The Regulatory Framework & Contract Formation
Weightage: The Indian Regulatory Framework unit plus Units 1 to 3 of the Indian Contract Act, 1872 — roughly 16 marks. Offer, acceptance and consideration between them generate more practical problems than any other part of the paper.
The Indian Regulatory Framework
This unit was added to the Foundation syllabus under the New Scheme, and it exists to give a candidate a map before dropping them into individual statutes.
Sources of law in India
The Constitution is the supreme source. It establishes the legislature, executive and judiciary, distributes legislative power between the Union and the States through the three lists in the Seventh Schedule, and guarantees fundamental rights. Any law inconsistent with it is void to the extent of the inconsistency.
Legislation is law made by a competent legislature — Parliament for the Union List, State Legislatures for the State List, and either for the Concurrent List, with Union law prevailing in the event of conflict. Delegated or subordinate legislation is made by the executive under authority conferred by a statute, and includes the rules, regulations, notifications and circulars that do most of the practical work of Indian regulation.
Judicial precedent is law declared by the courts. Under Article 141, the law declared by the Supreme Court is binding on all courts within India. Only the reasoning necessary to the decision — the ratio decidendi — binds; observations made in passing, the obiter dicta, are persuasive only.
Customs and usages are recognised where they are ancient, certain, reasonable and not contrary to statute. Their significance in commercial law is real: trade usages fill gaps in contracts and are expressly recognised in several provisions of the Sale of Goods Act.
Kinds of law
Criminal law concerns offences against the state and is prosecuted by the state, with punishment as the outcome. Civil law concerns disputes between private parties over rights and obligations, with compensation or specific relief as the outcome. The same conduct can attract both: issuing a cheque that is dishonoured for insufficiency of funds gives the holder a civil claim on the debt and, under section 138 of the Negotiable Instruments Act, exposes the drawer to criminal liability.
Substantive law defines rights, duties and liabilities — the Contract Act and the Sale of Goods Act are substantive. Procedural law governs how those rights are enforced — the Code of Civil Procedure and the rules of evidence are procedural.
The principal regulators
A chartered accountant works within a regulatory landscape, and Foundation expects familiarity with who does what.
- Ministry of Corporate Affairs (MCA) administers the Companies Act, 2013 and the Limited Liability Partnership Act, 2008, working through the Registrar of Companies, the National Company Law Tribunal and the Serious Fraud Investigation Office.
- Reserve Bank of India (RBI) is the central bank: it conducts monetary policy, issues currency, regulates and supervises banks and non-banking financial companies, and administers foreign exchange under FEMA.
- Securities and Exchange Board of India (SEBI) regulates the securities market, protects investors, and oversees stock exchanges, listed companies, brokers and mutual funds.
- Insurance Regulatory and Development Authority of India (IRDAI) regulates insurers and intermediaries.
- Competition Commission of India (CCI) enforces the Competition Act, 2002 against anti-competitive agreements and abuse of dominant position, and reviews combinations.
- Insolvency and Bankruptcy Board of India (IBBI) regulates insolvency professionals and the processes under the Insolvency and Bankruptcy Code, 2016.
- Institute of Chartered Accountants of India (ICAI) is itself a statutory regulator, constituted under the Chartered Accountants Act, 1949, regulating the profession and its members' discipline.
The court structure
The Supreme Court stands at the apex, with the High Courts below it in each State or group of States, and District and subordinate courts below them. Alongside sit specialised tribunals — the National Company Law Tribunal and its Appellate Tribunal, the Income Tax Appellate Tribunal, the Securities Appellate Tribunal — which handle specified subject matter with appeals ultimately lying to the Supreme Court.
The Indian Contract Act, 1872: what makes an agreement
The definitional chain
The Act builds its central concept through a chain of definitions in section 2, and being able to reproduce the chain is worth marks because everything after it depends on the terms.
A proposal is made when one person signifies to another a willingness to do or abstain from doing anything, with a view to obtaining that other's assent to the act or abstinence.
When the person to whom the proposal is made signifies assent, the proposal is said to be accepted, and an accepted proposal becomes a promise.
Every promise, and every set of promises forming the consideration for each other, is an agreement. So:
Agreement = Offer + Acceptance
An agreement enforceable by law is a contract. So:
Contract = Agreement + Enforceability
The consequence to state clearly: every contract is an agreement, but not every agreement is a contract. A promise to meet a friend for dinner is an agreement; it is not a contract, because the parties never intended it to create legal obligations.
Categories of agreement
Valid — enforceable by law, satisfying all the essentials.
Void — not enforceable by law. An agreement void ab initio was never enforceable, such as an agreement with a minor. A contract that becomes void ceases to be enforceable at some later point, such as a contract rendered impossible to perform after it was made.
Voidable — enforceable at the option of one party but not the other. This is the consequence where consent was obtained by coercion, undue influence, fraud or misrepresentation: the aggrieved party may affirm or rescind.
Illegal — forbidden by law. An illegal agreement is void, but the reverse does not follow: not every void agreement is illegal. The distinction matters practically because collateral transactions to an illegal agreement are also tainted and unenforceable, whereas collateral transactions to a merely void agreement can stand.
Unenforceable — substantively valid but not enforceable because of a technical defect, such as a want of the required writing, registration or stamping. Curing the defect can make it enforceable.
Essentials of a valid contract
Section 10 provides that all agreements are contracts if made by the free consent of parties competent to contract, for a lawful consideration and with a lawful object, and are not expressly declared void. Assembled with the rest of the Act, the essentials are:
- Offer and acceptance
- Intention to create legal relations
- Lawful consideration
- Capacity of parties
- Free consent
- Lawful object
- Not expressly declared void
- Certainty of meaning
- Possibility of performance
- Legal formalities where required
Note that intention to create legal relations is not stated in section 10 but is read into the Act. It is what distinguishes a social or domestic arrangement from a commercial one, and in commercial agreements the intention is presumed unless clearly excluded.
Offer
Essentials of a valid offer
The offer must be capable of creating legal relations; it must be certain and definite in its terms; it must be communicated to the offeree; and it must be distinguished from an invitation to offer. An offer may be express or implied from conduct. It may also be made subject to conditions, but the conditions must be communicated — a condition printed where the offeree could not reasonably see it before assenting does not bind them.
An offer cannot impose a burden of refusal. An offeror cannot say "if I hear nothing from you by Friday I shall treat the goods as sold to you", because silence is not acceptance.
Types of offer
Specific — made to a definite person, and acceptable only by that person.
General — made to the world at large, as in an advertisement of a reward, and acceptable by anyone who fulfils its terms. The contract is with whoever performs the condition, and no prior communication of acceptance is required where the offer contemplates acceptance by performance.
Cross offers — two parties make identical offers to each other in ignorance of each other's offer. There is no contract, because neither is an acceptance of the other; acceptance requires knowledge of the offer.
Counter offer — a purported acceptance that varies the terms. It is not an acceptance at all but a fresh offer, and it destroys the original offer, which cannot afterwards be accepted.
Standing or open offer — an offer kept open for a period, as with a tender to supply goods as and when required. Each order placed under it is a separate acceptance forming a separate contract.
Offer distinguished from invitation to offer
An invitation to offer is a preliminary step inviting others to make proposals. Goods displayed in a shop window with prices marked, a catalogue, a price list, an advertisement for the sale of goods, a prospectus inviting subscription, and an auctioneer's request for bids are all invitations to offer. The customer, the reader, the subscriber or the bidder makes the offer, which the trader is free to accept or decline.
The reason the law takes this position is practical. If a display were an offer, a shopkeeper with one television in the window would be in breach of contract to every person who purported to accept after the first, having contracted to sell what he no longer had.
Lapse and revocation
An offer comes to an end when: notice of revocation is communicated to the offeree; the time prescribed for acceptance expires, or a reasonable time passes where none was prescribed; the offeree fails to fulfil a condition precedent; the offeree rejects it or makes a counter offer; the offeror or offeree dies or becomes insane, provided the fact comes to the other's knowledge before acceptance; or the subject matter is destroyed or the law changes so as to make the contract illegal.
Acceptance
Essentials
Acceptance must be absolute and unqualified. Any variation makes it a counter offer.
It must be communicated to the offeror, and communicated by the offeree or a person authorised by them. Acceptance communicated by an unauthorised person is ineffective.
It must be in the prescribed manner where the offer prescribes one. Where the offeree deviates, the offeror may insist on the prescribed manner within a reasonable time; failing which, the deviated acceptance binds.
It must be given within the time prescribed, or within a reasonable time.
It cannot precede the offer, and it must be made in knowledge of the offer — which is why the finder of a lost article who returns it without knowing of the announced reward cannot claim it.
Silence is not acceptance. Mental acceptance not communicated is no acceptance at all.
When communication is complete
Section 4 provides different rules for the two parties, and this asymmetry is the single most examined point in the topic.
- Communication of a proposal is complete when it comes to the knowledge of the person to whom it is made.
- Communication of an acceptance is complete as against the proposer when it is put in a course of transmission to him, so as to be out of the power of the acceptor; and as against the acceptor when it comes to the knowledge of the proposer.
- Communication of a revocation is complete as against the person who makes it when it is put into a course of transmission, so as to be out of his power; and as against the person to whom it is made when it comes to his knowledge.
The practical effect: when the acceptor posts the letter of acceptance, the proposer is bound at that instant, but the acceptor is not bound until the proposer receives it.
Revocation of offer and acceptance
Section 5 provides that a proposal may be revoked at any time before the communication of its acceptance is complete as against the proposer, but not afterwards. Since acceptance is complete against the proposer on posting, the offeror's window to revoke closes the moment the acceptance is posted, and the revocation must actually reach the offeree before then.
An acceptance may be revoked at any time before the communication of the acceptance is complete as against the acceptor, but not afterwards. Since acceptance is complete against the acceptor only when the proposer receives it, the acceptor may revoke by a faster means that overtakes the letter.
Consideration
The definition and its parts
Section 2(d) defines consideration: when, at the desire of the promisor, the promisee or any other person has done or abstained from doing, or does or abstains from doing, or promises to do or abstain from doing something, such act or abstinence or promise is called a consideration for the promise.
Unpacking it yields the essentials:
At the desire of the promisor. An act done voluntarily, or at the desire of a third party, is not consideration. A person who extinguishes a fire at his neighbour's house unasked cannot claim on a later promise to pay for it as though it were a bargain — though section 25 may separately assist.
By the promisee or any other person. This is a significant departure from English law and produces the doctrine of constructive consideration: consideration may move from a stranger to the contract. It is why a promisee can enforce a promise even though the consideration was furnished by someone else.
Past, present or executed, or future or executory. Indian law recognises past consideration — something already done at the promisor's desire can support a later promise. English law does not.
Something of value. It need not be adequate, but it must be real and lawful.
Adequacy and reality
Consideration need not be adequate. The law will not measure whether the bargain was a good one; parties are free to make bad bargains. An explanation to section 25 makes this explicit. But inadequacy may be evidence that consent was not free, and a court may take it into account for that purpose.
Consideration must be real and not illusory, physically impossible, legally impossible or vague.
Performance of an existing obligation is generally not good consideration, since the promisee gives nothing new — a promise to pay extra for doing what one was already contractually bound to do is unsupported.
Privity of contract and privity of consideration
Two distinct doctrines, frequently confused, and the confusion is the point of many exam problems.
Privity of consideration is the rule that consideration must move from the promisee. This rule does not apply in India, because section 2(d) permits consideration to move from "any other person". A stranger to the consideration may sue.
Privity of contract is the rule that only a party to a contract can sue on it. This rule does apply in India. A stranger to the contract cannot sue on it, however much the contract was intended to benefit them.
The exceptions to privity of contract, where a stranger may nonetheless enforce, are:
- A beneficiary under a trust or a charge on specific immovable property.
- A family settlement or partition made provision for a member's marriage expenses or maintenance.
- Acknowledgement or estoppel, where a party acknowledges liability to the third person and thereby constitutes himself their agent.
- A covenant running with land, binding a purchaser with notice of a covenant affecting the land.
- Provision in a marriage settlement or partition for a party's benefit.
- Agency, where a person contracts through an agent and the principal, though not named, may sue.
Agreements without consideration
Section 25 provides that an agreement made without consideration is void, and then sets out the exceptions:
- Made on account of natural love and affection between parties standing in a near relation to each other, expressed in writing and registered. All four conditions must be satisfied together.
- A promise to compensate a person who has already voluntarily done something for the promisor, or done something the promisor was legally compellable to do.
- A promise in writing and signed by the person to be charged, to pay a time-barred debt, whether wholly or in part.
Two further cases outside section 25 are usually listed with them: a completed gift, which is valid between donor and donee notwithstanding the absence of consideration; and an agency, since section 185 provides that no consideration is necessary to create an agency.
How this chapter is examined
Practical problems dominate. The recurring patterns are: a posted acceptance racing a posted revocation, testing section 4 and section 5; a display of goods or an advertisement, testing offer against invitation to offer; a reward claimed by someone who acted without knowledge of it; a counter offer followed by an attempt to accept the original terms; a promise by an uncle or a relative, testing section 25's first exception with all four of its conditions; and a third party attempting to enforce a contract made for their benefit, testing privity.
Descriptive questions ask for the essentials of a valid contract, the essentials of a valid offer or acceptance, the distinction between an offer and an invitation to offer, the classification of agreements, and the exceptions to the rule that an agreement without consideration is void. Answer them in numbered points with a sentence of explanation each, and state every exception — problems are set on the exceptions precisely because they discriminate between candidates who learned a rule and candidates who learned its limits.
