took all kinds of precaution and did not suspect any

defective title of the instrument accepted by him.

21.3 DISTINCTION BETWEEN HOLDER AND HOLDER IN DUE COURSE

The discussion of holder and holder in due course brings out certain important

differences between them. Table 21.3 shows the differences between them.

Holder Holder in due course

Nature

Consideration

Title

A holder is a person who is

entitled to posses a negotiable

instrument as well as recovers

and receives the amount on it

from the parties.

The holder can receive an

instrument with or without

consideration.

A holder can only have a good

title on an instrument if the

previous parties do not have a

defective title.

A holder in due course is

a holder who has accepted

a technically correct

instrument before maturity

and in good faith.

A holder in due course

must receive the

instrument with some

consideration. Although

consideration may not be

adequate.

A holder in due course

who has acted in good

faith can acquire a good

title even if the previous

225

(1952) 2 Q B 216

482

Privileges A holder does not get any

privileges.

parties had a defective

title.

A holder in due course

has some special

privileges.

Table 23.3 Distinction between Holder and Holder in Due Course

Illustration 1: Shruti receives a gift cheque from her father. She is interested in

knowing whether she is a holder or holder in due course. Her friend Supriya advises

her that since she has not received the bill by any consideration she has acquired the

states of a holder.

In such a case Shruti cannot become a holder in due course because she has not

acquired the instrument with adequate or inadequate consideration.

Illustration 2: Sanyogita acquires a bearer a bill before maturity. She carefully

scrutinizes the technical details on the instrument and when she is sure that the title is

not defective she accepts it. Later on it is found that the title is defective. She requires

certain advice to find out whether she can be called a holder in due course. What

would be her status?

Sanyogita has acted in good faith and the technical details according to her were in

order. If she can prove that she was unaware of the defective title she will be able to

acquire the status of holder in due course.

Illustration 3: Suman gives a valuable consideration for a negotiable instrument to

her friend Pankaj knowing that the instrument is defective. She has acquired it before

maturity. Will the court accept her as a holder in due course?

Suman cannot be called a holder in due course because she has acquired the

instrument knowing that it had a defective title.

Illustration 4: Namrata lost her cheques and bills in the Gujrat earthquake.

Murarilal found one bill which was payable to bearer. What would be the rights of

Murarilal as he has found the bill in good faith and due to natural calamity?

483

Namrata continues to be the holder of the bill found by Murarilal. He cannot become

a holder in due course even though he acquired the bill before maturity and in good

faith. It does not belong to him and he must return it.

21.4 PRIVILEGES OF A HOLDER AND DUE COURSE

A holder in due course is considered to be in a superior position having certain special

privileges, which the holder does not have. He has the following rights:

He has a better title than that of the transferor

He has certain special privileges in case of inchoate stamped instruments.

He has rights against the prior parties.

He has privileges in case of fictitious bills

He has rights against conditionally delivered instruments

He has the right of estoppel in case of validity of the instrument.

He has the right of estoppel against the denying capacity of payee to endorsee.

Each one of these rights is discussed below:

1. Better title than that of the transferor: A holder has the same title as a transferor

but a holder in due course acquires a better title than the transferor. This means that if

a transferor has a defective title the holder will also have the same title but a holder in

due course gets a better title than the transferor. Thus, according to Section 58 if an

instrument is acquired in good faith and without any knowledge of the defects of the

instrument the holder in due course is in a privileged position. Therefore, if there is a

defense on the part of a person liable thereon that the instrument is lost or acquired by

fraud or unlawful consideration it cannot be pleaded against a holder in due course.

More privileges of a holder in due course are cited in section 53. According to it “A

holder of a negotiable instrument who derives title from a holder in due course has the

rights thereon of that holder in due course”. Accordingly a holder in due course is

cleansed of all the defects of the previous holders in due course. He serves as a

channel to protect all previous holders in due course. A transferee from a holder in

due course is like a holder in due course and can recover the amount from prior

parties even if he knew of the defects such as fraud or defective title. The exception to

this case is when the transferee is party to a fraud with a previous holder in due course

he cannot recover the amount as is cited in the case law Guildfort Trust V Goss226

. A

226

1926 43 TLR 167

484

forged instrument is not a defect but a lack of title. If an instrument is forged, its title

does not get cured because

Illustration1: Karan drew a bearer cheque for Manhar and gave it to Kusam to

deliver it. Kusam wrote her own name and indorsed it to Asif. Since Asif was a

holder-in due course who acquired the instrument for some consideration he was

interested in knowing his privileges and asked for advice.

Asif can collect the money from Karan as he is a holder in due course. He is entitled

to recover the amount.

Illustration2: Sanjana draws a bill and makes it payable to herself, on Kala and takes

her acceptance by fraud. Sanjana’s rights on the bill against Kala will be identified as

defective. If she indorses the bill in favour of Raju, the transferee he will have full

rights against Kala as holder in due course. However, if Raju indorses the bill in

favour of Navneet without consideration what type of rights would he acquire?

Navneet’s position is that he cannot become a holder in due course but he would have

a good title on the bill even if he knew that the title was defective.

Illustration3: Rajiv drew a bill on Reena and made it payable to himself taking her

acceptance by fraud. Now Rajiv indorses it to Ramesh who becomes a holder in due

course. Ramesh indorses it further to Rakesh who indorses it back to Rajiv. Is Rajiv

able to collect the money? What are his rights as holder in due course?

Rajiv cannot acquire a good title because he is party to the fraud.A forged instrument

cannot be cured of its defects.

2. Special privileges in case of inchoate stamped instruments: An inchoate stamped

instrument is one which is not complete in all respects. Under section 20, the original

payee, should fill in an amount that is authorized to enforce it. If the amount filled in

is more than the authorized amount he cannot recover the excess amount on it. If an

incomplete instrument is transferred to a holder in due course, exceeding the

authorized amount, he would be entitled to recover the entire amount on the

instrument. If the stamp affixed on it covers the amount.

485

Illustration4: Rajni signed a blank stamped instrument and gave it to Munish

authorizing him to fill in a promissory note for Rs 7,200 to take an advance from

Meenu. Munish fills it as a note for Rs 11000/- payable to Meenu who in good faith

advances Rs 11000/- to Munish. Meenu is entitled to receive the money from Rajni.

3. Rights against the prior parties: Under Section 36 a holder in due course has a

right against all prior parties covering drawer, acceptor and endorsees before him.

They are liable to him both jointly and severally. He can hold any of the parties

individually or jointly liable for payment of the instrument. Until the instrument is

completely discharged by the person who is primarily liable they continue to remain

liable.

Illustration5: Kavi drew a bill of exchange on Mattu payable to Somu. It is accepted

by Somu and endorsed by him to Dara who endorses it to Sukhmani. Since Sukhmani

becomes the holder in due course, she can realize the amount on the bill either from

Mattu who accepts the bill but also from Kavi and Dara.

All the prior parties remain liable to Sukhmani until she is satisfied that the bill is

duly discharged.

4. Privileges in case of fictitious bills: A person who accepts a bill that is drawn in a

fictitious name and is payable to the order of the drawer does not get relieved from his

responsibility towards the holder in due course because the bill was in a fictitious

name. However, according to Section 42, the holder in due course has to prove that

the signature of the first endorsee and the drawer are the same.

Illustration 6: Priya accepted a bill of exchange for Rs 5200/- drawn by Veeru and

payable to the fictitious person Meera.The bill was returned to Veeru after Priya

accepted the bill. Later, Veeru indorsed the bill to Rekha by signing as Meera the

endorser. During the course of negotiation the bill came in the hands of Mattu a

holder in due course. How can Mattu recover the money as holder in due course?

Mattu can recover the amount on the bill from Priya by showing that the signatures

of the drawer Veeru and the first endorser Meeru are in the same writing.

486

5. Rights against conditionally delivered instruments: An instrument which is

prepared for a special purpose or delivered conditionally as a collateral security or for

safe custody and not with the idea of transferring the rights of the property to the

endorser is negotiated to a holder in due course and a valid delivery is presumed then

under section 46 the holder in due course acquires a good title to it.

Illustration 7: Amir is the holder of a bill. He indorses it to Bali or order for the main

purpose that Bali gets it discounted. Bali endorses the bill to Kavita. She becomes a

holder in due course and acquires a good title to the bill and has the right to claim

the money from the prior parties.

As a holder in due course, Kavita can also sue all the prior parties to the instrument.

6. Right of estoppel in case of validity of the instrument. The drawer and acceptor of

a bill or cheque are liable to the holder in due course. If a holder in due course sues

any of those parties, they will not be permitted by court to deny that the instrument

was not valid. The drawer/maker are the prior parties responsible to the holder in due

course. They have prepared the original documents so they do not have the right to

deny the validity of the instrument due to right of estoppel of the holder in due course.

However, if the drawer can prove that the instrument is forged, then under Section 12

he can get relief.

Illustration 8: Amul draws a cheque in favour of Cheenu who endorses it to Mani for

some consideration. On the due date it is dishonoured. Mani gives a notice to Cheenu.

He cannot deny that he endorsed it.

Amul as the drawer of the cheque can also not deny that the instrument is valid.

However if he can prove that it is a forged instrument then Mani will not get relief.

7. Right of estoppel against the denying capacity of payee to endorsee: Under

Section 121 the maker of a promissory note or an acceptor of a bill are not permitted

to state to the holder in due course that the payee did not have the capacity to indorse

the bill or cheque. Therefore if the holder in due course files a suit against the

acceptor of a bill he will not be permitted to state that he was a minor when he

accepted the bill. However, the maker of the note or the acceptor can reject the

487

instrument by bringing out the fact that the bill was not genuine or the payee’s

endorsement was not valid.

Illustration 9: Abhay is the maker of the promissory note which is payable to Bani

who is a minor. Bani endorses it to another person by the name of Sanjay who

becomes the holder in due course. Abhay cannot state that Bani did not have the

capacity to make an endorsement.

The holder in due course Sanjay, can recover the money from Abhay who is the

drawer of the promissory note. Unless Sanjay’s claim is discharged he remains liable

to him.

To conclude, a holder is a person who will eventually become a holder in due course.

A holder has a right of entitled to receive and recover amount that he is entitled to

possess. When he transfers to another the instrument for some consideration, lawfully

before the maturity date and the instrument is technically complete, the person taking

the instrument acquires the rights of a holder in due course. The holder in due course

has certain special privileges. Therefore it is important to analyze the differences

between the holder and the holder in due course to understand their rights and

obligations.

21.5 POINTS TO REMEMBER

Definition of a holder

1. The person whose name is in the bill of exchange / promissory note / cheque or to

whose order the specific amount on it is payable is the payee or the holder.

20 He must be entitled to the possession of the instrument in his own name.

2. He must be entitled to receive or recover the amount due thereon from the parties

Entitled to possession requires the following necessary details.

! He should have a legal title

! A gift entitles a person to become a holder.

! A person can also become a holder by operation of law.

! An assignee of a bill is not a holder.

! A thief or a forger cannot become a holder as he does not have a legal title to it.

Entitled to receive or recover the amount due thereon from the parties requires the

following conditions.

488

26 He should have the legal right to recover the money.

27 In case of natural calamities or losses he continues to have the right to be called

holder.

28 The agent of the holder can collect money on his behalf but cannot become the

holder.

Who is a holder in due course?

! A holder in due course is a person who possesses the bill of exchange, promissory

note or cheque if payable to bearer or the payee or the endorsee / endorsee

! He should receive the instrument in good faith

! It should be received with some consideration and

20 It should be without any reason to believe that there is any defective title in the

instrument in his possession.

21 He should receive the instrument before the maturity date.

22 The instrument must be technically complete in all respects.

23 There should be no alterations and if there is any cutting on the instrument the

requisite signatures should be made.

Distinction between holder and holder in due course

21 A holder is entitled to receive possession and recover the amount on the

instrument. A holder in due course acquires an instrument with some

consideration, before maturity, and in good faith without belief of any defective

title..

22 Holder may receive instrument without consideration but holder in due course

must possess with some consideration

23 Holder can have good title only if previous parties do not have defective title but

holder in due course can have a good title even if previous parties do not have

good title.

24 A holder does not have the privileges that a holder in due course enjoys.

Privileges of a holder

He has a better title than that of the transferor

He has certain special privileges in case of inchoate stamped instruments.

He has rights against the prior parties.

He has privileges in case of fictitious bills

He has rights against conditionally delivered instruments

He has the right of estoppel in case of validity of the instrument.

489

27 He has the right of estoppel against the denying capacity of payee to endorsee

21.6 Objective Type Questions

State whether the following are true or false.

• A person can become a holder by mere assignment of the instrument.

• A holder is entitled to possess and recover the amounts thereon for some

consideration.

• A holder in due course should acquire the instrument before the maturity date to

get the rights.

• A holder has certain privileges that a holder in due course does not have.

• A holder in due course is cleansed of all the defects of the previous holders in due

course.

• A person who accepts a bill that is drawn in a fictitious name and is payable to the

order of the drawer gets relieved from his responsibility towards the holder in due

course

• All prior parties are liable to the holder in due course both jointly and severally.

• A holder has the same title as a transferor but a holder in due course acquires a

better title than the transferor.

• When the transferee is party to a fraud with a previous holder in due course he

cannot recover the amount.

• A gift entitles a person to become a holder of an instrument.

Answer: 1. F, 2. F, 3. T, 4. F, 5. T, 6. F, 7. T, 8. T, 9. T 10. T.

21.7Questions

24.2 Who is a holder? Discuss the features to show the differences between a holder

and a holder in due course.

24.3 What are the special privileges of a holder in due course?

24.4 How would you identify a holder in due course? What are the special

requirements to become a holder in due course?

24.5 Comment on the following statements:

(i.) He must be entitled to the possession of the instrument in his own name.

(ii) He must be entitled to receive or recover the amount due thereon from the

parties liable thereto.

490

21.8 Practical Problems

i) A bill was drawn in favour of Vibha, or order of Vibha. She has a to clear of

her debts to Pankaj and decides to endorse it in his favour. Pankaj takes the

bill and leaves it at his workplace on Friday. Over the weekend the peon

picks up the bill and forges his signature on it. He endorses the bill and

clears of his debts by giving it to Latika to whom he owes money. Latika

endorses it and gives it to her landlord clearing her debts. Can the landlord

recover the payment on the bill as he satisfies the condition of being the

holder in due course?

Answer: Since the bill is forged, the holder in due course does not have any valid

rights. A forged instrument does not give the right to any person. Even the

holder in due course cannot acquire a good title.

ii) Manoj drew a bill of Rs 27000/- on Jaya to be payable to a fictitious person

Heena. Jaya acceoted the bill and returned it to Manoj. Then the drawer

endorsed it to Shobha as payee. She negotiated it further and gave it Geeta.

Now Geeta has become the holder in due course. What is her position for

recovering the amount from Jaya?

Answer: Geeta can recover Rs. 27000, which is the money drawn on the bill if she

can prove that the signature of Manoj who is the drawer and the signature of

Heena who is the first endorsee are the same.

iii) Alok drew a bill of Rs 12000/- on Anuj. Parmar took the bill by fraud amd

endorsed it further. The bill was endorsed and negotiated and finally Jiva

became the holder in due course. Jiva further negotiated it in favour of

Murthy without any consideration. Can Murthy recover the amount on the

bill?

Answer: Murthy can recover the amount because a person to whom the amount is

transferred by a holder in due course has the rights that are at par with the

rights of that transferror.

491

iv) Ankita draws a bill on Sumant who accepts the bill but there is no

consideration attached to it. It is then transferred to Kavya again without

consideration but Kavya endorses in favour of Bhanu with consideration.

What rights does Bhanuhave against the prioir parties?

Answer: Bhanu has the right to recover from all the previous parties and she can sue

them to recover money. However, the rights of Kavya and Ankita are the

same. Since the bill was endorsed without consideration, they do not have

any rights against Sumant.

v) Akriti obtained a bill by fraud from the drawer. She indorses it in favour of

Shalini as a gift to her. What is the position of Shalini? Can she sue the

acceptor of the bill?

Answer: Shalini has a right to sue the acceptor of the bill as she being the holder in

due course has has the same rights as Akriti.

vi) Manju indorses a bill fraudulently to Damini for payment of her debt.

Damini endorses it to Aina who endorses it for some value but without

notice. She endorses it to Dass for some consideration. Dass knows of the

fraud but is not a party to it. What are the rights of Dass?

Answer: Dass acquires the rights of Aina. As he gave consideration to her he can sue

all the prior parties including Aina till his dues are discharged.

vii) Arun draws a promissory note for Rs. 8800/-. It is payable to Sunita. The

payee, Sunita endorses it to Alka for consideration. On the due date the

promissory note is dishonoured. How should Alka recover the money?

Answer: Alka can sue for recovery of the amount. Arun cannot deny that the

instrument drawn by him was not a valid instrument.

viii) Arpana is the holder of the bill. She negotiates it in favour of Minakshi for

discounting the bill. Minakshi fraudulently transfers it to Mukesh who

492

further transfers it to Abhay. What is Abhay’s position if he wants to sue the

acceptor for recovery of the money?

Answer: Abhay can sue Arpana and can prove that Minakshi has committed a fraud.

However, Abhay must prove that he is a holder in due course.

References:

Books:

i) Faizi OP &Aggarwal A.2008) Khergamvala on The Negotiable

Instruments Act 20th

Edition, Pages 53-69 Lexis Nexix Butterworths

India.

ii) Chadha P.R. (2001) Business Law pages 456-469 Galgotia Publishing

Company, India.

iii) Aggarwal S.K. Business and Industrial Laws, (2007 Pages 367-374

Galgotia Publishing Company, India.

iv) Bansal. C.L. Business and Corporate Laws (2006) Pages 311-321 Excel

Books, New Delhi., India.

v) Bhashyam and Adiga”s (2008) 18th

revised Edition Pages 136-148 Bharat

Law House, New Delhi.

Websites:

20.3.1 http://en.wikipedia.org/wiki/Holder_in_due_course

20.3.2 http://chestofbooks.com/business/law/American-Commercial-Law-

Series/Chapter-11

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Lesson – 22

NEGOTIATION AND ENDORSEMENT

by

Anu Pandey

This Lesson discusses the various aspects of Negotiation and Endorsement

22.1 Definition of Negotiation

22.2 Difference between Negotiation and Assignment

22.3 Definition of Endorsement

22.4 Kinds of Endorsements

22.5 Negotiation by Unauthorized Parties

One of the essential features of Negotiable Instrument is transferability. The

ownership of the negotiable instrument continues to be transferred from one to

another. The holder may not retain the instrument till its maturity. He/she may like to

transfer it to his/her creditor in payment of his/her debt, who in turn may again

transfer it to his/her creditor. This process of transferring the title or ownership of

negotiable instrument is called ‘negotiation.’

22.1 DEFINITION

According to section 14 of the negotiable instrument act “when a promissory note,

bill of exchange or cheque is transferred to any person, so as to constitute that person

the holder thereof, the instrument is said to be negotiated.”

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Characteristics of Negotiation

The various features of negotiable instruments are as follows:

1 Intention to pass the title: Mere delivery of negotiable instrument does not

lead to negotiation. The delivery should be made with the intention to transfer

the ownership rights so that the holder can sue in his own name on the

instrument and recover the amount due thereon.

Illustration1: Ramdin had received a cheque for rupees twenty thousand from

Somnath. He gave it to his wife to keep it in safe custody. This is bailment and not

negotiation. Ramdin’s wife is a bailee and not a holder.

Illustration 2: Ramdin had received a cheque for rupees twenty thousand from

Somnath. He gave the cheque to his creditor Dyal Singh in payment of his debt of

rupees twenty thousand which he owed to Dyal Singh. In this case Ramdin is the

creditor and Somnath is the debtor hence Ramdin is the holder of the cheque.

2 Transferability: Holder is a person in whose possession is the instrument. He

/she has a right to negotiate the instrument, provided the negotiability of such

instrument has not been restricted or excluded by any express words used in

the instrument.

Illustration 1: Sonia a boutique owner received a bearer cheque of rupees five

thousand from her customer Krishna for the payment of the dress she purchased.

Sonia owed rupees five thousand to Sangita. She handed over the cheque to Sangita

as the payment of her debt. Hence Sangita became the holder of the cheque.

Illustration 2: Sonia a boutique owner received a crossed cheque of rupees five

thousand from her customer Krishna for the payment of the dress she purchased.

Sonia owed rupees five thousand to Sangita. She handed over the cheque to Sangita

for the payment of her debt. As the cheque was crossed so it could not be transferred

from Sonia to Sangita. Hence negotiation was not possible.

495

There are two methods of negotiation of a negotiable instrument that are as follows:

1 Negotiation by delivery: According to section 47 an instrument payable to

bearer is negotiable by delivery. Only a bearer instrument may be negotiated

by delivery. It does not require the signature of the transferor therefore the

transferee becomes the holder of the instrument just by possession.

Illustration: Rachna received a bearer cheque of rupees two thousand from Ranbir

for the purchase of jewelry worth rupees two lakh. Rachna gave the same cheque by

hand to Swami as payment for the debt she owed to Swami.

2 Negotiation by endorsement and delivery: According to section 48 of the

Negotiable Instrument Act a negotiable instrument payable to order is

negotiable by the holder by endorsement and delivery. Hence the transferor in

order to transfer the instrument has to firstly endorse the instrument and then

deliver it. The holder endorses the instrument by signing on the face or back

of the negotiable instrument.

Illustration: Sundresh draws a cheque for rupees thousand payable to Kavita on 1st

December 2007 and gives it to her. The date of maturity of the instrument was 1st

March 2008. Kavita took some raw material for rupees thousand from Kalpana on

credit. She wrote on the back of the bill “Pay to Kalpana” and signed it. In this case

Kavita is the endorser and Kalpana is the endorsee.

22.2 DIFFERENCE BETWEEN NEGOTIATION AND ASSIGNMENT

Negotiable Instrument can be transferred from one person to another by either

negotiation or by assignment. The Negotiable Instrument Act does not deal with

transfer of negotiable instruments by assignment. The negotiable instrument act does

not deal with general law that regulates the transmission of negotiable instruments by

operation of law or by devolution. Transfer of negotiable instrument act by

assignment is dealt in accordance with the Transfer of Property Act.

496

Assignment is the right to recover payment of a debt by one person to another. It is

done through a written document. The differences between Negotiation and

Assignment are given as follows:

Basis of Distinction Negotiation Assignment

Formalities Negotiation can take place

by delivery or by

endorsement and delivery.

Assignment takes place by

writing a document signed

by the assignor.

Consideration Consideration is presumed. The assignee must prove

that he/she has obtained

the instrument for a

consideration

Notice No notice of transfer is to

be given to the debtor.

Notice of transfer is to be

given to the debtor by the

assignee and the debtor

should expressly or

impliedly give his assent

to it.

Defective title The title of the transferee

is free from any defects in

the title of the previous

transferors.

The title of the assignee is

subject to the defects in the

title of the assignor.

Right to sue The transferee can sue the

third party in his/her own

name.

The assignee cannot sue

the third party in his/her

own name.

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22.3 DEFINITION OF ENDORSEMENT

According to Section 15 of the Negotiable Instrument Act “Endorsement is the

signing by the holder of his /her name on a negotiable instrument for the purpose of

its negotiation to another person.” The holder signs on the back of the instrument or

may choose to sign on the face of the instrument or signs on a slip of paper called

“allonge” which is then attached to the negotiable instrument.

There are two parties to an endorsement:

1 Endorser

2 Endorsee

Endorser is the person who signs the instrument and endorsee is the person to whom

the instrument is transferred. The endorsement is complete only after the instrument is

delivered to the endorsee.

Illustration: Pompa purchased lots of dairy products from Ruksana who was a

supplier of dairy products. She draws a bill for rupees thousand payable to Ruksana

on 19th

August 2008 and gives it to her. The date of maturity of the instrument was

19th

November 2008. Ruksana used to buy the milk for preparations of her dairy

products from Jaggu. She took milk worth rupees thousand from Jaggu on credit. She

wrote on the back of the bill “Pay to Jaggu” and signed it. In this case Ruksana is

the endorser and Jaggu is the endorsee.

Only the payee and endorsee have the right to endorse the instrument. A stranger or a

thief cannot endorse the instrument. The drawer / maker of a bill cannot endorse

however if he / she has become the holder of the instrument in his / her own right

then he/she can endorse.

498

22.4 KINDS OF ENDORSEMENTS

There are various kinds of Endorsements, which are as follows:

1 Blank or General Endorsement: In this case the endorser only signs his/her

name. He /she does not mention the name of the endorsee. In such a case the

endorsement makes an order instrument payable to the bearer, and the property

therein is transferred by mere delivery.

Illustration: A bill of exchange is payable to Ravi. Ravi (endorser) signs only his

name at the back of the bill and delivers it to Krishna (endorsee) his creditor.

2 Special / Full endorsement: In this case the endorser not only signs his/her name

but also adds the name of the endorsee (the name of the person to whom the

instrument is being transferred).

Illustration: A bill of exchange is payable to Ravi. Ravi (endorser) signs his name and

also the name of his creditor Krishna (endorsee) at the back of the bill and delivers it

to him.

3 Restrictive Endorsement: In this case the endorsement prohibits the endorsee

from negotiating the instrument any further. It merely entitles the endorsee to receive

the amount on the instrument for the specific purpose.

Illustration: A bill of exchange is payable to Ravi. Ravi signs his name and also

writes on the bill ‘Pay Krishna only’ while delivering the bill to Krishna (endorsee).

Krishna is prohibited from negotiating the instrument any further.

499

4 Partial Endorsement: In this case the endorsement purports to transfer to the

endorsee only a part of the amount of the instrument. However such instruments are

not valid because they lead to plurality of action and interfere in its free circulation.

Illustration: A bill of exchange of rupees one thousand is payable to Ravi. Ravi signs

his name and also writes on the bill ‘Pay to Krishna Rs. 500’. As this is partial

endorsement hence it is invalid.

5 Conditional Endorsement: In this case the endorser makes his/her liability on the

instrument conditional on the happening of a particular event. This limits or negatives

the liability of the endorser. It may take any of the following forms:

a) Sans Recourse Endorsement: when an endorser does not want to incur any

liability to the endorsee or to any subsequent holder in the event of dishonour of a

negotiable instrument, he/she may exclude his/her liability by using the words ‘sans

recourse’, which means ‘without recourse.’

Illustration: A bill of exchange is payable to Ravi. Ravi signs his name and also

writes on the bill ‘Pay Krishna at his own risk’ while delivering the bill to Krishna

(endorsee). Hence Ravi is free from any liability, which may arise due to the

dishonoring of the bill.

b) Facultative Endorsement: In this case an endorser by express words increases

his/her liability, or gives up some of his/her rights under the negotiable instruments

act.

Illustration: A bill of exchange is payable to Ravi. Ravi signs his name and also

writes on the bill ‘Pay Krishna, notice of dishonour waived’ while delivering the bill

to Krishna (endorsee). Hence Ravi makes himself liable, for the dishonouring of the

bill.

500

c) Sans Frais Endorsement: In this case if the endorser does not want the endorsee or

any subsequent holder to incur any expenses on his/her account on the instrument.

Illustration: A bill of exchange is payable to Ravi. Ravi signs his name and also

writes on the bill ‘Pay Krishna, sans frais’ while delivering the bill to Krishna

(endorsee). Hence Krishna will not incur any expenses on Ravi’s account on the

instrument.

d) Contingent Endorsement: In this case the liability is dependent upon a

contingency, which may or may not happen.

Illustration: A bill of exchange is payable to Ravi. Ravi signs his name and also

writes on the bill ‘Pay Krishna on his marriage with Radha’ while delivering the bill

to Krishna (endorsee). Hence Krishna cannot get the payment until he marries

Radha.

An unconditional endorsement completed by delivery of the instrument shall have the

following effects:

1 The ownership of the instrument is transferred from the endorser to the endorsee.

Illustration: A bill of exchange is payable to Ravi. Ravi (endorser) signs his name and

also the name of his creditor Krishna (endorsee) at the back of the bill and delivers it

to him. Hence Krishna gets the ownership of the instrument.

2 The endorsee gets the right of further negotiation.

Illustration: A bill of exchange is payable to Ravi. Ravi (endorser) signs his name and

also the name of his creditor Krishna (endorsee) at the back of the bill and delivers it

to him. Hence Krishna gets the ownership of the instrument as well as the right to

further negotiate the instrument to any other party.

501

3 The endorsee can bring an action for recovery against all the parties whose names

appear on the instrument.

Illustration: A bill of exchange is payable to Ravi. Ravi (endorser) signs his name and

also the name of his creditor Krishna (endorsee) at the back of the bill and delivers it

to him. Krishna places the bill at the bank and the bill gets dishonored. Hence

Krishna can take action against Ravi as well as against all the other people who had

endorsed the bill and have their name written on it and make them liable for the

dishonoring of the bill.

NEGOTIATION BACK

Sometimes in the course of negotiation if a negotiable instrument is again endorsed by

the last endorsee to the original holder or a previous endorser it is called ‘Negotiation

Back’. The person who becomes the holder by reason of negotiation back cannot

make any of the intermediate endorsers liable on the instrument because as being a

prior party he/she is liable to all of them and so he/she will have to sue himself.

22.5 NEGOTIATION BY UNAUTHORIZED PARTIES

In case the instrument is lost or is obtained by unlawful means or has been obtained

for unlawful consideration then the following situation arises:

1 Lost instrument:

If a bill of exchange gets lost before it is due then the person who was its

holder may apply to the drawer to give him/her another bill. However the

drawer may ask the holder to give security to indemnify him/her against any

further claim thereon.

502

Illustration: Sita gave a bearer cheque to Sangita and Sangita lost it while going back

home. Sangita asked Sita to again draw a cheque in her name. Meanwhile Rahim a

passerby had picked up the cheque, and got the cheque encashed. Sangita cannot get

another cheque from Sita because Rahim had already encashed the cheque therefore

Sita is not liable to pay again.

If the drawer on request refuses to give such duplicate bill, he/she may be

compelled to do so by means of a suit. The right to obtain a duplicate of lost

instrument is also given to the holder of a promissory note and a cheque.

Illustration: Sita gave a bearer cheque to Sangita and Sangita lost it while going back

home. Sangita asked Sita to again draw a cheque in her name but Sita refused to give

another cheque. Sangita sued Sita for not giving the cheque.

The holder of the lost instrument should inform all parties liable on it and

should also give public notice by advertisement in local newspaper.

Illustration: Sita gave a bearer cheque to Sangita and Sangita lost it while going back

home. She informed Sita and gave a notice about the loss of cheque in a local

newspaper.

The finder of the lost instrument gets no title to it and cannot sue the party

liable thereon for its payment.

Illustration: Sita gave a bearer cheque to Sangita and Sangita lost it while going back

home. A passerby Rahim found the cheque lying on the road. He picked up the cheque

and went to the bank for getting it encashed. However the cheque bounced. Rahim

had no right to sue Sita for bouncing of the cheque as Sita was not liable to pay

Rahim.

The rightful holder is entitled to get back the instrument from him/her. If the

finder obtains payment of the instrument in his/her possession (for a bearer

document) then the payer will be discharged from his/her liability. The true

503

owner however will be entitled to recover the amount from the finder (Section

58 and 82).

Illustration: Sita gave a bearer cheque to Sangita and Sangita lost it on the road

while going back home. Rahim a passerby had picked up the cheque from the road,

and got the cheque encashed. Hence Sita is no longer liable to pay Sangita. However

Sita is entitled to get the money back from Rahim.

If the finder negotiates the instrument to a holder in due course, such holder

gets a good title to it and can obtain payment from the party concerned. The

true owner cannot take possession of the same from such a holder in due

course, of course he/she can claim damages from the finder, if traceable.

Illustration: Sita gave a bearer cheque to Sangita and Sangita lost it on the road

while going back home. Rahim a passerby had picked up the cheque from the road,

and gave the cheque to Mohan as payment for the money he owed to him. Mohan gets

a good title therefore Sangita (the true holder) cannot get back the possession of the

cheque from him and Mohan also has a right to sue Sita for non-payment. However

Sangita (the holder) has a right to sue Rahim (finder) for the damages.

2 Stolen Instrument:

The position in case of stolen instrument is the same as lost instrument; with the

difference that on being traced the thief is open to criminal prosecution while a finder

is not.

Illustration: Sita gave a bearer cheque to Sangita. Sangita had kept the cheque in her

bag and was traveling in a bus. Rahim a pick pocket snatched Sangita’s bag from the

moving bus and got the cheque encashed. After being traced Rahim was not only

liable to return the money but was also open to criminal prosecution.

3 Instrument obtained by Fraud:

If a person obtains a negotiable instrument by fraud, undue influence or coercion227

,

he/she is not entitled to enforce its payment, as his/her title is defective. If such an

227

See lesson 5, Free Consent of Indian Contract Act for more information on fraud,

undue influence and coercion.

504

instrument is transferred to a holder in due course, such a holder will acquire good

title to it and the plea of fraud will not be used against him/her (Section 58).

Illustration 1: Sita gave a bearer cheque to Sangita at gun point. Sangita took the

cheque to the bank for payment and the cheque got bounced. Hence Sangita could not

sue Sita for the bouncing of the cheque as the cheque was obtained by coercion

Illustration2: Sita gave a bearer cheque to Sangita at gun point. Sangita gave the

cheque to Mohan as payment for the money she owed to him. Mohan gets a good title

to the cheque therefore he has the right to get the money through the cheque.

4 Forged Instrument:

When the signature of the endorser is forged228

on a negotiable instrument it is called

a forged instrument. A forged endorsement is regarded in law as no endorsement. If

the party liable to pay on the instrument makes the payment to the endorsee who

holds it under a forged endorsement, he she shall be liable to the true owner. In case

of a bearer instrument or the one, which has been endorsed in blank, a forged

endorsement is immaterial and does not affect the title of the endorsee.

Illustration: A bill of exchange is payable to Ravi. Ravi’ brother Rakesh owes money

to Krishna. Rakesh forges his brother Ravi’s signature at the back of the bill and

delivers it to Krishna. This is not endorsement hence Krishna is to return the bill to

Ravi.

5 Instrument obtained for an Unlawful Consideration:

A negotiable instrument given for a consideration, which is illegal, or opposed to

public policy, or immoral, or specially prohibited by statute, is void and creates no

obligation between the parties thereto.

228

Forgery is the act of criminally making or altering a written instrument for the

purpose of fraud or deceit. It is the process of making, adapting, or imitating objects,

statistics, or documents with the intent to deceive.

505

Illustration: Rukmani asked Bhupendra to kill Manoj and for that she gave him a

cheque of rupees one lakh. Bhupendra killed Manoj and deposited the cheque in the

bank for payment. The cheque bounced. Hence Bhupendra could not sue Rukmani for

the bouncing of the cheque.

6 Instrument without Consideration:

If a negotiable Instrument is made, drawn, accepted, endorsed or transferred without

consideration then it creates no obligation of payment between the parties to the

transaction.

Illustration: Ram Narayan went to a jewelry shop and gave to the jeweler an advance

payment of rupees ten lakh through a cheque for the purchase, which his wife would

be make in days to come. His wife did not make any purchase hence the jeweler was

not entitled for payment.

22.6 POINTS TO REMEMBER

Definition and Characteristics of Negotiation

Intention to pass the title

Transferability

Difference between Negotiation and Assignment

Formalities

Consideration

Notice

Defective title

Right to sue

Kinds of Endorsement

Blank or General Endorsement

Special / Full endorsement

506

Restrictive Endorsement

Partial Endorsement

Conditional Endorsement

Negotiation Back

Negotiation by Unauthorized Parties

Lost Instrument

Stolen Instrument

Instrument obtained by Fraud

Forged Instrument

Instrument obtained for an Unlawful Consideration

Instrument without Consideration

22.7 QUESTIONS

Match the following

1 Negotiation a Notice to be given

2 Endorsement b Delivery

3 Assignment c Signing on the bill

4 Negotiation back d Instrument endorsed to the original

holder

Answers: 1b, 2c, 3a, 4d

Practical Problems

1 Sulekha loses a bearer cheque of which she was the payee. Manik a stranger

finds the cheque and delivers the cheque to his creditor Puneet. Puneet takes

the cheque in good faith and for a lawful consideration. Is Puneet a holder in

due course?

Answer: Yes, because the cheque is a bearer one the title passes through mere

delivery and Puneet took the cheque in good faith and for a lawful

consideration therefore he is a holder in due course.

507

2 Rani is a payee of an order cheque, which is stolen by Ranjeet. Ranjeet forges

Rani’s signature and endorses the cheque in his favour. Later Ranjeet endorses

the cheque in Zulfi’s name that is his creditor. Zulfi takes the cheque in good

faith. Can Zulfi claim to be holder in due course?

Answer: No, because the instrument has been endorsed by forgery therefore

Zulfi does not get a good title. Even if he acted in good faith still he cannot get

a good title.

3 Sandhya by using criminal force against Rupneet obtains a bearer cheque and

then hands it over to Pia. Pia takes the cheque in good faith and for valuable

consideration. What is Pia’s legal status?

Answer: Pia is holder in due course though Sandhya could not have enforced

payment. the answer will be the same even if the cheque were an order one.

4 Manu is the payee of a bill and he endorses it in blank to Bonney. Bonney

endorses and delivers it to Chandan. Chandan endorses it in full to Devendra.

What is the position of Devendra?

Answer: Devendra has a good title therefore both Manu and Bonney are liable

to pay Devendra.

Questions:

1 What is the difference between Negotiation and Assignment?

2 What are the various characteristics of Negotiation?

3 What are the various kinds of Endorsements?

22.8 REFERENCES

1 Bansal C.L. (2006): Business and Corporate Laws, first edition, Published by

Anurag Jain for Excel Books, New Delhi.

2 Faizi OP & Aggarwal A. (2008): Khergamvala on The Negotiable Instruments

Act, twentieth edition, LexisNexis Butterworths, India, Delhi.

3 Kuchhal M.C. (2005): Business Law, fourth edition, Vikas Publishing House,

Delhi

4 Bhashyam & Adiga’s (2008): The Negotiable Instruments Act, revised by

Justice Ranganath Misra, eighteenth edition, Bharat Law House, New Delhi.

5 Kapoor N.D. (2004): Business Law, Sultan Chand & Sons, New Delhi

508

Lesson 23

Crossing and Dishonour of Cheques by

Preeti Singh

This lesson provides a basic understanding of a cheque,

different types of crossing and bouncing of cheques.

23.1 Definition of banking, banker, customer

23.2 Crossing of cheques

23.3 Types of crossing

23.4 Refusal of payment by banker

23.5 Protection to paying banker

23.6 Rights of holder against banker

23.7 Bouncing of cheques

23.1 DEFINITION OF BANKING

Section 5B of the Banking Regulation Act defines the term banking “as accepting for

the purpose of lending or investment, of deposits of money from the public, repayable

on demand or otherwise and withdrawal by cheque, draft, order or otherwise.”

A banking company is described by the Act as that company which is engaged in the

business of banking in India. The banking company should accept deposits for further

lending and investing the same to the public. If the company decides to accept the

deposits for its own financing it would not be called a banking company. The deposits

have to be for the purpose of furthering the banking business. The banking company

in accordance with an agreement with the depositor has to repay the money on

demand to the depositor. The customer should make the demand through an order in

writing by cheque or draft. The money cannot be withdrawn through orders given

verbally.

509

The relationship of banker and a customer is established through communication and

interaction between the banker and the customer involving primarily in the activities

of the business of banking with respect to depositing and withdrawing funds and

taking loans from the bank. Such a relationship is not established if the customer uses

the services of a banker for transactions relating to en-cashing a cheque, transferring

funds or using the facilities of a locker in a bank. The services are considered as

additional services offered by the banker to create value to the main activity of the

business of banking described above.

23.1.1 Definition of Banker

A banker is engaged in the business of banking. He accepts deposits from public and

uses the funds of the public for further lending or investment. He has to honour the

cheques drawn by his customer from whom he receives the money in a savings bank

account and for whom he receives and pays money in a current account. Therefore by

definition a banker performs the functions of accepting deposits, lending and

investment and repaying customers on demand or order through cheques. The banker

has the following statutory obligations towards his customers:

20 Payment of cheques: Section 31 of the Negotiable Instruments Act states that

if the customer has available cash balance the banker has to honour his

payments. If the banker does not make the payment, the customer has the right

to recover monetary loss and personal loss due to injury to his reputation.

21 Secrecy of customers accounts: A banker has to be responsible while dealing

with his customer. He should not provide any information about the customer

and his accounts to other people which will in any way harm his reputation.

Utmost secrecy is required in maintaining the accounts of a customer.

22 Following instructions of customer: The banker has to carry out the

instructions given to him by his customer as he is under a contractual

relationship with him.

23 Record of accounts: A banker has to maintain a record of the transactions of a

customer. An amount deposited or withdrawn has to be carefully recorded.

Mistakes should be avoided by double checking to ensure that the customers

do not suffer any losses.

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23.1.2 Definition of Customer

A customer is a person who has opened an account in a bank. He has agreed to abide

the regulations and limitations of the bank. Although there is no definition of a

customer in the Act it is implied that a person who has opened an account in a bank to

engage in the business of banking is a customer. A customer can be an individual, a

company, a society or a government department. A customer should have the

following characteristics:

• Opening an account A person who has opened an account in his own name.

• Business of banking: An individual / firm / company or association that has

opened an account for carrying out the business of banking.

• Relationship of banking: The relationship of the customer should be

specifically towards banking business and not a personal relationship or any

other social capacity.

• Acceptance of services and facilities: The customer accepts the services and

facilities provided to him by the banker in accordance with the banking

provisions.

23.2 CROSSING OF CHEQUES

The bank allows a customer to withdraw his money from his account on demand.

However, the customer has to give his order in writing through a printed cheque

issued by the bank. Cheques may be open cheques or crossed cheques. The banker is

obliged to pay depending on the type of cheque. Certain cheques can be handed over

at the counter and money can be received immediately. Other cheques can be more

complex in nature. A cheque must be in writing with an express order to pay another

party. It should be definite and unconditional order. It consists of three parties. The

person who makes the cheque is called the drawer. The cheque is drawn on the banker

who is called is the drawee and the third party is the payee in whose favour the

cheque is drawn. The forms of different kinds of cheques are discussed below:

23.2.1. Open or Uncrossed Cheques

An open or uncrossed cheque is one which the banker has to pay cash across the

counter when it is presented by the customer. An open cheque is risky because if the

holder of the cheque looses it any person who is in possession of it can take the

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payment from the bank. The payment of such cheques can be stopped by the drawer

by writing a letter to the banker regarding loss of cheque. To make cheques secure

and useful crossing of cheques was adopted.

Illustration1: Sanjay gave a cheque to Mitra for Rs.12500/- on purchasing 50 metres

of silk cloth. He did not cross the cheque. Mitra was traveling in a bus and the pick

pocket took away his possessions and cashed the cheque over the counter at a bank. It

was an open bearer cheque. Sanjay has suffered a loss. Can Sanjay recover the

money?

Since the cheque was not crossed he was not protected. He cannot recover the

amount.

23.2.2. Meaning and Effect of Crossed Cheques

Crossed cheques were introduced to protect the owner of the cheque from losses due

to theft of a cheque. A crossed cheque is one in which two lines parallel to each other

are drawn in a cheque on the left hand top corner of a cheque. When a cheque is

crossed cash cannot be paid at the counter. It has to be paid only to the holder of the

cheque who deposits it in his own account. Since a cheque is a negotiable instrument

a crossed cheque continues to be negotiable like an uncrossed cheque. The purpose of

crossing a cheque is to give an order to the banker to pay the cheque only to the party

whose name has been provided in the cheque. The specimen of an uncrossed cheque

Figure 23.2.1 Specimen of an open uncrossed Cheque

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is given above in figure 23.2.1. The different types of crossing and their effects on

cheques is discussed below:

23.3 TYPES OF CROSSING

Crossing of cheques may be general, special or restrictive. These are explained below:

23.3.1 General Crossing

According to Section 123 of the Banking Regulation Act 1949, a general crossing on

a cheque can be made by inserting two parallel lines on the left hand top corner of a

cheque. The two lines themselves show that the cheque has to be treated in a special

way because something in addition to an uncrossed cheque has been inserted.

Between the two parallel transverse lines the options are to add certain words like ---

‘and company’, ‘& company’ or ‘not negotiable’.

The holder of such a cheque has the right to the cheque through his own account. He

can deposit the cheque and when it is cleared he will receive the money.

In a crossed cheque the banker on whom the holder draws the cheque has to pay the

amount indicated on the cheque to the collecting banker. When the words ‘not

negotiable’ are written on a crossed cheque, there is no restriction in transferring the

cheque but the rights of the transferee are acquired from the transferor. It takes the

title from the endorser that may be good or defective. If the transferor has a good title

he will pass on the rights of a good title to the transferee but if it is defective the

transferee will only get a bad title. The reason for this is that the transferee cannot get

a better title than the transferor of the cheque. Therefore, a not negotiable cheque is

deprived of negotiability229

. In such a cheque there cannot be a holder in due course.

The effect of such a crossing is that there is a dilution of the essence of negotiability.

Illustration 2: Shivu draws a cheque of Rs. 9,500 in favour of Minu as full and final

payment of his debt. He crosses the cheque by adding the words ‘& company’. Can

Minu take the money from the counter in the bank by signing her name?

This is a crossed cheque. Minu is required to deposit this cheque in her bank account

to get the money. The amount will be credited in Minu’s account.

229

Tailors Priya V Gulabchand AIR 1963 Cal 36

513

Specimen of general crossing is depicted through a diagram:

Types of General Crossing Specimen

• Two parallel transverse lines on

cheque.

• ‘And company’ between two

parallel lines.

• ‘& Co.’ between two parallel lines.

• ‘Not Negotiable’ between two

transverse parallel lines.

• ‘and company Not Negotiable’

crossing between two parallel lines.

• ‘& Co. not Negotiable’ written

between two parallel lines.

Table 23.3.1 Specimen of types of general crossing of cheques

23.3.2 Special Crossing

A special crossing was introduced to provide greater protection to the drawer of the

cheque. According to Section 124 a cheque is deemed to be specially crossed when in

the parallel transverse lines in a cheque the name of the banker is written with or

without the words ‘not negotiable’. Even two parallel transverse lines are not

necessary for a special crossing. When a cheque is specially crossed, cash can be

received only from the banker whose name appears on the face of the cheque with or

without the parallel lines (Section 126). The banker collecting the cheque can

authorize an agent bank to collect the funds on his behalf.

A cheque can be specially crossed in favour of more than one bank. However, Section

127 of the banking Act puts a restriction on it. In case it is necessary to put the name

of two banks, the second bank should be an agent of the first bank.

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Types of Special Crossing Specimen

20 Name of the bank without parallel

lines.

21 Name of the bank between two

parallel lines.

22 Name of the bank with the words

‘not negotiable’ between two

parallel lines.

23 Name of the bank with the words

‘and Company’ between two

parallel lines.

24 Name of a bank with the words ‘not

negotiable’ as well as ‘& Co.’

written between two parallel lines.

Table 23.3.2 Specimen of types of special crossing of cheques

Illustration3: Kaka draws a cheque of Rs 3500 in

full and final payment of some money that of Bank

Of Xena to get the money but the bank refused. Did

the bank take the right action?

This was a special crossing. Accordingly only

National Bank was empowered to pay the money.

The bank took the right action in not making a

payment over the counter.

23.3.3 Restrictive Crossing

Restrictive crossing involves the crossing of a cheque through two parallel lines on

the left corner of a cheque. The words A/c payee are inserted inside the parallel lines.

This restriction can be made through general or special crossing. It provides a higher

protection to the drawer of the cheque in case a cheque is misplaced or lost.

According to this crossing, the cheque can be collected by the bank only for the

person whose name is written on the cheque. This crossing restricts the negotiability

of the cheque because the banker cannot collect cheques on behalf of any person who

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is not named in the cheque. If the banker makes the mistake of collecting the cheque

on behalf of a person whose name is not written on the cheque, he will not be

provided with any statutory protection under section 131 of the Banking Regulation

Act.

An account payee not negotiable cheque is even more restrictive because as explained

a not negotiable cheque cannot give a better title to the receiver than the transferor of

the cheque. If a transferee is affected by a bad title given by the transferor, he will not

be able to claim the rights of a holder in due course even if he has received the cheque

for value as well as good faith.

Types of Restrictive Crossing Specimen

20 When the words account payee are

written in a crossed cheque. It is to be

credited only to the account of the

payee.

21 Between two parallel lines the words

account payee and not negotiable are

added. The cheque looses its

negotiability.

22 Two parallel lines in which the banks

name is written indicates payment in

that bank only and in the payees

account.

Table 23.3.3 Specimen of types of restrictive crossing of cheques

Illustration 4: Mr. Rawat draws a cheque of Rs. 1750 in favour of Mr. Rao for

purchasing books from him. He writes the words A/c payee and crosses the cheque so

that the cheque is protected and received by no one but Mr. Rao. On receipt of the

cheque what should Mr. Rao do? He does not know how to get his money.

This is a restrictive crossed cheque and the amount can only be credited to Mr. Rao’s

account. His bank will send the cheque for clearing to the drawer’s bank. When it is

cleared Mr. Rao’s bank account will be credited with the amount and Mr. Rawat’s

balance will be reduced from his account.

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23.3.4 Not Negotiable Crossing

A not negotiable cheque has to be carefully taken by the transferee. He must analyze

and enquire about the title of the transferor before accepting the cheque. Such a

cheque cannot be accepted either in good faith or for the value that is written on it

because it has some important implications for the transferee. The transferee as

explained above is not capable of getting a better title than the transferor even if he

can prove that he took the cheque in good faith.

A not negotiable cheque has important implications for the transferor also. The

transferor has a greater protection with the words not negotiable written on the

cheque. In case of loss in transit or misplaced cheque, it cannot be cashed by any

other person than that of the person whose name is written on it.

The banker has a responsibility attached to a ‘not negotiable’ crossing. He has to be

careful while presenting such cheques. He is protected under Section 128 if he Acts in

good faith, honestly and without negligence. The facts of a case determine whether

the banker has acted in good faith. Bankers have to be responsible and use a high

degree of care for protecting the interest of the true owner.

However, Section 128 does not protect the banker from forgery of the drawer’s

signatures. Section 131 protects the banker against forging of signatures if it has not

been negligent and has taken full precautions to see that the cheque is in complete

order.

Illustration 5: Atul crosses a cheque and marks it with the words ‘not negotiable’.

The cheque is to be transferred to Amul. While the cheque is transported from Dhaula

Kuan to Connaught Place it gets lost and Bali finds it. He gives value to the cheque

and endorses it in favour of Malti. She deposits the cheque in her own bank. Her

banker presents it and gets a payment from the drawee bank. Is the banker protected?

Under Section 128 and 131 the collecting bank and the paying bank are protected but

Malti has to refund the money to the owner as such a cheque is not a negotiable

instrument. She cannot get a better title than Bali who has stolen or found the cheque

that does not belong to him.

23.3.5 Double Crossed Cheque

In a cheque if two special crossings are made it is called a double crossed cheque. If a

banker receives a double crossed cheque with two special crossings to more than one

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banker he is not permitted to make a payment as specified under Section 127 of the

Act.

However, there is an exception to it. If the cheque is crossed in favour of an agent for

the purpose of collecting a cheque, it is acceptable and the bank cannot refuse its

payments. When two special crossings are made, the second special crossing has to be

specified by stating that the crossing of cheque is in favour of the banker who is an

agent for collection of the cheque and the cheque is being collected on behalf of the

first banker. Special double crossing is usually made when a particular bank is not

situated in the city where the cheque is being collected. The agent bank collects the

cheque on behalf of the prime bank. A specimen of double crossing is made in the

following form:

23.3.6 Provisions for Crossing Cheques

The Negotiable Instruments Act is silent on the provision of crossing cheques.

However, the prevailing practice is that the drawer of the cheque crosses it at the time

of issuing it. Crossing of a cheque is considered to be a material part of a cheque and

it cannot be altered by any person accept under Section 125 in the following cases:

a) Uncrossed into crossed cheques: If the drawer omits to cross a cheque, it is

possible for the holder to cross an open cheque.

b) General crossing into special crossing: The holder has a right to make a

change in the general crossing of a cheque and make it special crossing. He

can also add the words not negotiable to either general or specially crossed

cheques.

c) Banker can cross cheques: The banker has a right to cross an open cheque.

He can also make a generally cross cheque into a specially crossed one. He

can cross the cheque specially in favour of himself or cross it specially in

favour of another banker to whom he may a send the cheque for collection.

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The act however does not permit the conversion of a special crossing into general

crossing. It also does not allow any material changes on the cheque. The above

explanation is illustrated in table 23.3.6

Particulars Right to cross a cheque.

Uncrossed cheque

The holder of the cheque can make a

general or special crossing on an

uncrossed cheque.

Generally crossed cheque The holder can cross it into a specially

crossed cheque. The name of the banker

has to be added by him.

Cheques crossed generally or specially The holder of the cheque can insert the

words not negotiable.

Cheques crossed specially

The cheque crossed in favour of a

particular banker can make another

crossing in favour of another banker or

his agent for collection of the amount.

Table 23.3.6 Conditions and the right to cross a cheque

23.3.7 Payment of Crossed Cheques

A crossed cheque cannot be paid over the counter. The cheque has to be collected.

There is a procedure for making a payment and collecting the amount on a crossed

cheque. The rules are different for payment of a crossed cheque generally and a

crossed cheque specially. The procedures for the payment of different kinds of

crossed cheques are explained according to the rules provided under Section 126 of

the Act:

• Collection procedure for generally crossed cheques: A ‘generally crossed

cheque’ can be collected only through a banker. The paying banker does not

have the right of making a payment directly over the counter. If the banker

defaults in this procedure he becomes liable to the owner of the cheque for any

losses occurring to him because of the payment of the cheque to the wrong

person. He cannot charge the customer with the amount paid to a person other

than to whom the cheque has been given.

519

Illustration: Neeru draws a cheque of Rs 18000 and gives

it to Ravi in full and final payment of his dues. The cheque

is drawn on ICICI Bank. Ravi is the payee of the cheque.

The cheque has been crossed generally. How should Ravi

collect the money?

In cheques crossed generally the amount cannot be paid over the counter. On receipt

of the cheque Ravi must deposit the cheque in his bank. He may deposit it in his

account in Punjab National Bank. The cheque will be collected and the amount will

be credited to Ravi’s account. At ICICI Neeru’s account will be debited with the

amount.

• Collection procedure for specially crossed cheques: The procedure for

making a payment in a special crossing is that the person who is the payee

deposits the cheques in the bank. The banker requests the paying banker to

make the payment. The paying banker should pay the cheque only to that

banker in whose name the cheque is crossed or to his agent for collection of

the same. Under Section 129 if the paying banker makes a default and the

payment is made by mistake to some other person, he will be liable for losses

occurring out of such a transaction and will have to make good the loss to the

true owner of the cheque.

Illustration: Surya draws a cheque on State Bank of India. Nirmal is the payee of the

cheque. Nirmal crosses the cheque generally to Syndicate Bank. How will the

payment be collected?

Surya’s account in State bank will be debited only when it pays the cheque to

Syndicate Bank. If Syndicate Bank cannot present the cheque to State Bank of India,

because there is no branch in that area, it may cross it specially to its agent State

Bank of Patiala to get the cheque collected through that bank.

23.4 REFUSAL OF PAYMENT BY BANKER

A banker is responsible to his customers. It is necessary that he takes care to make the

payments to honour the customer’s account. In order to protect the customer there are

certain special circumstances where the customer is justified in not honouring the

cheques of the customers. Refusal to pay cheques by the banker is in different types

of circumstances. These are:

520

• Conditions when banker ‘may’ refuse to honour cheques and

• Conditions when banker ‘must’ refuse to honour the cheques.

23.4.1 Conditions When Banker ‘may’ refuse to Honour Cheques

A banker ‘may’ refuse to make a payment of his customer’s cheques. If he refuses a

payment he is actually making his position secure because if he pays these cheques

the court has the right to determine the liability of the banker after considering the

facts of the case. In the following conditions the banker has the right to ‘refuse’

cheques without incurring any liability:

20 When cheque is post dated: In India a cheque is valid for six months from

date of issue. If it is presented after the due date the banker ‘may’ refuse to

honour the cheque.

Illustration 1: Meera made a cheque of Rs. 50,000 in favour of Moti on 26th March,

2008. Moti presented the cheque to his bank on October 10th, 2008. The banker

refused to pay the amount because the validity of the cheque ended on 26th October,

2008 and it was considered as a stale cheque by the banker. What is the position of

the banker?

Since the cheque was presented after the validity date, the banker has a right to refuse

payment of such a cheque.

21 When balance is insufficient: If a customer has an insufficient balance and

he gives a cheque to another his banker has a right to refuse the payment if

the customer does not have any overdraft facility.

Illustration 2: Arti gave a cheque to Shyama for Rs. 8,500. When Shyama tried to en-

cash it with the banker, she was refused payment. On the cheque the bank stamped

cheque returned due to insufficiency of funds. Arti had in fact only Rs. 3,000 in her

bank. Can the bank refuse payment?

The bank in such a case was perfectly justified in not honouring the cheque of the

customer.

22 When customer has notified other commitments: If a customer of a bank has

committed the funds in his account for some specific purpose and the funds

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are not available for honouring a new cheque the banker may refuse to pay

another cheque.

Illustration 3: Mona had Rs. 75,000 in her bank account. She had authorized the

bank to pay Rs. 55,000 as her quarterly EMI for the house that she was purchasing.

She wrote a cheque in favour of Neetu for Rs. 35,000. The banker refused to pay the

amount because Mona had a assigned her funds for some specific purpose and the

bank did not have enough funds to honour a cheque of 35,000. Should the banker

have paid the amount of the cheque?

The banker has acted appropriately in not paying the amount because Mona’s

amount in her account had already been assigned.

23 When cheque is not properly presented: If a person has presented a cheque to

a bank in which he does not have an account or he presents a cheque after

banking hours it means that the cheque is not properly presented. The banker

has a right to dishonour the cheque.

Illustration 4: Mishra presented his cheque of Rs. 15,000 to a bank at 6:30 PM in the

evening. The bank manager and some staff were working on their annual reports but

bank time for customers was upto 4’O clock. Mishra pleaded with the bank manager

to give him money because he had to catch a train. The bank manager refused to

honour the cheque because it was presented after working hours. Does he have the

right to refuse payment?

The banker has a right to refuse payment on the grounds that the cheque was not

properly presented.

24 When validity is doubtful: When a customer presents a cheque in which the

amount does not match in figures and words the banker has the benefit of

doubt to make the payment on the cheque. He may not honour the cheque.

Illustration 5: Bublee made a cheque in favour of Braj for Rs. 25,000. By mistake she

wrote Rs. Twenty three thousand in words. The bank did not pay the cheque because

the amount was different in words and in figures. What reason can the bank give for

refusing payment?

522

The bank can give the reason as doubtful validity because of non-matching of words

and figures in the cheque.

23.4.2 When Banker ‘Must’ Refuse Payment of Cheque

In the following cases the banker ‘must’ refuse the payment of a cheque. If the banker

makes a payment he will have to bear the loss himself. If he does not honour the

cheque of the customer he will have no liability against him.

20 Stop Payment: A customer has the right to ask the banker not to pay the

cheque that he has issued in favour of another person. There may be many

reasons for it. The cheque issued to another may have been misplaced or lost

or stolen. In these circumstances the banker has to protect his customer. He

must immediately on receiving the written instructions from his customer stop

payment of the cheque. Stopping payment of cheque is also called

‘countermanding the payment’ by the customer or in other words issuing

instructions to stop payment.

Illustration 1: Neelu gave a cheque to Geeta for Rs.

8,500. She lost the cheque while going from her work

place to her house and she notified Neelu. Her immediate

reaction was to write to the bank to ‘stop payment’ of the

cheque so that some person who finds the cheque does not

take the cash from the bank. What should the banker do?

The banker must refuse to pay as he has received ‘stop payment’ orders from his

customer.

21 Death or insanity of the customer: If a customer of the bank dies and notice

is given to the bank in writing, the banker should not pay any cheques. This

rule is relevant even when a customer becomes insane because when he is in

that state of mind he is incapable of taking any decisions. Therefore on the

death or insanity of a customer the banker must refuse payment of the cheque.

Illustration 2: Ramu died on 21st October, 2008. Although the bank was not officially

informed in writing by his family members, the bank manager saw a big

advertisement stating a pooja ceremony and uthala of the person and he visited the

family. When some cheques came to the bank for clearing after his death the banker

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refused. In this case the banker protected himself from any losses. Is the procedure

correct?

The banker must refuse payment of the cheques and hand over the money only to the

legal nominee of his customer.

22 Notice of assignment: If a customer assigns his account in favour of another

person and sends a notice to the banker in writing, the banker must refuse

payment of the cheques from this account.

Illustration 3: Piya assigned her account in favour of her daughter Riya. The

assignment to the account was sent in writing to the banker. When some cheques

came for clearing the banker refused stating that the account had already been

assigned in favour of another person. Is the banker justified in his actions?

The banker is justified. He must not honour the cheque of the customer.

23 Garnishee order: This is a court order to attach the balance of a customer’s

account. When a banker receives this notice he has to honour it. He cannot

pay any cheques issued by the customer. In case he disobeys this order and

makes a payment, he will not be entitled to recover that amount. He must bear

any losses associated with such payments made by him.

Illustration 4: Ravi had a dispute with Subi regarding a properly matter. The court

attached the balance in Ravis account until the dispute was cleared by the court. The

balance was attached according to a ‘garnishee order’. What should the banker do?

The banker must refuse to honour the cheques of his customer because the court has

issued a garnishee order.

24 Defective title of the holder: When a banker receives a cheque and finds it in

order but has the knowledge that the person presenting the cheque has a

defective title because he has obtained a stolen or forged cheque he must

refuse to make the payment on the cheque.

Illustration 5: Amit stole a cheque of Rs. 22,000 made in favour of his roommate

Atul. When he presented to cheque to the bank he was refused payment because the

banker knew that it was a stolen cheque. Is the banker authorized to refuse payment?

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The banker was authorized to refuse payment of the cheque as it had a defective title

and he knew that the cheque had been stolen.

25 Irregularity in the cheque: The banker has a right to dishonour a cheque if

any material facts on a cheque are not entered like date, signature of the

customer not tallying with the specimen signature with the bank.

Illustration 6: Anuj gave a cheque to Dhanur for Rs. 19,000 but the bank refused to

honour the cheque because it gave the reason that it was not a valid cheque since

Anuj’s signature which was given a specimen to the bank did not match the signature

on the cheque. Does the banker have the right to take such a decision?

The bank took the right decision to refuse payment on the basis of irregularity of the

cheque.

26 Closing of account: If a customer closes his account with a bank, the banker

has a right not to honour any further cheques issued by the customer.

Illustration 7: After closing his account with his banker in Orissa Munish issued

several cheques. The banker refused to pay the cheques issued after his customer had

closed his account with them. Is the bank liable for this decision?

He stated that Munish was no longer their customer and therefore it was not his

responsibility to pay any more cheques that were issued after closing his account.

23.5 PROTECTION TO THE PAYING BANKER

Bankers are offered special protection under the Negotiable Instruments Act for

honouring the cheques of their customers in good faith and without negligence. This

protection is required because the banker has a connection only with the drawer of the

cheque and not the payee or other parties who are called holders of the instrument. If

525

the banker acts in good faith and takes special care to discharge his responsibility he

will be absolved of making a payment to a receiver of a defective title.

Protection to Banker in Case of Order Cheques

Under Section 85 (1) a banker is protected against payments made by him in good

faith and with responsibility even though later on it is found that the indorsement on

the cheque was forged and did not belong to the paying.

Protection in Case of Bearer Cheques

Under Section 85 (2) the provision regarding protection of paying banker of bearer

cheques is that it does not have to verify regularity of indorsement on the bearer

cheque. The banker is discharged of his responsibility if he makes a payment of an

uncrossed cheque to a bearer in due course. The cheque may be a stolen one but the

banker will be protected because a bearer cheque always remains the same and it does

not change its legality with the number of new indorsements. Therefore the banker is

absolved of his responsibility if he has made a payment in good faith after taking into

account all necessary precaution.

Protection in case of Forged Signature of the Drawer

The banker is not protected if he has made a payment in due course and the signature

of the drawer is forged and the banker makes a payment on the basis of a forged

signature. In such circumstances the banker will have to bear the losses incurred on

the payment of such a cheque. However, if the banker can prove to his customer that

he has not been negligent, yet he could not detect the forged signature and made a

wrong payment, he will be absolved from his responsibility. A customer should stop

payment if it comes to his knowledge that the cheque issued has been forged by

entering his signature. If he does not take this important step after coming to know of

forgery then the banker cannot be made responsible for payment made by him.

23.5.4 Protection to Collecting Banker

The banker who makes the collection of payment on a crossed cheque is called the

collecting banker. Under Section 131 protection is granted to a collecting banker who

has carried out his work in good faith and without negligence. If a customer has

collected a payment of a cheque which is crossed generally or specially and the

cheque is found to be defective, he will be protected if he has used full precautions

526

while clearing the cheque. The cheque should be crossed when the banker receives it

and he should have collected it on behalf of his customer or acted as an agent for

another banker for collecting the payment. However the banker is not protected if an

account payee crossed cheque is credited to incorrect account and the payee on it is

forged.

23.5.5 Negligence of Collecting Bank

A bank has to prove that it is not negligent in order to be protected and absolved of

his liability while collecting a cheque. In some of the following conditions the bank

will be guilty of negligence and will not be able to get protection under Section 131.

• If a banker collects a cheque that is payable to order but does not make

enquiries or verifies the endorsements or the cheque.

• When a banker collects a cheque that is crossed account payee and deposits it

into an account which is not that of a payee.

• If a banker collects a large amount for a customer that has a very low balance.

The banker from the very nature of his duty should become suspicious in such

cases and verify that the cheque is not stolen or forged.

• If the cheque that is payable is collected for the private account of an official

of the bank, it must be verified, otherwise the bank will be guilty.

• The collecting banker should only receive payment for his customer he cannot

get protection if he collects a payment for an individual who is not his

customer.

23.6 RIGHT OF HOLDER AGAINST BANKER

If a banker refuses to pay his customer a cheque wrongfully damaging the reputation

of his customer, he will be liable to his customer but not to the payee or holder of the

cheque. Therefore the holder is not protected against the banker because there is no

privacy in the contract between the banker and the holder for wrongful refusal to pay

a cheque. However, there are two exceptions to this case.

Delay in presenting cheque: If a bank becomes insolvent and the holder had

delayed presenting the cheque due to which, the banker had losses, the holder

becomes a creditor of the banker in its insolvency proceedings and is able to

recover the amount from the banker under Section 84.

527

Illustration 1: Manu draws a cheque of Rs. 7,500 and gives it to Sonu who delays in

presenting cheque to the bank. In the time gap the banker becomes insolvent. Manu,

the drawer of the cheque is discharged from making a payment but Sonu, the holder

has a right against the banker as a creditor.

Sonu should be able to prove that the bank was financially stable when he received

the cheque from Monu.

Liability for incorrect procedure in cheque payment: The banker is liable to

the holder who is the true owner of the cheque, if he pays a cheque crossed

generally over the counter or a cheque crossed specially to a banker whose

name is not written on the cheque. The banker under Section 129 is liable for

losses and he can recover the amount from the payee if he is able to identify

him.

Illustration 2: Reena draws a cheque in favour of Chinu. The cheque is crossed

generally. The banker pays the cheque over the counter. Can the banker make a

payment over the counter?

The banker is liable for any losses occurring to Reena on account of making a

payment over the counter instead of making the payment through the bank in a

cheque crossed generally.

BOUNCING OF CHEQUES AND PENALTIES TO THE DRAWER

Bouncing of cheques is a serious offence under section 138 to 142 of the amended

Banking, Public Financial Institutions and Negotiable Instruments Laws Act 1988.

This amendment was brought about to make the drawer of the cheque consider that a

promise to pay a cheque is serious business. If the amount on it is not paid by the

banker due to insufficiency of funds in the drawer’s account he would be penalized.

This offence is punishable with imprisonment of one year and/or a fine or both

extending to more than one year and up to a maximum two years with a fine of twice

the amount of the cheque. Therefore when a person draws a cheque he should keep

sufficient amounts for clearing the cheque to avoid being penalized. If a person has

committed an offence he will be liable to be proceeded against and punished

accordingly. However, if the drawer can prove that he did not commit the offence

knowingly and he has tried in every possible way not to inconvenience the payee then

528

he will not be liable. To summarize, the following holds good if a person is found

guilty of dishonouring a cheque:

Imprisonment for dishonouring cheque: Imprisonment of the drawer for a

period that may extend up-to two years.

Fine for default in payment: The drawer can be fined. The fine may extend to

be double the amount of the cheque.

Imprisonment and fine to drawer: The penalty to a drawer can include

imprisonment and also fine that extends to double the amount of the cheque.

23.7.1 Conditions for Applicability of Section 138

The following conditions should be identified to prove that the drawer committed an

offence and should be penalized:

Insufficient funds: When a banker receives a cheque he should compare the amount

drawn on the cheque with the customers credit balance and the amounts assigned by

him for his various other activities. If the amount is less than the required funds, he

has a right to dishonour the cheques of the drawer. When the cheque is dishonoured,

the drawer will be penalized.

Insufficiency of funds is thus recognized in the following two cases:

The funds in the drawer’s account are not sufficient for honouring the cheque

Or if the amount is greater than the amount of balance left in the drawer’s

account after paying the funds assigned by him for other purposes.

Case Law 1

In Modi Cements Ltd. V K. K. Nandi230

It was held that the drawer of the dishonoured

cheque had committed an offence and shall be punished with imprisonment which

may extend upto two years, he may have to pay a fine for twice the amount to cheque

or both imprisonment and fine.

230

JT 1998 (2) SC 198

529

Case Law 2

In KPO Moideenkutty Hajee V Pappu Manjooran231

It was held that if a cheque is

dishonoured because of insufficiency of funds to the credit of the drawer. The drawer

will be held responsible as a person committing an offence under Section 138.

Case Law 3

In Micon Ltd. V Magma Leasing Ltd.232

It was decided that if a cheque has been

drawn and on presenting the cheque it has been returned on the grounds of account

closed it amounts to dishonour of a cheque under Section 138 making the drawer

liable under an offence.

However, if the amount is dishonoured because of some technical reasons such as

words in the cheque not matching the figures it will not be applicable under section

138.

Case Law 3

In MMTC Ltd. V Medchl Chemicals and Pharma (P) Ltd233

it was held that if there

were sufficient funds in the customer’s account but he had given a ‘stop payment

notice’ for some important and valid reasons including that there were no existing

liabilities when the cheque was presented, section 138 will not be applicable upon the

drawer.

Presentation of cheque beyond validity period: A cheque should be presented within

6 months of the issue. If the date of drawing the cheque or the validity period has

expired the cheque will be dishonoured.

Discharge of legally enforced debt or liability: The drawer should have made the

cheque in favour of the payee as a payment for discharge of a legally enforceable debt

or liability wholly or a part of it.

231

JT 1996 (3) SC 329 232

JT 1999 (3) SC 374 233

( 2002) 1 SCC 234

530

Case Law 4

In C.V.Alexander V Joseph Chako234

It was decided that the debt or liability to

discharge a cheque that has been issued may not be only the liability as a drawer but

also as a surety of another person.

Under Section 138 of the Act If the cheque was drawn in favour of the payee by way

of

Gift or donation

Unlawful or illegal consideration or

Moral obligation and it gets dishonoured it will not be considered as an

offence.

Dishonour notice to the drawer: The payee or the holder of the cheque must send a

written notice to the drawer within 30 days of receiving a notice from the banker of

the dishonour of the cheque and demand the amount on the cheque from the drawer.

A notice must preclude a complaint.

Case Law 5

In Suman Sethi v Ajay K Kejriwal235

it was held

that a notice is legal even though other claims for

interest, damages and other charges are inserted

in it and the drawer must adhere to it otherwise he

will be considered as an offence.

Demand of Payee within 30 days of notice: Notice to a drawer is given so that he gets

a chance to rectify his mistake. If the drawer fails to pay within 30 days of the notice

given to the drawer that the cheque has been dishonoured, it will be considered as an

offence. However, if the drawer makes the payment within the time limit he will be

absolved of his liability.

234

1995 82 comp cas 368 235

2002 (2) SCC 380

531

Case Law 6

In Paramjith Singh V N.C. job236

It was held that the action should be taken only on

the failure to pay the amount to the payee within 30 days of giving the notice of

dishonour. Offence arises not on the date of issue of cheque but failure to make

payment within 30 days of notice period.

Payee should give a written complaint within one month: The payee should make a

written complaint within one month after the expiry of the notice period to the court

under section 138 to a first class magistrate or metropolitan magistrate. A court

inferior to this court cannot be allowed to try the offence case. The complaint has to

be filed in the place where the cheque was presented for collection or near the

business house of the payee a holder in due course. The complaint must also be

forwarded with details regarding the bank and its branch on which the cheque was

issued and the date and the number of the cheque when it was drawn and the reasons

given by the bank for not honouring the cheque. The court also requires the date when

the payee sent a notice demanding his payment from the drawer and if there were any

replies to the demand they were to be attached.

Section 139 also states that the court will presume that the cheque was given for

discharge of debt or liability unless the drawer proves that it is not so. Section 140

states that a drawer will not be able to take any defence under the fact that he

issued the cheque but did not expect it to be honoured.

Case Law 7

In S. Ramaswamy v K. Sudarshan Rao237

it was held that the complaint should be

within the time limit prescribed and if it is delayed there should be a sufficient reason

to explain why the complaint it delayed in the judicial magistrate or metropolitan

magistrate court. Further, it stated that the complaint should normally be filed by the

payee but it can also be filed by his authorized agent or power of attorney holder.

236

(1990) B.C. 177 Ker 237

(1995) 83 Comp Cas 673 Mad

532

23.7.2 Documents Required For Complaint

To file a criminal complaint in the court the applicant has to file certain documents

with the complaint. The holder should attach the following documents to prove that

he has not received payment:

Bounced cheque attached: The complaint sent to the court should be attached

with the bounced cheque.

Bank refusal statement: The document received by the payee from the banker

refusing payment of the cheque.

Legal notice: A copy of the legal notice sent to the drawer notifying him of

the dishonour of the cheque requesting the amount stated in the cheque.

Receipt of notice: The registered post receipt taken from the post office for

sending the legal notice of dishonour of cheque to the drawer.

Signed acknowledgement: Acknowledgement card of the legal notice signed

by the drawer.

Thus the relationship of a banker and his customer is of trust and confidence. The

customer and banker interaction is very important while cheques are being issued in

the course of business dealings. The banker has to create confidence in his customer

and act in good faith and without negligence and protect his customer’s interests.

23.8 POINTS TO REMEMBER

Definition Of Banking according to section 5B of the Banking Regulation Act.

3. Banking means accepting for the purpose of lending or investment, of deposits

of money from the public.

4. They are repayable on demand or otherwise and withdrawal is by cheque, draft,

order or otherwise.

Definition of Banker

! A banker is engaged in payment of cheques.

! Maintaining secrecy of accounts of their customers.

! Following customer’s instructions.

! Keeping a record of customers accounts.

Definition of Customer

533

29 A person who has opened an account in his own name.

30 An individual / firm / company or association that has opened an account for

carrying out the business of banking.

31 The relationship of the customer should be specifically towards banking

business.

32 The customer accepts the services and facilities provided to him by the banker.

Crossing of Cheques- Types

24 Open or uncrossed cheques

25 Cheques crossed generally

26 Cheques crossed specially

27 Restrictive crossing

28 Not Negotiable crossing

29 Double crossing

Payment of Crossed Cheques

26 A ‘generally crossed cheque’ can be collected only through a banker

24 A ‘specially crossed cheque’ can be collected only through the banker whose

name has been written in the cheque.

Refusal of Payment By Banker

Banker may refuse payment:

25 When cheque is post dated

26 When balance is insufficient

27 When customer has notified other commitments

28 When cheque is not properly presented

29 When validity is doubtful

Banker must refuse payment:

28 When payment is countermanded / stop payment notice is given by the customer

29 In the case of death or insanity of the customer

30 When there is notice of assignment

31 When Garnishee order is issued by court order to attach the balance in the

customer account.

32 When title of holder is defective.

33 If the loss of cheque is reported.

34 If there are irregularities in the cheque

35 When account of customer is closed.

534

Protection to the Paying Banker

Protection is given to banker in case of order cheques if he acted in good faith

and made a payment on which the indorsement was forged.

Protection in case of bearer cheques is given to the banker if he made the cheque

in good faith.

No protection is given to the banker when drawer’s signature is forged unless he

can prove that he has not been negligent in his duty.

Protection to Collecting Banker

Under Section 131 protection is granted to a collecting banker who has carried out his

work in good faith and without negligence.

Banker is not protected if an account payee crossed cheque is credited to incorrect

account and the payee’s signature on it is forged.

Right of Holder against Banker

If holder delays in presenting cheque and subsequently bank becomes insolvent.

Holder can become a creditor of the banker in the insolvency proceedings.

Banker is liable to the holder of the cheque if he pays a crossed cheque over the

counter.

Bouncing of Cheques attracts the following penalties for the drawer.

Imprisonment for dishonouring cheque up to a maximum of two years.

Fine for default in payment

Imprisonment and fine to drawer

Conditions For Penalties to the Drawer (Section 138)

Insufficient funds in the drawer’s account.

Presentation of cheque beyond validity period.

The cheque has been drawn for discharge of legally enforced debt or liability

Payee should make a demand within 15 days of notice.

Payee should give a written complaint within one month

The Following Documents Required For Complaint should be attached.

The complaint should be attached with the bounced cheque.

The document received by the payee from the banker refusing payment of the

cheque.

A copy of the legal notice sent to the drawer notifying him of the dishonour of

the cheque requesting the amount stated in the cheque.

The registered post receipt taken from the post office for sending the legal

535

notice of dishonour of cheque to the drawer.

Acknowledgement card of the legal notice signed by the drawer.

Objective Type Questions

State whether the following are true or false.

• When a bank dishonours a cheque because of insufficiency of funds the drawer is

guilty of an offence under Section 138.

• The maximum imprisonment for dishonour due to insufficiency of funds is six

years.

• ‘Once a bearer cheque always a bearer cheque’.

• General Crossing of a cheque can be changed to ‘no crossing’ by the drawer.

• Special crossing can be done even without parallel lines.

• An account payee cheque must be collected through a bank.

• A cheque is always payable on demand.

• Crossing a cheque brings about protection to the drawer.

• If the title of the cheque proves to be defective the banker is liable to the drawer

even if he acted in good faith and without negligence.

• A cheque crossed specially has to be paid only to the banker or his agent to whom

it is crossed.

Answer: 1. T, 2. F, 3. T, 4. T, 5. T, 6. T, 7. T, 8. T, 9. F, 10. T.

Questions

What is a crossed cheque? Why should a cheque be crossed? Explain the different

ways in which a cheque can be crossed?

What are the effects of the following types of crossing:

Account Payee cheque, (b) not negotiable crossing and (c) double crossing.

In what circumstance is it possible for a banker to dishonour a cheque of a customer?

Discuss the conditions in which a paying banker is protected when wrong payments

are made by him on bearer and order cheques.

Explain why it is said that (1) “once a bearer cheque always a bearer cheque”, (2) A

banker is bound to honour his customer’s cheques. Explain this statement.

How would you distinguish between

(a) Generally and specially crossed cheque?

(b) Not negotiable and a restrictively crossed cheque?

536

(c) Doublly crossed cheque and a not negotiable crossed cheque.

(d) A banker who collects the funds and a banker who pays the funds?

What are the penalties to a drawer for bouncing of a cheque? What are the conditions

for making these complaints?

Discuss the protection to a paying banker in case of bearer cheques and in case of

order cheques. Does the banker get protected when a drawer’s signature is forged?

Explain the requirements and documents for penalty to the drawer in case of bouncing

of cheques.

Practical Problems

Ankita draws a cheque and crosses it with the words not negotiable before he gives

it to Subu. The cheque is stolen and Saurab finds it and in good faith he

gives value for it. He deposits the cheque in his own bank and receives the

payment from the drawee - bank. What is the position of the drawee bank,

the collecting bank and Saurab?

Answer: The bank that pays the money and the bank that collects the money both get

protected under section 128 and 131and are absolved of their liability.

However Saurab becomes liable to the true owner since this cheque is not

negotiable. Saurab cannot get a better title to a stolen cheque. He has to pay

the amount to Ankita.

Bunny draws a cheque of Rs 3500/- and puts a restrictive crossing on it by writing

the words A/c Payee. . He gives the cheque to Sunny. However the cheque is

made in favour of Meeru. Sunny deposits the cheque in his account and the

cheque is collected from Bunny’s account. Later on when Meeru comes to

know that the cheque has been cleared, he holds the bank responsible for it.

According to him it is a cheque with a restrictive crossing and it can only be

credited to the payees account and not to any person who receives the

cheque. Can Meeru get relief?

Answer: The banker is wrong if he credits a restrictive cheque in the account of a

person other than the payee. Meeru must prove that the collecting bank has

been negligent in paying money to a person other than whose favour the

cheque has been issued to get relief.

537

Sumeet draws a blank cheque on 20th

March in favour of Rashmi as a security for a

loan taken from her of Rs. 45000/-. She promised to return the money by

May 15th

2008. When Sumeet did not pay the amount on the due date

Rashmi waited for 15 days and then with repeated phone calls and no

response from Sumeet she deposisted the security cheque which got

dishonoured. She gave a notice of dishonour to Sumeet and made a

complaint in the court of the first class magistrate. Can Rashmi recover the

money?

Answer: Rashmi can recover the money because once the cheque is issued, and it is

proved under section 138 a cheque issued for repayment of loan or for as

security does not make any difference.

Lovely issued a cheque in favour of Praveen of Rs. 15,000. Due to some mistake in

the accounts a dispute arose between them. Lovely gave written instructions

to its bank that the cheque was not to be paid due to some dispute. Praveen

presented the cheque but the bank refuse payment tot eh payee. Will he get

relief under Section 138 of the Negotiable Instruments Act 1881?

Answer: The banker is not liable to pay. He is not guilty of any offence. The chque

was dishonoured not because of insufficiency of funds but a stop payment

called countermanding instructions from his customer.

Malti’s secretary forged her signatures and withdrew money several times from her

account. When Malti became aware of it she did not inform the bank

immediately. The bank could not take any remedial action because of lack of

information of forged signature. The bank had paid in good faith and

without negligence. Can Malti hold the bank responsible for making a wrong

payment from her account?

Answer: Malti cannot get relief because she did not inform the bank even after

becoming aware of the forged signatures and the banker acted in good faith

and without negligence in doing his duty.

538

Suresh draws a cheque that is payable to ‘self or order’. The cheque is indorsed in

favour of Sneha. Since there were in sufficient funds in the account the bank

dishounring it. Sneha immediately gave a notice of offence to Suresh under

Section 138 she argued that the money be given to her. Suresh argued that

Section 138 only applies to cheques that have been drawn but not indorsed.

Will Sneha be able to get the money owed to her by Suresh?

Answer: Suresh is liable under Section 138 as he drew the cheque in his own name

and then also indorsed it in favour of his creditor Sneha. She will be able to

get the funds.

Bharat issues a cheque of Rs. 3,000 on 2nd June, 2008 and on 4th June he stops

payments by written instructions to the bank. The bank pays the amount on

6th June, 2008 by honoring the cheque. What is the position of the bank?

Answer: The banker is liable to Bharat because he receives the notice of stop payment

and still pays the cheque. He is not discharged of his liability.

Tarun has a balance of Rs. 850 in his bank. He has no overdraft facility with the

bank. He draws a cheque of Rs. 3,500. The banker refuses to pay to the

payee Sanjay because of insufficient balance. Sanjay realizes after six

months that he has still not received Rs. 3,500 and the cheque that he had

presented had been dishonoured. Can he now take action and bring the

question of offence under Section 138 of dishonour of a cheque?

Answer: Sanjay does not have any right to send a notice to Tarun because within 30

days of receiving a notice from the banker that his cheque has been

dishonoured he should have sent a notice to Tarun and filed a complaint in

the court of the magistrate to take action. Since he did not do it he cannot

legally look for the benefits as the time period is over.

539

References:

Books

20 Tulsian PC (2000) Business Law, pages 17.19 – 17.60, Tata McGraw-Hill

Publishing Company Ltd. New Delhi.

21 Faizi OP and Aggarwal A (2008) Khergamvala on The Negotiable

Instruments Act, Pages 343 – 533, Lexis Nexis Butterworths India.

22 Aggarwal S.K. and Singhal K.(2007) Indian Business Laws, pages 460-474,

Galgotia Publications Pvt. Ltd.

23 Chadha P.R., (2001), Business Law, Pages 521-534, Galgotia Publishing

Company.

24 Bansal G.L. Business and Corporate Laws (2006) Pages341-349, Excel

Books.

Websites:

http://en.wikipedia.org/wiki/Crossing_of_cheques

http://www.hinduonnet.com/businessline/iw/2001/07/29/stories/0729g252.htm

http://www.lawstudent.in/cl_legalroundup16.htm

http://www.thehindubusinessline.com/mentor/2004/01/19/stories/2004011900171000.

htm

540

Part IV Information Technology

Act-2000

Lesson 24- Information Technology Act-2000

Lesson 25- Electronic Records, E-Governance

and Subscriber

Lesson 26- Regulation of Certifying Authorities

Lesson 27- Contraventions, Offences and

Appellate Tribunal

541

Lesson-24

Information Technology Act-2000

by

Nidhi Dhawan

This Chapter discusses the following aspects of the Information

Technology Act:

24.1 Introduction

24.2 Applicability of the Act

24.3 Exceptions to the Act

24.4 Characteristics of Act

24.5 Objectives of the Act

24.6 Definitions for the understanding of the Act

24.7 Secure E-Commerce including:

(A) Digital Signature, (B) Cryptography

(C) Digital Signature Certificate

24.1 INTRODUCTION

The Information Technology Act was passed in the year 2000 and it came into force

on 17th

Oct., 2000. The Information Technology Act, 2000 consists of 13 Chapters

divided into 94 sections. The Act has four schedules on consequential amendments in

respect of certain other Acts. Chapters I to VIII are mostly Digital signature related.

Chapters IX to XIII are regarding penalties, offences, etc.

542

Information technology (IT), as defined by the Information Technology Association

of America (ITAA), is "the study, design, development, implementation, support or

management of computer-based information systems, particularly software

applications and computer hardware." IT deals with the use of electronic computers

and computer software to convert, store, protect, process, transmit, and securely

retrieve information.238

Objects and Reasons:

An Information Technology Act, 2000 provides legal recognition for transactions

carried out by means of electronic data interchange and other means of electronic

communication, (commonly referred to as "electronic commerce"), which involve the

use of alternatives to paper-based methods of communication and storage of

information, to facilitate electronic filing of documents with the Government agencies

and further to amend the Indian Penal Code, the Indian Evidence Act, 1872, the

Bankers' Books Evidence Act, 1891 and the Reserve Bank of India Act, 1934 and for

matters connected therewith or incidental thereto.239

The basic need for designing the Information Technology Act, 2000 was to give boost

to e-transactions, e-commerce and similar activities associated with commerce and

trade and to facilitate e- governance thus making a trouble free interaction of between

citizens and government offices.

The Act drew its inspiration from the Model law on Electronic Commerce

adopted by the United Nations Commission on International Trade Law

(UNCITRAL)240. The UNCITRAL adopted the Model Law on Electronic

Commerce in 1996. Indian Parliament enacted in the Fifty First year of the

238

http://en.wikipedia.org/wiki/Information_technology

239

IT Act, 2000.

The word ‘Act’ wherever used in this chapter means the IT Act, 2000. 240

The UN General Assemble by its resolution 2205(XXI) of 17th

Dec, 1966 created

United Nations Commission on International Trade(UNCITRAL).

543

Republic of India, an Act called the Information Technology Act, 2000. It came

into force on 17th Oct., 2000. It is the first Cyber Law in India.

Unlike similar legislation in Singapore, Malaysia, South Korea and Thailand, which

primarily focuses on the regulation of e-commerce, the Information Technology Act

2000 introduces and enacts for the first time in India a range of e-commerce and

Internet related criminal offences, and also provides a range of executive powers that

will significantly impair the rights of privacy and free speech of both citizens of India

and of other countries.

E-Commerce refers to the trading of goods over the internet. It refers to the business

transacted electronically. It is an online sale and purchase of goods and services for

value using Internet Technologies such as e-mail, www, web browsing, etc. The IT

Act has been designed to give boost to electronic commerce, e-transactions and

also to facilitate e-Governance by means of electronic records.

Signed and written documents are traditionally used for commercial transactions

(mainly

because of their evidentiary value). Also, Indian law requires certain documents and

contracts to be written and signed. The basic purpose of a signature is to

authenticate a document and to identify and bind the person who signs the

document.

Where contracts are entered online and documents are sent via e-mail, it might not be

possible for parties to actually “sign” the contract or document. Increasing use of

internet everywhere necessitated the creation of relevant cyber laws all over the

world. It is difficult to identify the originator of an online document and to verify its

authenticity. Cyber laws refer to all the legal and regulatory aspects of the internet and

the World Wide Web

.The concept of digital signatures has been devised to overcome this limitation and

theAct has been enacted to give legal backing to such digital signatures and regulate

them.

544

24.2 Applicability of the ACT

The Act extends to the whole of India (including Jammu and Kashmir). It applies also

to any offence or contravention committed outside India by any person, irrespective

of his nationality, if the act or conduct constituting the offence or contravention

involves a computer, computer system or computer network located in India.

24.3 Exceptions [Sec 1(14)] the provisions of the IT Act shall not apply to the

following documents.

“Negotiable Instruments” under the Negotiable Instruments Act, 1881.

“Power of Attorney” under the Powers of Attorney Act, 1882.

“Trusts” define in section 3 of the Indian Trusts Act,1882

“Will” define in clause (h) of Sec(2) of the Indian Succession Act, 1925 including

any other testamentary dispositions;

Entering into a contract for sale or conveyance of immovable property or

any interest in such property.

Any such class or document which Central Government may notify.

24.4 Basic Characteristics of the Act

Extends to the whole of India

Electronic contracts will be legally valid

Legal recognition of digital signatures

Security procedure for electronic records and digital signature

545

Digital signature to be effected by use of asymmetric crypto system and hash function

Appointment of Controller of Certifying Authorities to license and regulate the

working of Certifying Authorities

Controller to certify the public keys of the Certifying Authorities (CAs)

Controller to act as repository of all digital signature certificates

Certifying Authorities to get License from the Controller to issue digital signature

certificates

Various types of computer crimes defined and stringent penalties provided under the

Act

Appointment of Adjudicating Officer for holding inquiries under the Act

Establishment of Cyber Regulatory Appellate Tribunal under the Act

Appeal from order of Adjudicating Officer to Cyber Appellate Tribunal and not to

any Civil Court

Appeal from order of Cyber Appellate Tribunal to High Court

Act to apply for offences or contraventions committed outside India

Network service providers not to be liable in certain cases

Power of police officers and other officers to enter into any public place and search

and arrest without warrant

Constitution of Cyber Regulations Advisory Committee to advise the Central

Government and the Controller

546

24.5 Objectives of the Act

The Information Technology (IT) Act 2000 aims to provide a legal and regulatory

framework for promotion of e-Commerce and e-Governance. Information stored in

electronic form has many advantages. It is cheaper, creates paper free environment,

easier to store and retrieve. But due to lack of appropriate legal framework and

security of transactions, users are reluctant to conduct business online.

To prevent the possible misuse arising out of the transactions and other dealings

electronically, the IT Act provides for a regulatory regime to facilitate reliable e-

commerce and e-governance. The basic objectives of the IT Act are to provide for:

Legal recognition of Electronic Transaction, Records and Digital Signatures

Electronic Communication by means of reliable electronic record

E-Commerce, Electronic Data interchange and E-Governance

Electronic filing of documents and Retention of documents in electronic form

Uniformity of rules, regulations and standards regarding the authentication and

integrity of electronic records or documents

Publication of official gazette and Acceptance of contract by electronic means

Interception of any message transmitted in the electronic or encrypted form

Prevention of Computer Crime, forged electronic records, international alteration of

electronic records fraud, forgery or falsification in e-Commerce and electronic

transaction

Briefly stated, the IT Act mainly contains provisions to e-commerce, e-governance,

and electronic record and digital signature.

24.6 Definitions- (Section 2) some important definitions are given below for

understanding the concepts and legislative intents. Some illustrations are also given

below for the same purpose. These are:

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(a) "Access" with its grammatical variations and cognate expressions means gaining

entry into, instructing or communicating with the logical, arithmetical, or memory

function resources of a computer, computer system or computer network;

Illustration: Reena wants to use the computer system by instructing and

communicating it through its logical, arithmetical, or memory functions. It includes

the use of both the physical and virtual access.

(b) "Addressee" means a person who is intended by the originator to receive the

electronic record but does not include any intermediary;

(c) "Adjudicating officer" means an adjudicating officer appointed under

subsection (1) of section 46;

(d) "Affixing digital signature" with its grammatical variations and cognate

expressions means adoption of any methodology or procedure by a person for the

purpose of authenticating an electronic record by means of digital signature;

Illustration: Mina wants to authenticate its message to be sent by signing it

electronically. She can make use of encryption technique to do the same.

(e) "Appropriate Government" means as respects any matter,-

(i) Enumerated in List II of the Seventh Schedule to the Constitution;

(ii) relating to any State law enacted under List III of the Seventh

Schedule to the Constitution,

the State Government and in any other case, the Central Government;

(f) "Asymmetric crypto system" means a system of a secure key pair consisting of

a private key for creating a digital signature and a public key to verify the digital

signature;

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Illustration: Mohan has sent a digitally signed message using his private key to

the shyam and shyam has verified the same by using the public key. This is a dual-

key approach where one key (private key) is used to encrypt and other key (public

key) to decrypt.

(g) "Certifying Authority" means a person who has been granted a license to issue

a Digital Signature Certificate under section 24;

(h) "Certification practice statement" means a statement issued by a Certifying

Authority to specify the practices that the Certifying Authority employs in issuing

Digital Signature Certificates;

Illustration: The Certification Practice Statement explains the specific public

certification services of ABC Company (a Certifying Authority). These services

include certificate application, application validation, certificate issuance,

acceptance, use, suspension, activation, revocation and renewal of a Digital

Signature Certificate, operational security procedures for audit logging and

records retention. It is a contractual obligation to be fulfilled by ABC Company

vis- a - vis Controller and Subscriber.

(i) "Computer" means any electronic magnetic, optical or other high-speed data

processing device or system which performs logical, arithmetic, and memory

functions by manipulations of electronic, magnetic or optical impulses, and includes

all input, output, processing, storage, computer software, or communication facilities

which are connected or related to the computer in a computer system or computer

network;

(j) "Computer network" means the interconnection of one or more computers

through—

(i) the use of satellite, microwave, terrestrial line or other

communication media; and

(ii) terminals or a complex consisting of two or more interconnected

computers whether or not the interconnection is continuously

maintained;

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(k) "Computer resource" means computer, computer system, computer network,

data, computer data base or software;

(l) "Computer system" means a device or collection of devices, including input and

output support devices and excluding calculators which are not programmable and

capable of being used in conjunction with external files, which contain computer

programs, electronic instructions, input data and output data, that performs logic,

arithmetic, data storage and retrieval, communication control and other functions;

(m) "Controller" means the Controller of Certifying Authorities appointed under

sub- section (l) of section 17;

(n) "Cyber Appellate Tribunal" means the Cyber Regulations Appellate Tribunal

established under sub-section (1) of section 48;

Illustration: PCS Company, a certifying authority wants to make an appeal

against the order of the controller of certifying authority for the revocation of its

certificate without being given an opportunity of being heard. PCS Company can

make an appeal to the Cyber Appellate Tribunal.

(o) "Data" means a representation of information, knowledge, facts, concepts or

instructions which are being prepared or have been prepared in a formalized manner,

and is intended to be processed, is being processed or has been processed in a

computer system or computer network, and may be in any form (including computer

printouts magnetic or optical storage media, punched cards, punched tapes) or stored

internally in the memory of the computer;

(p) "Digital signature" means authentication of any electronic record by a subscriber

by means of an electronic method or procedure in accordance with the provisions of

the section.

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The pictorial representation of Digital Signature details of the Company is shown below:

Illustration: In E-environment, Krisna

authenticates the information send by

him to his friend Mohan by using a

digital signature technology( private

key for encryption) and Mohan

transforms it( public key for

decryption) and a hash algorithm.

(q) "Digital Signature Certificate" means a Digital Signature Certificate issued under

sub-section (4) of section 35;

(r) "Electronic form" with reference to information means any information generated,

sent, received or stored in media, magnetic, optical, computer memory, micro film,

computer generated micro fiche or similar device;

(s) "Electronic Gazette" means the Official Gazette published in the electronic form;

(t) "Electronic record" means data, record or data generated, image or sound stored,

received or sent in an electronic form or micro film or computer generated micro fiche;

(u) "Function", in relation to a computer, includes logic, control arithmetical process,

deletion, storage and retrieval and communication or telecommunication from or within

a computer;

(v) "Information" includes data, text, images, sound, voice, codes, computer program,

software and databases or micro film or computer generated micro fiche:

(w) "Intermediary" with respect to any particular electronic message means any person

who on behalf of another person receives stores or transmits that message or provides

any service with respect to that message;

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(x) "Key pair", in an asymmetric crypto system, means a private key and its

mathematically related public key, which are so related that the public key can verify a

digital signature created by the private key;

(y) "Law" includes any Act of Parliament or of a State Legislature, Ordinances

promulgated by the President or a Governor, as the case may be. Regulations made by

the President under article 240, Bills enacted as President's Act under sub-clause (a) of

clause (1) of article 357 of the Constitution and includes rules, regulations, bye-laws and

orders issued or made there under;

(z) "License" means a license granted to a Certifying Authority under section 24;

(za) "Originator" means a person who sends, generates, stores or transmits any

electronic message or causes any electronic message to be sent, generated, stored or

transmitted to any other person but does not include an intermediary;

(zb) "Prescribed" means prescribed by rules made under this Act;

(zc) "Private Key" means the key of a key pair used to create a digital signature;

(zd) "Public key" means the key of a key pair used to verify a digital signature and

listed in the Digital Signature Certificate;

(ze) "Secure system" means computer hardware, software, and procedure that-

(a) Are reasonably secure from unauthorized access and misuse;

(b) Provide a reasonable level of reliability and correct operation;

(c) Are reasonably suited to performing the intended functions; and

(d) Adhere to generally accepted security procedures;

(zf) "Security procedure" means the security procedure prescribed under section 16 by

the Central Government;

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zg) "Subscriber" means a person in whose name the Digital Signature Certificate is

issued;

(zh) "Verify" in relation to a digital signature, electronic record or public key, with its

grammatical variations and cognate expressions means to determine whether-

(a) the initial electronic record was affixed with the digital signature by the use of

private key corresponding to the public key of the subscriber;

(b) the initial electronic record is retained intact or has been altered since such

electronic record was so affixed with the digital signature

24.7Secure E-commerce

Basic Components of security As the Internet and other forms of electronic

communication become more prevalent, electronic security is becoming increasingly

important. All electronic communications must meet the fundamental requirements:

Authenticity-The sender authenticates the message so that recipient can determine who

really sent the message.

Message integrity- It is to determine whether message received has been modified

altered or is incomplete.

Non-repudiation-It means sender cannot deny sending the message.

Privacy-The message must be secure from any unauthorized person.

Security Measures

What are the various ways to get the online security? The basic requirement of

securing electronic transactions on the internet can be fulfilled by following one or more

security measures. They can be adopted to ensure safe online communications during e-

commerce. These security measures are enumerated below:

Digital Signatures- It means authentication of any electronic record by a subscriber by

means of an electronic method or procedure in accordance with the provisions of section

3.

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Encryption- It is a procedure to convert a regular text into a coded or secret text.

Digital Signature Certificate-It is an instrument of trust identifying the subscriber over

the networks.

All the above stated security measures are discussed hereunder in detail:

(A) Digital signature

It is an electronic signature that can be used to:

Authenticate the identity of the sender of a message or the signer of a document.

Ensure that the original content of the message or document that has been sent is

unchanged.

Ensure non-denial by the sender. He becomes committed to the contents of the

document and the intentions expressed therein.

Digital signatures are easily transportable, cannot be imitated by someone else, and can

be automatically time-stamped. The ability to ensure that the original signed message

arrived means that the sender cannot easily repudiate it later.

A digital signature can be used with any kind of message, simply so that the receiver can

be sure of the sender's identity and that the message arrived intact. A digital certificate

contains the digital signature of the certificate-issuing authority so that anyone can verify

that the certificate is real.

The procedure of creating a digital signature, sending it with the message and receiving it

at the other end is explained with the help of an illustration.

Illustration: Rena sends a digitally signed message to sheikh by using a hash algorithm

and applying a private key.

Message Hash Function

Message Digest

Signature Function (private key)

Digital Signature

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Sheikh decrypts the message by applying signer’s public key and computes a new hash

result of the original message and comparing it with the original hash result extracted

from the digital signature during the verification process.

It is important to know about the digital signature technology being used in creating a

digital signature.

Digital Signature Technology

A digital signature is not a digitized image of a handwritten signature. It is a block of

data at the end of the electronic message that attest to the authenticity of the said

message. It is a digitally signed hash result of the “message. It is unique to its message.

Digital signatures are actual transformation of an electronic message using cryptography.

It is used to protect e-mail messages, credit card information, and corporate data.

(B) Cryptography (Data Encryption Technique)

The art of protecting information by transforming it (encrypting it) into an unreadable

format, called cipher text. Only those who possess a secret key can decipher (or decrypt)

the message into plain text. Encrypted messages can sometimes be broken by

cryptanalysis, also called code breaking, although modern cryptography techniques are

virtually unbreakable.

Digital Signature

Signature Function

(Signer’s public key) Message Digest

Signature will verify if this Message Digest

is identical with the message digest of the

creation process of digital signature.

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Encryption is the transformation of data into some unreadable form. Its purpose is

to ensure privacy by keeping the information hidden from anyone for whom it is not

intended, even those who can see the encrypted data. It is a procedure to convert a

regular text into a coded or secret text. Decryption is the reverse of encryption; it is

the transformation of encrypted data back into some intelligible form.

Encryption and decryption require the use of some secret information; usually referred to

as a key (Key is a combination of digits representing a huge number generated by

mathematical formulae.) Depending on the encryption mechanism used, the same key

might be used for both encryption and decryption, while for other mechanisms, the keys

used for encryption and decryption might be different. A basic task in cryptography is

to enable users to communicate securely over an insecure channel in a way that

guarantees their transmissions privacy and authenticity. Providing privacy and

authenticity remains a central goal for cryptographic protocols.

Cryptography has also two types.

Kinds of cryptography: There are basically two kinds of cryptography in use.

I Secret key (symmetric)

With secret key, the same key is used to encrypt information and decrypt

information. Hence the operation is symmetric. . With secret key systems you don't

know who sent the message or if it is for a specific recipient, because anyone with the

secret key could create or read the message.

II Public/private key (asymmetric)

An algorithm generates two different and related keys: public and private key.

(1)”Private Key" means the key of a key pair used to create a digital signature;

Encryption Cipher text Decryption Plain text Plain text

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(2)"Public key" means the key of a key pair used to verify a digital signature and listed in

the Digital Signature Certificate;

With public/private key, the two keys are of different values. If you know the value of

one you can't calculate the value of the other. Encryption is done using one of them, and

decryption can then only be done using the other. Hence the operation is asymmetric.

With public/private systems it's very different. You can give your public key to everyone.

Then, if they want to send something to you they encrypt it with your public key and they

know that only you can read it. By the same terms, if you encrypt something using your

private key, then anyone who has your public key can check to see if they can decrypt it,

and if they can, they know it must have come from you.

Use of cryptography into digital signatures is done with a view to highly secure the

information transmission on the internet. This is explained below:

Digital Signature Using Encryption Technique:

Digital signatures are actual transformation of an electronic message using cryptography.

A digital signature actually provides a greater degree of security enabling

“authentication" of digital messages, assuring the recipient of a digital message of both

the identity of the sender and the integrity of the message.

After becoming aware of the techniques used in securing the message or any information

in the electronic environment with the help of digital signature, it is important to know

the procedure involved in the creation and verification of digital signature. They are

enumerated below:

According to the Act, Asymmetrical or ‘public key cryptography’ involving a pair of

keys (private and public key is used) is used for creating a digital signature.

Steps

Signer demarcates the message.

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Hash function in the signer’s software computes a hash result unique to the message.

The signer software then transforms (encrypts) the hash result into a digital signature

using a signer’s private key. The resulting digital signatures are unique to both the

message and the private key is used to create it.

The digital signature (a digitally signed hash result of the message) is attached to both its

message and stored or transmitted with its message. Digital signature is unique to its

message. Signer sends both digital signature and message to the recipient

The pictorial representation of the creation of digital signature is shown below:

Hash function is used in both creating and verifying a digital signature. It is an

algorithm that creates a digital representation or “fingerprint” in the form of hash

result. A hash value (or simply hash), also called a message digest, is a number

generated from a string of text. The hash is substantially smaller than the text itself, and

is generated by a formula in such a way that it is extremely unlikely that some other text

will produce the same hash value. The sender generates a hash of the message, encrypts

it, and sends it with the message itself. The recipient then decrypts both the message and

the hash, produces another hash from the received message, and compares the two

Hash

Encrypt

Private Key

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hashes. If they're the same, there is a very high probability that the message was

transmitted intact.) Hashing is also a common method of accessing data records.

A key is a combination of digits representing a huge number generated by

mathematical formulae. In Digital Signature, private key is used to encrypt the

message and public key is used to decrypt the message.

The recipient of a digitally signed message can verify both that the message originated

from the person whose signature is attached and that the message has not been altered

either intentionally or accidentally since it was signed. Furthermore, secure digital

signatures cannot be repudiated; the signer of a document cannot later disown it by

claiming the signature was forged.

Steps:

For verifying the digital signature first of all, the recipient receives digital signature and

the message.

He applies signer’s public key on the digital signature and recovers the hash result

from the digital signature.

After this, he computes a new hash result of the original message by applying the

same hash function used by the signer to create the digital signature.

Lastly, he compares the two hash results, if they are identical; it indicates that the

message has not been modified. If two hash results are not same, it would mean that the

message either originated somewhere else was altered after it was signed and the

recipient in such a case can reject the message.

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Digital signatures are created and verified using a data encryption technique

known as cryptography. Digital Signature operates on online software driven space

so, both the sender and the receiver must have digital signature software at their

respective ends. It means a person has to either purchase digital signature software

or download from the browser, and install it in his own computer.

The processes of creating and verifying a digital signature provide a high level of

assurance that the digital signature is genuinely the signers. These processes grant

legal sanctity to digital signatures.

This is the pictorial representation of the verification of digital signature explained above:

Difference between the handwritten and digital signatures

The digital signature cannot be forged unless the signer looses control of the private key.

Handwritten signatures can be attested by the Notary public/witnesses. Digital Signatures

are certified by the certifying authority.

The purpose of both the handwritten and digital signature is to authenticate the

message \document originated from the signer.

Message Digest

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Legal Recognition of Digital Signatures

According to section 5 of the Act, where any law provides that information or any other

matter shall be authenticated by affixing the signature or any document shall be signed or

bear the signature of any person, such requirement shall be deemed to have been

satisfied, if such information or matter is authenticated by means of digital signature

affixed in such manner as may be prescribed by the Central Government.

(C) Digital Signature Certificate

Digital Signature Certificate is an instrument of trust. It is the product of the PKI (Public

key infrastructure) system. It is a comprehensive system required to provide public-key

encryption and digital signature services is known as a public-key infrastructure.

It is only after obtaining a digital signature certificate from the Certifying authority; a

person will become entitled to legally use the digital signature.

A digital signature certificate is simply a certificate signed by an independent and trusted

third party known as a Certification Authority. These third party certificate authorities

have the responsibility

To confirm the identity of the certificate holder (subscriber)

As well as provide assurance to the website visitors that the website is one that is

trustworthy and capable of serving them in a trustworthy manner by providing

protection to a website from tampering and even theft, such as credit card

information.

This certificate has a standard format and is usually issued under the format called X.509.

A digital certificate is used in conjunction with a public key encryption system. A digital

signature is different from a handwritten one. It is unique and different every time it is

generated, and is related to the thing or things it is signing (an electronic document,

picture, program and so on).

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A certificate consists of the following three elements:

Name and Other Extensions

This part of the certificate contains information about the entity to which the

certificate is issued. Such information could include one's name, nationality and

email address, details of ones work place etc. It could also include the DSC

holders picture, a layout of his fingerprints, passport number etc.

Public Key Information

The DSC also contains information about the public key of the holder. The

certificate acts to bind the public key of the holder to him and attribute

information described above. The public key is usually a part of the asymmetric

key of the signature holder usually an RSA key.

Certifying Authority (CA)

A CA is a relied-upon entity that issues, publishes, suspends and revokes digital

certificates. The CA's role is to verify the identity of subscribers and provide

certificate management services. A CA acts like a trusted electronic notary

Public, telling everyone who the valid users are and what their digital signatures

should look like.

DSC creates a “binding linkages” between the subscriber and the issuer and not

only confirms the identity of the subscriber but also certifies other relevant

information such as subscriber’s pubic key and bona fides of the issuer of the

certificate. This certification is important for the relying party that trusts on the

accuracy of the said certificate.

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A digital certificate contains the name of the organization or individual, the business

address, digital signature, public key, serial number, and expiration date. When you

are online and your web browser attempts to secure a connection, the digital

certificate issued for that website is checked by the web browser to be sure that all is

well and that you can browse securely.

The web browser basically has a built in list of all the main certification authorities

and their public keys and uses that information to decrypt the digital signature.

This allows the browser to quickly check for problems, abnormalities, and if

everything checks out the secure connection is enabled. When the browser finds an

expired certificate or mismatched information, a dialog box will pop up with an

alert.

Points to Remember:

Introduction

The Information Technology Act came into force on 17th

Oct., 2000

It is a first cyber law in India

Basis of the Act - Model law on Electronic Commerce adopted by the United Nations

Commission on International Trade Law (UNCITRAL)

The Act extends to the whole of India (including Jammu and Kashmir)

It gives boost to E-commerce, E-transactions and also facilitates E-governance by

means of E-records.

Meaning ,Objectives and Some Important Features

Act provides legal recognition for transactions carried out by means of electronic

data interchange and other means of electronic communication

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It aims to provide a legal and regulatory framework for promotion of e-Commerce

and e-Governance

Electronic contracts will be legally valid

Legal recognition of digital signatures

Controller to certify the public keys of the Certifying Authorities (CAs)

Controller to act as repository of all digital signature certificates

Certifying Authorities to get License from the Controller to issue digital signature

certificates

Basic components of security for E-commerce

Authenticity

Message Integrity

Non-repudiation

Privacy

Methods adopted for securing online transactions

Digital Signatures

Encryption

Digital Signature Certificate

Digital Signature-Meaning

It is an electronic signature

Used to authenticate the identity of the sender of a message

To ensure that the original content of the message or document that has been sent is

unchanged.

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To ensure non-denial by the sender

Creation and verification of Digital Signature

Asymmetrical or ‘public key cryptography’ is used

Key pair is required

Private key

Public key

Encryption

It is a process of encrypting and decrypting the message.

Protects data against unauthorized access

Discloses unauthorized tampering

Authenticates the identity of the sender

Two types: symmetric and asymmetric cryptography

Digital Signature Certificate(DSC)

It is an instrument of trust

A certificate signed by an independent and trusted third party known as a

Certification Authority.

Three elements of DSC:-

Name and Other Extensions

Certifying Authority (CA)

Public Key Information

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Objective Type Questions

State whether the following statements are true or false:-

1 The IT Act,2000 has adopted symmetric cryptography system

2 A digital signature is an electronic image of the handwritten signature of a person.

3 A digital signature is unique to both e-record and private key used to create it.

4 The private key of the person is not known to any other person.

5 A digital signature certificate is an instrument of trust signed by an independent and

trusted third party.

6 A hash function is an Algorithm.

7 Entering into a contract for sale or conveyance of immovable property or

any interest in such property is an exception to an IT Act, 2000.

8 Controller to act as repository of all digital signature certificates

9 Certifying Authorities to get License from the Controller to issue digital signature

certificates

10 An IT Act, 2000 provides legal recognition for transactions carried out by means of

electronic data interchange and other means of electronic communication

11 Cyber laws refer to all the legal and regulatory aspects of the internet and the World

Wide Web.

12 An Act provides legal recognition of digital signatures and e-record.

13 Non-repudiation means sender can deny sending the message.

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14 Cryptography is a process of encrypting and decrypting messages.

15 With secret key, the same key is not used to encrypt information and decrypt

information.

Answers:1.F; 2.F; 3.T; 4.T; 5.T; 6.T;7.T;8.T;9.T;10.T;11.T;12.T;13.F;14.T;15.F

Questions

1 When Information Technology Act was came into force? What are its

objectives?

2 What are the exceptions to the IT Act, 2000?

3 Explain the basic components of security in online transactions.

4 What is a Digital Signature? How it is used for authentication?

5 Explain the steps for the creation and verification of Digital Signature?

6 What is a data encryption technique? Explain the types of cryptography.

7 What is a Digital Signature Certificate? Why DSC is required and who issues the

Digital Signature Certificate?

8 Explain the contents of Digital Signature Certificate.

9 Explain the provisions relating to the Legal recognition of Digital Signature?

10 Define the following terms: (a) Access, (b) computer, (c) computer resources, (d)

public key,(e) private key,(f)subscriber,(g) computer network.(h)Certification practice

statement (i) Certifying Authority (j) Information

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Practical Problems

R receives a message from M, where M codes the message into his own public key. R

wants to convert the decoded message into a plain text (original message). What should

be the action of R after receiving the message?

Answer. Without M’s private key, decoding by R is not possible. R should give

to M his own public key and obtain the message obtain in that public key

2. A symmetrical cryptography method is used by H for sending an electronic

offer to B.B is not interested in accepting the offer. But one of the office members

has stolen the key and sends the acceptance. Is there any contract between H and

B?

Answer: Symmetrical Cryptography method (where single key is used for

encrypting and decrypting the message) Yes, there is a contract between H and B

because an act of the office member cannot amount to forgery of signature and the

acceptance shall be deemed to be sent by B.

REFERENCES

Books:

References to Sections in this chapter are to Information Technology Act, 2000.

S.K.Aggarwal and K.Singhal (2006) Galgotia Publications, New Delhi, India Chapter 28

M.C.Kuchhal (2007) Business Law, Vikas Publishing House Pvt. Ltd. Delhi, India,

Chapter 31.

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Vakul Sharma (2007) Information Technology Law and Practice law and emerging

technology cyber law and E-commerce (Universal Publishing Company, Delhi, India

(Chapter1-9)

B.K.Goyal (2005) Business Law, R.Chand & Co, New Delhi, India, Chapter 35

D. Painttal, Law of Information Technology” Taxmann Publications Pvt. Ltd, New Delhi,

India.

Websites:

http://www.x5.net/faqs/crypto/q1.html, http://webopedia.internet.com/TERM/h/hashing.html

http://searchsecurity.techtarget.com/sDefinition/0,,sid14_gci211953,00.html

http://searchsqlserver.techtarget.com/sDefinition/0,,sid87_gci212230,00.html

http://www.mca.gov.in/MinistryWebsite/dca/dsc/faq_dsc.html

http://www.cca.gov.in

http://images.google.co.in,

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Lesson - 25

Electronic Records, E-Governance and Subscriber

by

Nidhi Dhawan

This Chapter discusses the following aspects of the IT Act,

2000:

25.1 Meaning of Electronic record

25.2 Secure electronic record, digital signature and authorized digital

procedure

25.3 Online Communication process involving different parties

25.4 E-governance

25.1 Meaning of Electronic Record

According to sec 2(1)(t), an electronic record means data, record or data

generated, image or sound stored, received or sent in an electronic form or micro

film or computer generated micro fiche.

Both the public networks (internet) and private networks (intranet, extranet, etc) are

open to virus attacks, thefts, hacking, and other forms of manipulations and so it is

important to protect the information and the technology infrastructure and make it

valuable for the users in terms of confidentiality, integrity, privacy and security.

The aim of the Act is to protect the information (electronic records and messages) by

providing it a security and reliability so that they can be accepted as a valid basis for

the determination of the legal rights and obligations between the two parties and for

this purpose Section 14 deals with the secure electronic records and Section 15

deals with the secure digital signature.

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25.2 Secure Electronic record, Digital Signature and Authorized

Digital

Procedure under the IT Act are enumerated below:

(A) Secure Electronic Records

Section 14 deals with as to when would an electronic record are accepted as a

secure record. It states that:

“Where any security procedure has been applied to an electronic record at a specific

point of time, then such record shall be deemed to be secure electronic record from

such point of time to the time of verification”.

Section 14 therefore consists of the following ingredients:

It is a secured electronic record

It is the creation of secure electronic record by applying some security procedure such

as the application of a digital signature.

It is the verification of this record by the person who receives it. It means that the

receiver or the recipient has to verify that the record sent is retained without any

alterations during the transmission of the record.

Secure

Electronic

Record

Secure

Digital

Signature

Authorized

Security

Procedure

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The electronic record is secured from the time when any security procedure has been

applied to it, at the time of creating it, till its verification at the receiving end.

The following illustration explains this point:

Illustration: Champa writes to the publisher through e-mail since it is consider to be

a valid electronic record. She applies her signature on the letter through some

security measure. This signature helps to verify the authenticity of the record to her

publishers. The publishers are now sure that the message received is secured.

(B) Secure Digital Signature

Section 15 deals with as to when would a digital signature be accepted as a

secure signature. It states that:

“If, by application of a security procedure agreed to by the parties concerned, it can be

verified that a digital signature, at the time it was affixed, was-

(a) Unique to the subscriber affixing it;

(b) Capable of identifying such subscriber;

(c) Created in a manner or using a means under the exclusive control of

the subscriber and is linked to the electronic record to which it relates in

such a manner that if the electronic record was altered the digital signature

would be invalidated, then such digital signature shall be deemed to be a

secure digital signature.”

Section 15 therefore consists of the following ingredients:

There is a digital signature. Signature is signed by the subscriber

The subscriber who signs it has to be unique in nature and is one who can be

identified.

The digital signature is under the exclusive control of the subscriber

Exclusive control means that that any alteration in the electronic record would

invalidate the digital signature.

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The following illustration explains this point:

Illustration: Puja sends an e-mail to jyoti and puts her signature on it. This e-

mail is a secure electronic mail, signed by puja and under her control Puja is the

subscriber who has created the e-mail by applying the digital signature. Jyoti

receives the e-mail without any changes in it. It means jyoti has received a secure

electronic record.

Security procedure

Section 16 deals with the technical procedure that subscriber must adopt to

secure the records and the signatures. The Central Government prescribes the

security procedure with regard to commercial circumstances prevailing at the time

when the procedure was used. It includes the following parameters:

(a) The nature of the transaction;

(b) The level of sophistication of the parties with reference to their

technological capacity;

(c) The volume of similar transactions engaged in by other parties;

(d) The availability of alternatives offered to but rejected by any party;

(e) The cost of alternative procedures; and

(f) The procedures in general use for similar types of transactions or

communications.

25.3 Online Communication process involving different parties

The IT Act, 2000 has not amended or substituted the Indian Contract Act, 1872, in

any manner, whatsoever. In order to form a valid electronic record, one still needs a

‘promisor’ and ‘the ‘promisee’ 241

241 Sec.2(c) of the Indian Contract Act,1872 states: The person making the proposal is

called the ‘promisor’ and the person accepting the proposal is called the ‘promisee’

(refer lesson No. 1)

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The Act grants legal recognition to communication process involving computer,

computer system and computer network by identifying attribution,

acknowledgement, and dispatch of electronic records as key statutory provisions.

Parties involved in the communication process

The parties involved in the communication process are originator, addressee and the

intermediary. These are discussed below:

The Originator Sec2(1)(za)-"Originator" means a person who sends, generates,

stores or transmits any electronic message or causes any electronic message to be

sent, generated, stored or transmitted to any other person but does not include an

intermediary

Illustration: Lovely sends an electronic message generated and stored in his

computer system to sukumar. Lovely sends the message. Lovely being the sender

or generator of an electronic message is the originator of the message.

The addressee Sec 2(1)(b) -"Addressee" means a person who is intended by the

originator to receive the electronic record but does not include any intermediary

Illustration: In the above illustration, sukumar was intended by lovely, the

originator, to receive the electronic message. Sukumar is the receiver of the

Originator

Addressee

Intermediary

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message. He is an addressee to whom the message has been intended to be

transmitted by lovely.

The intermediary Sec2(1)(w)-"Intermediary" with respect to any particular

electronic message means any person who on behalf of another person receives, stores

or transmits that message or provides any service with respect to that message.

An intermediary is a facilitator, a third party service provider who on behalf of the

other person receives, stores or transmits or provides any service with respect to

that message. They perform a role of providing computer resources for storage

and transmission of messages between the originator and the addressee.

Illustration: From the above illustrations, it is clear that Lovely, the sender of the

message is the originator. Sukumar, the reciever of the message, is the receiver of

the message. Intermediary is the computer resource that has been used in between

the lovely and the sukumar for the purposes of the storage and the transmissions

of the message.

The communication process through computer, computer system and

computer network by originator, addressee and the intermediary involves the

understanding of certain statutory key provisions related to attribution of

electronic records, acknowledgement of receipt and time and place and

dispatch and receipt of electronic record. These provisions are enumerated

below:

(25.3.1) Attribution of electronic records

Attribution of E-records

Acknowledgement of Receipt

Time and place of Dispatch and

Receipt of E-record

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According to Section 11 of the Act:

“An electronic record shall be attributed to the originator—

(a) if it was sent by the originator himself;

(b) by a person who had the authority to act on behalf of the originator

in

respect of that electronic record; or

(c) by an information system programmed by a an originator or on

behalf of the originator to operate automatically.”

Thus Section 11 consists of the following ingredients:

The electronic record was indeed sent by the originator itself.

By simply ascribing that the sender is the originator of the electronic record may be

wrong.

One may have to prove that electronic record is attributed to the originator itself.

Electronic record may be sent by a person who had the authority to act on behalf of

the originator.

Electronic record may be sent by the information system which has been programmed

by the originator or the person on behalf of the sender or originator.

Illustration; Nitish, through an internet, received an offer in the computer

program of the company and he is interested in becoming the subscriber to an

electronic magazine of a company. The subscription fee is Rs. 500 per month.

Programmed computer sends an electronic reply to Nitish about the subscription

fee and he agrees to pay the same. The company is deemed to be the originator

from the programmed computer under section 11 of the Act.

(25.3.2) Acknowledgment of receipt

According to Section 12 of the Act, Acknowledgment of the receipt plays a very

important role in the communication process involving computer, computer

system and computer network.

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(1)” Where the originator has not agreed with the addressee that the

acknowledgment of

receipt of electronic record be given in a particular form or by a particular method,

an acknowledgment may be given by-

(a) Any communication by the addressee, automated or otherwise; or

(b) Any conduct of the addressee, sufficient to indicate to the originator that

the electronic record has been received.

(2) Where the originator has stipulated that the electronic record shall be binding only

on receipt of an acknowledgment of such electronic record by him, then unless

acknowledgment has been so received, the electronic record shall be deemed to have

been never sent by the originator.

(3) Where the originator has not stipulated that the electronic record shall be binding

only on receipt of such acknowledgment, and the acknowledgment has not been

received by the originator within the time specified or agreed or, if no time has been

specified or agreed to within a reasonable time, then the originator may give notice to

the addressee stating that no acknowledgment has been received by him and

specifying a reasonable time by which the acknowledgment must be received by him

and if no acknowledgment is received within the aforesaid time limit he may after

giving notice to the addressee, treat the electronic record as though it has never been

sent.”

Section 12 consists of the following ingredients:

Acknowledgement procedures are to be used at the discretion of the originator.

Acknowledgement of electronic records by the addressee.

Acknowledgement received by the originator within a reasonable time.

Acknowledgement does not mean acceptance. It only signifies that the message has

been received.

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If originator has not prescribed any method for the acknowledgement, the same may

be sent in any form of communication by the addressee or any conduct of the

addressee sufficient to indicate that the message has been received.

If originator has specified the method of acknowledgement of electronic record, then

it must be communicated in the same way, otherwise, it will be deemed as never sent.

If originator has not stipulated any conditions as to the time and method of receiving

the acknowledgement and at the same time, he has not received the acknowledgement

also, then, the originator may specify the reasonable time by which the

acknowledgement must be received by him. If still, he does not receive it then, after

giving a due notice to the addressee, he can treat the electronic record as it has never

been sent.

(25.3.3)Time and place of dispatch and receipt of electronic record

E-commerce portals usually specify detailed transaction rules in accordance with

which any specific transaction can be initiated, conducted and concluded. A

contract concluded over the internet involves sending the proposal by the off error

to the other party. The other party is the acceptor of the electronic record. This

process involves the dispatch of the proposal and the receipt of the proposal by the

party who sends it. If the other party accepts the proposal, the acceptance will be

communicated to the proposer in the same way.

Section 13 of the Act deals with the manner and time when dispatch and receipt

of an electronic record occur. It consists of the following sub clauses. These are

enumerated below:

(1) Dispatch of electronic record means the transmission of the record by

originator to the addressee and the dispatch of an electronic record occurs, "when

it

enters a computer resource outside the control of the originator", unless agreed

to the contrary between the originator and the addressee.

Computer resource outside the control of the originator includes the originators e-mail

servers, other servers including addresses and intermediary e-mail servers. Dispatch

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means the successful communication of an electronic record to the intended

addressee.

(2) The time of receipt of an electronic record will be determined as follows:

(a) if the person to whom the e-mail has been sent has a computer designated

specially for the work of receiving electronic records

There are two conditions under this:

(i) When electronic record enters designated computer and the receiver is using the

resource.

Illustration: Bela sends a message to meena on 23rd

Dec., 2008. Meena receives it

on the computer designated to her by her office.

(ii)When the electronic message to the addressee is not being used on the designated

computer resource but he is able to retrieve it.

Illustration: Mona sends an e-mail to alka on 5th Dec., 2008. She is in Chennai. She

is not using her designated computer provided by her office but she can retrieve it.

(b) If the person to whom the e-mail has been sent does not have a computer

designated for receiving the electronic record, then the receipt occurs at the time

when the electronic record is retrieved by the addressee.

Illustration: Neena sends an electronic record to the Rana on 12th

Dec., 2008. Rana

does not have a designated computer for retrieving the electronic record. He retrieves

the record on a later date from some other computer. In this case the electronic

record would be considered as retrieved by him on such later date.

(3) The place of business is considered to be the place of dispatch of electronic

record and it is presumed that the electronic record has been received at the place

of business of the addressee.

(4) In electronic communication, the location of the information system where the

message is received by the addressee may be far away from the location of the

addressee himself or it may even be unknown.

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Therefore, the place of receipt of message has been determined to be the

place which has a reasonable connection with the addressee himself.

Addressee’s place of business is the most reasonable place for this purpose.

Illustration: Sukumar is in Mumbai but his information system where all the

messages are received is in Delhi. His place of business is also Delhi. Shyam sends

him the document. In such a situation, the place of receiving the message is the place

having the reasonable connection with the Sukumar. Delhi, being the place of

business will be considered as a place for dispatch and retrieval of the message.

(5)Place of business of the addressee have two parameters:

(a) If the originator or the addressee has more than one place of business, the principal

place of business will be the place of business.

(b) If the originator or the addressee does not have a place of business, his usual

place of residence shall be deemed to be the place of business; "Usual place of

residence" means the place where it is registered.

25.4 ELECTRONIC GOVERNANCE

Electronic Governance refers to the use of internet technology as a platform for

exchanging information, providing services and transacting with citizens, businesses,

and other arms of government. It is the governance by the government through

procedures involving electronic communication.

The World Bank defines “e-governance as the use of information and communication

technologies by Government agencies to transform relations with citizens, business

and other arms of government.” It has also been referred to as i-governance 242 as it

integrates people, processes, information and technology in the service of achieving

governance objectives.

242

Integrated Governance Heeks, Richard (2001): Government working paper series

ISBN 1 902518934, Published by Institute for Development Policy and Management,

Manchester.

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The primary delivery models used to facilitate the interaction are

Between Government-to-Citizen (G2C), Government-to-Business (G2B) , called e-

services

Between Government-to-Government (G2G) or the internal government operations,

called e-administration

For improving external interactions called e-society.

25.4.1 Significance of Electronic Governance

The importance of e-governance is that it has provided technological advancement in

services. The following points describe significance of electronic governance. These

are enumerated below:

E-governance provides much faster, convenient interaction between the government

and its people.

It is dynamic and needs dynamic laws to keep pace with the technological

advancement.

E-Government may be applied by the legislature, judiciary, or administration, in

order to improve internal efficiency, the delivery of public services, or processes of

democratic governance.

E-Governance involves access to government information and services 24 hours a

day, seven days a week, in a way that is focused on the needs of the citizens.

E-Gov relies heavily on the effective use of Internet and other emerging technologies

to receive and deliver information and services easily, quickly, efficiently and

inexpensively.

E-governance is beyond the scope of e-government. While e-government is defined as

a mere delivery of government services and information to the public using electronic

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means, e-governance allows direct participation of constituents in government

activities.

25.4.2 The Act gives legal recognition to facilitate Electronic

Governance

Sections 4-10 of the IT Act contain the provisions of electronic-governance. These are

discussed below:

25.4.2.1 Legal recognition of electronic record

Section 4 of the IT Act deals with the legal recognition of the electronic record.

“Where any law provides that information or any other matter shall be in writing or in

the typewritten or printed form, then, notwithstanding anything contained in such law,

such requirement shall be deemed to have been satisfied if such information or matter

is-

(a) Rendered or made available in an electronic form; and

(b) Accessible so as to be usable for a subsequent reference”.

Section 4 of the Act, therefore, consists of the following ingredients:

Act has made electronic form as functional equivalent of writing or typewritten or

printed form.

The information has to be in writing, or printed form, if it is required under the Act.

The electronic form means any information generated , sent , received, in computer

memory of the system.

Illustration: Sheena sends an e-mail to Prem on 7th

Nov., 2008 giving her details of

certain office procedures which must be satisfied. According to the legal provisions,

the information could be accepted either in printed form or through a typewriter.

Since sheena is sending the details through e-mail, according to section 4 of the Act,

information will be acceptable by e-mail.

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25.4.2.2 Legal recognition of digital signatures

Section 5 of the Act deals with the legal recognition of the digital signatures. It runs

as follows:

“Where any law provides that information or any other matter shall be authenticated

by affixing the signature or any document shall be signed or bear the signature of any

person then, notwithstanding anything contained in such law, such requirement shall

be deemed to have been satisfied, if such information or matter is authenticated by

means of digital signature affixed in such manner as may be prescribed by the Central

Government”.

Section 5 consists of the following ingredients:

Act has made digital signatures as functional equivalent of “handwritten signature”

If any information or any other matter is required by law to be authenticated by

affixing the signature, then such requirement must be fulfilled.

Such information must be authenticated by the digital signature.

Digital signature must be affixed in such a manner as prescribed the Central

Government.

Illustration: Rishit sends an office document to Devansh on 15th

Dec by affixing

a digital signature on it in order to authenticate the document as required under

the law. As per section 5 of the Act, Rishit has to authenticate the document to

make it legally sound. Digital signatures are functional equivalent of handwritten

signatures by law.

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25.4.2.3 Section 6 of the Act deals with the use of electronic record

and digital signature in Government and its agencies

(1) “Where any law provides for-

(a) The filing of any form. application or any other document with any office,

authority, body or agency owned or controlled by the appropriate Government in a

particular manner;

(b) The issue or grant of any license, permit, sanction or approval by whatever name

called in a particular manner;

(c) The receipt or payment of money in a particular manner,

then, notwithstanding anything contained in any other law for the time being in force,

such requirement shall be deemed to have been satisfied if such filing, issue, grant,

receipt or payment, as the case may be, is effected by means of such electronic form

as may be prescribed by the appropriate Government.”

(2)”The appropriate Government may, for the purposes of sub-section (1), by rules,

prescribe-

(a) the manner and format in which such electronic records shall be filed,

created or issued;

(b) the manner or method of payment of any fee or charges for filing,

creation or issue any electronic record under clause”

Illustration: Rachna is working in a Government organization from the last 10 years.

She wants to renew her bank particulars. She has to apply in the particular format for

that purpose and if required, has to pay a fee as specified for it.

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25.4.2.4 Section 7 of the Act deals with the retention of electronic

records. The following conditions are laid down under the Act for the same. These

are explained below:

If, by Law, any information is to be retained for any specific period then such

information must be accessible for subsequent reference.

Information must be in a format in which it was originally generated.

The details related to the information showing its identification must also be retained

such as origin, date and time of the dispatch or receipt of electronic record.

Non- compliance of any aforesaid conditions may render the electronic record

inadmissible in the court of law.

Any information generated automatically solely for the purpose of enabling an

electronic record to be dispatched or received, is non applicable under Section 7.

Nothing in this section shall apply to any law that expressly provides for the retention

of documents, records or information in the form of electronic records.

25.4.2.5 Section 8 of the Act deals with the Publication of rule,

regulation, etc., in Electronic Gazette

“Where any law provides that any rule, regulation, order, bye-law, notification or any

other matter shall be published in the Official Gazette, then, such requirement shall be

deemed to have been satisfied if such rule, regulation, order, bye-law, notification or

any other matter is published in the Official Gazette or Electronic Gazette:

Provided that where any rule, regulation, order, bye-law, notification or any other

matter is published in the Official Gazette or Electronic Gazette, the date of

publication shall be deemed to be the date of the Gazette which was first published in

any form.

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Section 8 therefore consists of the following ingredients:

This provision has an immense importance as it makes available rule, regulations,

order, bye-law, notification in the form of electronic record.

Electronic Gazette is at par with the official Gazette.

The date of publication will be the date of Gazette which was first published in any

form.

25.4.2.6 Section 10 of the Act deals with the Power to make rules

by Central Government in respect of digital signature

The rules made by the Central Government in respect of digital signature are related

to the type of digital signature, the manner and format in which the digital signature

will be affixed by the subscriber an at the same time, it will also identify the person

affixing it.

The Act also aimed at securing the information by protecting its integrity,

confidentiality and availability to the authorize user. So the rules related to the control

processes and security are also prescribes

Act also includes any other matter which is necessary to give legal effect to digital

signature.

Subscriber

25.1 Meaning

According to the IT Act, 2000, "Subscriber" means a person in whose name the

Digital Signature Certificate is issued. It is only after obtaining a digital signature

certificate from the Certifying authority; a person will become entitled to legally use

the digital signature.

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Any person can make an application to the Certifying Authority for the issue of

Digital Signature Certificate in such form as may be prescribed by the Central

Government.

25.2 To become a subscriber the following steps will be required:

Approach the Registration Authority (RA)/ Local Registration Authority (LCA), of a

licensed Certifying Authority with a request to issue a Digital Signature Certificate.

Fill the application form for this purpose and submit the necessary documents. Also

select the kind of ‘class’ certificate required and approach the Certifying Authority

with the request to issue a digital signature certificate.

Enter into a ‘Certifying Authority-Subscriber’ Agreement.

Applicant to generate confidentially signing key pair by applying the security

procedure and prove the possession of the private key corresponding to the public

key.

After verifying (validation procedure) the credentials, the Certifying Authority

generates the digital signature certificate for the public key.

Subscriber to download the digital signature certificate from the website of the

Certifying Authority and verify its contents before accepting it.

Subscriber to verify the contents of digital signature certificate before he accepts it.

Upon acceptance of digital signature certificate by the subscriber, the certifying

authority publishes the digital signature certificate in its repository.

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25.3 Duties of Subscriber

There are three duties of the subscriber. These are the following:

Generating Key Pair

Acceptance of Digital Signature certificate

Control of private key

Each one of these is discussed:

(1)Section 40 deals with the Generating Key Pair

“Where any Digital Signature Certificate, the public key of which corresponds to the

private key of that subscriber which is to be listed in the Digital Signature Certificate

has been accepted by a subscriber, then, the subscriber shall generate the key pair by

applying the security procedure.”

Section 40 consists of the following ingredients:

Generating a signing Key pair (Private / public key).

Generating Key Pair

Acceptance of Digital Signature Certificate

Control of Private Key

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The private and public key is generated confidentially using the standards specified in

the Act.

It is before the generation of a digital signature certificate by a certifying authority,

the subscriber must generate a signing key pair successfully.

Illustration: Mohan, the subscribe of digital signature certificate has to generate a

signing key pair (private/ public key) by applying a security procedure before

receiving the digital signature certificate from the certifying authority. He generated

the key pair. His public key would be listed in the digital signature certificate and

corresponding private key will be known to him.

(2) Section 41 of the Act deals with the Acceptance of Digital Signature

Certificate Acceptance of the digital signature certificate is directly related to its

publication. It provides a reasonable opportunity for the subscriber to verify the

contents of the digital signature certificate before he accepts it. Upon the acceptance

of the issued digital signature certificate by the subscriber, the certifying authority

will publish a signed copy of the digital signature certificate in a repository.

By accepting a Digital Signature Certificate the subscriber certifies to all the

following information so that the user can rely on him. The information that

subscriber discloses is as follows:

(a) He holds the private key corresponding to the public key listed in the Digital

Signature Certificate and is entitled to hold the same;

(b) All representations made by the subscriber to the Certifying Authority and all

material relevant to the information contained in the Digital Signature Certificate are

true;

(c) All information in the Digital Signature Certificate that is within the knowledge of

the subscriber is true.

(3) Section 42 of the Act deals with the Control of private key

It is the duty of the subscriber to prevent the disclosure of the private key. By

accepting a certificate, the subscriber assumes a duty to retain control of the private

589

key and to take a reasonable precaution to prevent its loss, modification or

unauthorized use.

If private key is lost then the subscriber will communicate the same without any delay

to the certifying authority in such a manner as may be specified by the regulations.

Points to Remember

Electronic record-Meaning

It is the data, record or data generated, image or sound stored, received or sent in an electronic

form or micro film or computer generated micro fiche.

Aim of the Act is to protect the e-records and messages.

Act provides for secure e-records(Sec14)

Secure digital signatures(Sec15)

Authorized security procedure

Communication process

Valid e-record requires promisor and promise

Legal recognition to communication process involving computer, computer system and

computer network

Parties involved in this process are originator, addressee and intermediary

Various provisions

Attribution of e-records(sec 11)

Acknowledgement of receipt(sec 12)

Time and place of dispatch and receipt of electronic record(sec.13)

E-governance

An application of Information Technology to the functioning of the Government

Transforms the relations with citizens, business and other arms of the government.

Primary models are e-services, e-administration, and e-society.

Act provides Legal recognition to facilitate e-governance

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State whether the following statements are true or false:

An electronic record means data, record, image, received or sent in an electronic form

Addressee means a person who is intended by the originator to receive the electronic

record but does not include any intermediary

An electronic record shall be attributed to the originator if it was sent by the

originator himself

Acknowledgement of receipt means acceptance.

Legal recognition of electronic records(Sec.4)

Legal recognition of digital signatures (Sec. 5)

Use of e-records and digital signatures in Government and its agencies(Sec.6)

Retention of e-records(sec.7)

Publication of rule, regulation, etc in e-gazette(sec.8)

Power to make rules by Central Government in respect of digital signature(sec.10)

Subscriber-Introduction

A person in whose name the Digital Signature Certificate is issued.

Certifying authority issues a Digital Signature Certificate to the subscriber

Any person can make an application to the Certifying Authority for the issue of DSC

Duties of subscriber

Generating key pair (Sec.40)

Acceptance of Digital Signature Certificate (Sec.41)

Control of private key (Sec 42)

591

If the originator or the addressee has more than one place of business, the principal

place of business, shall be the place of business

E-governance is an application of Information technology to the functioning of the

Government

E-governance will facilitate paper-less administration

An Act provides legal recognition of e-records and digital signature

An electronic message is said to be received at the time when it enters the computer

of the addressee

Secure E-record means where any security procedure has been applied to an

electronic record at a specific point of time.

Originator means a person who sends, generates, stores or transmits any electronic

message or causes any electronic message to be sent, generated, stored or transmitted

to any other person but does not include an intermediary.

Answers: 1.T;2.T;3.T;4.F;5.T;6.T;7.T;8.T;9.F;10.T;11.T

Questions

What do you understand by an “Electronic record”? What are the provisions relating

to secure electronic record and secure digital signature?

Explain the provisions of the Act relating to Time and place of dispatch and receipt of

electronic record?

Explain the “Attribution of Electronic records”.

Explain the concept of “Place of Business” in relation to the e-records.

What do you understand by Electronic Governance?

Explain the provisions relating to the power to make rules by Central Government in

respect of digital signature (Sec.10).

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Explain the provisions of the Act relating to the use of electronic records and

digital signatures in Government and its agencies.

Explain the provisions of the Act relating to the retention of electronic records.

Define the term” Subscriber”. What are the duties of the subscriber?

Explain the procedure of becoming a subscriber under the Act.

Practical problems

1 Through the internet, an offer is received in the computer program of the

company by M who is interested in becoming the subscriber to an electronic

magazine of a company. The subscription fees is Rs. 500 pm. Programmed

computer sends an automatic reply to M about the subscription fee and he

agrees to pay the fees. Is there any contract between M and the company?

Answer. Yes, even if the company is not aware of the communication; the

company is deemed to be the originator of the communication from the

programmed computer under section 11.

2 M has a place of business in jaipur. Contract arises between M and Z. When

Z sends an acceptance to an offer send by M by a secure electronic message,

M was in Chennai. What would be deemed to be the place of business of

making a contract? Jaipur or Chennai.

Answer. Jaipur because as per sec13 (3), the place of business of addressee is

the place of receipt of the message.

References:

Books:

References to Sections in this chapter are to Information Technology Act, 2000.

S.K.Aggarwal and K.Singhal (2006) Galgotia Publications, New Delhi, India Chapter

28

M.C.Kuchhal (2007) Business Law, Vikas Publishing House Pvt. Ltd. Delhi, India,

Chapter 31.

593

Vakul Sharma (2007) Information Technology Law and Practice law and emerging

technology cyber law and E-commerce (Universal Publishing Company, Delhi, India

(Chapter1-9)

B.K.Goyal (2005) Business Law, R.Chand & Co, New Delhi, India, Chapter 35

D. Painttal, Law of Information Technology” Taxmann Publications Pvt. Ltd, New

Delhi, India.

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Lesson - 26

Regulation of Certifying Authorities

by

Nidhi Dhawan

The lesson discusses the Regulation of Certifying Authorities under the IT

Act, 2000

26.1 Rationale

26.2 PKI (Public Key Infrastructure)

26.3 Controller of Certifying Authorities (CCA)

26.4 Certifying Authorities (CA)

26.1 RATIONALE

Internet is an infrastructure that links hundreds and thousands of networks to one

another that is, linking businesses, educational institutions, government agencies and

individual together. In this electronic environment, trust is central to the growth of e-

commerce and e-governance and the future of online transactions and contracts

depends upon the trust that the transacting parties place in the security of transmission

and the data or content of communication.

The working of the computer, computer network and computer system is more

process based than personalized, therefore, it is necessary to have an identification

strategy, that is, a system of identity authentication is required to ascertain the

integrity, confidentiality and authentication of communication channels and

processes.

All electronic communications must meet the fundamental requirements viz:

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Authenticity- The authenticity of the sender of the message must be determined so

that recipient can determine who really sent the message.

Message integrity- It determines whether the message that has received modified,

altered or is incomplete.

Non-repudiation- It means sender cannot deny sending the message.

Privacy-The message must be secure from an unauthorized person.

The paper based concepts of identification; declaration and proof are carried through

the use of digital signatures in electronic environment. A system is required for

identity authentication and that has to be in the form of one or more trusted third

parties which will not only authenticate that a digital signature belongs to a specific

signer but also dispense the public keys.

The following are the trusted parties enumerated below:

The “Certifying Authority”. Issues Digital Signature Certificates. Its function is to

verify and authenticate the identity of the subscriber (a person in whose name

Digital Signature certificate is issued).

A Certifying authority has to take a license from the “Controller of Certifying

Authorities” or ‘root’ certifying authority of India (RCAI) before it starts issuing

digital signature certificates to the subscribers.

The digital signature of the issuing certification authority on the digital signature

certificate can also be verified by using the public key of the certification authority

listed in the repository of the controller of certifying authority.

A Certifying Authority issues, publishes, suspends and revokes digital

certificates. The CA's role is to verify the identity of subscribers and provide

certificate management services.

CCA

Certifying Authority

Subscriber

596

A Public Key Infrastructure (PKI) is developed having a set of Certifying

Authorities subordinate to the superior Certifying Authorities (controller of certifying

authorities)

26.2 PKI (Public Key Infrastructure) - A comprehensive system required to

provide public-key encryption and digital signature services is known as a public-key

infrastructure. It is an arrangement in cryptography that facilitates third party

examination of, and vouching for, user identities.

Public-key infrastructure (PKI) is the combination of software, encryption

technologies, and services that enables enterprises to protect the security of their

communications and business transactions on networks. PKI integrates digital

certificates, public-key cryptography, and certificate authorities into total, enterprise-

wide network security architecture. 243

The purpose of a public-key infrastructure is to manage keys and certificates.An

organization establishes and maintains a trustworthy networking environment by

managing keys and certificates.through PKI. A PKI enables the use of encryption and

digital signature services across a wide variety of applications.A comprehensive PKI

must implement the following items:

Public key certificates

Automatic update of key pairs and certificates

Management of key histories

A certificate repository

Key backup and recovery

Support for non-repudiation of digital signatures

Support for cross-certification

Certificate revocation

243

http://www.cca.gov.in

597

Client-side software interacting with all of the above in a secure, consistent, and

trustworthy manner.

It involves the following:

Subscriber-Subscriber is an individual or entity identified by the certificate.

Certifying Authority-The issuer of the certificate

Relying party -The company, agency or individual relying on the certificate.

From the above, it is clear that double role is to be performed by the certifying

authority. (a) It has to issue Digital Certificate to the subscriber and (b) identify and

authenticate the subscriber’s information contained in the said certificate for the

benefit of the relying party.

26.3 Controller of Certifying Authorities (CCA)

Appointment of Controller and other officers (section 17)

Functions of Controller (section 18)

Recognition of foreign Certifying

Authorities(section 19)

Controller to act as repository (section 20)

License to Certifying Authorities to issue Digital

Signature Certificates (Section21)

Who can apply for grant of license to act as a Certifying Authority?

(a) Application for license(section 22)

(b) Renewal, grant or rejection of license (section 23, section24)

(c) Suspension for license and its notice (section

25, section 26)

(d) Powers of CCA (sec27 to 29)

PKI

SUBSCRIBER CERTIFYING AUTHORITY RELYING PARTY

598

All sections given above are discussed below.

Regulator of the Digital signature infrastructure in India is the Controller of

Certifying Authorities (CCA); called the Controller, primarily act an

administrative authority rather than quasi- judicial body. The various provisions

relating to this Authority under the IT Act, 2000 are as follows:-

26.3.1 Section 17 of the Act deals with the Appointment of Controller

and other officers

The Central Government has appointed the Controller of Certifying Authority on

Nov.1, 2000. The office of he Controller of Certifying Authority has three main

functional departments (a) Technology (b) Finance and Legal(c) Investigation. Each

department has Deputy and Assistant controller who work under the superintendence

and control of the controller of certifying authority.

(1) “The Central Government may, by notification in the Official Gazette, appoint a

Controller of Certifying Authorities for the purposes of this Act and may also by the

same or subsequent notification appoint such number of Deputy Controllers and

Assistant Controllers as it deems fit.

(2) The Controller shall discharge his functions under this Act subject to the general

control and directions of the Central Government.

(3) The Deputy Controllers and Assistant Controllers shall perform the functions

assigned to them by the Controller under the general superintendence and control of

the Controller.

(4) The qualifications, experience and terms and conditions of service of Controller,

Deputy Controllers and Assistant Controllers shall be such as may be prescribed by

the Central Government.

(5) The Head Office and Branch Office of the office of the Controller shall be at such

places as the Central Government may specify, and these may be established at such

places as the Central Government may think fit.

(6) There shall be a seal of the Office of the Controller.”

599

Therefore, Section 17 has the following basic ingredients:

Central Government appoints the controller of certifying authority and other officers

who will discharge the duties assigned to them under the Act.

The qualifications, experience and terms and conditions of the Controller and other

officers are also prescribed by the Central Government.

The Central government also prescribes the places at which their Head office and

branch office will be located.

26.3.2 Functions of Controller of Certifying Authority

According to the Section 18 of the Act, the Controller may perform all or any of the

following functions, namely:-

(a) Exercising supervision over the activities of the Certifying Authorities;

(b) Certifying public keys of the Certifying Authorities;

(c) Laying down the standards to be maintained by the Certifying Authorities;

(d) Specifying the qualifications and experience which employees of the Certifying

Authorities should possess;

(e) Specifying the conditions subject to which the Certifying Authorities shall conduct

their business;

(f) Specifying the contents of written, printed or visual materials and advertisements

that

may be distributed or used in respect of a Digital Signature Certificate and the

public

key;

(g) Specifying the form and content of a Digital Signature Certificate and the key

(h) Specifying the form and manner in which accounts shall be maintained by the

Certifying Authorities;

(i) Specifying the terms and conditions subject to which auditors may be appointed

and

the remuneration to be paid to them;

(j) Facilitating the establishment of any electronic system by a Certifying Authority

600

either solely or jointly with other Certifying Authorities and regulation of such

systems;

(k) Specifying the manner in which the Certifying Authorities shall conduct their

dealings with the subscribers;

(l) Resolving any conflict of interests between the Certifying Authorities and the

subscribers;

(m) Laying down the duties of the Certifying Authorities;

(n) Maintaining a data base containing the disclosure record of every Certifying

Authority containing such particulars as may be specified by regulations,

which shall be accessible to public.

26.3.3 Section 19 of the Act deals with the Recognition of Foreign

Certifying Authorities

The Controller, may, with the prior approval of the Central Government, by

notification in the Official Gazette, recognize any foreign certifying authority for the

purposes of the Act. The digital signature certificate issued by such certifying

authority will be valid for the Act.

The controller may revoke such recognition by giving notification in writing in the

Official Gazette, if any of the condition or restriction on the basis of which the

certificate was issued was contravened by the authority.

Illustration: Trustline Company is recognized as a foreign Certifying Authority, by

the Controller of certifying authority under the Act. Trustline did certain activities

which were not according to the provisions of the Act on the basis of which it was

working as a certifying authority. Can his recognition be revoked?

Controller of certifying authority can revoke the recognition of TrustLine Company as

a foreign certifying authority, if it is satisfied that any of the conditions or restrictions

has been contravened by the company.

601

26.3.4 Controller to act as repository

According to section 20 of the Act, the Controller will be the repository of all Digital

Signature Certificates issued under this Act. He can make use of hardware, software

and procedures that are secure from intrusion and misuse.

Controller has to observe the standards as prescribed to him by the Central

Government in order to ensure that the secrecy and security of the digital signatures

are assured. He will also maintain the database of all public keys in such a manner

that such database and the public keys are available to any member of the public.

The Controller o Certifying Authority maintains the National Repository of

Digital Certificates (NRDC), which contains all the certificates issued by all the

Certifying Authorities in the country. The Controller certifies the public keys of

Certifying Authorities using its own private key, which enable users in the

cyberspace to verify that a given certificate is issued by the licensed Certifying

Authorities.

26.3.5 License to Certifying Authorities to issue Digital Signature

Certificates

According to Section 21 of the Act, any person may approach the Controller for the

issue of the license to issue digital signature certificate. He has to submit the

application for the same. The license will be issue to him only when he fulfils all the

conditions related to the qualifications, expertise, manpower, financial resources and

other infrastructure facilities, etc.

The license issued will be valid subject to the terms and conditions of the Act and also

will be valid for a period as prescribed by the Central Government. Also the license is

not transferable.

602

26.3.6 Who can apply for grant of license to act as a Certifying

Authority (CA)?

The following persons can apply to the Controller for grant of license in the

prescribed form:

an individual, being a citizen of India and having a capital of five crores of rupees or

more in his business or profession;

a company having -

paid up capital of not less than five crores of rupees; and

net worth of not less than fifty crores of rupees

a firm having -

capital subscribed by all partners of not less than five crores of rupees; and

net worth of not less than fifty crores of rupees

Central Government or a State Government or any of the Ministries or Departments,

Agencies or Authorities of such Governments

The following parameters related to the grant of license to the subscriber are

discussed below:

(A) Application of license

(B)Renewal of license

(C) Suspension of license

26.3.7 (A) Application for license

According to section 22 of the Act, applications can be made in a form as prescribed

by the Central Government, for obtaining a license to operate as a certifying authority.

603

Every application must be accompanied by the documents including certification

practice statement; payment of fee and other documents related to the identification of

the applicant and such other documents as may be prescribed by the Central

Government necessary for the submission of the application.

Certification practice statement: means a statement issued by the Certifying

Authority to specify the practices that certifying authority employs in issuing digital

Signature Certificate.

Illustration: ABC Company having a paid-up capital of two crores of rupees and a

net worth of less than 20 crores of rupees has applied for the grant of license. Can the

license be issued to the ABC Company?

The conditions of applying for the grant of license are not met by the company.

License cannot be issued.

(B) Renewal of license

According to section 23 of the Act, a certifying authority can make an application for

the renewal of license. It has to be in such form and accompanied by such fees, not

exceeding Rs. 5,000 as the case may be, prescribed by the Central Government. The

license will be made not less than forty five days before the date of expiry of period of

the validity of the license.

Illustration: PeterX Company is a certifying authority made an application for the

renewal of license in 55 days after the expiry of the validity of the license. Can the

license be renewed?

No. Application has to be made by the PeterX Company within forty five days before

the date of expiry of the period of validity of the license.

604

Procedure for grant or rejection of license

According to section 24 of the Act, the controller can grant the license or reject the

application for the renewal of the license after considering whether the necessary

documents have been attached with as prescribed under the Act under subsection (1)

of section 21 of the Act in which any person may make an application to the

controller for getting a license to issue digital signature certificates.

No rejection of application can be done by the controller unless the applicant has been

given a reasonable opportunity of presenting his case.

(C) Suspension of license

According to section 25 of the Act, the controller may revoke the license, if he is

satisfied after making a proper enquiry that it would be proper to do so. The following

may be the grounds for such a suspension:

(a) A statement in, or in relation to, the application for the issue or renewal of the

license is incorrect or false in material particulars.

(b) The licensee has failed to comply with the terms and conditions subject to which

license was granted.

(c) He has failed to maintain the standards specified under section 20 of the Act

which

ensures that the secrecy and the security of the digital signatures are assured.

(d)He has contravened any of the provisions of this Act, rule, regulation or order

made

thereunder.

However, a license will not be revoked unless the Certifying Authority has been given

a reasonable opportunity of showing cause against the proposed revocation.

If there is a ground to believe that license is to be revoked, then controller can

suspend such a license. The license will not be suspended for a period exceeding 10

605

days unless the certifying authority has given a reasonable opportunity to the

applicant of showing the cause against the proposed rejection.

No Certifying Authority whose license has been suspended will issue any Digital

Signature Certificate during such suspension.

Illustration: Controller of Certifying Authority has revoked the license of Mohan on

the basis of failing to comply with the standards specified under the Act without

giving the reasonable opportunity of being heard him. Can the license be revoked?

The license will not be suspended for a period exceeding ten days unless the

reasonable opportunity of showing the cause against the proposed revocation is given

to him.

Notice of suspension or revocation of license (Sec.26)

According to section 26 of the Act if the license of the Certifying Authority is

suspended or revoked, the Controller will publish the notice of such suspension or

revocation, as the case may be, in the database maintained by him. In case there are

one or more repositories, the controller will publish notices of such suspension or

revocation in all such repositories. The database containing the notice of such

suspension or revocation will be made available through a website which will be

accessible round the clock.

26.3.8 Powers of CCA

According to the Act, following powers have been conferred on the controller of

certifying authority. These powers are enumerated as below:

Power to Delegate

Power to investigate Contraventions

Access to computers and data

606

Power to delegate

According to section 27 of the Act, the controller can delegate any of his powers

and may authorize the Deputy and Assistant controller or any officer to exercise

the same.

Power to investigate contraventions

According to section 28 of the Act, the Controller or any officer authorized by

him in this behalf will take up the investigation of any contravention of the

provisions of this Act, rules or regulations made there under.

The Controller or any officer authorized by him in this behalf will exercise

the like powers which are conferred on Income-tax authorities under Chapter

XIII of the Income-tax Act, 1961

Access to computers and data

According to section 29 of the Act, the controller may have access to any

computer resources of any person to acquire any information during the course of

exercising his duties.

The controller in case of a suspected contravention of rules can have access to

any computer system or a related source for the purpose of searching and

obtaining any information or data contained in such computer system helpful in

conducting his exercise.

Controller can also direct any person who is in-charge of or concerned with the

operation of the computer system to provide him with such reasonable technical

assistance as necessary for his working.

607

26.4 Certifying Authorities (CA)

26.4.1 Procedure to be followed by CA

26.4.2 Functions and powers of CA

(a) Certifying Authority to issue Digital

Signature Certificate (DSC)

(b) Representations to be checked while

issuing DSC

(c) Suspension of DSC

(d) Revocation of DSC

26.4.3 List of CA Certificates

Certifying Authorities are professional agencies, individuals, or corporate

bodies, which possess the technical skills to issue Digital Signature Certificates to

those who want to send secure e-records and digital signatures. In India, National

Information Center (NIC) and Tata Consultancy Services (TCS) are among the

leading certifying authorities.

The IT Act, 2000 has laid down the following Rules as the

responsibilities of certifying authority.

26.4.1 Certifying Authorities to follow certain procedures

According to section 30 of the Act, every Certifying Authority will follow certain

procedures. These are enumerated below:

(a) Make use of hardware, software and procedures that are secure from intrusion and

misuse;

(b) Provide a reasonable level of reliability in its services which are reasonably suited

to the performance of intended functions;

(c) Adhere to security procedures to ensure that the secrecy and privacy of the digital

signatures are assured; and

(d) Observe such other standards as may be specified by regulations.

608

Certifying Authority to ensure compliance of the Act etc.

According to section 31 of the Act, every Certifying Authority will ensure that every

person employed or otherwise engaged by it complies, in the course of his

employment or engagement, with the provisions of this Act, rules, regulations and

orders made there under.

Display of license

According to section 32, every Certifying Authority will display its license at a

conspicuous place of the premises in which it carries on its business.

Surrender of license

According to section 33 of the Act, the following points are to be noted:

(1) Every Certifying Authority whose license is suspended or revoked shall

immediately after such suspension or revocation, surrender the license to the

Controller.

(2) Where any Certifying Authority fails to surrender a license under sub-section (1),

the person in whose favor a license is issued, shall be guilty of an offence and shall be

punished with imprisonment which may extend up to six months or a fine which may

extend up to ten thousand rupees or with both.

Illustration: Trust point Services Company is a certifying authority issuing the digital

signature certificate even after the suspension of the license. Is this act allowed under

the Act? A person in whose favor a license is issued will be punished with

imprisonment which may extend up to six months or a fine which may extend up to ten

thousand rupees or with both.

Disclosure

Section 34 deals with the disclosure that are expected from the certifying authority.

Every certifying authority will disclose the following factors enumerated below:

(a) Its Digital Signature Certificate which contains the public key corresponding to

the private key used by that Certifying Authority to digitally sign another Digital

Signature Certificate

609

(b) Any certification practice statement relevant thereto

(c) Notice of the revocation or suspension of its Certifying Authority certificate, if

any

(d) Any other fact that materially and adversely affects either the reliability of a

Digital Signature Certificate, which that Authority has issued, or the Authority's

ability to perform its services.

If in the opinion of the Certifying Authority any event has occurred or any

situation has arisen which may materially and adversely affect the integrity of its

computer system, the Certifying Authority will use reasonable efforts to notify any

person who is likely to be affected by that occurrence or act in accordance with the

procedure specified in its certification practice statement to deal with such event

situation.

26.4.2 Functions and power of certifying Authority

The following are the functions of certifying authority:

To issue the Digital Signature Certificate (section 35)

To check the representations while issuing digital signature certificate (Section36)

To suspend the digital signature certificate(Section 37)

To revoke the digital signature certificate (Section 38)

These functions are discussed as under:

(a) Certifying Authority to issue Digital Signature Certificate

According to section 35, following steps are required to be followed by the certifying

authority to issue digital signature certificate.

Any person can make an application to the Certifying Authority for the issue of

Digital Signature Certificate in such form as may be prescribed by the Central

Government.

610

Every such application shall be accompanied by such fee not exceeding twenty five

thousand rupees as may be prescribed by Central Government to be paid to the

certifying authority.

Provided that while prescribing fees under sub-section (2) different fees may be

prescribed for different classes of applicants.

(3) Every such application shall be accompanied by a certification practice

statement or where there is no such statement, a statement containing such

particulars, as may be specified by regulations.

(4) On receipt of an application under sub-section (1), the Certifying Authority

may, after consideration of the certification practice statement or the other

statement under sub-section (3) and after making such enquiries as it may

deem

fit, grant the Digital Signature Certificate or for reasons to be recorded in

writing, reject the application

No Digital Signature Certificate shall be granted unless the Certifying Authority is

satisfied that-

(a) The applicant holds the private key corresponding to the public key to be listed in

the Digital Signature Certificate;

(b) The applicant holds a private key, which is capable of creating a digital signature;

(c) The public key to be listed in the certificate can be used to verify a

digital signature affixed by the private key held by the applicant:

No application shall be rejected unless the applicant has been given a reasonable

opportunity of showing cause against the proposed rejection.

Illustration: Mohan was not granted the Digital Signature Certificate by the

Certifying Authority as he was not holding the private key corresponding to the public

611

key to be listed in the digital signature certificate. His private key was lost. The

Certifying Authority can reject the application on this ground after giving the

applicant a reasonable opportunity of showing cause against the proposed rejection.

(b)Representations to be checked while issuing Digital Signature

Certificate

According to section 36 of the Act, a Certifying Authority is required to certify the

following while issuing a digital signature certificate.

(a) The Subscriber has complied with the provisions, rules and regulations made

under the Act.

(b) The Digital Signature Certificate has been published and is available to the

persons relying on it and accepted by the subscriber

(c) The subscriber holds the private key corresponding to the public key, listed in

the Digital Signature Certificate

(d) The subscriber's public key and private key constitute a functioning key pair

(e) The information contained in the Digital Signature Certificate is accurate and

(f) He has no knowledge of any material fact, which if it had been included in the

Digital Signature Certificate would adversely affect the reliability of the

representations made in clauses (a) to (d)

Illustration ABC Company, a Certifying Authority, issued a Digital Signature

Certificate to Raja. ABC Company must certify that Raja has accepted the digital

signature certificate and holds the private key corresponding to the public key listed

in the digital signature certificate.

612

(c) Suspension of Digital Signature Certificate

According to section 37 of the Act, the digital signature certificate may be suspended

by the certifying authority on two parameters:

(a)On the basis of a receipt of request from the subscriber listed in the digital

signature certificate. This may be done by any other person duly authorized to act on

behalf of the subscriber.

(b) If certifying authority is in the opinion that the digital signature certificate must be

suspended in the public interest.

The suspension will not be for a period exceeding fifteen days unless the subscriber

has been given an opportunity of being heard in the matter.

The certifying authority will communicate to the subscriber about the suspension of

the digital signature certificate.

Illustration: Trustline Company, a Certifying Authority suspended the Digital

Signature Certificate issued to Mohan in public interest without giving him the

opportunity of being heard. Can Trustline Company suspend the Digital signature

Certificate this way?

Mohan must be given an opportunity of being heard in this matter before the

suspension of the digital signature certificate.

(d) Revocation of Digital Signature Certificate

According to section 38 of the Act, a digital signature certificate may be revoked by

the certifying authority on the basis of request made by the subscriber or any person

duly authorized to do so or upon the death of the subscriber or upon the dissolution of

the firm or winding up of the company where the subscriber is a firm or a company.

A Certifying Authority may revoke a Digital Signature Certificate on its own at any

time if it is of opinion that-

613

(a) A material fact represented in the Digital Signature Certificate is false or has been

concealed

(b) A requirement for issuance of the Digital Signature Certificate was not satisfied

(c) The Certifying Authority's private key or security system was compromised in a

manner materially affecting the Digital Signature Certificate's reliability;

(d) The subscriber has been declared insolvent or dead or where a subscriber is a firm

or a company, which has been dissolved, wound-up or otherwise ceased to exist

A Digital Signature Certificate will not be revoked unless the subscriber has been

given an opportunity of being heard in the matter. On revocation of a Digital

Signature Certificate, the Certifying Authority shall communicate the same to the

subscriber.

Illustration: A Certifying Authority has revoked the Digital Signature Certificate of

the puja on the ground that the certification practice statement was not accompanied

in the application for the issue of the license. A certifying authority can revoke her

license in such a case. The same fact must be communicated to her and published in

the repository specified in the DSC.

Notice of suspension or revocation

According to section 39 of the Act, if a Digital Signature Certificate is suspended or

revoked under section 37 or section 38, the Certifying Authority will publish a notice

of such suspension or revocation, as the case may be, in the repository specified in the

Digital Signature Certificate for publication of such notice.

Where one or more repositories are specified, the Certifying Authority will publish

notices of such suspension or revocation, as the case may be in all such repositories.

It is mandatory for the certifying authority to publish a notice of suspension or

revocation of digital signature certificates in its repository to maintain the integrity of

digital signature certificates and to create the atmosphere of mutual trust between the

certifying authority, subscriber and the relying party.

614

Also, it is mandatory for the certifying authority to make this information relating to

the suspension or revocation of digital signature certificates available to the controller

for inclusion of the same in the National Repository.

26.4.3 List of Certifying Authority CertificatestnlTrustLine Public Primary

Certification Authority

Safescrypt Time Stamping Authority

Safescrypt India-RCAI Class

Tata Consultancy Services Certifying Authority

NIC Certifying Authority244

Points to remember

Introduction

It is necessary to have an identification strategy to ascertain the integrity,

confidentiality and authentication of communication channels and processes.

For this, system is required in the form of one or more trusted third parties which will

not only authenticate that a digital signature belongs to a specific signer but also

dispense the public keys.

Trusted Third Party

Certifying Authority

Controller of Certifying Authority

Public Key Infrastructure

It is an arrangement in cryptography that facilitates third party examination of, and

vouching for, user identities.

It involves-Subscriber, Certifying authority, Relying Party

244

http://www.cca.gov.in/

615

Controller of Certifying Authority(CCA)

Appointment of CCA by Central Government by notification in the Official Gazette.

Performs various functions

It may with the previous approval of the Central Government recognize any foreign

certifying authority.

Acts as repository of all Digital Signature Certificates

Issues the Digital Signature Certificate to an applicant for becoming a certifying

authority.

Renewal of license in the format prescribed by the Central Government shall be made

not less than forty five days before the expiry of the validity of the license.

Suspension of license by controller if CA fail to comply with the terms and conditions

subject to which license was granted

The Controller shall publish notice of suspension or revocation, as the case may be, in

the database maintained by him

Powers of CCA

Power to delegate

Power to investigate contraventions

Access to computers and data

Certifying Authority

Possess the technical skills to issue Digital Signature Certificate to those who want to

secure e-records and digital signatures.

Observe such other standards as may be specified by regulations.

Every Certifying Authority shall display its license at a conspicuous place of the

premises in which it carries on its business

Every Certifying Authority whose license is suspended or revoked shall immediately

616

after such suspension or revocation, surrender the license to the Controller

Functions and power of Certifying Authority

Issue the Digital Signature Certificate(DSC)

Check the representations while issuing DSC

Suspend the DSC

Revoke the DSC

List of CA Certificates

mtnlTrustLine Public Primary

Safescrypt Time Stamping Authority

Safescrypt India-RCAI Class 3 CA

Tata Consultancy Services Certifying Authority

NIC Certifying Authority

Objective type Question

Certifying bodies must be the Government bodies.

CCA is a regulatory authority working under the control of the Supreme Court.

The subscribers have to take their grievances against the Certifying Authorities

before the CCA

The license granted to the Certifying authority cannot be revoke or suspend by CCA

The function of the Controller is to exercise supervision over the activities of the

Certifying Authorities and to lay down the standards to be maintained by the

Certifying Authority

The Controller cannot recognize foreign certifying authority as a certifying authority

for the purposes of the Act.

The Controller shall be the repository of all Digital Signature Certificates issued

under this Act

617

An individual being a citizen of India and having a capital of five crores of rupees or

more in his business or profession can apply to the controller for the grant of license

in the prescribed form

Certification practice statement means a statement issued by the Certifying Authority

to specify the practices that certifying authority employs in issuing digital Signature

Certificate.

Answer: 1.F; 2.F; 3-T; 4.F; 5.T; 6.F; 7.T; 8.T; 9.T

Questions

Who are Certifying authorities? Who can apply for license to act as certifying

authority?

What are the responsibilities, functions and powers of Certifying authority?

What are the Functions of Controller of Certifying Authority?

Explain the powers of CCA.

What are the provisions relating to the “License to Certifying Authorities to issue

Digital Signature Certificates (Sec21)”?

Explain the provisions relating to the Renewal of license and grant or rejection of

license of Certifying Authority.

Practical Problems

The license of the Certifying authority is revoked by CCA because of a serious lapse

and no intimation is given to the CA. The name of the CA is also removed from the

databases of the CCA Can CA go against this revocation. Decide.

Answer. Yes. A Certifying Authority can go against this revocation. The

revocation is invalid because the CA should have been given the opportunity

of being heard or to present the case.

618

There is a contract between the two parties using the keys sanctioned in the Digital

Signature Certificate. The contracting parties have no idea as to the revocation of

digital signature certificate of a subscriber. If the other person backs out of the

contract on the ground that the keys were not valid and e-record is not secured.

Decide.

Answer. The contract is valid because revocation of certificate was not notified.

According to sec. 39, where DSC is suspended, the CA shall publish a notice of such

suspension, as the case may be in the repository specified in the DSC.

The Certifying Authority fails to submit the necessary information demanded by the

Controller of Certifying authority regarding some important issues. What maximum

fine can the controller impose on the Certifying authority?

Answer. A Controller of Certifying Authority can impose a fine of Rs.1, 50,000 under

Sec 44 of the IT Act, 2000.

References:

Books:

References to Sections in this chapter are to Information Technology Act, 2000.

S.K.Aggarwal and K.Singhal (2006) Galgotia Publications, New Delhi, India Chapter

28

M.C.Kuchhal (2007) Business Law, Vikas Publishing House Pvt. Ltd. Delhi, India,

Chapter 31.

Vakul Sharma (2007) Information Technology Law and Practice law and emerging

technology cyber law and E-commerce (Universal Publishing Company, Delhi, India

(Chapter1-9)

B.K.Goyal (2005) Business Law, R.Chand & Co, New Delhi, India, Chapter 35

D. Painttal, Law of Information Technology” Taxmann Publications Pvt. Ltd, New

Delhi, India.

Websites

http://www.cca.gov.in

www.google.com http://www.legalserviceindia.com

619

Lesson 27

Contraventions, Offences and Appellate Tribunal

by

Nidhi Dhawan

The Chapter discusses the following aspects of the

Information Technology Act, 2000.

27.1 Introduction

27.2 Cyber Contraventions (Section 43-45)

27.3 Adjudication

27.4 Cyber Regulations Appellate Tribunal (CRAT)

27.5 Offences and Penalties

27.1 Introduction

Chapters IX, X, and XI of the IT ACT, 2000, deal with the contraventions, offences

and penalties. The Act has broadly categorized contraventions of two types stated as

under:

Which is of a criminal nature subject to imprisonment and fine and

Other contraventions.

The fundamental approach of the Act is towards validating and legalizing electronic

and on-line transactions. Though the Internet has made the world a smaller place to

live in, it has also made it unsafe.

In spite of the security measures adopted by the owner of the computer, computer

system and computer network, there are theft and intrusion. Computer and Cyber

Crimes will hopefully be curbed and offenders will be strictly penalized. Moreover, it

is relatively more difficult and sometimes practically impossible to locate guilty party.

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To make Information valuable it is required that it must retain its confidentiality,

security, and integrity. It is a continuous process and requires a strict adherence to

well laid security measures. According to the Act, two categories of behaviors are

there with respect to the use of computer resources by a person, these are

contraventions245

and Offences246

.

27.2 Cyber Contraventions

Sections 43 to 45 of Chapter IX of the Act deal with Cyber Contraventions such as

making unauthorized copies, unauthorized access to records, introduction of

'computer contaminants', denial of access, etc. A violation of such nature would result

in monetary penalty and/or compensation to be paid to the affected party.

Cyber Contraventions

Section 43 Damage to computer, computer system, etc.

B Section 44 Maintaining books of accounts, records, furnishing

results

C Section 45 Residuary Penalty

These cyber Contraventions are discussed below:

(A) Section 43 of the Information Technology Act, 2000 identifies the eight

different factors and the penalty for causing damage to computer, computer

system or computer network. These factors are discussed below:

Section 43 provides that if any person without permission of the owner or any other

person who is in charge of a computer, computer system or computer network, does

any of the following acts, he will be guilty of a contravention of the Act. These are:

245

Contravention is a civil wrong or a breach of a rule.

246

An offence is an act prohibited by law. Such as tampering with source codes, hacking, publication or transmission of obscene

information; misrepresentation of facts for obtaining DSC, publication of a false DSC, etc. These are punishable with

imprisonment as well as monetary penalty.

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(a) Accessing or securing access to such computer, computer system or computer

network.

Access signifies communicating or gaining a possibility of instructing with the

logical, mathematical or memory resources of the computer.

(b)Downloading, copying or extracting any data, computer data base247

or information

from such computer, computer system or computer network including information or

data held or stored in any removable storage medium.

This provision is related to the situations of theft or extracting any database

information of any format prepared in a formalized manner. This also covers a

violation of the rules of the copyrights.

Illustration: Satish copies the data prepared in the format required for the working of

the system from the computer system of Ramesh and he was not aware of this fact

Satish copied the data without his permission. Is this act of satish allowed under the

Act?

Copying the data from the databases of the Ramesh’s computer system is not allowed

under the Act. This is a violation of copyright rules so satish will be liable to pay

damages by way of compensation for such unauthorized access.

(c) Introducing or causing to be introduced any computer contaminant248

or

247 "computer data base" means a representation of information, knowledge, facts, concepts or

instructions in text, image, audio, video that are being prepared or have been prepared in a formalized

manner or have been produced by a computer, computer system or computer network and are intended

for use in a computer, computer system or computer network;

248 "Computer contaminant" means any set of computer instructions that are designed-(a) to modify,

destroy, record, transmit data or program residing within a computer, computer system or computer

network; or

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computer

virus249

into any computer, computer system or computer network.

It includes all those set of instructions created for the purpose of destroying the data

or modifying the data residing in the computer system or computer network. It also

covers the instructions that can badly affect the normal working of the computer

system.

The set of instructions can also be created in the manner that affects the performance

of the computer system. The system may start working slow or these instructions may

attach itself to some files in the computer and starts operating when the program is

executed.

(d) Damaging250

or causing to be damaged any computer, computer system or

computer network, data, computer data base or any other programs residing

in such computer, computer system or computer network.

Damage can result in deleting a file or set of instructions from a file, thus stopping its

proper functioning. It may also include adding instructions to the file that starts

working when the program is executed and thus giving a different unwanted output.

(b) by any means to usurp the normal operation of the computer, computer system, or computer

network;

249 "computer virus" means any computer instruction, information, data or program that destroys,

damages, degrades or adversely affects the performance of a computer resource or attaches itself to

another computer resource and operates when a program or instruction is executed or some other event

takes place in that computer resource

250 "Damage" means to destroy, alter, delete, add, modify or rearrange any computer resource by any

means.

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Illustration: Mohan altered the data residing in the database of Arun’s computer

system without his permission. He wanted to damage the data so that it could not be

used later by Arun.

Alteration of data amounts to a damage caused to the database of Arun. Mohan will

be liable to pay the compensation for the same under the Act.

(e) Disrupting or causing disruption of any computer, computer system or computer

network.

Disruption may be because of any reason. It may be caused by providing some

damage to the computer system either by adding or deleting the file or by way of

sending virus the computer system thus resulting in its slowdown working.

(f) Denying or causing the denial of access to any person authorized to access any

computer, computer system or computer network by any means.

The authorized person of the computer system is being stopped from using the

services provided to him by the internet service providers. This may be done by the

mischievous persons interested in disrupting the normal functioning of the internet by

flooding the internet with the unnecessary traffic.

(g) Providing any assistance to any person to facilitate access to a computer,

computer system or computer network in contravention of the provisions of this Act,

rules or regulations made there under.

This provision creates an obligation upon the owners and users of the computer

resources not to help any other person on gaining any access to computer resources in

violation of the provisions of the Act.

(h) Charging the services availed of by a person to the account of another person by

tampering with or manipulating any computer, computer system, or computer

network.

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The provisions seek to protect the rights of the authorized account holders of internet

facilities. A person my use the internet facility by stealing the internet hours from the

account of an authorized user, such an attempt has been declared as a contravention of

this provision.

Penalty: The person guilty of such acts described above will be liable to pay damages

by way of compensation not exceeding one crore rupees to the person so affected.

(B) Section 44 of the Act deals with contraventions and penalty relating to

maintaining books of accounts, records, furnishing or filling any return or information

to the controller or the certifying authority.

These contraventions are enumerated below:

(a)Failure to furnish any document, return or report to the Controller or the Certifying

Authority when required to do so.

Penalty: The penalty for such an act will be a fine not exceeding one lakh and

fifty thousand rupees for each such failure.

Illustration: Mohan fails to furnish to Controller of Certifying Authority any

document, return or report required under the Act. Is he liable for any penalty? He

shall be liable to a penalty not exceeding one lakh and fifty thousand rupees for each

such failure.

(b) Failure to file any return or furnish any information, books or other documents

within

the time specified in the regulations.

Penalty: The penalty for such an act will be a fine of an amount not exceeding

five

thousand rupees for every day during which such failure continues.

(c) Failure to maintain books of account or records.

Penalty: In such a case, penalty will be a fine not exceeding ten thousand rupees

for every day during which the failure continues.

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Illustration: Sheena fails to maintain the record required to maintain under the

provision of section 44 of the Act. Sheena, in such a case would be liable to a fine of

the amount not exceeding Rs.10, 000 for everyday during which the failure continues.

(C) Residuary Penalty

Section 45 of the Act deals with imposing Residuary Penalty.

According to section 45, there is a residuary penalty for all those acts, rules and

regulations under this Act for which no penalty has been separately provided.

Penalty: The penalty will be a fine of an amount not exceeding Rupees twenty

thousand to the person affected by such a contract.

27.3 Section 46 of the Act deals with the Adjudication on

Contraventions

The following parameters highlighting the adjudication on contraventions are

discussed hereunder. These are:

(a)Who will adjudicate?

(b)Powers of the officers to adjudicate

(c)Factors to be taken into account while adjudication

These parameters are enumerated by the qualifications of an Adjudicating Officer for

the purpose of adjudging whether any person has committed a contravention of any

provisions of the IT Act, 2000 or of any rule, regulation or order made there under

are:

The Central Government shall appoint any officer not below the rank of the Director

to the Government of India.

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He will be an adjudicating officer for holding an enquiry in the manner prescribed by

the Central Government in those cases where rules and regulations have not been

followed.

He will conduct an enquiry for such contraventions of the provisions as prescribed by

the Central Government.

He has been given the powers of the Civil Court.

The adjudicating officer will adjudicate on specific cases in accordance with the

provisions of the Act.

(b) Power of the officers to Adjudicate

The following are the powers of the adjudicating officer for dealing with the

contraventions under the Act.

The adjudicating officer will give a reasonable opportunity to the accused person for

making representation in the matter.

If, on such inquiry, he is satisfied that the person has committed the contravention, he

may impose such penalty or award such compensation as he thinks fit in accordance

with the provisions of that section

Adjudicating Officer must possess an experience in the field of information

technology and legal or judicial experience as may be prescribed by the Central

Government.

No person can become an Adjudicating officer if he has not possessing an experience

of information technology.

Where more than one adjudicating officers are appointed, the Central Government

will specify by order the matters and places with respect to which such officers will

exercise their jurisdiction.

Every adjudicating officer will have the powers of a civil court which are conferred

on the Cyber Appellate Tribunal.

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(c)Factors to be taken into account by the adjudicating officer

According to section 47 of the Act, while adjudging the quantum of

compensation, the adjudicating officer will have due regard to the following

factors. These factors are:

(1) The amount of gain of unfair advantage, wherever quantifiable, made as a

result of the default.

(2) The amount of loss caused to any person as a result of the default.

(3) The repetitive nature of the default.

27.4 Cyber Regulations Appellate Tribunal (CRAT)

A certifying authority or a subscriber may feel aggrieved by the order of the controller

or of an adjudicating officer. They may like to appeal against the order. For this

purpose, Act has provided suitable machinery for the fast disposal of such appeals.

The machine is in the form of Cyber Regulation Appellate Tribunal (CRAT).

Following are the important parameters to be known regarding Cyber Regulation

Appellate Tribunal. These are:

Cyber regulations Appellate Tribunal is established by the Central Government.

The Central Government shall specify the matters and places in relation to which the

tribunal may exercise jurisdiction.

Section 48: According to section 48, Central government is authorized by notification

to establish one or more appellate tribunals to be known as the Cyber Regulations

Appellate Tribunal. The Central Government will also specify all the matters and

places in relation to which the Cyber Appellate Tribunal may exercise its jurisdiction.

Section 49: According to section 49 of the Act, a Cyber Appellate Tribunal will

consist of one person only (known as the Presiding Officer of the Cyber Appellate

Tribunal). He will be appointed by the Central Government by notification.

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Any appeal against any decision/order of the Controller of Certifying Authorities or

any other certifying authorities can be made to Cyber Regulation Certifying

Authority.

Any person aggrieved by the order of this Tribunal may prefer an appeal to the High

Court

An appeal to the High Court can be made within 60 days from the date of

communication of the order of the Tribunal.

This is the pictorial representation of the hierarchy of Authorities under the

Information Technology Act, 2000.

27.4.1 Qualifications for appointment as Presiding Officer of the Cyber

Appellate

Tribunal

According to section 50 a person will not be qualified for appointment as the

Presiding Officer of a Cyber Appellate Tribunal unless he or she fulfill the condition

given below:

(a) He is, or has been or is qualified to be, a Judge of a High Court; or

(b) He is, or has been a member of the Indian Legal Service and is holding or has held

Cyber Regulations Appellate Tribunal

(CRAT)

Adjudicating Officer

Controller of Certifying Authority (CCA)

Certifying authority

Subscriber

High Court

629

a

post in Grade I of that Service for at least three years.

27.4.2 Term of office

According to section 51 of the Act, the Presiding Officer of a Cyber Appellate

Tribunal will hold office for a term of five years.

This term will be calculated from the date on which he enters upon his office or until

he attains the age of sixty-five years, whichever is earlier.

27.4.3 Salary, allowances and other terms and conditions of service of Presiding

Officer

Section 52 of the Act provides and prescribes the rules relating to salary and

allowances payable to, and the other terms and conditions of service including

pension, gratuity and other retirement benefits of the Presiding Officer of a Cyber

Appellate Tribunal will be such as may be prescribed.

The exceptions to the rule are that any alteration in the terms and conditions of the

service of the Presiding Officer including his salary and allowances will not be done

after his appointment which puts him into any kind of loss. In other words, any

alteration in this connection which deprives him of his rights under the terms and

conditions is not desirable.

27.4.4 Appeal to Cyber Appellate Tribunal

According to section 57 of the Act, under the following circumstances an appeal is

allowed to be made to Cyber Regulation Appellate Tribunal. These circumstances are:

Any person aggrieved by an order made by Controller or an adjudicating officer under

this Act may refer an appeal to a Cyber Appellate Tribunal having jurisdiction in the

matter.

No appeal will lie to the Cyber Appellate Tribunal from an order made by an

adjudicating officer with the consent of the parties.

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Every appeal will be filed within a period of forty-five days from the date on which a

copy of the order made by the Controller or the adjudicating officer is received by the

aggrieved party.

Every appeal will be in such form and be accompanied by such fee as may be

prescribed.

Cyber Appellate Tribunal may entertain an appeal after the expiry of the said period

of forty-five days if it is satisfied that there was sufficient cause for not filing it within

that period.

The Cyber Regulation Appellate Tribunal may pass such orders as it thinks fit. It may

confirm, modify or set aside an order appealed against.

Cyber Regulation Appellate Tribunal may pass such an order after giving an

opportunity of being heard in this matter.

The Cyber Appellate Tribunal will send a copy of every order made by it to the

parties to the appeal and to the concerned Controller or adjudicating officer.

The Cyber Appellate Tribunal has to expeditiously deal with the order as soon as

possible. Cyber Appellate Tribunal shall make an effort to dispose of the appeal

finally within six months from the date of receipt of the appeal.

Procedure and powers of the Cyber Appellate Tribunal

According to section 58, the following procedures have to be followed:

The Cyber Appellate Tribunal shall not be bound by the procedure laid down by the

Code of civil Procedure, 1908.

He will be guided by the principles of natural justice.

Subject to the other provisions of this Act and of any rules, the Cyber Appellate

Tribunal will also have the powers to regulate its own procedure including the place

at which it shall have its sittings.

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The Cyber Appellate Tribunal for the purposes of discharging its functions will have

the same powers as are vested in a civil court under the Code of Civil Procedure,

1908, while trying a suit, in respect of the following matters, namely:-

(a) Summoning and enforcing the attendance of any person and

examining him on oath.

(b) Requiring the discovery and production of documents or other

electronic records.

(c) Receiving evidence on affidavits.

(d) Issuing commissions for the examination of witnesses or

documents.

(e) Reviewing its decisions.

(f) Dismissing an application for default.

(g) Any other matter which may be prescribed.

Every proceeding before the Cyber Appellate Tribunal shall be deemed to be a

judicial proceeding within the meaning of sections 193 and 228, and for the purposes

of section 196 of the Indian Penal Code and the Cyber Appellate Tribunal shall be

deemed to be a civil court for the purposes of section 195 and Chapter XXVI of the

Code of Criminal Procedure, 1973.

27.4.6 Right to legal representation

According to section 59, the appellant may either appear in person or authorize one or

more legal practitioners or any of its officers to present his or its case before the

Cyber Appellate Tribunal.

27.4.7 Limitation

According to section 60, the provisions of the Limitation Act, 1963, will, as far as

may be, apply to an appeal made to the Cyber Appellate Tribunal.

27.4.8 Civil Court not to have jurisdiction

According to section 61, No court shall have jurisdiction to entertain any suit or

proceeding in respect of any matter for which an adjudicating officer appointed under

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this Act or the Cyber Appellate Tribunal constituted under this Act is empowered by

or under this Act to determine and no injunction shall be granted by any court or other

authority in respect of any action taken or to be taken in pursuance of any power

conferred by or under this Act.

27.4.9 Appeal to High Court

According to section 62, an appeal can be made to the High Court.

The order passed by the Cyber Regulation Appellate Tribunal may be filed to a High

Court by an aggrieved party.

An appeal can be made against the order of Cyber Regulation Appellate Tribunal by

the aggrieved party within 60 days from the date of communication of the order of the

Cyber Regulation Appellate Tribunal to him on any question of fact or law arising out

of such order.

High Court may allow the aggrieved party to file an appeal within a further period not

exceeding 60 days, if it is satisfied that the appellant was prevented by the sufficient

cause from filling the appeal.

27.4.10 Compounding of contraventions

Section 63 provides for the possibility of a compromise between the controller or

adjudicating officer and the accused person regarding the quantum of penalty. The

provision states the following aspects:

Any contravention under this act by a person may be compounded by the controller or

by adjudicating officer, or such other officer as may be specially authorized by him in

this behalf, as the case may be.

This may be either before or after the institution of adjudication proceedings.

The amount so compromised will not in any case exceed the maximum amount of the

penalty imposed under this Act for the contravention so compounded.

633

A person cannot avail this facility if he commits the same or similar contracts within a

period of three years from the date on which the first contravention committed by him

was compounded.

Where any contravention has been compounded, no proceeding or further proceeding,

as the case may be, shall be taken against the person guilty of such contravention in

respect of the contravention so compounded.

27.4.11 Recovery of penalty

According to section 64, a penalty imposed under this Act, if it is not paid, will be

recovered as an arrear of land revenue.

The license or the Digital Signature Certificate, as the case may be, will be suspended

till the penalty is paid.

27.5 Cyber Offences

Sections 65 to 76 of Chapter XI of the Act describe several offences such as

tampering with source codes, hacking, publication or transmission of obscene

information; misrepresentation of facts for obtaining digital signature certificate,

publication of a false digital signature certificate, etc. These acts are punishable with

imprisonment as well as monetary penalty.

A contravention is a mere violation of law or procedure which does not result in a

criminal prosecution. It may result in a civil prosecution. It may be punishable with a

liability to pay a penalty or compensation. On the other hand, an offence is an act

forbidden by law and made punishable by fine and /or imprisonment.

Section 65 to 76 of the IT Act deals with the criminal penalty either imprisonment for

the offence or imposition of fine or both. Under the Act, there are various cyber

offences and each one is described below:-

Tampering with computer source documents

634

According to section 65, this offence takes place when a person tampers with the

valuable computer programs of another person.

Meaning: This section states that a person will be guilty of an offence if intentionally

or knowingly, he conceals, destroys or alter any computer source code used for a

computer, computer program, computer system or computer network, when the

computer source code251

is required to be kept or maintained by law for the time being

in force,

Penalty: such a person shall be punishable with imprisonment up to three years or

with fine which may extend up to two lakh rupees, or with both.

Illustration: Raja intentionally alters and destroys the computer program of Mohan

residing in his computer system. This program was valuable. Mohan was required to

maintain this computer program under the provisions of the law.

Raja has committed an offence of tampering. He tried to alter the valuable source

document of Raja. Raja shall be liable to pay damages under section 65.

Hacking with computer system

251 "Computer source code" means the listing of program, computer commands, design and layout and

program analysis of computer resource in any form.

635

Meaning: According to section 66, Hacking is a punishable offence. Any person with

intent to cause any loss or damage to the public or any person destroys or deletes or

alters any information residing in the computer resource or diminishes it utility by any

means, commits hack.

Penalty: Whoever commits hacking will be punished with imprisonment up to three

years, or with fine which may extend up to two lakh rupees, or with both.

Illustration; Rohan diminishes the value and utility of the information residing in the

computer resource of Sohan by some means. Is he liable for the punishment?

The act committed by Rohan is hacking. Hacking with the computer system is an

offence and he shall be liable for the same under sec 66.

Publishing of information which is obscene in electronic form

Meaning: According to section 67 of the Act, this offence takes place when a person

publishes or transmits or causes to be published in the electronic form, any material

which is lascivious or appeals to the prurient interest or if its effect is such as to tend

to deprave and corrupt persons who are likely, having regard to all relevant

circumstances, to read, see or hear the matter contained or embodied in it.

Penalty: Any person committed such an act will be punished on first conviction with

imprisonment of either description for a term which may extend to five years and with

fine which may extend to one lakh rupees and in the event of a second or subsequent

conviction with imprisonment of either description for a term which may extend to

ten years and also with fine which may extend to two lakh rupees.

Power of Controller to give directions

Meaning: According to section 68, the Controller may direct by order a Certifying

Authority or any employee of such Authority to take such measures or cease to carry

on such activities as specified in the order if they are necessary to ensure compliance

with the provisions of this Act, rules or any regulations made there under.

636

Penalty: Any person who fails to comply with an order of the controller shall be

guilty of an offence and shall be liable on conviction to imprisonment for a term not

exceeding three years or to a fine not exceeding two lakh rupees or to both.

Directions of Controller to a subscriber to extend facilities to decrypt

information

Meaning: According to section 69, the controller may direct any agency of the

Government to intercept any information transmitted through any computer resource.

The controller will do so if he is satisfied that it is necessary to do so in the interest of

the sovereignty or integrity of India, the security of the State, friendly relations with

foreign Stales or public order or for preventing incitement to the commission of any

cognizable offence, for reasons to be recorded in writing, by order.

Any agency which has been directed to do so may call upon the subscriber or any

person in-charge of the computer resource to extend all facilities and technical

assistance to decrypt the information.

Any failure to do so by a person will be an offence,

Penalty: The subscriber or any person who fails to assist the agency in his work will

be punished with an imprisonment for a term which may extend to seven years.

Protected system

According to section 70, the Government may declare that any computer, computer

system or computer network to be a protected system.

It may also authorize specific persons only who can access the protected systems

Any person who secures access or attempts to secure access to a protected system

commits an offence in contravention of these provisions.

Penalty: A person working against the provisions of this Act and accessing a

protected system will be punished with imprisonment of either description for a term

which may extend to ten years and shall also be liable to fine

637

Illustration: Rajeev access the protected system. He was not given the authority to

access protected system. He committed this act in contravention of the provisions of

Section 70. Is Rajeev liable for any punishment for gaining access to the systems to

which he was prohibited under the Act?

Rajeev is liable to pay damages for the same and will be punished with imprisonment

of either description for a term which may extend to ten years and shall also be liable

to fine.

Penalty for misrepresentation

According to section 71, if any person makes any misrepresentation or suppress any

material fact from the certifying authority or controller for obtaining the digital

signature certificate.

Penalty: Such a person has committed an offence and he will be punished with

imprisonment for a term which may extend to two years, or with fine which may

extend to one lakh rupees, or with both.

What constitutes the Penalty for breach of confidentiality and privacy?

Breach of confidentiality and privacy under section 72 of the Act means that a person

having an authority has secured any access to any electronic record, book, register,

correspondence, information, document or other material.

If such an access to a material or document etc is done without the consent of the

person concerned and such record have been disclosed to any other person. Then such

a person who has access this material without the permission has committed an

offence.

Penalty: A person committing such an offence will be punished with imprisonment

for a term which may extend to two years, or with fine which may extend to one lakh

rupees, or with both.

638

Illustration: Mohan has secured an access to a document that belongs to Parth and

discloses it to some other person without the consent of Parth. Mohan has committed

an offence by disclosing parths document to someone else without his permission.

This is a case of breach of confidentiality and privacy. Mohan will be punishable with

imprisonment which may extend to two years, or with fine which may extend to one

lakh rupees, or with both.

Penalty for publishing Digital Signature Certificate false in certain particulars

According to section 73, “No person shall publish a Digital Signature Certificate or

otherwise make it available to any other person with the knowledge that-

(a) The Certifying Authority listed in the certificate has not issued it; or

(b) The subscriber listed in the certificate has not accepted it; or

(c) The certificate has been revoked or suspended,

Unless such publication is for the purpose of verifying a digital signature created

prior to such suspension or revocation”

Section 73, therefore, has the following basic ingredients:

It may happen that a digital signature certificate gets issued in spite of the fact that

some error had crept in the whole process of issuing it.

Issuing of such kind of digital signature certificate may be because of the reason that

the certifying authority has not issued the certificate or the subscriber listed in the

certificate has not accepted it or the certificate has been revoked.

No person will make a public announcement of such an erroneous certificate

knowingly the above stated facts.

If a person does so intentionally, it will amount to be an offence under section 73 of

the Act.

639

Penalty: Any person who contravenes the provisions will be punished with

imprisonment for a term which may extend to two years, or with fine which may

extend to one lakh rupees, or with both.

Publication for fraudulent purpose

According to section 74, this offence takes place when a person knowingly creates,

publishes or otherwise makes available a Digital Signature Certificate for any

fraudulent or unlawful purpose.

Penalty: A person will be punished with imprisonment for a term which may extend

to two years, or with fine which may extend to one lakh rupees, or with both.

Act to apply for offence or contravention committed outside India

According to section 75, the provisions of this Act will apply to any offence or

contravention committed outside India by any person irrespective of his nationality.

This Act relates to any person who has committed an act or conduct that constitutes

an offence or contravention involving a computer, computer system or computer

network located in India.

Confiscation

According to section 76 of the Act, the following factors are to be noted in relation to

the confiscation:

It includes any computer hardware including a computer, computer system, floppies,

compact disks, tape drives or any other accessories related thereto, in respect of

which, any provision of this Act is contravened.

The result of the contravention of this provision will be that such computer hardware

will be liable to confiscation.

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If to the satisfaction of the court adjudicating the confiscation ,it is found that the

person is possessing any such computer, computer system, floppies, compact disks,

tape drives or any other accessories relating thereto.

And such a person is not responsible for the contravention of the provisions of this

Act, rules, orders or regulations made there under,

The court will not make any order for the confiscation of such computer, computer

system, floppies, compact disks, tape drives or any other accessories related thereto.

Instead , court will make such an order authorized by this Act against the person

contravening of the provisions of this Act, rules, orders or regulations made there

under as it may think fit.

Illustration: Satish contravenes the provisions of the Act as he was found with the

tape drives relating to which the provisions or rules have been made under the Act.

He has committed an offence. In such a case the tape drives will be liable to

confiscation.

Penalties or confiscation not to interfere with other punishments

According to section 77, no penalty imposed or confiscation made under this Act will

prevent the imposition of any other punishment to which the person affected thereby

is liable under any other law for the time being in force.

Power to investigate offences

The Act has granted substantial powers to police. These powers are to be exercised

only by a high ranking police officer. These powers are given them to investigate any

offence under this Act and as a consequence thereof, to make search and seizure

operations against offenders without warrant.

Section 78 grants the power of investigation to the police officer not below the rank of

Deputy Superintendent of Police or above who will investigate any offence under this

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Act. Section 80 grants to such an officer or any other officer authorized by the

Government for this purpose the power of search and seizure without warrant.

Points to Remember

Introduction

The fundamental approach of the Act is towards validating and legalizing electronic

and on-line transactions.

Chapter IX, Sec 43-45 of the Act deals with Contraventions – A civil wrong.

Chapter X of the Act deals with Adjudicating officer and Cyber regulations Appellate

Tribunal(CRAT)

Chapter XI, Sec 65-74 deals with the Offences and penalty- Offence, a criminal act

prohibited by law

Cyber Contraventions Sec.43

Identifies the eight different factors for causing damage to computer,

computer system or computer network

Penalty- shall be liable to pay damages by way of compensation not exceeding one

crore rupees to the person so affected.

Section 44

Deals with maintaining books of accounts, records, furnishing or filling any return or

information to the controller or the certifying Authority

Penalty-shall be liable to a penalty not exceeding one lakh and fifty thousand rupees

for each such failure

Sec45: Residuary penalty

For a contravention where no penalty has been separately provided

Penalty- not exceeding twenty-five thousand rupees to the person affected.

Adjudicating Officer

Central Government shall appoint any officer not below the rank of the Director to the

Government of India to be an adjudicating officer.

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Every such officer shall have the powers of a civil court.

Cyber Regulations Appellate Tribunal(CRAT)

Established by the Central Government

Comprises of a Presiding officer to be appointed vide a notification by the Central

Government.

An aggrieved party (a Certifying Authority or a subscriber) by the order of the

Controller of Certifying Authorities or of an adjudicating officer may like to appeal

against the order to the CRAT.

The Central Government shall, by notification, establish one or more appellate

tribunals.

CRAT has same powers as are vested in a civil court under the Code of Civil

Procedure, 1908

Civil Court not to have jurisdiction

Appeal to High Court by an aggrieved person within sixty days from the date of

communication of the decision or order of the CRAT

Offences

Tampering with computer source documents

Hacking with computer system

Publishing of information which is obscene in electronic form

Penalties

Tampering and Hacking-Imprisonment up to 3 years or fine which may extend up to

two lakh rupees, or with both.

Misrepresentation -shall be punished with imprisonment for a term which may extend

to two years, or with fine which may extend to one lakh rupees, or with both.

Breach of confidentiality and privacy -shall be punished with imprisonment for a term

which may extend to two years, or with fine which may extend to one lakh rupees, or

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with both.

Penalty for publishing Digital Signature Certificate false in certain particulars

Publication for fraudulent purpose shall be punished with imprisonment for a term

which may extend to two years, or with fine which may extend to one lakh rupees, or

with both

Objective type Question

Under sec. 43, a person shall be liable to pay damages by way of compensation not

exceeding one crore rupees to the person so affected.

Every adjudicating officer shall have the powers of a civil court which are conferred

on the Cyber Appellate Tribunal under sub-section (2) of section 58.

An appeal shall lie to the Appellate Tribunal against any decision/order of the

Controller of Certifying Authorities or any other certifying authorities.

A Cyber Appellate Tribunal shall consist of five persons only, to be appointed, by

notification, by the Central Government.

Tampering with computer source documents is an offence under sec 65

The Central Government may establish more than one Appellate Tribunal

Answers: 1.T; 2.T; 3T; 4.F; 5.T; 6.T

Questions

Explain the provisions relating to the criminal offences stipulated by IT Act 2000?

Explain the provisions relating to the civil offences under the IT Act 2000?

What is the maximum penalty for the offences?

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What does damage to computer system mean?

How does IT Act deal with Hacking?

In case of any contravention of the provisions of Act, who will adjudicate?

In case of dispute, where can an appeal be made?

Explain the provisions of the Act relating to “Appeal to Cyber Appellate

Tribunal (Sec.57)

Explain the procedures and powers of Cyber Appellate Tribunal.

What is residuary penalty (Sec.45)?

Explain the provisions of the Act relating to “Appeal to Cyber Appellate

Tribunal(Sec.57)

Explain the following offences.

Tampering with computer source documents

Publishing of information which is obscene in electronic form

Breach of confidentiality and privacy

Publication for fraudulent purpose

Publishing Digital Signature Certificate false in certain particulars

Practical Problems

If any person without permission of the owner or any other person who is in charge of

a computer, computer system or computer network, accesses or secures access to such

computer, computer system or computer network; downloads, copies or extracts any

data, computer data base or information from such computer, computer system or

medium. What is the penalty imposed?

Answer. The person shall be liable to pay damages by way of

compensation

not exceeding one crore rupees to the person affected under section 43 of

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the

Act.

What is the penalty of the person who makes any misrepresentation or suppresses any

material fact from the Controller or the Certifying Authority for obtaining any license

or Digital Signature Certificate?

Answer. According to Sec. 71, the person, as the case may be shall be

punished with imprisonment for a term which may extend to two years, or

with fine which may extend to one lakh rupees, or with both.

References:

Books:

References to Sections in this chapter are to Information Technology Act, 2000.

M.C.Kuchhal (2007) Business Law, Vikas Publishing House Pvt. Ltd. Delhi, India,

Chapter 31

S.K.Aggarwal and K.Singhal (2006) Galgotia Publications, New Delhi, India Chapter

28.

Vakul Sharma (2007) Information Technology Law and Practice law and emerging

technology cyber law and E-commerce (Universal Publishing Company, Delhi, India

(Chapter1-9)

B.K.Goyal (2005) Business Law, R.Chand & Co, New Delhi, India, Chapter 35

D. Painttal, Law of Information Technology” Taxmann Publications Pvt. Ltd, New

Delhi, India.

Websites

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