UNIT I
LESSON 1:
INTRODUCTION TO LAW AND THE
MEANING AND ESSENTIALS OF
CONTRACT
Learning Outcomes
At the end of this chapter, you will be able to know:
• The meaning of law
• The main sources of mercantile law
• The meaning of contract
• The essential elements of valid contract
Introduction
Business laws are essential for the students of management to
understand the legal rules and aspects of business. Just like any
other study even business management is incomplete without a
proper study of its laws. Any form of business needs legal
sanction. Therefore, it is imperative that a manager understands
the various ways in which businesses can be organized. This
subject introduces some of the common forms of business
organizations, including some forms unique to India like the
Joint Hindu Undivided Family firm. Different types of
organizations like Sole Ownership, Partnership, Private Limited
Company, Public Limited Company, Joint Stock Company
along with the rationale for adopting these forms are explored.
What form of business organization is the best under a
particular set of conditions? What advantage or disadvantage
does it have over other forms of business? Formalities to be
gone through and some the quasi-legal processes required for
starting a business will be discussed in detail in this subject.
For the proper working of the society, there must exist a code
of conduct. As you all know, in the ancient times the society
was not organized. The rights of the individuals were not
recognized. Gradually, the society evolved and the state came
into being. As we all know, to regulate the state, there should be
a specific code of conduct, which should be followed by
everyone. As a result of which law evolved as a system of rights
and obligations including all the rules and principles, which
regulate our relations with other persons and with the state.
These rules and regulations took the form of statutes.
To enforce the law and to resolve the conflicts arising there
from, courts of law were setup by the state.
Laws were made to govern almost every walk of life. You all
must know that criminal laws were made to control criminal
activities in the society like Indian Penal Code, which enumer-
ates which activities are considered criminal and what will be the
punishment for committing a crime. Likewise, mercantile law
was evolved to govern and regulate trade and commerce. Hence,
the term mercantile law can be defined as that branch of law,
which comprises laws concerning trade, industry and commerce.
It is an ever-growing branch of law with the changing circum-
stances of trade and commerce.
Now the question arises as to what are the sources of mercantile
law in India. The answer is
The Indian statutes on mercantile law
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English/ Foreign law
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Precedents(previous judgments of the courts.)
Customs and usage
I must tell you that most of the Indian Mercantile Law is
contained in the statutes. The prime legislation is the Indian
Contract Act 1872 but it is not exhaustive to deal with all kinds
of contracts. In addition to this there are the Sale of Goods
Act, 1930, The Indian Partnership Act 1932, The Negotiable
Instruments Act 1881 etc. wherever the Indian Contract Act is
silent, the Indian courts may apply the principles of the English
Common Law.
It is interesting to know that in England there is no English
Contract Act in the form of a statute. It has been derived from
common law, the usage of merchants and traders in different
spheres of trade, substantiated or ratified by decisions in the
court of law. The judicial precedents are an important source of
law. Sometimes, there is no provision, which can answer a
particular question of law. In such cases the court will look into
the previous decisions on similar matters to find the relevant
law.
Custom and usage of a trade play an important role in business
dealings of that trade. To have a binding force, the custom or
usage must be certain, reasonable and well known.
Now it is more than a century that that the mercantile laws are
governing trade and commerce. The law of contract is the
foundation upon which the superstructure of modern business
is built. It is common knowledge that in business transactions
quite often promises are made at one time and the performance
follows later. In such a situation if either of the parties were free
to go back on its promise without incurring any liability, there
would be endless complications and it would be impossible to
carry on trade and commerce. Hence the law of contract was
enacted which lays down the legal rules relating to promises,
their formation, their performance, and their enforceability.
Explaining the object of the law of contract Sir William Anson
observes. “The law of contract is intended to ensure that what a
man has been led to expect shall come to pass, that what has
been promised to him shall be performed”.
The law of contract is applicable not only to the business
community but also to others. Every one of us enters into a
number of contracts almost everyday, and most of the time we
do so without even realizing what we are doing from the point
of law. A person seldom realizes that when he entrusts his
scooter to the mechanic for repairs, he is entering into a contract
of bailment; or when he buys a packet of cigarettes, he is
making a contract of the sale of good; or again when he goes to
the cinema to see a movie, he is making yet another contract;
and so on.
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 Besides, the law of contract furnishes the basis for the other
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branches of mercantile law. The enactments relating to sale of
goods, negotiable instruments, insurance, partnership and
insolvency are all founded upon the general principles of
contract law. That is why the study of the law of contract
precedes the study of all other sub-division of mercantile law.
The Indian contract act was enacted from the 1st day of Septem-
ber; 1872.it is applicable to the whole of India except the state
of Jammu and Kashmir. There may be some occasions where
Indian law disagrees with the English laws. In such cases, the
Indian law will prevail.
Now we will move on to the definition and concept of the
contract.
The Indian Contract Act, 1972
The law of contract in India is contained in the Indian Contract
Act 1872. This Act is based mainly on English common law,
which is to a large extent made up of judicial precedents. (there
being a separate contract act in England). It extends to the
whole of India except the state of Jammu and Kashmir and
came into force on the first day of September 1872(Sec.1 Indian
Contract Act 1872). The act is not exhaustive. It does not deal
with all the branches of the law of contract. There are separate
acts, which deal with contracts relating to negotiable instru-
ments, transfer of property, sale of goods, partnership,
insurance, etc. Again the act does not affect any usage or custom
of trade (Sec.1).
Scheme of the Act.
The scheme of the Act may be divided into two main groups.
1. General principles of the law of contract (Secs. 1-75).
2. Specific kinds of contracts, Viz;
(a) Contracts of indemnity and Guarantee (Secs. 124-147).
(b) Contracts of Bailment and pledge (Secs. 148-181).
(c) Contracts of Agency (Secs. 182-238).
Before 1930 the Act also contained provisions relating to
contracts of sale of goods and partnership. Sections 76-123
relating to sale of goods were repealed in 1930 and a relating to
partnership were repealed in 1932 when the Indian separate Act
called the Sale of Goods Act was enacted. Similarly, sections
239-266 partnership Act was passed.
But we will not study the specific kinds of contracts for the time
being but only concentrate on contracts generally.
Before we take up the discussion of the various provisions of
the Indian contract Act. It will be proper to see some of the
basic assumptions underlying the Act.
Definition of contract
According to section 2(h) of the Indian Contract Act: “ An
agreement enforceable by law is a contract.” A contract therefore,
is an agreement the object of which is to create a legal obligation
i.e., a duty enforceable by law.
From the above definition, we find that a contract essentially
consists of two elements: (1) An agreement and (2) Legal
obligation i.e., a duty enforceable by law. We shall now examine
these elements detail.
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1. Agreement. As per section 2 (e): “ Every promise and every
set of promises, forming the consideration for each other,
is an agreement.” Thus it is clear from this definition that a
‘promise’ is an agreement. What is a ‘promise’? the answer
to this question is contained in section 2 (b) which defines
the term.” When the person to whom the proposal is
made signifies his assent thereto the proposal is said to be
accepted. A proposal, when accepted, becomes a promise.”
An agreement, therefore, comes into existence only when
one party makes a proposal or offer to the other party and
that other party signifies his assent (i.e., gives his
acceptance) thereto. In short, an agreement is the sum total
of ‘offer’ and ‘acceptance’.
On analyzing the above definition the following
characteristics of an agreement become evident:
(a) At least two persons. There must be two or more
persons to make an agreement because one person
cannot inter into an agreement with himself.
(b) Consensus-ad-idem. Both the parties to an agreement
must agree about the subject matter of the agreement
in the same sense and at the same time.
2. Legal obligation. As stated above, an agreement to become
a contract must give rise to a legal obligation i.e., a duty
enforceable by law. If an agreement is incapable of creating
a duty enforceable by law. It is not a contract. Thus an
agreement is a wider term than a contract. “ All contracts are
agreements but all agreements are not contracts,”
Agreements of moral, religious or social nature e.g., a
promise to lunch together at a friend’s house or to take a
walk together are not contracts because they are not likely to
create a duty enforceable by law for the simple reason that
the parties never intended that they should be attended by
legal consequences.
I shall give you a very simple example to explain this point.
An agreement to sell a car may be a contract but an agreement to
go for lunch may be a mere agreement not enforceable by law.
Thus all agreements are not contracts. In business agreements
the presumption is usually that the parties intend to create legal
relations. Thus an agreement to buy certain specific goods at an
agreed price e.g., 200 bags of rice at Rs.100 per bag is a contract
because it gives rise to a duty enforceable by law, and in case of
default through a court provided other essential elements of a
contract was made by free consent of the parties competent to
contract, for a lawful consideration and with a lawful object .
Thus it may be concluded that the Act restricts the use of the
word contract to only those agreements, which give, rise to legal
obligations between the parties.
It will be appropriate to point out here that the law of contract
deals only with such legal obligations which arise form
agreements, obligations which are not contractual in nature are
outside the purview of the law of contract.
Before moving further we must know the conditions which
must be satisfied for the contract to become valid.
Essential Elements of a Valid Contract
A contract has been defined in section 2(h) as “an agreement
enforceable by law.” To be enforceable by law, an agreement
must possess the essential elements of a valid contract as
contained in sections 10, 29 and 56. According to section 10, all
agreements are contracts if they are made by the free consent of
the parties, competent to contract, for a lawful consideration,
with a lawful object, are not expressly declared by the Act to be
void, and where necessary, satisfy the requirements of any law as
to writing or attention or registration. As the details of these
essentials form the subject matter of our subsequent chapters,
we propose to discuss them in brief here.
The essential elements of a valid contract are as follows.
1. Offer and acceptance. There must a ‘lawful offer’ and a
‘lawful acceptance’ of the offer, thus resulting in an
agreement. The adjective ‘lawful’ implies that the offer and
acceptance must satisfy the requirements of the contract act
in relation thereto.
2. Intention to create legal relations. There must be an
intention among the parties that the agreement should be
attached by legal consequences and create legal obligations.
Agreements of a social or domestic nature do not
contemplate legal relations, and as such they do not give
rise to a contract. An agreement to dine at a friend’s house
in not an agreement intended to create legal relations and
therefore is not a contract. Agreements between husband
and wife also lack the intention to create legal relationship
and thus do not result in contracts.
Try to work out the solution in the following cases and then go
to the answer.
Illustrations.
(a) M promises his wife N to get her a necklace if she will
sing a song. N sang the song M did not bring the
necklace for her.
(b) The defendant was a civil servant in Ceylon. He and his
wife were enjoying leave in England. When the
defendant was due to return to Ceylon, his wife could
not accompany him because of her health. The
defendant agreed to send her £ 30 a month as
maintenance expenses during the time they were thus
forced to live apart. She sued for breach of this
agreement.
Answers
(a) N cannot bring an action in a court to enforce the
agreement as it lacked the intention to create legal
relations.
(b) Her action was dismissed on the ground that no legal
relations had been contemplated and therefore there
was no contract.(Balfour vs. Balfour)
In commercial agreements an intention to create legal relations is
presumed. Thus, an agreement to buy and sell goods intends
to create legal relationship hence is a contract, provided other
requisites of a valid contract are present. But if the parties are
under a legal obligation, even a business agreement does not
amount to a contract. The case of Rose & Frank co, vs.
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Crompton & Brothers Ltd. Provides a good illustration on the
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point.
Illustration In the above case R Company entered into an
agreement with C Company. By means of which the former was
appointed as the agent of the latter. One clause of the agree-
ment was as follows. “This arrangement is not entered into as a
formal or legal agreement. And shall not be subject to legal
jurisdiction in the law courts.” It was held that there was no
intention to create legal relations on the part of parties to the
agreement and hence there was no contract.
Now let us go to the third essential of a contract i.e.
3. Lawful consideration. The third essential element of a valid
contract is the presence of ‘consideration’. Consideration
has been defined as the price paid by one party for the
promise of the other. An agreement is legally enforceable
only when each of the parties to it gives something and
gets something. The something given or obtained is the
price for the promise and is called ‘consideration’ subject to
certain exceptions; gratuitous promises are not enforceable
at law.
The ‘consideration’ may be an act (doing something) or
forbearance (not doing something) or a promise to do or not
to do something. It may be past, present or future. But only
those considerations are valid which are ‘lawful’. The consider-
ation is ‘lawful’. unless it is forbidden by law; or is of such a
nature that, if permitted it would defeat The provisions of any
law; or is fraudulent; or involves or implies injury to the person
or property of another; or is immoral; or is opposed to public
policy (sec.23).
4. Capacity of parties. The parties to an agreement must be
competent to contract. But the question that arises now is
that what parties are competent and what are not. The
contracting parties must be of the age of majority and of
sound mind and must not be disqualified by any law to
which they are subject (sec.11). If any of the parties to the
agreement suffers form minority, lunacy, idiocy,
drunkenness etc. The agreement is not enforceable at law,
except in some special cases e.g., in the case of necessaries
supplied to a minor or lunatic, the supplier of goods is
entitled to be reimbursed from their estate (sec 68).
5. Free consent. Free consent of all the parties to an
agreement is another essential element. This concept has
two aspects.(1) consent should be made and (2) it should
be free of any pressure or misunderstanding. ‘Consent’
means that the parties must have agreed upon the same
thing in the same sense (sec. 13). There is absence of ‘free
consent,’ if the agreement is induced by (i)coercion, (ii)
undue influence, (iii) fraud, (iv) mis-representation, or (v)
mistake (sec. 14). If the agreement is vitiated by any of the
first four factors, the contract would be voidable and
cannot be enforced by the party guilty of coercion, undue
influence etc. The other party (i.e., the aggrieved party) can
either reject the contract or accept it, subject to the rules laid
down in the act. If the agreement is induced by mutual
mistake which is material to the agreement, it would be
void (sec. 20)
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 6. Lawful object. For the formation of a valid contract it is 3. A invites B to see a picture with him. B accepts the offer. A
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also necessary that the parties to an agreement must agree purchase a ticket for B and waits for him outside the
for a lawful object. The object for which the agreement has cinema hall. B does not turn up has A any cause of action
been entered into must not be fraudulent or illegal or against B. [Hint: No]
immoral or opposed to public policy or must mot imply 4. A agrees with B to murder C for Rs. 10,000. Is this a valid
injury to the person or the other of the reasons mentioned contract?
above the agreement is void. Thus, when a landlord
[Hint: No]
knowingly lets a house to a prostitute to carry on
prostitution, he cannot recover the rent through a court of 5. X agrees to pay Y Rs. 1000 if Y writes 100 pages for him
law or a contract for committing a murder is a void contract in one minute. Is it a valid contract? [Hint: No]
and unenforceable by law. 6. State whether there is any valid contract in the following
7. Writing and registration. According to the Indian contract cases?
Act, a contract to be valid, must be in writing and 7. (i) X boards a DTC bus at Mayur Vihar for Shalimar
registered. For example, it requires that an agreement to pay Bagh.
a time barred debt must be in writing and an agreement to (ii) X and Y agree to go for fishing
make a gift for natural love and affection must be in
(iii) X buys an evening paper
writing and registered to make the agreement enforceable
by law which must be observed. (iv) X a minor borrows Rs. 5000 from Yand agreed to
repay back the same within a week.
8. Certainty. Section 29 of the contract Act provides that “
Agreements, the meaning of which is not certain or capable References
of being made certain, are void.” In order to give rise to a • Kapoor, N.D. (2003), “Elements of Mercantile Law,”
valid contract the terms of the agreement must not be Sultan Chand and Sons, New Delhi.
vague or uncertain. It must be possible to ascertain the • http://www.indialawinfo.com/bareacts/soga.html
meaning of the agreement, for otherwise, it cannot be
• M.C. Kucchal ( 2002), “ Business Law”, Vikas Publishing
enforced
House Pvt. Ltd, Delhi.
Illustation. A, agrees to sell B “ a hundred ton of oil” there is
• P.C. Tulsian (2002), “ Business Law”, Tata Mc. Graw Hill
nothing whatever to show what kind of oil was intended. The
Pvt. Ltd, Delhi.
agreement is void for uncertainly.
9. Possibility of performance. Yet another essential feature of
a valid contract is that it must be capable of performance. Notes:
Section 56 lays down that “An agreement to do an act
impossible in itself is void”. If the act is impossible in
itself, physically or legally, the agreement cannot be enforced
at law.
Illustration. A agrees with B, to discover treasure by magic. The
agreement is not enforceable.
10. Not expressly declared void. The agreement must not have
been expressly declared to be void under the Act. Sections
24-30 specify certain types of agreements that have been
expressly declared to be void. For example, an agreement in
restraint of marriage, an agreement in restraint of trade,
and an agreement by way of wager have been expressly
declared void under sections 26, 27 and 30 respectively.
Before dealing with the various essentials of a valid contract one
by one in detail, it will be appropriate to discuss the ‘kinds of
contracts’. First, because we shall be using the terms like
‘voidable contract’, ‘void contract’, ‘void agreement’, etc. very
often in the course of our discussion.
Here we end our discussion on essentials of a valid contract.
Now attempt the following questions for a better understand-
ing:
1. Comment that the all contracts are agreements but all
agreements are not contract.
2. What are the essential elements of a valid contract?

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