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Law and Business

Notes

Section

1
Ignorance of law excuses no man: Not that all men know the law, but because
it is an excuse every man will plead, and no man can tell how to refute him.
John Seldon
STRUCTURE
1.1

Law and Society.

1.2

Meaning of law.

1.3

Branches of law.

1.4

What is business law?

1.5

Sources of business law in India.

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1.1 Law and Society


Notes

Law pervades almost every part of human life. Without law there will be chaos and confusion in
society. No games, be it cricket, football or hockey can be played without rules to govern the
players. Traffic rules are important to regulate traffic. Knowledge of law is, therefore, necessary
for all persons who live in a society. Moreover, there is a familiar maxim ignorantia juris non
excusat (ignorance of law is no excuse).

1.2

What is Law?

The Oxford English Dictionary defines the word Law as the rule made by authority for the
proper regulation of a community or society or for correct conduct in life. The term law has been
defined by some of the legal scholars in the following words:
A law is a rule of conduct imposed and enforced by the sovereign.

Austin

Law is the body of principles recognised and applied by the state in the administration of justice.
Salmond
Law in its most general and comprehensive sense signifies a rule of action and is applied
indiscriminately to all kinds of actions whether animate or inanimate, rational or irrational.
Blackstone
Law is rule of external human actions enforced by Sovereign Political authority.
Holland
Hence law is a set of rules laying down rights and obligations, which the state enforces. It includes
rules and principles, which regulate our relations with other individuals and with the state.

1.3

Branches of Law

With the growth of civilisation, human beings social and economic behaviour has assumed many
facets. It is therefore essential that multi-dimensional human activities should be controlled through
different set of rules and principles. Almost all civilised societies, therefore, provide and enforce
different set of rules and guiding principles for different kinds of social, economical, and political
objectives. Hence, there are several branches of law, such as International Law, Constitutional
Law, Criminal Law, Civil Law, Business or Mercantile Law.

1.4

What is Business Law?

The terms Business, Commercial, and Mercantile, in relation to law, are used in the same
sense. Business Law is that branch of law, which comprises laws concerning trade, industry and
commerce. Business law refers to those rules and regulations, which govern the formation and
execution of business transactions made by various persons in the society. These provisions comprise
the legal environment of business. Business law is intended to infuse the much needed certainty
in commercial dealings. Business law includes laws relating to contract, sale of goods, negotiable
instruments, partnership, company and many other economic laws having a bearing on trade,
industry, and commerce.

1.5

Sources of Business Law in India

The main sources of business law in India are shown in the table and briefly discussed thereafter:

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Sources of Business Law in India


Notes

English Law

Judicial Decisions
or Case Law

English Common
Law

Equity

Customs and
Usages

Law Merchant or
Maritime Usage

Indian Statutes

Statutes Law

1.5.1 English Law


Indian business law is modelled on the lines of English mercantile law, as India was under British
rule before its independence. The differences in the laws of India and England are primarily on
account of their different business environment, customs, and trade practices. The sources of
business law in India are generally the English laws which, in turn, have their roots in the following:
a)

English Common Law: It refers to a system of law based upon English customs, usages,
and traditions, which were developed over centuries by the English Courts. These are
unwritten or the non-statutory laws. These are found in the reported decisions of the courts
of law.

b)

Equity: It refers to that branch of the English Law, which was developed separately from
the common law. It is based on the principle of fairness, and concepts of justice developed
by the judges whose decisions became precedents.

c)

Law Merchant or Maritime Usage: It refers to the usages or customs of merchants and
traders that have been ratified by the courts of law. The object is to protect the interest of
trade. The courts in these cases assume that the parties have dealt with each other on the
footing of customs or usages prevailing generally. This law, thus, gets incorporated into the
common law and the courts honour it.

d)

Statute Law: The statute law refers to the law laid down in the Acts of Parliament. It is
superior to and overrides any rules of the common law, equity or law merchant. The courts
of law interpret the meaning of such enactments and apply them.

1.5.2 Judicial Decisions or Case Law


The judicial decisions, usually referred to as precedents, are binding on all courts having jurisdiction
lower to that of the court, which gave the judgement. This is also called judge made law.

1.5.3 Customs and Usages


Customs or usages of a particular trade also guide the courts in deciding disputes arising out of
mercantile transactions. Such a custom or usage must be widely known, certain and reasonable,
and must not be opposed to any legislative enactment. But, where a statute specifically provides
that the rules of law contained therein are subject to any well-recognised custom or usages of
trade, the latter may override the statute law.

Check Your Progress


1. Define Law
2. What is Business Law?
3. What are the different
Branches of Law?
4. From where does the
Indian Business Law is
derived from?

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1.5.4 Indian Statutes


Notes

The constitution of India confers power to enact law on its parliament and legislatures of states.
When a bill is passed by the parliament/state legislatures and assented to by the President or
Governor of a state, it becomes an Act or Statute. The bulk of Indian Mercantile Law is statute
law. The Indian Contract Act, 1872, The Negotiable Instruments Act, 1881, The Sale of Goods
Act, 1930, The Indian Partnership Act, 1932, The Companies Act, 1956 are instances of the statute
law.

1.5.5 Business Law and Managers


Knowledge of relevant aspects of law is necessary for proper functioning of any business. Managers
may face a variety of situations that would involve legal issues. A broad understanding of business
law or legal aspects of business is necessary for managers. Knowledge of business law enables
them to arrive at correct decisions, and this is one of the essential functions of managers. Thus, law
is a major factor in decision making. Therefore, it is necessary that all managers have a working
knowledge of the important business laws and the legal system.

Summary
Law permeates every part of human activity. No civilised society can exist without a legal order.
Ignorance of law is no excuse for any human being. Law is a rule of conduct imposed and enforced
by authority. There are various branches of law like International Law, Constitutional Law, Criminal
Law, Civil Law, Business Law or Mercantile Law. The terms Business, Commercial or Mercantile
Law are used in the same sense. Business law refers to rules and regulations concerning Trade,
Industry, and Commerce. The main sources of business law in India are English law, Judicial
decisions (or Case law), Customs and Usages, and Indian statutes. Knowledge ofbusiness law is
necessary so that various managerial decisions, which managers are required to take in their dayto-day activities, are within the boundaries of law.

Review Questions
True or False
State with reasons whether the following statements are True or False:

Check Your Progress


5.

6.

What do you
understand by statute
law?
How law and business
are related?

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1.

Law is the body of Principles enforced by Judiciary.

2.

Business Law in India is primarily an adaptation of the English Law.

3.

Business Law is applicable to businessmen only.

4.

Business Law is one of the branches of law.

5.

Business Law relates to trade only.

6.

Customs and Usages are an important source of Business Law.

7.

Statutes are the only source of Business Law.

8.

There is no difference between a Bill and an Act.

9.

Managers can function effectively without any knowledge of law.

10.

Managers can come to proper decisions when they have working knowledge of law.

Test Questions
1.

What is Law? What is teh need for the knowledge of law?

2.

Elaborate different sources of law.

3.

What is the scope of Business or Mercantile law?

4.

What does the term Business Law include?

5.

How does English Law affect Business Law in India?

Notes

Short Questions
1.

Law and business are closely related disciplines. Comment.

2.

Ignorance of law is no excuse. Give your views on this statement.

3.

Discuss the different sources of business law in India.

4.

Define Law. What is the need for managers to know about Law?

5.

What is Business Law? How it is relevant for managers?

Answers to True or False


1. True, 2. True, 3. False, 4. True, 5. False, 6. True, 7. False, 8. False, 9. False, 10. True

Answers to Check Your Progress


Following are the answers to Check Your Progress, indicating respective paragraphs for reference.
1) 1.2

2) 1.4

3) 1.3

4) 1.5

5) 1.5.4

6) 1.5.5

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Notes

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Law of Contract

Notes

Section

2
No cause of action arises from a bare promise.
Legal Maxim
STRUCTURE
2.1

Introduction to the law of contract.

2.2

Basis and extent of the law of contract.

2.3

Meaning of a contract.

2.4

What is an agreement?

2.5

What is enforceability of an agreement?

2.6

Essential elements of a valid contract.

2.7

Classification of contracts.

2.8

Proposal (offer) and Acceptance.

2.9

Communication of proposal, acceptance and revocation.

2.10 Consideration.
2.11 Capacity of parties.
2.12 Free consent.
2.13 Legality of object and consideration.
2.14 Void agreement.
2.15 Contingent contract.
2.16 Quasi contract.
2.17 Performance of contract.
2.18 Discharge of contract.
2.19 Remedies for breach of contract.
2.20 Indemnity and guarantee.
2.21 Bailment and Pledge.
2.22 Agency
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2.1 Introduction
Notes

The law of contracts is the basis upon which the super structure of all business is built. It affects
every person in one way or the other, as all of us enter into some kind of contract every day. All
contracts are based on agreements, which are either express or implied. Everyone of us enters into
a number of contracts almost everyday. Most of the time we do so without realising what we are
doing from the view point of law. A person seldom realises that when he gives clothes for drycleaning,
or when he buys milk, bread or biscuits, or when he goes to the auditorium to see a movie, he is
entering into a contract. In business transactions, normally, first promises are made followed by
performance. If parties were free to go back on their promises without incurring any liability, it
would be impossible to carry on any trade, industry or commerce. Hence, the law of contract was
made laying down rules for performance and discharge of a contract, and the remedies available to
the aggrieved party in case of breach of contract. Explaining the object of law of contract, Sir
William Anson observes that The law of contract determines the circumstances in which promises
made by the parties to a contract shall be legally binding on them. It is intended to ensure that what
a man has been led to expect shall come to pass, and that what has been promised to him shall be
performed. Besides, the law of contract furnishes the basis of the other branches of Business
Law. The enactments relating to sale of goods, negotiable instruments, monopolies, restrictive
trade practices, and intellectual property 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 laws relating to
trade and industry.

2.2

Basis and Extent of The Law of Contract

In India, the law of contract is contained in the Indian Contract Act, 1872, hereinafter referred to
as the Act. It extends to whole of India except the State of J&K and came into force on the first
day of September, 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 instruments, transfer of property, sale of goods, partnership, insurance, etc.

2.3 Meaning of Contract


The word contract is derived from the Latin Contractum meaning drawing together. According to the Act, An Agreement enforceable by law is a contract1. Some authors have defined
contract in the following words:
Every agreement and promise enforceable at law is a contract.
An agreement creating and defining obligations between the parties.

Sir Frederick Pollock


Salmond

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.
Sir William Anson
An analysis of these definitions would show that a contract must have the following two elements:
(a)

An agreement, and

(b)

Its enforceability (legal obligation)

In the form of an equation, it can be shown as under:


Contract = An agreement + its enforceability
Now the question arises, what is an agreement? and what is enforceability of an agreement?

2.4 What is an Agreement?


According to the Act, Every promise and every set of promises forming the consideration for
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each other, is an agreement.2


Now the question is, What is a Promise? According to the Act, A proposal when accepted becomes a promise3.

Notes

Example - Ram offers to sell his car to Shyam for Rs. 2,00,000/-. Shyam accepts the offer. This
offer after acceptance becomes promise and this promise is treated as an agreement between Ram
and Shyam.

Check Your Progress

Thus an agreement consists of a proposal (offer) by one party and its acceptance by the other. In
the form of an equation it can be shown as under:

1.

Why the law of


contract precedes the
study of any branch of
law?

2.

Is the ICA, 1872


enforceable throughout
India?

3.

Define a Contract.

Agreement = Proposal (or Offer) + Acceptance of Proposal (or Offer)


An analysis of the definition of the term agreement shows the following two characteristics of
agreement:
(a)

Plurality of Person: There must be two or more persons to make an agreement.

(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.

2.5 What is an Enforceability of Agreement?


An agreement is enforceable by law if it creates some Legal Obligation. In other words, the
parties to an agreement must be bound to perform their promises. In case of social or domestic
agreements, the usual presumption is that the parties do not intend to create legal relations.

Example - Madhur invites his friend Vidur to a dinner and Vidur accepts the invitation. If Vidur
fails to turn up for dinner, Madhur cannot go to the Court to claim his loss.
In commercial or business agreements the usual presumption is that the parties intend to create
legal relations. Example - Vikreta offers to sell his car to Kreta for Rs. 1 lakh. Kreta accepts the
offer. Such an agreement is a contract because it creates legal obligation, i.e. a duty enforceable by
law. From this, it will be clear that all contracts are agreements, but all agreements are not contract.
Salmond has rightly observed The Law of Contracts is not the whole law of agreements, nor is it
the whole law of obligations. It is the law of those agreements which create obligations and those
obligations which have their source in agreements.

2.6 Essential Elements of A Valid Contract


We have seen that a contract is an agreement enforceable by law. To be enforceable by law, an
agreement must possess the essential elements of a valid contract. The Act (sections 10, 29 and 56)
provides that 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
to be void, and where necessary, satisfy the requirements of any law as to writing or registration.
The essential elements of a valid contract are the following:
a)

Proposal (offer) and Acceptance

b) Intention to Create Legal Relations


c)

Lawful Considerations

d) Capacity of Parties
e)

Free Consent

f)

Lawful Object

g) Writing and Registration


h) Certainty
i)

Possibility of Performance

j)

Agreement not expressly declared void


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2.6.1 Proposal and Acceptance


Notes

There must be a lawful proposal and a lawful acceptance of that proposal, thus resulting in an
agreement. The word lawful before offer and acceptance signifies that proposal and acceptance
must satisfy the requirements of the law of contract. There must be two parties to an agreement, i.e.
one party making the proposal and the other party accepting it. The terms of the proposal must be
definite and the acceptance of the proposal must be absolute and unconditional. The acceptance
must also be according to the mode prescribed and must be communicated to the proposer.

2.6.2 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 or legal relationship. If there is no such intention on the
part of the parties, there is no contract between them. Agreements of a social or domestic nature do
not contemplate legal relationship. As such they are not contracts.

Illustration:
A husband promised to pay his wife a household allowance of $30 every month. Later the parties
separated and the husband failed to pay the amount. The wife sued for the allowance. Held,
agreements such as these were outside the realm of contract altogether.4
In commercial and business agreements, an intention to create legal relations is presumed. But this
presumption is rebuttable, which means that it must be shown that the parties did not intend to be
legally bound.

Illustration:
There was an agreement between R Company and C Company by means of which the former was
appointed as the agent of the latter. One clause in the agreement was: This agreement is not entered
into... as a formal or legal agreement, and shall not be subject to legal jurisdiction in the law courts.
Held, there was no binding contract as there was no intention to create legal relationship.5

2.6.3 Lawful Consideration


An agreement must be supported by lawful considertion. Consideration means an advantage or
benefit moving from one party to the other. It is the essence of a bargain. In simple words, it means
something in return. The agreement is legally enforceable only when both the parties give something
and get something in return. A promise to do something, getting nothing in return, is usually not
enforceable by law. Consideration need not necessarily be in cash or kind. It may be an act or
abstinence (abstaining from doing something) or promise to do or not to do something. It may be
past, present or future. But it must be real and lawful {Secs. 2(d), 23 and 25}. Consideration must
be lawful, i.e. not forbidden by law. (This has been elaborated in paragraph 2.10)

2.6.4 Capacity of Parties


The parties to an agreement must be competent to contract, otherwise it cannot be enforced by a
court of law. In order to be competent to contract the parties must be of the age of majority and of
sound mind and must not be disqualified from contracting by any law to which they are subject.6
This has been discussed in paragraph 2.11.

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2.6.5 Free Consent


It is essential to the creation of every contract that there must be a free and genuine consent of the
parties to the agreement. The consent of the parties is said to be free when they are of the same
mind on all the material terms of the contract. The parties are said to be of the same mind when they
agree about the subject-matter of the contract in the same sense and at the same time.7 Consent is
said to be free when it is not caused by (i) Coercion, (ii) Undue influence, (iii) Fraud, (iv)
Misrepresentation, or (v) Mistake.8 (See paragraph 2.12).

Notes

Check Your Progress


4.

What are the essential


elements of a valid
contract?

5.

What do you
understand by
Possibility of
Performance?

6.

Are orally made


contracts enforceable
by law?

7.

When the consent is


said to be free?

2.6.6 Lawful Object


The object of an agreement must be lawful. The object is considered lawful unless it is forbidden
by 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.9 Thus, when a landlord knowingly lets a house to a prostitute
to carry on prostitution, he cannot recover the rent through a court of law. (See paragraph 2.13).

2.6.7 Writing and Registration


A contract may be oral or in writing. As regards the legal effects, there is no difference between a
contract in writing and a contract made by word of mouth. It is, however, in the interest of the
parties that the contract should be in writing. There are some other formalities also which have to
be complied with in order to make an agreement legally enforceable. In some cases, the document
in which the contract is incorporated is to be stamped. In some other cases, a contract, besides
being a written one, has to be registered. Thus where there is a statutory requirement that a contract
should be made in writing or in the presence of witnesses or registered, the required
statutory formalities must be complied with.10 Example, the law requires that an agreement to pay
time barred debts, or arbitration agreement must be in writing. Similarly, the law makes it compulsory
for all agreements relating to transfer of immovable property to be registered.

2.6.8 Certainty
In order to give rise to a valid contract the terms of the agreement must not be vague or uncertain.
If it is vague and it is not possible to ascertain its meaning, it cannot be enforced. Example - Amar
agrees to sell Bharat hundred tons of oil. This agreement is void on the ground of uncertainty
because it is not clear what kind of oil is intended to be sold.

2.6.9 Possibility of Performance


An agreement to do an impossible act is void (Sec. 56). Example - X agrees with Y to enclose some
areas between two parallel lines and Y agrees to pay Rs. 1000/- to X. This agreement is void
because it is an agreement to do an impossible act.

2.6.10 Agreement not Expressly Declared Void


The agreement must not have been expressly declared to be void, under the Act11. Example Agreement in restraint of marriage, agreement in restraint of trade, agreement in restraint of legal
proceedings and agreement by way of wager have been expressly declared void. (See paragraph
2.14)

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2.7
Notes

Classification of Contracts

Contacts may be classified as follows:

2.7.1 On the Basis of Enforceability


a)

Valid Contracts: Contracts which satisfy all the essential elements of a valid contract,12 are
enforceable in a court of law.

b)

Void Contract: A contract which ceases to be enforceable by law becomes void when it
ceases to be enforceable.13 A void contract is a nullity from its inception. No rights accrue
thereunder.

c)

Voidable Contract: An agreement which is enforceable by law at the option of one or more
of the parties thereto, but not at the option of the other or others, is a voidable contract.14 A
contract is voidable when one of the parties to the contract has not exercised his free consent.
One of the essential elements of a formation of a contract is free consent. All voidable
contracts are those which are induced by coercion, undue influence, fraud or
misrepresentation.

d)

Illegal Contracts: It is contrary to law and hence void ab initio.

e)

Unenforceable Contracts: An unenforceable contract is a valid contract in law, but due to


the fact that it is incapable of proof, or because of some technical defect therefore it cannot
be enforced in a Court of Law.

2.7.2 On the Basis of Mode of Creation


a)

Express Contract: When the terms of a contract are reduced in writing or are agreed upon
by spoken words at the time of its formation, the contract is express.

b)

Implied Contract: The terms of a contract are inferred from the conduct or dealings between
the parties. When the proposal or acceptance of any promise is made otherwise than in
words, the promise is said to be implied. Such an implied promise leads to an implied
contract. Example - A boards a bus. It is implied from his conduct that A has entered into an
implied promise to purchase a ticket.

c)

Quasi Contract: Constructive or Quasi contracts arise out of obligations enjoyed by one
person from the voluntary acts of the other which are intended to be performed only on the
happening of some future uncertain event.(See paragraph 2.16)

2.7.3 On the Basis of the Extent of Execution

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a)

Executed Contract: Where both the parties have performed their obligations, it is an
executed contract. Even when one party to the contract has performed his share of the
obligation, the contract is executed, though the other party is still under an outstanding
obligation to perform his part of the promise.

b)

Executory Contract: Where neither party to the contract has performed his share of the
obligation, i.e. both the parties have yet to perform their promises, the contract is executory.

c)

Contingent Contract: A contingent contract is one in which a promise is conditional and


the contract shall be performed only on the happening of some future uncertain event. (See
paragraph 2.15)

2.8

Proposal (Offer) and Acceptance


Notes

2.8.1 Meaning of Proposal


Proposal of the Act is synonymous with the term offer of the English Law. The words proposal
and offer are used inter-changeably.
When one person signifies to another his willingness to do or to abstain from doing anything, with
a view to obtaining the assent of that other to such act or abstinence, he is said to make a proposal.15
The first step towards creating a contract is that one person shall signify or make a proposal to the
other, with a view to obtaining the assent or acceptance of that another to that act or abstinence. A
proposal is then said to be made.
In order to constitute a contract, a person should offer to do something. This offer must be sufficiently
communicated to the person for whom he intends to do something with a view to obtaining his
assent to it. The person who makes such an offer or proposal is called the Offerer or Proposer,
the person to whom the proposal or offer is made is called the Proposee or Offeree and the
person accepting it is called the Promisee or Acceptor.

2.8.2 Essentials of a Proposal


The definition of the word proposal given in the Act reveals the following three essentials of a
proposal.
a)

The expression of willingness to do or to abstain from doing something.

b)

This expression must be to another person.

c)

This must be made with a view to obtaining the assent of the other person.

2.8.3 Legal Rules Regarding a Valid Proposal


A valid proposal must be in conformity with the following rules:
a)

Express or Implied: A proposal may be made either by words or by conduct. A


proposal which is expressed by spoken or written words, is an express proposal
and the one which is inferred from the conduct of a person or the circumstances of the case
is called an Implied Proposal.

Illustration:
i.

A says to B that he will sell hs car to him for Rs. 80,000. This is an express
proposal.

ii. The Delhi Transport Corporation (D.T.C) runs Omni buses on different routes
to carry passengers at the scheduled fares. This is an implied proposal by the DTC.
b)

Terms Certain & Not Loose or Vague: If the terms of a proposal are vague or
indefinite, its acceptance cannot create any contractual relationship.

Illustration:
i.

X says to Y I will sell you a car. X owns three different cars. The proposal is
not definite.

ii. T offered to take a house on lease for three years at $ 285 per annum if the
house was put into thorough repair and drawing rooms handsomely decorated
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according to the present style. Held, the proposal was too vague to result in
a contractual relation.16

Notes
c)

To give Rise to Legal Consequences and be Capable of Creating Legal Relations: A proposal
will not become a promise even after it has been accepted unless it was made with a view to
create legal relations, e.g. invitation to a dinner which has no intention to create legal
relationship.

d)

An Invitation to Proposal is not a Proposal: Display of goods by a shopkeeper in his


window, with prices marked on them, is not an offer but merely an invitation to the public
to make a proposal to buy the goods at the market price. Likewise, quotations, catalogues,
advertisements in a newspaper for sale of an article, or circulars sent to potential customers
do not constitute a proposal. They are instead an invitation to the public to make a proposal.
Similarly, a declaration by a person that he intends to do something gives no right of action
to another.

e)

May be Specific or General: A proposal is specific when it is made to a definite person


or persons. Such a proposal can be accepted only by the person or persons to whom it is
made. On the other hand, proposal is general when it is made to the world at large or
public in general and may be accepted by any person who fulfills the requisite conditions.

Illustration:
The leading case on the subject of general offer is that of Carlill vs. Carbolic Smoke Ball Co. In
the above case, the Carbolic Smoke Ball Co. issued an advertisement in which the Company offered
to pay 100 to any person who contracts influenza, after having used their Smoke Balls three times
daily for two weeks, according to the printed directions. Mrs. Carlill, on the faith of the advertisment,
bought and used the Balls according to the directions but she, nevertheless, subsequently suffered
from influenza. She sued the company for the promised reward. The company was held liable.17
f)

Communicated to the Proposee: A proposal is effective only when it is


communicated to the proposee. As Lord Lindlay puts it, A state of mind not
communicated cannot be regarded as dealings between man and man. This is
applicable to both specific as well as general offers.

Illustration:
The defendants nephew absconded from home. He sent his servant, the plaintiff, in search of the
boy. After the servant had left, the defendant announced a reward of Rs. 501 to anybody giving
information relating to the boy. The servant, before seeing the announcement, had traced the boy
and informed the defendant. Later, on reading the notice of reward, the servant claimed it. His suit
was dismissed on the ground that he could not accept the offer, unless he had knowledge of it.18

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g)

Should not Contain a Term the Non-compliance of Which Would Amount to


Acceptance: A proposer cannot say that if acceptance is not communicated up to
a certain date, the proposal would be presumed to have been accepted. If the
proposee does not reply, there is no contract, because no obligation to reply can
be imposed on him, on the grounds of justice.

h)

Can be Made Subject to Any Terms and Conditions: A proposer may attach any
terms and conditions to the proposal he makes. He may even prescribe the mode
of acceptance. The proposee will have to accept all the terms and conditions of
the proposal.

i)

Two Identical Cross-offers do not Make a Contract: When two parties make identical
offers to each other, in ignorance of each others offers, the offers are crossoffers. They do not constitute acceptance of ones offer by the other and as such
there is no completed agreement.

2.8.4 Lapse and Revocation of Proposal


A proposal lapses and becomes invalid in the following circumstances:
a)

An offer lapses after stipulated or reasonable time.19

b)

A proposal lapses by not being accepted in the mode prescribed, or if no mode is prescribed,
in some usual and reasonable manner.20

c)

A proposal lapses by rejection by the proposee.

d)

A proposal lapses by the death or insanity of the proposer or the proposee before acceptance.

e)

A proposal lapses by recovation by the proposer before acceptance.21

f)

Revocation by non-fulfillment of a condition precedent to acceptance.22

g)

A proposal lapses by subsequent illegality or destruction of subject matter.

Notes

2.8.5 Acceptance
A contract as already observed, emerges from the acceptance of an offer. Acceptance is defined
when the person to whom a proposal is made signifies his assent thereto the proposal is said to be
accepted. A proposal when accepted becomes a promise.23 The person making the proposal is
called the Promisor, and the person accepting the proposal is called the Promisee.24 Performance of
the conditions of a proposal, the acceptance of any consideration for reciprocal promise which may
be offered with a proposal is an acceptance of the proposal (Sec. 8). An acceptance need not
always be expressed in words. Performance of the conditions of a proposal is an acceptance of the
proposal. In order that there must be a binding contract, there must be absolute and unconditional
acceptance of the terms of a proposal.

Illustration:
A offers to sell his house for Rs. 2,50,000 to B. B accepts the offer to purchase the house for Rs.
2,50,000. This is acceptance.

2.8.6 Essentials of a Valid Accptance


Sections 7 and 8 of the Act lays down following rules to convert a proposal into a promise:
a)

Acceptance Must be Absolute and Unqualified: Acceptance of a proposal with conditions,


variations and reservations is no acceptance at all. Acceptance with variations is a counterproposal and there is no contract until this counter proposal is accepted by the original
proposer. To constitute a valid acceptance, it should be unqualified. This means that the
parties to the contract must be consenses-ad-idem that is, consenting on the same thing in
the same sense. Conditions imposed by the offerer that the proposal shall be accepted only
on payment of deposit or earnest money or on executing a certain document will lapse the
proposal, if such a condition is not accepted by the offeree.

b)

Acceptance Must be Expressed in Some Usual and Reasonable Manner - Mode of Accept
ance: Acceptance may be made either by words or by conduct. It may also be expressed by
post or by telegram. If the proposer prescribes the manner in which the proposal is to be
accepted and the acceptance is not made in such manner, the proposer may, within a rea
sonable time after the acceptance is communicted to him, insist that his proposal shall be
accepted in the prescribed manner, and not otherwise; but if he fails to do so; he accepts the
acceptance. Usual and reasonable manner would mean the parties intended to perform the
contract in the ordinary course of trade or business. The proposer has the right to prescribe
the manner in which the proposal can be accepted but not the manner in which it may be
refused.

Check Your Progress


8. What are the essential
elements of a proposal?
9. Discuss the significance
of communication in
proposal.

Self-Learning Material 17

c)
Notes

Mental Acceptance is not Sufficient in Law: Silence cannot amount to acceptance. Mere
uncommunicated or mental acceptance is not enough. Acceptance to be complete must be
communicated by words or conduct by an offeree to the proposer. There must be some
external manifestation (overt act) of that intent by speech, writing or other act.

Illustration:
A tells B that he intends to buy Cs office, but does not tell anything to C of his intention. This is no
contract.
d)

Acceptance Must be Communicated to the Proposer: It should be signified and


communicated to the proposer himself. If the acceptance is not communicated to
the proposer, no contract is created. Intentions must be communicated. A draft
agreement relating to the supply of coal was sent to the manager of a Railway
Company for his acceptance. The Manager wrote the words approved on the
agreement but by oversight, the document remained in the drawer. It was held
that there was no contract. Acceptance and intimation of acceptance are both
necessary to result in a binding contract. In the case of proposal and acceptance
by telephone conversation, contract is made at a place where acceptance is
received.

e)

Acceptance Must be Given Within Reasonable Time and Before the Proposal Lapses and/
or is Revoked: To be legally effective acceptance must be given within the specified time
limit, if any, and if no time is stipulated, acceptance must be given within a reasonable time.
Again, the acceptance must be given before the proposal is revoked or lapses by reason of
proposees knowledge of death or insanity of the proposer.

f)

Acceptance of the Proposal: Acceptance of the proposal is the acceptance of all the terms
even though the proposee is ignorant of some of the terms of the proposal, except where the
terms are not apparent on the face and no resonable cautionis taken to draw attention of the
acceptor, e.g. a ticket issued by the Railways with the terms and conditions printed over
leaf. Even if the proposee does not read the terms and conditions, it will be assumed that the
proposee has accepted the terms and conditions of travel, provided the terms and condi
tions are legible and if reasonable notice thereof is given.

Illustration:
A who travels by a ship sustains injury on account of the negligence of the crew. The Shipping
Company raised a plea that the terms and conditions were printed overleaf and the liability of the
company was limited in various ways. However, the clause limiting the liability of the Shipping
Company was obscured by the words stamped across in red ink. The company did not take reasonable
care to make the conditions legible and therefore, A was entitled to recover damages. If the terms
and conditions had not been so obliterated, then the company would not have been held liable.

18 Self-Learning Material

g)

Acceptance of the Proposal Need not Always be Expressed in Words: Performance


of the conditions of a proposal is an acceptance of the proposal. 25 Where the
insurance company accepts the cheque as per the terms of the proposal towards
the premium, encashment of cheque is a sufficient acceptance of the proposal.26

h)

Acceptance Must be by a Certain Person: A proposal may be made to an


unascertained number or to the world at large but no contract can arise until it
has been accepted by a certain person who first gives information either by words
or by conduct. Such an offer is called a general offer. The general offer is closed
as soon as it is accepted by a definite person.

Illustration:
A gives an advertisement in the newspaper offering Rs. 10,000 to one who gives information of his
lost son. B gives the information. B is entiled to the reward of Rs. 10,000.
i)

Notes

If the Act is done in Ignorance of the Proposal, it is no Acceptance of the Proposal: Act
done in ignorance of the proposal is no acceptance, because to anuncommunicated
offer, there can be no consent or assent.

Illustration:
A advertises a reward of Rs. 10,000 to anyone who gives information of his lost son: B gives the
information but is ignorant of the reward. After some time, he claims the reward. It was held that B
is not entitled to the reward as he gave the information without being aware of the offer.

2.9 Communication of Proposal, Acceptance and Revocation


The communication of proposal and acceptance must complete so as to bind the concerned parties
because as soon as the communication is complete the parties loose the right of withdrawal or
revocation. The legal provisions relating to the communication of proposal, acceptance and
revocation are as under:
a)

Communication of an Proposal: The communication of proposal is complete when it


comes to the knowledge of the person to whom it is made, i.e. when the letter containing
the proposal reaches the proposee.

b)

Communication of an Acceptance: The communication of acceptance is complete at dif


ferent times for the proposer and acceptor. The communication of acceptance is
complete:
i.

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, i.e. when the letter of acceptance is duly
posted.

ii. as against the acceptor, when it comes to the knowledge of the proposer i.e.
when the letter of acceptance is received by the proposer.
c)

Communication of a Revocation: The term revocation means taking back or


withdrawal. The communication of revocation is complete:
i.

as against the person who makes it, when it is put into a course of transmission
to the person to whom it is made, so as to be out of the power of the person
revoking, i.e. when the letter of revocation is posted, and

ii. as against the person to whom it is made, when it comes to his knowledge, i.e.
when the letter of revocation is received by him.
d)

Time During Which an Offer or Acceptance can be Revoked: A proposal may be


revoked at any time before the communication of its acceptance is complete as
against the proposer, but not afterwards. An acceptance may be revoked at any
time before the communication of the acceptance is complete as against the
acceptor but not afterwards.

2.10 Consideration
2.10.1 Meaning of Consideration
Consideration is one of the essential elements of a valid contract. When a person promises to do
Self-Learning Material 19

Notes

something, he must get something in return. If he does not get something in return, the contract
is, generally, not valid. This something is known as consideration. In other words, consideration
is the price for which the promise of the other party is bought. The Act defines consideration as
when at the desire of the promisor, the promisee or any other person has done or abstained from
doing, or does or abstains from doing, or promises to do or to abstain from doing, something, such
act or abstinence or promise is called a consideration for the promise.27

llustration:
A agrees to sell his house to B for Rs. 5,00,000. Here As promise to sell his house is for Bs
consideration to pay Rs. 5,00,000. Similarly, Bs promise to pay Rs. 5,00,000 is for As consideration
to sell his house to B.
Thus the essential condition for the enforceability of the contract is consideration. The rule is
expressed by the Latin maxim ex nudo-pacto non-oritur actio, i.e. out of a bare promise no
cause of action can arise. Therefore, a gratuitous promise, such as a promise to make a gift or
charity for no return is not supported by consideration. Hence it is unenforceable by the promisee.
The basis of consideration is that of reciprocity. A promisee would be able to enforce the promise
only if he has given or promised to give or unless the promisor has obtained or has been promised
something in exchange of it. The word consideration implies something in return for the promise
or the price of promise or quid pro quo. According to Sir Frederick Pollock, an act or forbearance
of one party of the promise thereof, is the price for which the promise of the other is bought and the
promise thus given for value is enforceable. Blackstone defines consideration as the recompense
given by the party contracting to the other.

2.10.2 Essentials of a Valid Consideration


The essentials of consideration are as follows:
a)

Consideration Must Move at the Desire of the Promisor: The act or abstinence forming the
Consideration must be done at the desire or request of the promisor. If it is done at the
instance of the third party or without the desire of the promisor it is not consideration.
Example - Amar sees Bhushans house on fire and helps in extinguishing it. Amar cannot
demand payment for his services because Bhushan never asked him to come for help.

b)

Consideration May Move from the Promisee or any other Person: The consideration need
not move from the promisee alone but may proceed from any third person. Thus, as long as
there is a consideration for a promise, it is immaterial who has furnished it. This means that
even a stranger to the consideration can sue on a contract, provided he is a party to the
contract. This is also called as Doctrine of Constructive Consideration. For example - X
by a deed of gift transferred certain property to her daughter Y with a direction that Y
should pay Z an annuity. Y executed a deed in writing in favour of Z and agreed thereby to
pay the annuity. Later Y refused to pay annuity on the plea that no consideration had
moved from Z. It was held that Z was entitled to maintain suit because a consideration
need not necessarily move from the promisee, it may move from any other person (i.e. X in
the present case).28

c)

Consideration may be past, present or future.

d)

Consideration Must be Something of Value (The consideration need not be adequate to


the promise but it must be of some value in the eye of the law).

e)

Consideration must be legal.

f)

Consideration may be doing something, or abstaining from doing something (positive


or negative act) or a promise to do something.

Check Your Progress


10. How can a proposal be
revoked?
11. Are there any exceptions to the rule
- No Consideration No
Contract?
12. When the consideration
is said to be valid?

20 Self-Learning Material

2.10.3 No Consideration No Contract


The general rule is that an agreement made without consideration is void. But there are a few
exceptions to this rule. These exceptions are as follows:
a)

Notes

Agreement Made on Account of Natural Love and Affection: An agreement made


without consideration is enforceable if, it is
i.

Made on account of natural love and affection.

ii. Between parties standing in a near relation to each other.


iii. Expressed in writing.
iv. Registered as per law.
b)

Agreement to Compensate for past Voluntary Service: Example - A finds Bs purse and
gives it to B. B promises to give A Rs. 100/-. This is a Contract.

c)

Agreement to Pay a Time Barred Debt: Where there is an agreement, made in writing
and signed by the debtor or his authorised agent, to pay wholly or in part a debt barred
by the law of limitation, the agreement is valid even though it is not supported by any
consideration.

d)

Completed Gift: A completed gift does not require consideration in order to be valid.

e)

Contract of Agency: No consideration is necessary to create an agency.29

f)

Remission by the Promisee, of Performance of the Promise: For compromising a due


debt, i.e. agreeing to accept less than what is due, no consideration is necessary.30

g)

Contribution to Charity: A promise to contribute to charity, though gratuitous, would be


enforceable, if on the faith of the promised subscription, the promisee takes definite
steps in furtherance of the object and undertakes a liability, to the extent of liability
incurred, not exceeding the promised amount of subscription.

2.11 Capacity of Parties


2.11.1 Who is Competent to Contract?
According to the Act31 every person is competent to contract, who:
a)

is of the age of majority, according to the law to which he is subject,

b)

is of sound mind, and

c)

is not disqualified from contracting by any law to which he is subject.

2.11.2 Who is a Minor?


As per the Indian law,32 a person domiciled in India, who is under 18 years of age is a minor.
Accordingly every person who has completed the age of 18 years becomes a major. Only when a
person is under the guardian ship of court of wards or under a person appointed under the Guardians
and Wards Act, then he attains majority on completion of 21 years of age.

2.11.3 Position of Agreements by Minor


The law regarding minors agreements may be summed up as under:
a)

An Agreement by a Minor is Absolutely Void and Inoperative as Against Him: Law protects
the rights of the minors, because their mental faculties are not mature -they donot possess
Self-Learning Material 21

the capacity to judge what is good or bad for them. In the leading case of Mohori Bibi vs.
Dharam das Ghose,33 a minor executed a mortgage for Rs. 20000/- and received Rs. 8000/from the mortgagee. The mortgagee filed a suit for the recovery of his mortgage money and
for sale of the property in case of default. It was held that an agreement by a minor was
absolutely void as against him and therefore the mortgagee could not recover the mortgage
money nor could he have the minors property sold under his mortgage.

Notes

22 Self-Learning Material

b)

No Restitution Except in Certain Cases: A minor cannot be ordered to make compensation


for a benefit obtained under a void agreement. However, under the Specific Relief Act,
196334, a minor may be asked to restore any benefit which he may have received from
other party.

c)

Beneficial Agreements are Valid Contracts: Any agreement which is of some benefit to the
minor and under which he is required to bear no obligation, is valid. In other words, a
minor can be a beneficiary.

d)

No Ratification on Attaining the Age of Majority: Ratification means the subsequent


adoption and acceptance of an act or agreement. A minors agreement being a nullity and
void ab-initio, has no existence in the eyes of law. It cannot be ratified by the minor on
attaining the age of majority.

e)

The Rule of Estoppel does not Apply to a Minor: A minor is not estopped from pleading
minority in a suit against him, even in those cases, where he had earlier misrepresented
himself as a major to the other party.

f)

Minors Liability for Necessaries: Minors property is liable for reimbursing the person
who has supplied necessaries to a minor (Sec. 68).

g)

Specific Performance: Specific performance means the actual carrying out of the
contract as agreed. Only a contract entered on behalf of a minor, by his guardian
is binding on the minor and can be specifically enforced by or against the minor.
Other than this, no other minors agreement can be ordered for a specific
performance.

h)

Minor Agent: A minor can be an agent.35 He binds his principal by his acts but is
not liable to him in any manner for losses suffered by the principal.

i)

Minor Partner: A minor being incompetent to contract cannot be a partner in a


partnership firm. But he can be admitted as a partner for the benefits of partnership
(only for sharing of profits and not losses).

j)

Minor and Insolvency: A minor cannot be declared insolvent as he is not competent to


contract.

k)

Contract by Minor and Adult Jointly: Where a minor and an adult jointly enter into an
agreement with another person, the minor has no liability but the contract as a whole can be
enforced against the adult.

l)

Surety for a Minor: When an adult stands surety for a minor, the adult is liable under the
contract, and the minor is not.

m)

Position of Minors Parents: The parents of a minor are not liable for agreements made by
a minor, whether the agreement is for the purchase of necessaries or not. The parents can be
held liable only when the child is contracting as an agent for the parents.

n)

Minor Shareholder: A minor, being incompetent to contract, cannot be a shareholder of the


company. A company can also refuse to register transfer of shares in favour of a minor
unless the shares are fully paid, and articles of association of the company do not prohibit
minor to hold shares.

2.11.4 Persons of Unsound Mind


For a valid contract, it is necessary that each party to it must have a sound mind.

Notes

2.11.5 What is a Sound Mind?


The Act provides A person is said to be of sound mind for the purpose of making a contract, if at
the time when he makes it, he is capable of understanding it and of forming a rational judgement as
to its effects upon his interests. A person who is usually of unsound mind but occasionally of sound
mind may make a contract when he is of sound mind. A person who is usually of sound mind but
occasionally of unsound mind may not make a contract when he is of unsound mind.36

2.11.6 Position of Agreement with Persons of Unsound Mind


a)

Lunatics: A lunatic is a person who is mentally deranged due to some mental strain or other
personal experience. He suffers from intermittent intervals of sanity and insanity. He can
enter into contracts during the period when he is of sound mind.

b)

Idiots: An idiot is a person who has completely lost his mental powers. Idiocy is permanent
whereas lunacy denotes periodical insanity with lucid intervals. An agreement of an idiot is
void.

c)

Drunken/Intoxicated Persons: A drunken or intoxicated person suffers from temporary


incapacity to contract, i.e. at the time when he is so drunk or intoxicated that he is incapable
of forming a rational judgement. The position of a drunken or intoxicated person is similar
to that of a lunatic.

d)

Agreements Entered into by Persons of Unsound Mind are Void: However, there is one
exception. Persons of unsound mind are liable for necessities supplied to them or to anyone
whom they are legally bound to support. But even in such cases, no personal liability attaches
to them. It is only their estate (property) which is liable.37

2.11.7 Persons Disqualified by Law


The third type of incompetent persons are those who are disqualified from contracting by any law
to which they are subject. They are:
a)

Alien Enemies: An alien (citizen of a foreign state) is a person who is not a citizen of India.
When there is a war between India and another country, that countrys citizen becomes an
alien enemy and cannot enter into contract.

b)

Foreign Sovereigns and Ambassadors: They can enter into contracts and enforce those
contracts in our courts but they cannot be sued in our courts without the sanction of the
Central Government unless they choose to submit themselves to the jurisdiction of our courts.

c)

Convict: A convict is one who is found guilty by a court and is undergoing sentence of
imprisonment. During the period of his imprisonment, he is incompetent to contract and
also to sue on contract made before conviction.

d)

Company or Corporation: A company/corporation is an artificial person created by law. It


cannot enter into contract outside the powers, conferred upon it by its Memorandum of
Association (object clause) or by the provisions of its Special Act.

e)

Insolvents: When a persons debts exceed his assets, he is adjudged insolvent and his property
stands vested in the Official Receiver or Official Assignee appointed by the court. Such a
person cannot enter into contracts relating to his property.

Self-Learning Material 23

2.12 Free Consent


Notes

2.12.1 Meaning of Consent


Check Your Progress
13. When can a minor be
said to be competent to
contract?
14. Which persons are
disqualified by law to
be competent to
contract?

Consent means an act of assenting to an offer. Two or more persons are said to consent when they
agree upon the same thing in the same sense.38

2.12.2 Free Consent


Consent is said to be free when it is not caused by:
a)

Coercion, or

b)

Undue Influence, or

c)

Fraud, or

d)

Misrepresentation, or

e)

Mistake.39

2.12.3 Effect of Absence of Free Consent


When there is consent but it is not free (caused by coercion, undue influence, fraud or
misrepresentation), the contract is voidable, at the option of the party whose consent was so caused.
When consent is caused by bilateral mistake as to a matter of fact essential to the agreement, the
agreement is void.

2.12.4 Coercion
Coercion means compelling a person to enter into a contract under a pressure or a threat. The Act
defines Coercion as follows:
Coercion is the committing or threatening to commit, any act forbidden by the Indian Penal Code,
or the unlawful detaining or threatening to detain, any property, to the prejudice of any person
whatever, with the intention of causing any person to enter into an agreement.40
Example - A Hindu widow was forced to adopt a boy under threat that her husbands dead body
would not be allowed to be removed if she does not adopt the boy, She adopted the boy. Here,
Widows consent has been obtained by co-ercion because preventing the dead body from being
removed for cremation is an offence under section 297 of the Indian Penal Code. (Ranganayakamma
V. Alwar Setti).

2.12.5 Essentials of Co-ercion


To constitute coercion the following are the essential features:
a)

Coercion may proceed from any person and it is not necessary that it must be exercised by a
party to the contract.

b)

It may be directed against any person and not necessarily against the other contracting party.

c)

Coercion may be an act causing physical hardship or unlawful detention of property belonging
to another. It may also include those cases where the party is subjected to mental agony.

2.12.6 Undue Influence


The Act defines the term Undue Influence as follows:
24 Self-Learning Material

A contract is said to be induced by undue influence where the relations subsisting between the
parties are such that one of the parties is in a position to dominate the will of the other, and uses that
position to obtain an unfair advantage over the other.41

Notes

The Act further lays down that a person is deemed to be in a position to dominate the will of
another.
a)

If he holds a real or apparent authoring over the other (e.g. the relationship between father
and son, or master and servant).

b)

If he stands in a fiduciary relation to the other (e.g. the relationship between doctor and
patient, spiritual guru and disciple, lawyer and client).

c)

Where he makes a contract with a person whose mental capacity is temporarily or permanently
affected by reason of age, illness or mental or bodily distress (e.g. old illiterate persons).42

2.12.7 Distinction Between Coercion and Undue Influence


Distinction
Points of
Distinction

Coercion

Undue Influence

1. Basis

Consent is obtained by threat of


an offence. In this, the person is
forced to give his consent.

Consent is obtained by the dominating


will of the other. Consent is given in
good belief, but under moral influence.
Confidence is reposed but betrayed.

2. Nature

It is mainly of physical
character.

It is moral character.

3. Character

It is of violent character.

It is most subtle in Character.

2.12.8 Fraud
According to the Act, Fraud means and includes any of the following acts committed by the party
to a contract, or with his convinance, or by his agents, with intent to deceive another party there to
or his agent, or to induce him to enter into the contract:
a)

The suggestion as a fact, of that which is not true, by one who does not believe it to be true;

b)

The active concealment of a fact by one having knowledge or belief of the fact;

c)

A promise made without any intention of performing it;

d)

Any other act fitted to deceive; and

e)

Any such act or ommission as the law specially declares to be fraudulent.43

2.12.9 Essential Elements


Essential elements of fraud are as follows:
a)

The fraud must be committed by a party to a contract or by anyone with his connivance or by
his agent.

b)

There must be a false representation and it must be made with the knowledge of its falsehood.

c)

The representation must relate to a fact.

d)

The fraud must have actually deceived the other party.

e)

The party acting on the representation must have suffered loss.


Self-Learning Material 25

2.12.10 Misrepresentation
Notes

The Act, defines the term misrepresentation, as follows:


Misrepresentation means and includes a)

The positive assertion, in a manner not warranted by the information to the person making
it, of that which is not true, though he believes it to be true.

b)

Any breach of duty which, without an intent to deceive, gains an advantage to the person
committing it, or anyone claming under him, by misleading another to his prejudice or to the
prejudice of anyone claiming under him.

c)

Causing, however innocently, a party to an agreement, tomake a mistake as to the substance


of the thing which is the subject of the agreement.44

2.12.11 Essential Elements


Essential Elements of misrepresentation are as follows:
a)

By a Party to a Contract: The representation must be made by a party to a contract or by


anyone with his connivance or by his agent.

b)

False Representation: These must be a false representation and it must be made without
knowledge of its falsehood.

c)

Representation as to Fact: The representation must relate to a fact. In other words, a mere
opinion, a statement of expression or intention does not amount to misrepresentation.

d)

Object: The representation must be made with a view to inducing the other party to enter
into contract but without the intention of deceiving the other party.

e)

Actually Acted: The other party must have acted on the faith of the representation.

2.12.12 Distinction between Misrepresentation and Fraud


Distinction

26 Self-Learning Material

Points of
Distinction

Misrepresentation

Fraud

1. Intention
to deceive

There is no intention to deceive.

There is intention to deceive.

2. False
Statement

A false innocent statement without


any intention to deceive is
misrepresentation.

A fasle statement deliberately


made to deceive is fraud.

3. Belief of the
person making
statement

The person making the


statement believes it to be true.

The person making the statement


does not believe it to be true.

4. Effects of
breach

It makes contract voidable at the


option of the party injured.

Besides making the contract


voidable at the option of the party
injured, it gives right to an
independent action in tort.

5. Effect of
discovering
the truth

The contract cannot be avoided


if the party whose consent was
so caused, had the means of
discovering the truth with
ordinary diligence.

This plea can not be raised in case


of fraud, except in cases when
silence amounts to fraud.

2.12.13 Mistake
The Act does not define the term mistake. Mistake is an erroneous belief concerning something.
The types of mistake are shown below :

Notes

Type of Mistake
Mistake of Fact

Mistake of Law

Of Foreign Law

Of Indian
Law
As to Subject

As to Possibility

Matter

Performance

Bilateral

Identity of
Persons

Unilateral

Nature of
Contract

2.12.14 Mistake of Indian Law


Does not vitiate a contract because everyone is supposed to know the law of his country. The
maxim ignorance of law is no excuse applies.

2.12.15 Mistake of Foreign Law


Is treated as mistake of fact, i.e. the contract is void if both the parties are under a mistake as to a
foreign law because one cannot be expected to know the law of other country.

2.12.16 Mistake of Fact - Bilateral


Where both the parties to an agreement are under a mistake as to a matter of fact essential to the
agreement, the agreement is void.45

2.12.17 Mistake of Fact - Unilateral


A contract is not voidable merely because it was caused by one of the parties to it being under a
mistake as to matter of fact.46

2.12.18 Remedies Available


Where a contract is caused by a mistake which is void, the remedies available are:
a)

Any person who has received any advantage under the agreement is bound to restore it.47

b)

A person to whom money has been paid or anything delivered by mistake must repay or
return it.48

2.13 Legality of Object and Consideration


The object and the consideration of an agreement must be lawful, otherwise the agreement is void.
According to the Act, the consideration or the object of an agreement is unlawful in the following
cases:
a)

If it is Forbidden by Law: An act, action or thing is said to be forbidden (i.e. prohibited) by


Self-Learning Material 27

law when it is punishable under any enactment. For example -Rangeela, a Hindu already
married and his wife alive, entered into a marriage agreement with Kumari an unmarried
girl. This agreement is void because the second marriage is forbidden by Hindu Law.

Notes
b)

If it is of such a Nature that, if Permitted it would Defeat the Provisions of any Law: Such an
agreement is void. For example - Nirdhan borrowed Rs. 1 lakh from Kuber and agreed not
to raise any objection as to the limitation and that Kuber may recover the amount even after
the expiry of limitation period (i.e. three years). This agreement is void as it defeats the
provisions of Limitation Act.

c)

If it is Fraudulent: An agreement whose object or consideration is to defraud others, in


unlawful and hence void. For example - A, B and C enter into an agreement of the division
among them of gains acquired by them by fraud. The agreement is void, as its object is
unlawful.

d)

If it Involves or Implies Injury to a Person or Property of Another: If the object or consid


eration of an agreement is injury to the person or property of another, it is void, being an
unlawful agreement. Example - An agreement to put certain property to fire is unlawful and
void.

e)

If the Court Regards it as Immoral or Opposed to Public Policy: If the object or considera
tion of an agreement is immoral or opposed to public policy, the agreement is void. Any
agreement which interferes with marital relations of persons is regarded as immoral. When
ever an agreement is harmful to the public welfare or any established interest of society, it
would be void as being against public policy.49

Track Your Learning


15. Why insurance is not a
wagering agreement?

Example - 1
X gave Rs. 1 lakh to Y a married woman to obtain a divorce from her husband. X agreed to marry
her as soon as she obtained a divorce. It was held that X could not recover back the amount because
the agreement was void as its object was immoral.

Example - 2
A agrees to pay B, a major in the Army, Rs. 50,000 if he will assist his brother to desert the army.
The object of the agreement is opposed to public policy and hence void.

2.14 Void Agreement


An agreement not enforcable by law is said to be void50. Thus a void agreement does not give rise
to any legal consequences and is void ab-initio.

2.14.1 Void Agreement Already Discussed


The following type of void agreements have already been discussed:

28 Self-Learning Material

a)

Agreements by or with a person incompetent to contract. (paragraph 2.11)

b)

Agreements made under a bilateral mistake of fact material to the agreement.


(paragraph 2.12.15)

c)

Agreements made without consideration. (paragraph 2.10)

d)

Agreements the meaning of which is uncertain. (paragraph 2.6.8)

e)

Agreements of which the consideration or object is unlawful. (paragraph 2.13)

f)

Agreements to do impossible acts. (paragraph 2.6.9)

2.14.2 Expressly Declared Void Agreements


One of the essential elements of a valid contract is that it must not be one which is expressly
declared to be void under the Act. The following agreements have been expressly declared to be
void:
a)

Agreements in Restraint of Marriage: Every individual enjoys the freedom to marry.


According to the Act, Every agreement in restraint of the marriage of any person, other
than a minor, is void.51 The restraint may be general or partial. An agreement agreeing
not to marry at all, or a certain person, or a class of persons, or for a fixed period is void.
A promise to marry a particular person, does not imply any restrain of marriage and is a
valid contract. For example - Preeti agrees with Sambandh for good consideration that
she will not marry Kurup. It is void agreement.

b)

Agreements in Restraint of Trade: The constitution of India guarantees the freedom of


trade and commerce to every citizen. According to the Act, Every agreement by which
any one is restrained from exercising a lawful profession, trade or business of any kind, is
to that extent, void52. There are some exceptions to this rule like sale of goodwill, partners
agreements, trade combinations or negative stipulations in service agreements where in
some reasonable restrictions on trade are permitted in law.

c)

Agreements in Restraint of Legal Proceedings: According to the Act53, the following


agreements amount to restraint of legal proceedings and are thus void to that extent:

i.

Agreements Restricting Enforcement of Rights: An agreement by which any


party is restricted absolutely from enforcing his legal rights under or in respect
of any contract is void to that extent. Example - A clause in a contract provided
that no action should be brought upon it in case of breach. Such a clause is void
because it restricts both the parties from enforcing their legal rights.

ii.

Agreements Limiting the Period of Limitation: An agreement which limits the


time within which an action may be brought so as to make it shorter than that
prescribed by the law of limitation, is void. For example - A clause in a contract
provides that no action should be brought after two years. Such a clause is void
because it limits the period of limitation to two years which is less than the
period of limitation (i.e. three years) prescribed by the law of limitation.

Notes

Exceptions - Agreements or clause referring the dispute to arbitration or subject to one courts
jurisdiction are valid.
d)

Wagering Agreements: The word wager means a bet. A wagering agreement is


an agreement between two persons under which money or moneys worth is
payable, by one person to another on the happening or non-happening of a future
uncertain event. Example - X promises to pay Rs. 1,000 to Y if it rained on a
particular day, and Y promises to pay Rs. 1,000 to X if it did not. Such agreement
is a wagering agreement and thus void.54

The essentials of wagering agreements are:


i.

There must be a promise to pay money.

ii. Promise must be conditional on event happening or not.


iii. The event must be an uncertain, i.e. not in their hands.
iv. Each party must stand to win or loose.
v.

No party should have a proprietary interest in the event.

An insurance contract which seems to have a trace of speculation is not a wagering contract. There
is an insurable interest in an insurance contract while there is no such interest in a wagering contract.

Self-Learning Material 29

2.14.3 Distinction Between Insurance and Wagering Agreements


Notes

Distinction
Points of Distinction

Insurance Agreement

Wagering Agreements

1. Insurable Interest

There is an insurable
interest

There is no insurable interest.

2. Interest of the Parties

Both parties are interested


in the subject matter.

Neither party has any interest


in the happening or nonhappening of an event.

3. Validity

These are valid contracts.

These are void agreements as


they are opposed to public
policy.

4. Types of contract

These are contracts of


indemnity except life
insurance contracts which
are contingent contracts.

These are conditional contracts.

2.15 Contingent Contract


2.15.1 Meaning
A contingent contract is a contract to do or not to do something, if some event collateral to such
contract does or does not happen.55 Example - A contracts to indemnify B upto Rs. 20,000 in
consideration of B paying Rs. 1,000 annual premium, if Bs factory is burnt. This is a contingent
contract. Contracts of insurance and contracts of indemnity and guarantee are other examples of
contingent contracts.

2.15.2 Essentials of Contingent Contract


The essential features of a contingent contract are as follows:
a)

Dependence on a Future Event: The performance of a contingent contract depends upon


the happening or non happening of some future event.

b)

Collateral Event: The event must be collateral (i.e. incidental) to the contract.

c)

Uncertain Event: The event must be uncertain.

2.15.3 Rules Regarding Contingent Contracts


a)

Enforcement of Contracts Contingent on Happening of a Future Uncertain Event:56


Contingent contracts to do or not to do anything if an uncertain future event
happens can be enforced only when the event happens.

Illustration:
A makes a contract with B to buy Bs house if A survives C. This contract cannot be enforced by
law unless and until C dies in As life time.
30 Self-Learning Material

b)

Enforcement of Contracts on the Non-happening of a Future Uncertain Event:57


Contingent contracts to do or not to do anything if an uncertain future event
does not happen can be enforced only when the happening of the event becomes
impossible, and not before.

Notes

Illustration:
A agrees to pay B a sum of money if a certain ship does not return. The ship is sunk. The contract
can be enforced when the ship sinks.
c)

Contracts Contingent on Future Conduct of a Living Person:58 If the future event


on which a contract is contingent is the way in which a person will act at an
unspecified time, the event shall be considered to become impossible when such
person does anything which renders it impossible that he should so act within
any definite time, or otherwise than under future contingencies.

Illustration:
A agrees to pay B a sum of money if B marries C. C married D. The marriage of B to C must now
be considered impossible although it is possible that D may die and that C may afterwards marry B.
d)

Contracts Contingent on a Specified Event Happening Within a Fixed Time: 59


Contracts contingent to do or not to do anything if a specified uncertain event
happens within a fixed time would become void if, at the expiration of the time
fixed, such event does not happen or if before the time fixed, such event becomes
impossible.

Illustration:
A promises to pay B a sum of money if a certain ship returns within a year. The contract may be
enforced if the ship returns within the year, and becomes void if the ship is burnt within the year.
e)

Enforcement of Contingent Contracts on Specified Event not Happening Within a


Fixed Time: 60 Contingent contracts to do or not to do anything if a specified
uncertain event does not hapen within a fixed time, may be enforced when such
event has not happened, or shall not happen within the time fixed.

Illustration:
A promises to pay B a sum of money if a certain ship does not return within a year. The contract
may be enforced if the ship does not return within the year, or is burnt within the year.
f)

Agreements Contingent on Impossible Events: 61 Contingent agreements to do or


not to do anything if an impossible event happens, are void.

Illustration:
A agrees to pay B Rs. 1,000 if B will marry As daughter, C.C was dead at the time of the agreement.
The agreement is void.

Self-Learning Material 31

2.15.4 Distinction Between a Contingent Contract and Wagering Contract


Notes

Distinction
Points of
Distinction

Contingent Contracts

Wagering Contracts

1. Mutual
promise as
a basis

It is not necessary that there should


be mutual promises. All contingent
contracts are not wagers. For
examples, insurance contracts,
contracts of indemnity and guarantee.

It is agreement by mutual promises


each of them conditional on the
happening or not happening of an
unknown event. all wagers are
contingent but all contingent
contracts are not wagers.

2. Sole
Condition

Determination of an uncertain event


is not the sole condition of the
contingent contract.

There must be determination of an


uncertain event as the sole condition of the contract.

3. Void
agreement

A contingent contract is not void

Wagering contract is void.

4. Interest of
the parties

These are contracts of indemnity


except life insurance contracts
which are contingent contracts.

The parties are not intersted in the


occurance or non-occurrence of the
event.

5. Future
event

The future event is merely collateral


or incidental to the contract.

The future event is the sole


determining factor of the contract.

2.16 Quasi-Contract
2.16.1 Meaning of Quasi-Contract
A Quasi-Contract is not a contract at all because the essential elements for the formation of a
contract are absent. It is an obligation imposed by law upon a person for the benefit of another even
in the absence of a contract. It is based on the principle of equity (i.e. fairness, moral justice or
ethics), which means no person shall be allowed to unjustly enrich himself at the expense of another.
Such obligations are called quasi-contracts or implied contracts because the outcome of such
obligations resemble those created by a contract.

2.16.2 Kinds of Quasi-Contracts


The various kinds of quasi contract (or quasi-contractual obligations) are given below:
a)

32 Self-Learning Material

Claim for Necessaries Supplied to a Person Incapable of Contracting or on his Account:


If a person, incapable of entering into a contract, or anyone whom he is legally bound to
support, is supplied by another person with necessaries suited to his condition in life, the
person who has furnished such supplies is entitled to be re-imbursed from the property of
such incapable person.62 [Refer to paragraphs 2.11.3(f) and 2.11.5(d)] Example - A supplies
the wife and children of B, a lunatic, with necessaries suitable to their condition in life. A is
entitled to be reimbursed from Bs property.

b)

Reimbursement of Person Paying Money due by Another, in Payment of Which he is


Interested: 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 re-imbursed by the other.63 For
example - A, sub-tenant pays the arrears of rent due by the tenant to the landlord, in order to
save the tenancy from forefeiture. The subtenant is entitled to recover from the tenant, the
amount paid by him to the landlord, although there is no contract between the two.

c)

Obligation of Person Enjoying Benefit of Non-gratuitous Act: Where a person lawfully


does anything for another person, or delivers anything to him, not intending to do so
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.64 For
example-A, a tradesman, leaves goods at Bs house by mistake. B treats the goods as his
own. B is bound to pay A for them.

d)

Responsibility of Finder of Goods: A person who finds goods belonging to another and
takes them into his custody, is subject to the same responsibility as a bailee.65 For example
- X a guest found a diamond ring on a birthday party of Y. X told Y and other guests about
it. He has performed his duty to find the owner. If he does not able to find the owner he can
retain the ring as bailee.

e)

Liability of Person to Whom Money is Paid, or Thing Delivered by Mistake or Under


Co-ercion: A person to whom money has been paid, or anything delivered by mistake or
under co-ercion, must repay or return it.66 For example - A and B jointly owe Rs. 1000 to C.
A alone pays the amount to C, and B, not knowing this fact, pays Rs. 1000 over again to C.
C is bound to repay the amount to B.

Notes

2.16.3 Distinction Between a Contract and Quasi Contract


Distinction
Points of
Distinction

Contract

Quasi Contract

1. Purpose

Contract results from the will of


the parties expressed with a view
to create an obligation.

Quasi contract is an obligation


resembling that created by a contract.

2. Agreement

A contract is an agreement.

There is no agreement at all.

3. Essential
Elements

The contract has certain essential


elements.

Essentials for formation of a contract


are absent.

4. Nature

It is a full-fledged contract and


is binding.

A quasi contract resembles a contract.


It is not a full fledged contract. It is
an implied contract, but its results
resemble those created by a contract.

2.17 Performance of Contracts


2.17.1 Meaning of Performance
Performance of contract means fulfilling of the terms of the contract by the respective parties to the
contract. The Act lays down The parties to a contract must either perform, or offer to perform,
their respective promises, unless performance is dispensed with or excused under the provisions of
this Act, or of any other law.67 It means that the performance may be either actual - by fulfilling all
Self-Learning Material 33

Notes

obligations by the parties under the contract or attempted where an offer to perform ones obligations
has been made by the promisor, but the performance is not complete unless the offer of performance
is accepted by the promisee. Such offer to perform ones obligation under a contract is called
tender. The second part of the definition lays down that the parties are excused from performance
under the provisions of this Act or any other law. For example, an insolvent is excused from
performing his part of the contract by law.
Promises bind the legal representatives of the promisors in case of death of such promisors before
performance, unless a contrary intention appears from the contract. The liability of the legal
representative is limited to the extent of the value of the property inherited from the deceased.

Illustration:
a)

A promises to deliver goods to B on a certain day on payment of Rs. 1,000. A dies before
that day. As representatives are bound to deliver the goods to B and B is bound to pay Rs.
1,000 to As representatives.

b)

A promises to paint a picture for B by a certain day, at a certain price. A dies before the day.
The contract cannot be enforced either by As representatives or by B.

2.17.2 Who Can Demand Performance?


It is only the promisee who can demand performance of the promise. The general rule is that a
person cannot acquire rights under a contract to which he is not a party.68

2.17.3 Who Should Perform the Promise?


a)

In case of personal contract by the promisor personally.

b)

In case of non-personal contract


i.

By the promisor personally.

ii. By a third person on behalf of the promisor.


iii. In the event of the death of promisor - by his legal representatives.
c)

In case of Joint promisor - by the promisors jointly or third person on behalf of


the promisors or their legal representatives.

2.18 Discharge of Contract


2.18.1 Meaning
Discharge of a contract means discontinuation of the contractual relations between the parties.
When the rights and obligations arising out of a contract are extinguished, the contract is said to be
discharged or terminated.

2.18.2 Mode of Discharge


A contract may be discharged in any of the following ways:
a)

Discharge by Performance: A contract can be discharged by performance, which


can be:
i.

Actual - When the parties to the contract perform their promises in accordance
with the terms of the contract.

ii. Attempted - When the promisor has made an offer of performance to the
34 Self-Learning Material

promisee but the offer has not been accepted by the promisee.
b)

Discharge by Mutual Consent or Agreement: Since a contract is created by mutual


agreement, it can also be discharged by mutual agreement. Discharge by mutual
agreement can be done in any of the following ways:
i.

Notes

Novation 69 - Novation means the substitution of a new contract for the


original contract either between the same parties or between different parties.

ii. Rescission69 - Recission means cancellation of the contract by any party or all
the parties to a contract.
iii. Alteration 69 - Alteration means a change in the terms of a contract with the
mutual consent. Alteration discharges the original contract and creates a
new contract.
iv. Remission 70 - Remission is the acceptance of a lesser sum than what was
contracted for or a lesser fulfillment of the promise made.
v.
c)

Waiver - Waiver means intentional relinquishment of a right under the


contract.

Discharge by Subsequent or Supervening Impossibility or Illegality:


1.

Cases where the doctrine of supervening impossibility applies


i. Destruction of subject matter.
ii. Death or personal incapacity of promisor.
iii.Outbreak of war.
iv. Change of law.
v. Non-existence or non-occurrence of a particular state of things (failure of
ultimate purpose).

2.

Cases not covered by supervening impossibility i. Difficulty of performance or less profitable.


ii. Commercial impossibility.
iii.Default of a third person.
iv. Strikes, lockouts and civil disturbances.
v. Partial impossibility or failure of one of the objects.

d)

Discharge by Lapse of Time - A contract is discharged if it is not performed or


enforced within a specified period, called period of limitation. The Limitation
Act, 1963 has prescribed the different periods for different contracts , e.g. period
of limitation for exercising right to recover a debt is 3 years.

e)

Discharge by Operation of Law:


i.

By death of the promisor.

ii. By insolvency.
iii. By merger.
iv. By unauthorised material alteration.
f)

Discharge by Breach of Contract - A contract is said to be discharged by breach of contract


if any party to the contract refuses or fails to perform his part of the contract or by his act
makes it impossible to perform his obligation under the contract. A breach of contract may
occur in the following two ways:
i.

Anticipatory breach of contract - It occurs when the party declares his intention
of not performing the contract before the performance is due.

ii. Actual breach of contract - It can occur either on due date of performance or
during the course of performance.

Self-Learning Material 35

2.19 Remedies for Breach of Contract


Notes

2.19.1 Meaning of Breach of Contract


A breach of contract occurs if any party refuses or fails to perform his part of the contract or by his
act makes it impossible to perform his obligation under the contract. In case of breach, the aggrieved
party (i.e. the party not at fault) is relieved from performing his obligation and gets a right to
proceed against the party at fault. As stated earlier [Refer to paragraph 2.18.2(f)] a breach of
contract may either be anticipatory or actual.

2.19.2 Remedies of Breach of Contract


A remedy is the courses of action which are available to an aggrieved party for the enforcement of
a right under a contract. The various remedies available are:
a)

Rescission of Contract71: Rescission means a right not to perform obligations. Incase of


breach of a contract, the promisee may put an end to the contract. In such a case, the
aggrieved party is discharged from all the obligations under the contract and is entitled to
claim compensation for the damage which he has sustained because of the non-performance
of the contract.

b)

Suit for Damages: Damages are monetary compensation allowed for loss suffered by the
aggrieved party due to breach of contract. Damages may be of five kinds:
i.

Ordinary or General or Compensatory Damages: (i.e. damages arising naturally


from the breach).

ii. Special Damages: (i.e. damages in contemplation of the parties at the time of
contract).
iii. Exemplary, Punitive or Vindictive Damages: (i.e. damages which are in the
nature of punishment).
iv. Nominal Damages: (i.e. awarded only for the name sake).
v.

Check Your Progress


17. In what ways can a
contract be discharged?
18. What remedies are there
to a breach of contract?
19. What is Quantum
meruit?
20. What kinds of damages
are covered under breach
of contract?

36 Self-Learning Material

Liquidated Damages: means a sum fixed up in advance, which is a fair and


genuine pre-estimate of the probable loss that is likely to result from the
breach.

c)

Suit for Specific Performance: means demanding the courts direction to the
defaulting party to carry out the promise according to the terms of the contract. For example
- X agreed to sell an old painting to Y for Rs. 50000. Subsequently X refused to sell the
painting. Here, Y may file a suit against X for the specific performance of the contract.

d)

Suit for Injunction: means demanding courts stay order Injunction means an order of the
court which prohibits a person to do a particular act. For example -W agreed to sing at Ls
theatre only during the contract period. During the contract period, W made contract with Z
to sing at another theatre and refused to perform the contract with L. It was held that W
could be restrained by injunction from singing for Z.

e)

Suit for Quantum Meruit: Quantum - meruit means as much as is earned. In this suit, claim
is made to compensate for the work already done. For example -C an owner of a magazine
engaged P to write a book to be published by instalments in his magazine. After a few
instalments were published, the publication of the magazine was stopped. It was held that P
could claim payment for the part already published.

2.20 Indemnity and Guarantee


Notes

2.20.1 Contract of Indemnity


2.20.1A Meaning
The term Indemnity means to make good the loss or to compensate the party who has suffered
some loss. A contract by which one party promises to save the other from loss caused to him by the
conduct of the promisor himself, or by the conduct of any other person, is called a contract of
indemnity.72 For example - A and B go into a shop. B says to the shopkeeper Let A have the
goods, I will see you paid. The contract is one of Indemnity.

2.20.1B Parties
The person who promises to make good the loss is called the Indemnifier (promisor), and the
person whose loss is to be made good is called the Indemnified or Indemnity holder (promisee).

2.20.2 Contract of Guarantee


2.20.2A Meaning
A contract of guarantee is a contract to perform the promise or discharge the liability of a third
person in case of his default.73 For example - A and B go into a shop. A says to the shopkeeper, C,
Let B have the goods, and if the does not pay, I will. This is a contract of guarantee.

2.20.2B Parties to a Contract of Guarantee


There are three parties to a contract of gaurantee.
i.

Principal Debtor: The person in respect of whose default the guarantee is given is called
the principal debtor. In the above example B is the principal debtor.

ii.

Creditor: The person to whom the guarantee is given is called the creditor. C is the
creditor in the above said example.

iii.

Surety: The person who gives the guarantee is called the surety A is the surety in the
above said example.

2.20.2C Kinds of Guarantee


Guarantee may be classified under the following two categories:
a)

Specific Guarantee: A guarantee which extends to a single debt or specific transaction is


called a specific guarantee. The liability of the surety comes to an end when the guaranteed
debt is duly discharged or the promise is duly discharged.

b)

Continuing Guarantee: A guarantee which extends to a series of transactions is called a


continuing guarantee. A suretys liability continues until the revocation of the guarantee.

2.20.2D Discharge of Surety from Liability


A surety is said to be discharged when his liability as surety comes to an end. A surety is freed from
his obligation under a contract of guarantee under any of the following circumstances:
Self-Learning Material 37

a)

Notice of Revocation: A specific guarantee cannot be revoked once it is acted upon. But a
continuing guarantee may at any time, be revoked by the surety as to future transactions by
giving notice to the creditor.74

b)

Death of Surety75: In case of a continuing guarantee the death of a surety also discharges
him from liability as regards transactions after his death, unless there is a contract to the
contrary.

c)

Variance in Terms of Contract76: Any variance made without the suretys consent, in the
terms of the contract between the principal debtor and the creditor, discharges the surety as
to transactions subsequent to the variance.

d)

Release or Discharge of Principal Debtor77: The surety is discharged by any contract between
the creditor and the principal debtor, by which the principal debtor is released, or by any
act of omissions of the creditor, the legal consequence of which is the discharge of the
principal debtor.

e)

Arrangement by Creditor with Principal Debtor without Suretys Consent78: A contract


between the creditor and principal debtor, by which creditor makes a composition with, or
promises to give time to, or not to sue the principal debtor, discharges the surety, unless the
surety assents to such contract.

f)

Creditors Act or Omission Impairing Suretys Eventual Remedy79: If a creditor does any
act which is inconsistent with the rights of the surety, or omits to do any act, which is his
duty to the surety requires him to do, and the eventual remedy of the surety himself against
the principal debtor is thereby impaired, the surety is discharged.

g)

Loss of Security80 :If the creditor loses (by negligence or carelessness) or without the consent
of the surety, parts with security given to him, the surety is discharged from liability to the
extent of the value of security.

h)

Invalidation of the Contract of Guarantee: (In between the creditor and the surety)
A surety is also discharged from liability when the contract of guarantee (in
between the creditor and the surety) is invalid. A contract of guarantee is invalid
where such a contract has been obtained by means of misrepresentation or fraud
or keeping silence as to material part of the transaction, by the creditor or with
creditors knowledge or assent81. Failure of co-surety to join a surety also makes
the guarantee invalid.82

Notes

2.20.3 Distinction Between a Contract of Indemnity and a Contract of


Guarantee
Distinction
Points of
Distinction

38 Self-Learning Material

Indemnity

Guarantee

1. Number of
parties

There are two parties -the


indemnifier and the indemnity
holder.

There are three parties the creditor,


the principal debtor and the surety.

2. Object or
purpose

For the reimbursement of loss.

For the security of a debt or good


conduct of an employee.

3. Number of
contracts

Only one contract between the


indemnifier and the indemnified.

Three contracts - one between the


principle debtor and creditor, the
second between creditor and the
surety, and the third between the
surety and the principal debtor.

Distinction
Points of
Distinction

Indemnity

Guarantee

4. Nature of
liability

The liability of the indemnifier is


primary in nature.

The liability of the surety is


secondary, i.e. the surety is liable
only on default of the principal
debtor.

5. Request by
the debtor

The
indemnifier
acts
independently without any request
of the indemnity holder or the third
party.

It is necessary that the surety


should give the guarantee at the
request of the debtor.

6. Existing
debt or duty

In most cases, there is no existing


debt or duty.

There is an existing debt or duty,


the performance of which is
guaranteed by the surety.

7. Right to sue

The indemnifier cannot sue the


third party for loss in his own
name, because there is no privity
of contract. He can do so only, if
there is an assignment in his favour.

The surety, after he discharges the


debt owing to the creditor, can
proceed against the principal
debtor in his own right.

Notes

2.21 Bailment and Pledge


2.21.1 Meaning of Bailment
The word Bailment is derived from the French word baillier which means to deliver. According
to the 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 direction of the person delivering them.83
The person delivering the goods is called the bailor. The person to whom the goods are delivered
is called the bailee.

2.21.2 Essential Features of Bailment


A bailment has the following characteristic features:
a)

It is the delivery of movable goods.

b)

The goods are delivered for some purpose.

c)

Return of specific goods - The goods which form the subject matter of a bailment must be
returned to the bailor or otherwise disposed of according to the directions of the bailor,
after the accomplishment of purpose or after the expiry of period of bailment.

2.21.3 Kinds of Bailment


Bailment may be classified from the point of view of benefit or reward. The benefit may be exclusive
to the bailor or bailee or mutual. Bailment on the basis of reward may be:
a)

Gratuitous: Neither the bailor nor the bailee is entitled to any remuneration i.e. loan of
Self-Learning Material 39

Notes

book to a friend, depositing of goods for safe custody. It is for the exclusive benefit of the
bailor or bailee.
b)

Non Gratuitous: Here the goods are given for reward, remuneration or for some consideration,
e.g. car let out on hire, goods given for repairs or tailoring for charges.

c)

Pawn or Pledge: Goods delivered to another as a security for money borrowed is called
Pledge.

2.21.4 Bailment, Sale and License


In Sale the ownership is transferred to the buyer, whereas in the bailment the ownership in goods
is not transferred. In a contract of License, one party is permitted to place his goods in the premises
belonging to other person. Thus in a contract of license, the goods are not delivered to the licensor,
while in bailment the goods are delivered to the bailee for safe custody.

2.21.5 Duties of Bailee


His duties are as follows:
a)

To take reasonable care of goods delivered to him.

b)

Not to make unauthorised use of goods entrusted to him.

c)

Not to mix goods bailed with his own goods.

d)

To return the goods.

e)

To return accretions to the goods.

f)

Not to set up any adverse title.

2.21.6 Duties of Bailor


His duties are as follows:
a)

To disclose faults / defects in goods bailed.

b)

To repay necessary expenses in case of gratuitous bailment.

c)

To repay any extra ordinary expenses in case of non-gratuitous bailment.

d)

To indemnify bailee.

e)

To receive back the goods.

2.21.7 Rights of Bailee


Check Your Progress
21. Who is a surety?
22. Does the contact of
guarantee hold good
in case of death of
surety and loss of
security?
23. What is pledge?

His rights are as follows:


a)

Enforcement of bailors duties.

b)

To deliver goods to one of several joint bailors.

c)

To deliver goods, in good faith, to bailor without title.

d)

Lien - is of two types - general or particular. Bailee has particular lien unless the contract
provides otherwise. Particular lien means the right to retain that particular property in
respect of which the charge is due. General lien means the right to retain all the goods of
the other party until all the claims of the holder against the party are satisfied.

2.21.8 Rights of Bailor


His rights are as follows:

40 Self-Learning Material

a)

Enforcement of bailees duties.

b)

To terminate bailment if the bailee uses the goods wrongfully.

c)

To demand return of goods at any time in case of gratuitous bailment.

Notes

2.21.9 Pledge or Pawn


The bailment of goods as security for payment of a debt or performance of a promise is called
pledge. The bailor in this case is called the pawner. The bailee is called the pawnee.84 Pledge
is therefor a kind of bailment.

2.21.10 Distinction between Pledge and Bailement


Distinction
Points of Distinction

Pledge

Bailment

1. Purpose

It is a bailement for a specific purpose, i.e. to provide


a security for a loan.

Goods may be bailed for any


purpose , i.e. for repairs, safe
custody etc.

2. Right of sale

The pledge has a right of sale,


on default after giving notice
to the pledgor.

No such right of sale to the


bailee.

3. Right of using the


goods

The pledge has no right of


using the goods pledged.

No such restriction exists for the


bailee if the nature of transaction so requires.

2.22 Agency
2.22.1 General
It is not always possible for a person to do everything himself, hence it becomes necessary to
delegate some of the acts to be performed by another person. Such other person is called an agent.

2.22.2 Definitions of Agent and Principal


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 represented, is called the principal.85
The contract which creates the relationship of principal and agent is called an agency. For
example - X appoints Y to buy ten bags of wheat on his behalf, X is the principal, Y is the agent and
the contract between the two is agency.

2.22.3 General Rules of Agency


There are two important general rules regarding agency, viz:
a)

What one person can himself lawfully do, can as well get it done by any other person. This
rule is of course, subject to some exceptions, e.g. in case of acts required to be performed
personally like marriage.

b)

What a person does by another, he does by himself. In other words the acts of the agent are,
for all legal purposes, the acts of the principal.
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2.22.4 Who May Employ an Agent?


Notes

Any person who is competent to contract may employ an agent. A minor or a person of unsound
mind cannot employ an agent.86

2.22.5 Who May be an Agent?


The Act lays down that as between the principal and third persons any person may become an
agent. Thus even a minor or a person of unsound mind can be appointed as agent, but in such a
case the principal shall be liable.87

2.22.6 No Consideration is Necessary


No consideration is necessary to create an agency.88

2.22.7 Creation of Agency


An agency may be created in any one of the following ways:
a)

Agency by Express Agreement: An agency by express agreement is created when by spoken


or written words an express authority is given to an agent. For example - X who owns
a shop, appoints Y to manage his shop by executing a power of attorney in Ys favour.

b)

Agency by Implied Agreement: Implied agency arises when agency is inferred from the
circumstances of the case, or from the conduct of the parties on a particular occasion, or
from the relationship between parties.89 Implied agency includes the following:
i.

ii. Agency by Holding Out: This is a type of agency by estopped. Such agency
arises when a person by his past affirmative and positive conduct leads third
person to believe that person doing some act on his behalf is doing with
authority. For example - X allows Y, his servant to purchase goods for him on
credit from Z, and later on pays for them, one day X pays cash to Y to purchase
goods. Y misappropriates the money and purchases goods on credit from Z. Z
can recover the price of goods from X because X had held out before Z that Y is
his agent.

Check Your Progress

iii. Agency by Necessity: Agency by necessity arises under the following two
conditions:

24. What is a lien?


25. Define an agent.
26. Does agency need
consideration?
27. In what ways, an
agency can be
terminated?

42 Self-Learning Material

Agency by Estopped: Agency by estopped arises where a person by his words or


conduct induces third persons to believe that a certain person is his agent. The
person who induces as such is estopped or prevented from denying the truth of
agency.90 For example - X tells Y in the presence and hearing of Z that he (X)
is Zs agent. Z does not contradict this statement. Later on Y enters into a
contract with X believing that X is Zs agent. In such a case, Z is bound by this
contract and in a suit between Z and Y, Z cannot be permitted to say that X
was not his agent, even though X was not actually his agent.

c)

a.

There is an actual and definite necessity for acting on behalf of the principal, and

b.

It is impossible to obtain the consent of the principal. For example - X consigned


some vegetables from Delhi to Mumbai by a truck. The truck met with an accident.
The vegetables being perishable were sold by the transporter. This sale is binding
on X. In this case the transporter became an agent by necessity.

Agency by Ratification: Where acts are done by one person on behalf of another, but with
out his knowledge or authority, the latter may elect to ratify (adopt and accept) or to disown

such acts. If he ratifies them, the same effect will follow as if they had been performed by
his authority.(Section 196) Ratification may be express or implied in the conduct of person
on whose behalf the acts are done. For example - A, without authority, buys goods for B.
After wards B sells them to C on his own account. Bs conduct implies a ratification of the
purchases made for him by A.
d)

Notes

Agency by Operation of Law: Agency by operation of law is said to arise where the law
treats one person as an agent of another. For example - on formation of a partnership,
every partner becomes the agent of other partners. Such agency is said to arise by
operation of law.

2.22.8 Meaning of Sub Agent


A sub-agent is a person employed by, and acting under the control of, the original agent in the
business of the agency.91 Thus a person employed by an agent is called sub-agent.

2.22.9 Meaning of Substituted Agent


An agent names or appoints a substituted agent at the request of the principal and thereafter drops
out altogether from the scene. Such person is an agent of the principal.92

2.22.10 Duties of Agent


An agent has the following duties towards the principal:
a)

To follow principals directions or customs.

b)

To carry out the work with reasonable skill and diligence.

c)

To render accounts.

d)

To communicate, in case of difficulty.

e)

Not to deal on his own account in the business.

f)

Not to make any profit out of his agency except his remuneration.

g)

On termination of agency by principals death or insanity to protect and preserve the


interests entrusted to him.

h)

Not to delegate authority.

2.22.11 Right of Agent


An agent has the following rights against the principal:
a)

To receive remuneration.

b)

Retainer - out of any sums received on account of the principal.

c)

Lien - to retain goods. Agent has a particular lien unless the contract provides otherwise.

d)

To be indemnified against consequences of lawful acts.

e)

To be indemnified against consequences of acts done in good faith.

f)

To compensation for injuries sustained by him due to principals neglect or want of skill.

g)

Stoppage of goods in transit.

2.22.12 Duties of Principal


The duties of principal are indirectly the rights of an agent.
Self-Learning Material 43

2.22.13 Rights of Principal


Notes

The rights of principal are indirectly the duties of an agent.

2.22.14 Termination of Agency


Termination of Agency

By Act of Parties
Agreement
Revocation by the Principal

By Operation of Law
Completion of Business of agency
Expiry of time
Death of Principal or Agent

Renunciation by the Agent

Insolvency of the Principal


Destruction of the subject matter
Principal or Agent becoming alien
enemy
Dissolution of Company

Summary
Contract
A contract is an agreement made between two parties and enforceable by law. An agreement consists
of a proposal by one party and its acceptance by the other party. Two or more parties who enter into
an agreement must agree upon the subject matter in the same sense and at the same time, i.e.
consensus ad idem. An agreement, in order to be a contract, must give rise to legal consequences
and remedies in the Law Court in case of its breach.
Essentials of a Contract: There must be 1. an agreement i.e. proposal and acceptance 2. an intention
to create legal relations 3. Lawful consideration 4. parties competent to contract 5. free consent 6.
lawful object 7. certainty 8. possibility of performance 9. not expressly declared void, and 10. in
writing or registered / stamped where there is such a requirement by law.
Classification of Contract: Contract can be classified as below:
Valid - enforceable by law.
Void - Not enforceable by law.
Voidable - Enforceable at the option of one party only. Illegal - Contrary to law
Unenforceable - Due to lack of proof or some technical defect cannot be enforced in a
Court of law.
Executed - Performed by both the parties or by one party.
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Executory - Performance by both the parties is yet to take place.


Partly Executed, partly executory - One party has performed but the other party has yet to
perform.

Notes

Contingent - Contract is performed only on happening of some future uncertain event.


This is also called conditional contract.
Quasi-Contract - an obligation created by law.
Meaning of Proposal: When one person signifies to another his willingness to do or to abstain from
dong anything, with a view to obtaining the assent of that other to such act or abstinence he is said
to make a proposal.
Legal Rules Regarding a Valid Proposal: 1. A proposal must be made by express words spoken or
written or implied when it is inferred from the conduct of the proposer or from the circumstances of
the case 2. The terms must be certain and not loose or vague 3. Must give rise to legal consequences
and be capable of creating legal relations 4. It must be distinguished from invitation to proposal 5.
May be specific or general 6. Must be communicated to the proposee 7. Should not contain a
term, the non-compliance of which would amount to acceptance 8. Can be made subject to any
terms and conditions, and 9. Two identical cross-offers donot make a contract.
Revocation and Lapse of Proposal: A proposal lapses under circumstances like after stipulated or
reasonable time, by not being accepted in the mode prescribed, by rejection, by death or insanity of
either party, by rejection, before acceptance, and by destruction of the subject matter. It is revoked
by non fulfillment of a condition precedent to acceptance.
Acceptance: A contract emerges from the acceptance of a proposal. The proposal is said to be
accepted when the person to whom the proposal is made signifies his assent thereto.
Essentials of a Valid Acceptance: 1. Must be absolute and Unqualified 2. Expressed in some usual
and reasonable manner 3. Mental acceptance is not sufficient 4. Acceptance must be communicated
to the proposer 5. Acceptance must be given within reasonable time and before the proposal lapses
and / or is revoked 6. It is acceptance of the terms and conditions of the proposal 7. It can be
implied 8. It must be made by the person to whom the proposal is made. General offer way be
accepted by anyone 9. If the act is done in ignorance of the proposal, it is no acceptance.
Communication of Proposal, Acceptance and Revocation: The Communication of a proposal is
complete when it come to the knowledge of the person to whom it is made. The 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. The communication of a revocation is complete as against the person
who makes it, when ti is put into a course of transmission to the person to whom it is made, so as to
be out of the power of the person revoking; and as against the person to whom it is made, when it
comes to his knowledge.
Consideration - Meaning: Consideration means something in return. When at the desire of the
promisor, the promisee or any other person has done or abstained from doing, or does or abstain
from doing, or promises to do or abstain from doing, something, such act or abstinence or promise
is called a consideration for the promise.
Essentials of a Valid Consideration: 1. Consideration must move at the desire of the promisor 2. It
may move from the promisee or any other person 3. Consideration may be past, present or future 4.
It must be something of value 5. It must be legal 6. Consideration is doing something or abstaining
from doing something.
No Consideration no Contract: An agreement made without consideration is void. No consideration
is required in case of 1. An agreement made on account of natural love and affection 2. Agreement
to compensate for past voluntary service 3. Agreement to pay a time barred debt 4. Completed gift
5. Contract of agency 6. Remission by the promisee, of performance of the promise, and 7.
Contribution to charity.
Capacity of Parties: Every person is competent to contract who is of the age of majority according
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Notes

to the law to which he is subject, and who is of sound mind, and is not disqualified from contracting
by any law to which he is subject.
Minor: A minor is one who has not completed the age of 18 years. The position of agreements by
a minor is 1. Absolutely void and inoperative as against him 2. That there is no restitution 3.
Agreement beneficial to a minor is valid 4. No ratification on attaining the age of majority 5. The
rule of estoppel does not apply 6. Minors property is liable for necessaries 1. Minor can be an agent
8. Minor can be admitted in partnership only for profit 9. Minor can be admitted in partnership ony
for profit 9. Minor cannot be declared insolvent 10. Specific performance can not be ordered for
minors agreement 11. Surety for a minor is liable 12. A minor cannot be a shareholder of the
company, unless the shares are fully paidup and the articles of association donot prohibit.
Persons of Unsound Mind: Agreemetns entered in by person of unsound mind are void. A Lunatic
or a Drunken or Intoxicated person can enter itno a contract when he is of sound mind. Agreements
of an idiot are void. Persons of unsound mind are liable (only their property) for necessaries supplied
to them or their legal dependants.
Persons disqualified by law: Such persons are - 1. Alien enemy 2. Foreign sovereigns and
ambassadors 3. Convict 4. Company beyond the objects contained in its memorandum of association
5 Insolvents.
Free Consent: two or more persons are said to consent when they agree upon the same thing in the
same sense. Contracts in order to be valid must be made by the free consent. Consent is said to free
when it is not casued by 1. Coercion, or 2. Undue influence, or 3. Fraud, or 4. Misrepresentation, or
5. Mistake. When Consent is not free, the contract is voidable at the option of the party whose
consent was so caused.
Coercion: Coercion is the committing or threatening to commit any act forbidden by the Indian
Penal Code, or the Unlawful detaining, or threatening to detain any property, to the prejudice of
any person, whatever, with the intention of causing any person to enter into agreement.
Undue Influence: A Contract is said to be induced by Undue Influence where the relations subsisting
between the parties are such that one of the parties is in a position to dominate the will of the other,
and uses that position to obtain an unfair advantage over the other.
Fraud: Fraud exists 1. When a false representation has been made 2. Knowingly, or without belief
in its truth, or 3. Recklessly, not caring whether it is true or false, and 4. The maker intended the
other party to act upon it 5. With an intention to deceive. It also exists when there is a concealment
of a material fact.
Misrepresentation: It is a misstatement of a material fact made innocently with an honest belief as
to its truth or non-disclosure of a material fact, without any intent to deceive the other party.
Mistake: It is an erroneous belief concerning something. Mistake is of two types 1. Mistake of Law
2. Mistake of Fact.
Mistake of Law: is again of two types 1. Mistake of Indian law. It does not vitiate a contract
because ignorance of law is no excuse 2. Mistake of foreign law. It is treated as a mistake of fact.
Mistake of Fact: It may be a 1. Bilateral mistake. Where both the parties to an agreement are under
a mistake as to a matter of fact essential to the agreement; the agreement is void. 2. Unilateral
mistake - where only one of the parties is under a mistake as to a matter of fact, the contract is not
voidable.
Legality of Object and Consideration: The object and the consideration of an agreement must be
lawful. Otherwise the agreement is void. It is unlawful, if 1. It is forbidden by law 2. It is of such
a nature that if permitted it would defeat the provisions of any law 3. It is fraudulent 4. It involves
or implies injury to a person or property of another 5. The court regards it as immoral or opposed
to public policy.
Agreements Expressly Declared Void: 1. Made by incompetent persons 2. Made under a bilateral
mistake of fact 3. Made without consideration 4. The meaning of which is uncertain 5. The
consideration or object is unlawful 6. To do impossible acts 7. In restraint of marriage 8. In restraints

46 Self-Learning Material

of trade 9. In restraint of legal proceedings 10. Wagering agreements.


Contingent Contract: A contingent contract is a contract to do or not to do something if some event
collateral to such contract does or does not happen. The essentials of a contingent contract 1. Its
performance depends upon the happening or non-happening in future of some event 2. The event
must be collateral, and 3. Uncertain.

Notes

Rules Regarding Contingent Contract: 1. Enforcement of contracts contingent on happening of a


future uncertain event can only be done only when the event happens 2. Enforcement of contracts
on the non-happening of a future uncertain event can only be done only when the happening of the
event becomes impossible, and not before 3. Contracts contingent on future conduct of a living
person, is considered impossible, when such person does anything which renders it impossible 4.
Contracts contingent on a specified event happening within a fixed time, would become void if at
the expiration of the time fixed such event does not happen or becomes impossible 5. Agreements
contingent on impossible events are void.
Quasi-Contract: It is an obligation imposed by law upon a person for the benefit of another even in
the absence of a contract.
Kinds of Quasi-Contract: 1. Claim for necessaries supplied to a person incapable of contracting or
on his account 2. Reimbursement of person paying money due by another, in payment of which he
is interested 3. Re-imbursement of person enjoying benefit of non-gratuitous act 4. Responsibility
of finder of goods 5. Liability of person to whom money is paid or thing delivered by mistake or
under Co-ercion.
Performance of Contract: Performance of Contract means fulfulling of the terms of the contract by
the respective parties to the Contract. Only the promisee can demand performance of the promise.
Contract can be performed 1. In a personal contract by the promisor personally 2. In a non-personal
contract by the promisor, by a third person on behalf of the promisor or by the legal representative
if the promisor is dead, and 3. In case of joint promisors by them jointly.
Discharge of Contract: It means discontinuation of the contractual relations between the parties.
Various modes of discharges of a contract are by 1. Performance - actual or implied 2. Mutual
Consent or agreement. This can be done by novation, rescission, alteration, remission or waiver 3.
Subsequent or supervening impossibility or illegality 4. Lapse of time 5. Operation of law 6. Breach
of contract - can be anticipatory or actual.
Remedies for Breach of Contract: A breach of contract occurs if any party refuses or fails to perform
his part of the contract or by his act makes it impossible to perform his obligation under the contract.
The Various Remedies of Breach of Contract: 1. Rescission of contract 2. Suit for damages - which
can be ordinary or general, special, exemplary, nominal, and liquidated 3. Suit for specific
performance 4. Suit for injunction 5. Suit for quantum merrit.

Indemnity and Guarantee


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, is called a contract of
Indemnity. The person who promises to make good the loss is called Indemnifier. The person
whose loss is to be made good is called the indemnified or indemnity holder.
Guarantee: A contract of guarantee is a contract to perform the promise or discharge the liability of
a third person in case of his default. There are three parties to a contract of guarantee, principal
debtor, creditor and the surety. These are two kinds of guarantee namely specific or continuing. A
surety is descharged from liability by 1. Giving a notice of revocation 2. Death of surety 3. Variance
in terms of contract 4. Release or discharge of principal debtor 5. Arrangement by creditor with
principal debtor without suretys consent 6. Creditors act or omission imparing suretys eventral
remedy 7. Loss of security, and 8. Invalidation of contract of guarantee.

Self-Learning Material 47

Bailment and Pledge


Notes

Bailment: 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 desposed by
according to the direction of the person delivering them. The person delivering the goods is called
the bailor. The person to whom the goods are delivered is called the bailee. There are three kinds of
bailment, gratuitous, non-gratuitous or Pawn (Pledge). The duties of bailee are 1. To take reasonable
case of goods delivered to him 2. Not to make unauthorised use of goods entrustd to him 3. Not to
mix good bailed with his own goods 4. To return the goods 5. To return accretions to the goods, and
6. Not to set up any adverse title. The duties of bailor are 1. To disclose faults / defects in goods
bailed 2. To repay necessary expenses in case of gratuitous bailement 3. To repay any extra ordinary
expenses in case of non-gratuitous bailment 4. To indemnify bailee, and to receive back the goods.
The Right of bailee are 1. Enforcement of bailors duties 2. To deliver goods to one of several joint
bailors 3. To deliver goods, in good faith, to bailor without title, and 4. Lien which may be general
or particular. The Right of bailor are 1. Enforcement of bailees duties 2. To terminate bailment if
the bailee uses the goods wrongfully, and 3. To demand return of goods at any time in case of
gratuitous bailment.

Pledge or Pawn
The bailment of goods as security for payment of a debt or performance of a promise is called
pledge. Pledge is a kind of bailment.

Agency
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 represented, is called the principal.
The contract which creates the relationship of principal and agent is called an agency. Principal
must be a person competent to contract. A minor or a person of unsound mind can be appointed as
agent, but in such a case the principal shall be liable. No consideration is necessary to create an
agency.
Creation of Agency: Can be done by 1. Express agreement, 2. Implied agreement -which may be by
estoppel, or by holding out or by necessity 3. Ratification 4. Operation of law. Sub-agent is a
person employed by an agent. Substituted agent is one who is appointed at request of the principal
and then the agent drops out altogether from the scene. The Duties of agent are 1. To follow
principals directions or customs 2. To carry out the work with reasonable skill and diligence 3. To
render accounts 4. To communicate, in case of difficulty 5. Not to deal on his own account in the
business 6. Not to make any profit out of his agency except his remmuneration 1. On termination of
agency by principals death or insanity to protect and preserve the interests entrusted to him; and 8.
Not to delegate authority. The rights of agent are 1. To receive remuneration 2. Retainer 3. Lein 4.
To be indemnified against consequences of lawful acts 5. To be indemnified against consequences
of acts done in good faith 6. To compensation for injuries sustained by him due to principals
neglect or want of skill, and 1. Stoppage of goods in transit. The Duties of principal are indirectly
the rights of an agent and the Rights of principal are indirectly the duties of an agent. An agency can
be terminated by 1. Act of parties - which include agreement, revocation by the principal or by the
agent, and 2. Operation of law which would cover completion of business of agency, expiry of
time, death or insanity of principal or agent, insolvency of the principal, destruction of the subject
matter, principal or agent becoming an alien enemy, and dissolution of company.

48 Self-Learning Material

Review Questions
Notes

True or False
1.

Law of contract is the whole law of agreements and the whole law of obligations.

2.

A contract is usually treated as voidable when the consent of a party has not been free.

3.

A general offer can be accepted by anyone.

4.

A contract with a minor is voidable at the option of the minor.

5.

An act of co-ercion must necessarily proceed from a party to the contract.

6.

A stranger to consideration can sue.

7.

Agreement in restraint of legal proceedings is altogether void.

8.

The event in a contingent contract must be essential to the contract.

9.

In case of several joint promisors, the promisee can demand the performance from anyone
or more of joint promisors.

10.

Actual breach of a contract may take place during the performance of the contract.

11.

A contract of indemnity is not a contingent contract.

12.

A continuing guarantee can be revoked as to the past transaction by giving notice to the
creditor.

13.

Placing of ornaments in a bank locker is a contract of bailment.

14.

Consideration for agency is necessary.

15.

The principal may revoke agency for future acts only.

Practical Problems
Attempt the following problems giving reasons:
1.

Madhur of Mussourie invites Mitr of Mumbai to stay with him during summer vacation.
Mitr accepts the invitation and informs Madhur accordingly. When Mitr reaches Madhurs
home, he finds it locked and he has to stay in a five star hotel. Can Mitr claim damages from
Madhur?

2.

Amar sold his business to Bharat but this fact was not known to an old customer Chander.
Chander placed an order for certain goods to Amar by name. Bharat supplied the goods to
Chander. Is there a valid contract?

3.

Dhaniram, executed a mortgage in favour of Chotu, a minor who has advanced the money.
Is this mortgage valid?

4.

Pratinidhi, an agent, refused to hand over the account books of the principal to the new
agent appointed in his place unless the principal released him from all liabilities. The principal
had to give a release deed as demanded. Is this release deed binding upon the principal?

5.

Kuber gifted Rs. 50000 to Sundari his neighbours wife by executing a registered gift deed
without any consideration. There is no near relation between Kuber and Sundari. Is this gift
valid?

6.

Amir granted a loan to Garib a guardian of kumari who is of 14 years of age, to enable Garib
to celebrate Kumaris marriage. Can Amir recover his loan from Garib?

7.

Adhar agreed to pay Bhushan Rs. 50000 if Bhushan marries Chandra. Chandra was already
married to Deepak at the time of agreement. Is the agreement valid?

8.

Shaitan asks Kathore to beat Komal and promises to indemnify Kathore against the
Self-Learning Material 49

Notes

consequences. Kathore beats Komal and is fined Rs. 1000. Can Kathore claim Rs. 1000
from Shaitan?
9.

Swaranlata delivered her gold jewellery to Joharimal her husband who is a goldsmith for
the purpose of making new one out of it. Every evening she used to receive the unfinished
jewellery and to put it into a box kept at Joharimals shop. She kept the key of that box with
herself. Is there a contract of bailment?

10.

Mukhiya, the principal, instructed Sevak his agent to put goods in Bhandaris warehouse.
Sevak puts half of the goods in Bhandaris warehouse and the balance in another equally
safe warehouse. All the goods were destroyed by fire without any negligence on part of
Sevak. Is Sevak liable to Mukhiya?

Test Questions
1.

What is the object and nature of the law of contract?

2.

Illustrate the distinction between void, voidable and illegal agreements.

3.

Explain what is meant by i) lapse of an offer, and ii) a counter-offer.

4.

An agreement enforceable by law is a Contract. Discuss the definition and explain


the essentials of a valid contract.

5.

Comment on the following:


a)

All contracts are agreements, but all agreements are not contracts.

b) The law of contracts is not the whole law of agreements, nor is it the whole
law of obligations.

50 Self-Learning Material

6.

Give the various classification of contracts.

7.

Define a proposal and state the essential of valid proposal.

8.

When is a valid proposal made? Distinguish it from an invitation to an offer.

9.

Explain circumstances under which an offer lapses and becomes invalid.

10.

What do you understand by the term acceptance? What are the essentials of a valid
acceptance?

11.

Discuss briefly the law relating to communication of proposal, acceptance and


revocation.

12.

Define and explain consideration in a contract. State exceptions to the rule that
an agreement without consideration is void.

13.

What do you mean by a consideration to a contract? Should there be adequate consideration


to make a valid contract?

14.

No consideration, No Contract. State exceptions, if any, to the rule.

15.

Insufficiency of consideration is immaterial: but an agreement without consideration is


void. Comment.

16.

A stranger to a contract cannot sue. Are there any exceptions to this rule?

17.

What do you understand by capacity to contract? What is the effect of agreements made
by persons of unsound mind?

18.

Discuss in detail the provisions of law relating to minors agreements.

19.

State briefly the law relating to competence of parties to a contract.

20.

What are necessaries? When is a minor liable on a contract for necessaries?

21.

Examine the legal position of i) a minor promisor, ii) a minor promisse, and iii) a minor
agent.

22.

Discuss consent. When consent is said to be free consent?

23.

Define undue influence and distinguish it from coercion.

24.

Define misrepresentation and distinguish it from fraud.

25.

A contract caused by mistake is void. Discuss. Or

Notes

A mere silence as to the facts is not fraud. Discuss.


26.

Two or more persons are said to consent when they agree upon the same thing in the
same sense. Explain this statement and give illustrations.

27.

An agreement requires a meeting of the minds. Comment.

28.

What is misrepresentation? Distinguish it from fraud.

29.

Enumerate the agreements expressly declared to be void under the Indian Contract
Act. Is the party who has received some benefit under a void contract bound to
restore it to the other party?

30.

Distinguish between wagering and Insurance agreements.

31.

What are wagering agreements and essentials of wagering agreement?

32.

Explain contingent contracts. When can a party enforce such contracts?

33.

Distinguish between Contingent and Wagering Contracts.

34.

Under what circumstances is the object or consideration of a contract deemed unlawful?


Illustrate with example.

35.

An agreement in restraint of trade is void. Examine this statement mentioning exceptions,


if any.

36.

Insurance contracts are basically wagering agreements. Comment.

37.

Explain the meaning or a contingent contract. What are the rules relating to contingent
contracts?

38.

A Quasi-contract is not a contract at all. It is an obligation which the law creates. Amplify
and state the quasi contracts recognised under the Indian Contract Act.

39.

What are the several ways in which a contract is discharged?

40.

What are the remedies available to an aggrieved party in case of breach of contract?

41.

What are the rules laid down by the Indian Contract Act with regards to the assessment of
damages on a breach of contract?

42.

When a party to a contract refuses altogether to perform or is disabled from performing


his part of it, the other party has a right to rescind it. Discuss.

43.

What do you understand by performance of a contract?

44.

Impossibility of performance is, as a rule, not an excuse for non-performance of a contract.


Discuss.

45.

Explain breach of contract as a mode of discharge of contract.

46.

If a contract is broken, the law will endeavour, so far as money can do it, to place the
injured party in the same position as if the contract had been performed.

47.

Define: Special Damages: Exemplary Damage: Nominal Damages: Liquidated Damages:


Injunction.

48.

What are quasi-contracts? Enumerate the quasi-contracts dealt with under the Indian Contract
Act, 1872.

49

Quasi-contracts rest on the ground of equity that a person shall not be allowed to enrich
himself unjustly at the expense of another. Explain.

Self-Learning Material 51

Notes

50.

What do you understand by contract of indemnity?

51.

Define contract of guarantee and distinguish it from contract of Indemnity?

52.

What is the extent of the liability of the surety?

53.

State the circumstances in which a surety is discharged from liability.

54.

What is bailment? Is the bailor under any duty to disclose to the bailee any defects or faults
in the goods bailed?

55.

What are the rights of bailor and bailee?

56.

Explain Pledge and Bailment and their distinction.

57.

The position of a finder of goods is exacly that of a bailee in the case of a deposit.
Comment and discuss.

58.

Define agent and principal. Is consideration needed in a contract of agency?

59.

What is a contract of agency? What are the essentials of relationship of agency?

60.

Write notes on i) Agency by estoppel, ii) Agency by holding out, and iii) Agency by necessity.

61.

How is the agency constituted?

62.

Explain Principals rights and duties for the agent and what are the Agents rights and
duties for the Principal?

63.

Write short notes on:


i.

Termination

ii. Ratification of agency

Practical Problems

52 Self-Learning Material

1.

Mitr cannot claim any damages from Madhur because the agreement between Madhur
and Mitr is not enforceable by law. It is a social agreement and the usual presumption in
such agreement is that the parties do not intend to create legal relationship.

2.

These was no contract at all between Bharat and Chander because chanders offer was a
specific offer to Amar and Amar alone could accept it. (Leading Case: Boulton v Jones).

3.

The mortgage is valid and hence the money advanced to Dhaniram can be recovered because
a minor can be a promissee (Leading Case: Raghave Charier v. Srinivasa).

4.

The release deed is not binding on the principal and he can avoid the contract on the
ground of coercion, Principals consent is not free as it has been obtained by unlawful
detaining of the property (i.e. account books) (Leading Case: Muthia v. Karuppan).

5.

The gift is valid. A completed gift needs no consideration and need not be a result of
natural love and affection or near relation.

6.

Amir cannot recover his loan from Garib. The agreement is void because an object (i.e.
minors marriage in contravention of the child Marriage Restraint Act) is unlawful. (Leading
Case: Srinivas V.K. Raja Ram Mohan).

7.

Such agreement is void and hence not enforceable by law as marriage of Bhushan to Chandra
is impossible at present.

8.

Kathore cannot claim Rs. 1000/- from Shaitan becuase the object of the agreement was
unlawful.

9.

There was no contract of bailment because Joharilal (bailee) had re-delivered the jewellery
bailed to, Swaranlata (bailor) (Leading Case: Kalia Derumal Pillai v. Visalakshmi).

10.

Sevak is not liable for the loss of goods put in Bhandaris warehouse because he acted
according to the directions of Mukhiya. Sevak is liable for the loss of goods put in another
warehouse because he has not acted according to the directions of Mukhiya.

Answers to True & False


1. False 2. True 3. True 4. False 5. False 6. True 7. False 8. False 9. True 10. True 11. False
12. False 13. False 14. False 15. True

Notes

Answers to Check Your Progress


Following are the answers to Check Your Progress, indicating respective paragraphs for reference.
I) 2.1 2) 2.2 3) 2.3 4) 2.6 5) 2.6.9 6) 2.6.7 7) 2.6.5 8) 2.8.2 9) 2.8.3.f 10) 2.8.4 11) 2.10.3 12) 2.10.2
13) 2.11.3 14) 2.11.6 15) 2.14.3 16) 2.16.3 17) 2.18.2 18) 2.19.2 19) 2.19.2e 20) 2.19.2 b 21)
2.20.2B iii 22) 2.20.2D b.g 23) 2.21.9 24) 2.21.7 d 25) 2.22.2 26) 2.22.6 27) 2.22.14

References
1

Section 2(h) 2Section 2(e) 3Section2(b)

Balfour v. Balfour (1919) 2 K.B. 571. 5Rose


and Frank Co. v. Crompton Bros. (1925) A.C.
445 6Section 11

Section 3 of the Indian Majority Act, 187533


(1903) 30 Cal. 539
34

Section 34 of the Specific Relief Act, 1963

35

Section 184

36

Section 12

37

Section 68

38

Section 13

Section 10, paragraph 2

39

Section 14

Sections 24 to 30

40

Section 15

Section 13

Section 14

Section 23

10
11

32

12

As laid down by Section 10

41

Section 16(1)

13

Section 2(j) 14Section 2(i) 15Section 2(a)

42

Secion 16(2)

16

Taylor v. Portington. (1885) All. E.R. 128

43

Section 17

44

Section 18

45

Section 20

46

Section 22

47

Section 65

48

Section 72

49

Section 23

50

Section2(g)

51

Section 26

52

Section 27

53

Section 28

54

Section 30

55

Section 31

56

Section 32

57

Section 33

58

Section 34

59

Section 33

60

Section 35

17

Mrs Carlill v. Carbolic Smoke Ball Co. (1893)


I Q B. 256

18

Lalman Shukla v. Gauri Dutt (1913) All L.J.


489

19
20
21
22
23
24
25
26

Section 6(2)
Section 7
Section 6(1)
Section 6(3)
Section 2(b)
Section 2(c)
Section 8
Hindustan Co-operative Society v. Shyam

Sunder AIR 1952 Cal. 691


27

Section2(d)

28

Chinnaya v. Ramayya (1882) 4 Mad. 137

29

Section 185

30

Section 63

31

Section 11

Self-Learning Material 53

Notes

54 Self-Learning Material

61

Section 36

62

Section 68

63

Section 69

64

Section 70

65

Section 71 - See Section 151 and 152

66

Section 72

67

Section 37

68

T.G. Venkataraman v. State of Madras AIR 1970 SC 508

69

Section 62

70

Section 39

71

Section 75

72

Section 124

73

Section 126

74

Section 130

75

Section 131

76

Section 133

77

Section 134

78

Section 135

79

Section 139

80

Section 141

81

Sections 142 and 143

82

Section 144

83

Section 148

84

Section 172

85

Section 182

86

Section 183

87

Section 184

88

Section 185

89

Section 187

90

Section 237

91

Section 191

92

Section 194

The Law of Sale of Goods

Notes

Section

3
The Law is experience developed by reason and applied continually to further
experience.
Roscoe Pound
STRUCTURE
3.1

Introduction to The Sale of Goods Act

3.2

Meaning of contract of sale?

3.3

Essential elements of sale.

3.4

Sale and agreement to sell.

3.5

Sale and hire purchase.

3.6

Agreement to sell and hire purchase agreement.

3.7

How a contract of sale is made?

3.8

Condition and warranty.

3.9

The doctrine of caveat emptor.

3.10 Transfer of property.


3.11 Performance of a contract of sale.
3.12 Delivery to carrier and wharfinger
3.13 Carriage by sea.
3.14 Unpaid seller.
3.15 Auction sale.

Self-Learning Material 55

3.1 Introduction
Notes

The sale of goods is the most common of all commercial transactions. A knowledge of the main
principles of the sale of goods is important to all and particularly to the managers. The law relating to sale of goods is contained in the Sale of Goods Act, 1930 (hereinafter referred to as the
Act), which came into force on 1st July, 1930. This Act extends to the whole of India except the
state of Jammu and Kashmir. The general provisions of the Indian Contract Act, 1872, continue to
be applicable to the contract of sale of goods in so far as they are not inconsistent with the express
provisions of the Act.1

3.2

Meaning of Contract of Sale

According to the Act, A contract of sale of goods is a contract whereby the seller transfers or
agrees to transfer the property in goods to the buyer for a price. There may be a contract of sale
between one part-owner and another.2 A contract of sale of goods may be absolute or conditional
according to the desire of buyer and seller.

3.3

Essential Elements of Contract of Sale

This definition reveals the following essential elements of a contract of sale of goods.

3.3.1 Two Parties


There must be two distinct parties to a contract of sale of goods, viz. a buyer and a seller. A person
can not buy his own goods.

3.3.2 Transfer of Property


Property means the general property in goods, and not merely a special property.3 General property in goods means ownership of goods. Special property in goods means possession of goods.
If A owns certain goods, he has general property in goods. If he pledges with B, B has special
property in the goods. Thus, there must be either a transfer of ownership of goods or an agreement
to transfer the ownership of goods.

3.3.3 Goods
The subject matter of the contract of sale must be goods. According to the Act, goods means
every kind of moveable property other than actionable claims and money; and includes stock and
shares, growing crops, grass, and things attached to or forming part of the land which are agreed to
be severed before sale or under the contract of sale.4 Thus every kind of movable property except
actionable claims and money, is regarded as goods. Goodwill, trademarks, copyrights, patent right,
water, gas, electricity,5 decree of a court of law are all regarded as goods. Sale of immovable
property is governed by the Transfer of Property Act, 1882.
a)

The actionable claims mean claims which can be enforced through the courts of law, e.g.
a debt due from one person to another is an actionable claim.

b)

The money here means the legal tender (i.e. currency of the country) and not old coins.

3.3.4 Price
There must be a price. Price means the money consideration for the sale of goods.6 When the
consideration is only goods, it amounts to barter and not sale. However, the consideration may
be partly in money and partly in goods.
56 Self-Learning Material

3.3.5 Includes Both a Sale and An Agreement to Sell


The term contract of sale is a generic term and includes both a sale and an agreement to sell
(This is clear from the definition of the term as is given in paragraph 3.2)

Notes

3.3.6 No Formalities to be Observed


The Act does not prescribe any particular form to constitute a valid contract of sale. Neither
payment nor delivery is necessary at the time of making the contract of sale.

3.4

Sale and Agreement to Sell

3.4.1 Sale
Where under a contract of sale the property in the goods is transferred from the seller to the buyer,
the contract is called a sale.7 It refers to an absolute sale, i.e. outright sale. There is immediate
transfer of ownership and mostly of the subject matter. Delivery may be given in future. It is an
executed contract.

3.4.2 An Agreement to Sell


Where the transfer of property in the goods is to take place at a future time or subject to some
condition thereafter to be fulfilled, the contract is called an agreement to sell.8 It is an executory
contract and refers to a conditional sale. A contract of sale of goods can be made by mere offer
and acceptance by the seller or the buyer. Neither payment nor delivery is necessary at the time of
making the contract of sale. For example, where articles are exhibited for sale and the customer
picks up an item and the sales assistant packs it up, there has resulted a contract of sale of goods
by the conduct of the parties.9

3.4.3 Distinction Between Sale and Agreement to Sell


S. No.

Points of
Distinction

Sale
Sale is an executed
contract, where one of the
parties has already
performed his part of the
contract.

Agreement to Sell

1.

Nature of Contract

Agreement to sell is an
executory contract, where both
the parties are yet to perform
their mutual promises within
agreed time.

2.

Creation of right

Sale creates a Jus-in-rem,


i.e. right on the goods
against the whole world.

It creates a Jus-in-personam,
i.e. personal right only against
the person in default for
fulfilling his part of agreement.

3.

Passing of
property

The property in the goods


passes to the buyer with
the risk.

In this, risk and property do not


pass to the buyer immediately.

Self-Learning Material 57

S. No.
Notes

Points of
Distinction

Sale

4.

Remedies on
breach of contract

5.

Risk of loss

The loss will be borne by


the buyer even if the
possession of goods is
with the seller.

The loss will be borne by the


seller since the ownership in
the goods has not passed to the
buyer.

6.

Insolvency of
buyer before he
pays for the goods

The seller is entitled to sue


for the price of the goods
and also has a right of lien,
stoppage in transit, and
resale.

The seller has the right only to


sue for damages for
nonperformance of the
contract.

7.

Insolvency of
seller if the buyer
has already paid
the price

The buyer is entitled to sue


for the price of the goods
and also has a right of lien,
stoppage in transit, and
reasale.

The buyer has to prove the


amount he has paid and can
only claim a rate-able
dividend. He cannot compel
receiver to sell and deliver the
goods.

8.

Right to resale

The property is with the


buyer and as such the seller
(in possession of goods
after sale) cannot resell the
goods.

The seller can dispose of the


goods as he likes and the
original buyer can sue him for
breach of contract only.

3.5

The seller is entitled to sue


for the price of the goods
and also has a right of lien,
stoppage in transit, and
resale.

Agreement to Sell
The seller has the right only to
sue for damages for
nonperformance of the
contract.

Sale and Hire Purchase

Contracts of sale resemble contracts of hire purchase as the real object of contract of hire purchase is the sale of goods ultimately. In hire purchase, property does not pass when agreement is
made out but only passes when the option is finally exercised after complying with all the terms of
agreement.

3.5.1 Distinction Between Sale and Hire Purchase


S. No.
1.

58 Self-Learning Material

Points of
Distinction
Transfer of
property in goods

Sale
In a sale, property in the
goods is transferred to the
buyer immediately at the
time of contract.

Hire Purchase
In hire purchase, property in
the goods passes to the hirer
upon payment of the
instalment.

S. No.

Points of
Distinction

Sale

Hire Purchase
Notes

2.

Position of the
buyer

3.

Power to terminate
the contract

The
buyer
cannot
terminate the contract and
is bound to pay the price
of the goods.

The hirer, may terminate the


contract by returning the goods
to its owner without paying
remaining instalments.

4.

Risk of loss from


the insolvency of
the buyer

The seller takes the risk of


any loss resulting from the
insolvency of the buyer.

The owner takes no such risk.


If the hirer fails to pay an
instalment, the owner takes
back the goods.

5.

Tax payable

Trade tax is levied at the


time of the contract.

Trade Tax is not leviable until


it turns into a sale.

6.

Nature of contract

Contract of sale includes


both sale and agreement to
sell.

Hire purchase agreement is


bailment plus agreement to
sell.

3.6

The position of the buyer


is that of the owner of the
goods.

The position of the hirer is that


of a bailee till he pays the last
instalment.

Distinction between Agreement to Sell and Hire Purchase


Agreement

S. No.

Points of
Distinction

Agreement to Sell

Hire Purchase
Agreement

It is step to contract of sale

It becomes a sale only after the


payment is made in full.

1.

Nature of
agreement

2.

Transfer of goods

Conveyance of goods may


take subsequently

Conveyance is immediately
transferred while ownership
remains with the seller.

3.

Rights of ownership

The buyer can sell or


pledge the goods.

The buyer cannot exercise any


ownership rights hence cannot
sell or pledge these goods.

4.

Implied conditions
and warranties

The buyer can take


advantage of implied
conditions and warranties
under the Act.

The hirer cannot so claim the


benefits of implied conditions
unless it becomes a sale.

5.

Law applicable

It is regulated by sale of
Goods Act, 1930.

It is regulated by Hire
Purchase Act, 1972.

Check Your Progress


1. Does possession of
goods directly mean the
ownership?
2. In the law of sale of
goods, what is the
consideration?
3. What is a Hirepurchase agreement?
How it differs from
sale?

Self-Learning Material 59

3.7
Notes

Contract of Sale - How is it made?10

a)

A contract of sale may be made in writing or by word of mouth or partly in writing and partly
by word of mouth or may be implied from the conduct or dealings of the parties.

b)

There must be an offer to buy or sell goods for a price and acceptance of such offer by
another.

c)

The contract may provide for immediate delivery of the goods or delivery by instalments or
delivery at a future date.

d)

The contract may provide for immediate payment of the price (money) or payment
by instalment or payment may be postponed.

e)

The contract of sale of goods may be for existing or future goods.

f)

Contract of sale of goods must possess all the essentials of an ordinary contract.

3.8

Conditions and Warranties

3.8.1 Terms or Stipulations


A contract of sale of goods contains various terms or stipulations regarding the quality of goods,
the price and the mode of its payment, the delivery of goods and its time and place. But all of them
are not of equal importance. Some of these stipulations may be major terms which go to the very
root of the contract (conditions). There may also be some stipulations which may be minor terms,
which are not so vital that their breach may seem to be a breach of the contract as such (warranty).
Thus a stipulation in a contract of goods may be a condition or warranty.11

3.8.2 Meaning of Condition


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.12 In addition, he may maintain an action for
damages for loss suffered, if any.
Example: X asked a car dealer to suggest him a car suitable for touring purposes. The dealer
suggested a particular car. Accordingly, X purchased it but found it unsuitable for touring purpose.
In this case, suitability of car for touring purpose was a condition of contract. X was, therefore,
entitled to reject the car and have refund of the price paid.

3.8.3 Meaning of Warranty


A warranty is a stipulation collateral to the main purpose of the contract, the breach of which gives
rise to a claim for damages but not to a right to reject the goods and treat the contract as repudiated.13
Example: X asked a car dealer to suggest him a good car and while suggesting the car, the dealer
said that it could run for 20 km per litre of petrol. But the car could run only 15 km per litre of
petrol. In this case the statement made by the seller was a warranty. X was, therefore not entitled to
reject the car but he was entitled to claim the damages.

3.8.4 How to Determine Whether Stipulation is a Condition or Warranty?


There is no hard and fast rule as to which stipulation is a condition and which one is a warranty. The
Act lays down to the same effect, thus whether a stipulation in a contract of sale is a condition or
a warranty depends in each case on the construction of the contract. A stipulation may be a condition
though, called a warranty in the contract.14
60 Self-Learning Material

3.8.5 Distinction Between Condition and Warranty


Notes

S. No.

Points of
Distinction
Stipulation

1.

2.

3.

Breach

Treatment

Condition

Warranty

A condition is an essential
stipulation to the main
purpose of the contract.

Warranty is a stipulation
collateral to the main purpose.

Check Your Progress

Breach of condition gives


right to repudiate the
contract and also to claim
damages.

Breach of warranty gives right


to claim damages only.

Breach of condition may


be treated as breach of
warranty.

A breach of warranty cannot be


treated as a breach of
condition.

4. What is known as
stipulation?
5. What is Caveat
Emptor?
6. Is warranty different
from condition?
Explain.

3.8.6 Express Conditions and Warranties


Conditions and warranties may be either express or implied. They are said to be express when at
the will of the parties they are inserted in a contract.

Examples:
1.

A buyer desires to buy a Sony TV model no. 2062. Here model no. is an express condition.

2.

In an advertisement for Khaitan fans, guarantee for 5 years is an express warranty.

3.8.7 Implied Conditions and Warranties


Conditions and warranties are said to be implied when the law presumes their existence in the
contract automatically though they have not been put into it in express words.

3.8.8 Implied Conditions


Unless otherwise agreed, the law incorporates into a contract of sale of goods the following implied
conditions:
a)

Conditions as to Title: There is an implied condition on the part of the seller


that (i) In the case of a sale, he has a right to sell the goods, and (ii) In the case
of an agreement to sell, he will have a right to sell the goods at the time when
the property is to pass.15
Example: X purchased a car from Y. After 6 months Z, the true owner of car demanded it
from X. X had to return it to its true owner. X was entitled to recover the full price even
though he had used the car for 6 months.16

b)

Conditions in a Sale by Description: Where there is a contract for the sale of


goods by description, there is an implied condition that the goods shall correspond
with the description. 17 The description may be in terms of the qualities or
characteristics of the goods.

Self-Learning Material 61

Notes

Example: Long staple cotton, Kalyan wheat, Sugar C -30, Basmati rice or may simply mention
the trademark, brand name or the type of packing, etc.
c)

Condition in a Sale by Sample: When under a contract of sale, goods are to be


supplied according to a sample agreed upon, the implied conditions are:
i.

That the bulk shall correspond with the sample in quality.

ii. That the buyer shall have a reasonable opportunity of comparing the bulk
with the sample.
iii. That the goods shall be free from any defect (latent).18
d)

Condition in a Sale by Sample as well as by Description: If the sale is by sample


as well as by description, the goods must correspond both with the sample as
well as the description.19
Example: G bought from N Foreign refined rapeseed oil which was warranted to be equal
to sample. The oil supplied was equal to the sample. The sample was actually a mixture of
rapeseed oil and hemp oil. G was entitled to reject the goods because the goods supplied did
not correspond with the description.20

e)

Condition as to Fitness or Quality: Ordinarily in a contract of sale there is no


implied condition or warranty as to quality or fitness for any particular purpose
of goods supplied; the rule of law being Caveat Emptor (i.e. let the buyer beware).
But an implied condition is deemed to exist on the part of the seller that the
goods supplied shall be reasonably fit for the purpose for which the buyer wants
them, if the following conditions are satisfied:
i.

The particular purpose for which goods are required must have been disclosed
(expressly or impliedly) by the buyer to the seller.

ii. The buyer should rely on the sellers skill or judgment.


iii. The sellers business must be to sell such goods.21
Example: X purchased a hot water bottle from Y, a retail chemist. X asked Y if it would
stand boiling water. The chemist (Y) told him that the bottle was meant to hold hot water.
The bottle burst when hot water was poured into it and injured Xs wife. Y is liable to refund
the price and pay damages because bottle was unfit for the purpose for which it was
purchased.22
f)

Condition as to Merchantability: 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 the goods
shall be of merchantable quality. The expression merchantable quality means
that the quality and condition of goods must be such that a man of ordinary
prudence would accept them as the goods of that description. Goods must be
free from any latent or hidden defects.23
Example: Where the underwears supplied contained certain chemicals which could cause
skin disease to a person wearing them next to skin. It was held that because of such a defect
the underwears were not of merchantable quality and the buyer was entitled to reject the
goods.24

g)

Condition as to Wholesomeness: In case of eatables or provisions or food stuffs,


there is an implied condition as to wholesomeness, i.e. free from any defect
which render them unfit for human consumption.
Example: W bought a bottle of beer from H, a dealer in wines. The beer was contaminated
with arsenic. W, on taking the beer fell ill. H was held liable to W for the consequent illness.25

62 Self-Learning Material

3.8.9 Implied Warranties


Unless otherwise agreed, the law also incorporates into a contract of sale of goods the following
implied warranties:
a)

Notes

Warranty of Quiet Possession: There is an implied warranty that the buyer shall have and
enjoy quiet possession of the goods. This is an extension of the implied condition as to
title.26
Example: M a lady purchased a second hand type-writer from B. She thereafter spent some
money on its repair and used it for some months. Unknown to the parties the type-writer was
a stolen one and M was compelled to return the same to its true owner. She was held entitled
to recover from the sellers for the breach of this warranty damages reflecting not merely the
price paid but also the cost of repair.27

b)

Warranty of Freedom From Encumbrances: 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.28 Example: X borrowed Rs. 500 from Y and hypothecated
his radio with Y as security. Later on X sold this radio to Z who bought in good faith. Here
Z can claim damages from X because his possession is disturbed by Y having a charge.

c)

Warranty of Disclosing the Dangerous Nature of Goods to the Ignorant Buyer: There is an
implied warranty on the part of the seller that in case the goods are of dangerous nature he
will warn the ignorant buyer of the probable danger. Example: C purchases a tin of disinfected
powder from A. A knows that the lid of the tin is defective and if it is opened without special
care it may be dangerous, but tells nothing to C. C opens the tin in the normal way where
upon the disinfectant powder flies into her eyes and causes injury. A is liable in damages to
C as he should have warned C of the probable danger.29

3.9

The Doctrine of Caveat Emptor

3.9.1 Meaning of the Doctrine of Caveat Emptor


The expression Caveat Emptor means let the buyer be aware. It is not part of the sellers duty to
point out defects of the goods which he offers for sale, rather it is the duty of the buyer to satisfy
himself about the quality as well as the suitability of goods.30
Example: Pigs were sold subject to all faults and the seller knew that the pigs were suffering from
swine-fever but he did not inform the buyer about this defect. The seller was not liable for damages
because Caveat Emptor is the rule.31

3.9.2 Exceptions
In the following cases, doctrine of Caveat Emptor does not apply.
a)

Custom or Usage of Trade: An implied warranty or condition as to quality or fitness for a


particular purpose may be annexed by the custom or usage of trade. However, custom should
not be unreasonable and inconsistent with the express terms of the contract.

b)

Fraud: Where the seller obtains the consent of the buyer by fraud or conceals a defect, the
seller is liable.

c)

For Specific Purpose: (i) Where the goods are ordered for specific purpose, and (ii) the
seller is made aware of it, and (iii) the buyer relies on the skill or judgment of the seller, there
is an implied condition that the goods shall be reasonably fit for such purpose.

d)

Merchantable Quality: Where (i) the sale is by description and (ii) purchased from the seller
who deals in goods of that description, there is an implied condition that the goods shall be
of merchantable quality.
Self-Learning Material 63

e)
Notes

Goods are Sold by Sample or Description: In such cases, doctrine of Caveat Emptor does
not apply.

3.10 Transfer of Property


3.10.1 Meaning of Transfer of Property
The phrase tranfer of property in goods means transfer of ownership of goods and not the physical
possession of goods.

3.10.2 Significance of Transfer of Property


The time of transfer of ownership of goods decides various rights and liabilities of the seller and
the buyer. This is important to know the answers of the following questions:
a)

Who shall bear the risk? - It is the owner who has to bear the risk and not the person who has
the possession of goods.

b)

Who can take action against the third party? - It is the owner who can take action and not the
person who has the possession.

c)

Can a seller sue for price? - The seller can sue for the price only if the ownership of goods
has been transferred to the buyer.

d)

In case of insolvency of a buyer can the official receiver or assignee take the possession of
goods from seller? - Yes only if the ownership of goods has been transferred to the buyer.

e)

In case of insolvency of a seller can the official receiver or assignee take the possession of
goods from buyer? - Yes, only if the ownership of goods has not been transferred to the
buyer.

3.10.3 Rules regarding Transfer of Property


The rules regarding transfer of property can be classified under the following categories:
a)

In Specific or Ascertained Goods: Specific goods mean goods identified and agreed
upon at the time when a contract of sale is made. 32 The ownership of specific or
ascertained goods is transferred to the buyer at such time as the parties intend it
to be transferred. 33 For the purpose of ascertaining the intention of the parties,
regard shall be had to the terms of the contract, the conduct of the parties, and
the circumstances of the case. However, when the intention of the parties cannot
be judged, the following rules shall apply:
i.

When goods are in a deliverable state.34

ii. When goods have to be put into a deliverable state.35


iii. When the goods have to be measured etc. to ascertain price.36
b)

In Unascertained or Future Goods: Unascertained goods mean goods which have


not been identified and agreed upon at the time when contract of sale is made.
Future goods mean goods to be manufactured or produced or acquired by the
seller after the making of the contract of sale. The ownership of unascertained
goods is transferred to the buyer when the following two conditions are fulfilled:
i.

The goods must have been ascertained.

ii. The goods must have been unconditionally appropriated by the seller or the
buyer with the consent of the other.
c)
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In Goods sent on Approval or on Sale or Return basis: Goods sent on approval

or on sale or return basis mean those goods in respect of which the buyer has
option either to return or retain. The property in such type of goods passes to the
buyer:
i.

Notes

When he signifies his approval or acceptance to the seller or does any other act adopting
the transactions, e.g., uses the goods, pledges the goods, or resells them.

ii. If he does not signify his approval or acceptance to the seller but retains the goods,
without giving notice of rejection, beyond the time fixed for the return of goods, or if no
time is fixed, beyond a reasonable time.

3.11 Performance of a Contract of Sale

Check Your Progress


7.

Why is Transfer of
Property important?

8.

Can the Transfer of


Property happen
before the actual/
physical delivery of
goods?

9.

When the seller is


bound to make a
delivery?

3.11.1 Duty of the Seller and the Buyer


It is the duty of the seller to deliver the goods and of the buyer to accept and pay for them, in
accordance with the terms of the contract of sale.37 Buyers and sellers are free to provide any terms
they like, about the time, place and the manner and acceptance of delivery of goods and payment of
the price.

3.11.2 Delivery

10. Who bears the


expense of the
delivery?

Delivery means voluntary transfer of possession of goods from one person to another.38 Delivery
should have the effect of putting the buyer in possession of the goods so that he may acquire the
position of exercising some degree of control over the goods, directly or through any of his
representatives.

3.11.2.1 Modes of Delivery


Delivery of goods may be:
a)

Actual Delivery: Where the goods are physically handed over by the seller or his authorized
agent to the buyer.

b)

Symbolic Delivery: Where the goods are bulky and incapable of actual delivery. Delivering
of key of the warehouse, bill of lading, railway receipt etc. are the examples of symbolic
delivery.

c)

Constructive Delivery: Where a third person in possession of goods acknowledges to hold


goods on behalf of and at the disposal of the buyer, the delivery is constructive.

3.11.2.2 Rules Regarding Delivery


a)

Delivery May be Either Actual or Symbolic or Constructive: Delivery of goods sold may be
made by doing anything which the parties agree shall be treated as delivery. The seller need
not be the owner of the goods. To constitute delivery to the buyer, he himself may not be in
actual possession of the goods.39

b)

Delivery and Payment are Concurrent: Unless otherwise agreed, delivery of goods and
payment of the price are concurrent conditions. The seller shall be ready and willing to give
possession of the goods to the buyer in exchange for the price and buyer shall be ready and
willing to pay the price in exchange for possession of the goods.40

c)

Delivery to be Made to Buyer: Delivery of goods sold has the effect of putting the goods in
possession of the buyer or of any person authorized to hold them on his behalf.41

d)

Part Delivery: Delivery of part of the goods, in progress of delivery of the whole amounts to
delivery of the whole, if there is no intention of severing of such part from the whole.42
Self-Learning Material 65

Notes

e)

Buyer to Apply for Delivery: Seller of goods is not bound to deliver the goods until the
buyer applies for delivery thereof.43

f)

Mode of Delivery: Mode of delivery depends on the contract between the parties whether it
is for the buyer to take possession of the goods or for the seller to send them to the buyer is
a question depending in each case on the contract, express or implied, between the parties.44

g)

Place of Delivery: Apart from such a contract:


i.

Goods sold are to be delivered at the place at which they are at the time of
sale.

ii. Goods agreed to be sold are to be delivered at the place at which they are at the
time of the agreement to sell.
iii. Goods not then in existence are to be delivered at the place at which they are
manufactured or produced.45
h)

Time of Delivery: Where no time for sending the goods is fixed the seller is bound to send
them within a reasonable time.46 It implies that where time is fixed, the seller must send the
goods in time. If the delivery is to be done as and when required, demand for delivery must
be made at a reasonable time.

i)

Demand at Reasonable Hour: Demand for or tender of delivery must be made at a reasonable
hour. What is a reasonable hour is a question of fact.47

j)

Goods in Possession of Third Person: Where the goods at the time of sale are in possession
of a third person, delivery to the buyer is only effected when such third person acknowledges
to the buyer that he holds the goods on his behalf.48

k)

Expenses: Expenses of and incidental to delivery are as a general rule to be borne by the
seller. The parties may however, agree otherwise.49

l)

Instalment Delivery: Buyer of goods is not bound to accept delivery thereof by instalments
unless otherwise agreed.50 An agreement for delivery by instalments is made either expressly;
or inferred from circumstances or from the conduct of the parties.

m)

Goods Delivered at Distant Place: Where the seller of goods agrees to deliver the goods at
his own risk at a place other than that where they are when sold, the buyer shall unless
otherwise agreed, take any risk of deterioration in the goods necessarily incidental to the
course of transit.51 The necessary deterioration of merchantable quality of goods is on the
buyer, even if the seller agrees to deliver the goods at his own risk.

3.11.2.3 Delivery of Wrong Quality52


Wrong quantity may be either short delivery, excess delivery or mixed delivery.
a)

In Case of Short Delivery: The buyer may reject the goods delivered. If he accepts, he must
pay for them.

b)

In Case of Excess Delivery: The buyer may accept the goods included in the contract and
reject the rest or he may reject the whole. If he accepts the whole, he must pay for them.

c)

Where the Seller Mixes his Goods with the Buyers Goods: The buyer may accept the goods
which are in accordance with the contract and reject the rest or he may reject the whole.

3.11.2.4 Acceptance of Delivery53


a)

66 Self-Learning Material

Acceptance of Delivery by the Buyer: In order that the delivery of goods may constitute a
valid acceptance, the buyer must have a reasonable opportunity of examining them. The
buyer is deemed to have accepted the goods when he intimates so to the seller or he acts in
a manner which is inconsistent with the ownership of the seller or retains the goods without
intimating to the seller that he has rejected them. The buyer is not bound to return the rejected

goods. The following rules are relevant:


Rule 1: Examining Goods: The buyer is not deemed to have accepted the goods unless and
until he has had a reasonable opportunity of examining them, for the purpose of ascertaining
whether they are in conformity with the contract. When the seller tenders delivery of goods
to the buyer he is bound on request to afford the buyer a reasonable opportunity of examining
the goods. Right of inspection may be waived by agreement between the parties.54
Rule 2: When Accepted?: The buyer is deemed to have accepted the goods when:
i.

Notes

Check Your Progress

He intimates to the seller that he has accepted them; or

ii. Where goods have been delivered to him and he does any act in relation to
the goods which is inconsistent with the ownership of the seller, for example,
he pledges the goods, or sends the goods to his sub-purchaser or when he resells them.
iii. When after the lapse of a reasonable time, he retains the goods without
intimating to the seller that he has rejected them. The buyer after direct or
indirect acceptance cannot reject the goods. He may be however, entitled to
damages.55
Rule 3: Buyer not Bound to Return the Rejected Goods: Unless otherwise agreed where
goods are delivered to the buyer and he refuses to accept them he is not bound to return the
rejected goods to the seller. Mere intimation to the seller that he refuses to accept is sufficient.
The goods are then at the sellers risk.56

11. What should be done,


when the buyer wants
delivery in
installments?
12. Shall the buyer return
the rejected goods?
13. What right does a
buyer has in case of
breach of contract?

3.11.2.5 Buyers Liability for Rejecting, Neglecting or Refusing Delivery of


the Goods
Where the seller is ready and willing to deliver the goods and requests the buyer to take delivery,
and the buyer does not take delivery of the goods within a reasonable time after such request, he is
liable to the seller for:
a)

Any loss occasioned by his neglect or refusal to take delivery; and

b)

A reasonable charge for the care and custody of the goods.

Provided that where the neglect or refusal of the buyer to take delivery amounts to a repudiation of
the contract, the seller may sue for the price or for damages.57

3.11.3 Rights and Duties of the Buyer


a)

Rights
i.

To receive delivery of the goods.

ii. To repudiate the contract if the seller commits breach of contract.


iii. To have reasonable opportunity to examine the goods.
iv. To sue the seller for damages for non-delivery of the goods.
v.

To recover the amount paid if the seller fails to deliver the goods.

vi. To sue the seller for specific performance of the contract.


vii. To sue seller for damages for breach of warranty.
viii. In case of breach of contract by the seller, when the buyer sues for the refund of
the price, the buyer has a right to claim interest on the amount of price paid
from the date on which the payment was made.
b)

Duties
i.

To pay for the goods and take delivery thereof.


Self-Learning Material 67

ii. To apply for the delivery of goods as the seller is not bound to deliver the goods
until the buyer applies for delivery.

Notes

iii. To compensate the seller for any loss occasioned by his neglect or refusal to
take delivery of the goods and also for reasonable charge for care and custody of
the goods.

3.11.4 Rights and Duties of the Seller


a)

Rights
i.

To receive the price of the goods.

ii.

To receive compensation or sue for damages for any loss occasioned by him by
neglect or refusal of the buyer to take delivery of the goods.

iii.

To receive reasonable charge for care and custody of the goods.

iv.

If he is unpaid seller then to exercise his right of lien, to exercise his right of
stoppage in transit; and to exercise his right of resale.

v.

To sue the buyer for damages for wrongfully neglecting or refusing to accept the
goods.

vi.

To recover interest from the buyer if there is specific agreement to that effect or
charge interest on the price when it becomes due.

vii. To sue for the price of the goods.


viii. To sue for damages on buyer repudiating the contract.
b)

Duties
i.

To deliver the goods when buyer demands the delivery thereof.

ii.

To compensate the buyer in case he repudiates the contract or commits breach of


the contract.

iii.

To give reasonable opportunity to the buyer to examine the goods.

iv.

To refund the amount paid by the buyer in case he fails to deliver the goods.

v.

To compensate the buyer in case of delivery of wrong quantity.

3.12 Delivery to Carrier or Wharfinger58


a)

Delivery of the goods by the seller to a carrier for purpose of transmission whether named
by the buyer or not or wharfinger for safe custody, prima facie constitutes delivery of the
goods to the buyer.

b)

The seller shall make such a contract on behalf of the buyer that the delivery must make
carrier or wharfinger responsible for the goods. If the seller omits to do so, and if the goods
are lost or damaged the buyer may decline to treat the delivery or may hold the seller
responsible for damages.

c)

Where goods are sent by seller to the buyer by a route involving sea transit, the seller shall
give such notice to the buyer as may enable him to insure the goods during sea transit. If the
seller fails to do so, the goods shall be deemed to be at the sellers risk during such sea
transit.

3.13 Carriage by Sea

68 Self-Learning Material

In case of sea transit, the duty of insuring the goods is thrown on the buyer. There are three common
types of contracts as regards carriage by sea, i.e. when the seller sends goods to the buyer involving
sea transit.

a)

C.I.F. Contracts: It means Cost-Insurance-Freight. C.I.F. contract includes the price of


the goods, cost of insurance and freight charges. The seller agrees to sell the goods inclusive
of the cost of the goods, its insurance and freight charges. In C.I.F. contract buyer cannot
insist on actual delivery of goods. Mere tender of shipping documents through a bank is
sufficient performance on part of seller to entitle him to claim payment. As the buyer pays
for the documents, he is not allowed inspection of the goods. However, in case of loss or
damage to the goods in the course of transit, the buyer can recover the damages from the
insurance or shipping company. In the C.I.F. contract, if there is a breach of contract or if the
goods are not according to the specifications, the buyer may reject the goods and recover the
price paid by him.

b)

F.O.B. Contract: F.O.B means Free on Board. The seller puts the goods on board at his
own expense. No sooner the goods are placed on the board, the sellers liability ceases, and
the buyers liability begins. The buyer is responsible to pay freight and also insurance charges
and other expenses. The seller pays cost of loading and other expenses for placing the goods
on ship. The seller gives the notice of the shipment to the buyer to enable him to insure the
goods. Failure to give notice makes the seller liable for risk, unless the buyer waives the
notice. The buyer must name the ship on which the goods are to be delivered, or he must
authorize the seller to select the ship, failing which the seller can sue for damages for nonacceptance.

c)

Ex-Ship Contracts: By ex-ship contract, the seller does not merely ship the goods, but he
has to deliver the goods to the buyer after the arrival of the ship on the port of delivery to
buyers place where the goods are to be delivered at his own expense. The seller has to pay
the freight. The property in the goods passes to the buyer only when the goods are delivered
to him. The goods are at the sellers risk during the voyage.

Notes

3.14 Unpaid Seller


3.14.1 Who is an Unpaid Seller?
The seller of goods is deemed to be an unpaid seller
a)

When the whole of the price has not been paid or tendered.

b)

Where a bill of exchange or other negotiable instrument has been received as a conditional
precedent, i.e. subject to the realization thereof, and the same has been dishonoured.59

3.14.2 Characteristics of an Unpaid Seller


Check Your Progress
The following characteristics of an unpaid seller should be there:
a)

He must sell goods on cash terms and not on credit, and he must be unpaid.

b)

He must be unpaid either wholly or partly.

c)

He must not refuse to accept payment when tendered.

3.14.3 Rights of Unpaid Seller


The rights of an unpaid seller can be studied under two heads:
a)

When the Property in the Goods Has Passed to the Buyer: The Act lays down that
notwithstanding that the property in the goods may have passed to the buyer,
the unpaid seller of goods, as such has by implication of law:
i.

A lien on the goods for the price while he is in possession of them.

14. What are FOB and


CIF contracts?
15. What are Ex-ship
contracts?
16. Describe
characteristics of an
unpaid seller.
17. How auction sales
are completed?
18. Once the bidding is
made, can it be
revoked? If yes, then
how?

Self-Learning Material 69

ii. In case of the insolvency of the buyer a right of stopping the goods in transit after
he has parted with the possession of them.

Notes

iii. A right of re-sale.60


b)

When the Property in the Goods has not Passed to the Buyer: Where the property
in the goods has not passed to the buyer, the unpaid seller has in addition to his
other remedies, a right of withholding delivery similar to and co-extensive with
his rights of lien and stoppage in transit where the property has passed to the
buyer. In short, the rights of an unpaid seller are:

Rights of an Unpaid Seller


Where the property in the
goods has not passed

Where the property in the


goods has passed

Lien

Stoppage in
transit

Resale

Withholding
delivery

To sue for price,


damage and
interests

3.15 Auction Sales


In an auction sale, the auctioneer invites bids from prospective purchasers and sells the goods to
the highest bidder. Auction sale is sale for purpose of the Act.62 The Act lays down the following
rules governing the auction sales.63

70 Self-Learning Material

a)

The sale is complete when the auctioneer announces its completion by the fall of the hammer
or in other customary manner.

b)

A bidder is at liberty to withdraw his bid at any time before it is accepted by the auctioneer.

c)

The auctioneer is not bound to sell articles advertised to the highest bidder except when the
sale is with reserve.

d)

The auctioneer is not bound to hold auction on the date of advertisement. His advertisement
is not an offer but a mere invitation.

e)

The auctioneer has the right to make the auction subject to any conditions he likes.

f)

A condition in an auction sale the biddings once made cannot be withdrawn is not
enforceable. The bidding can be withdrawn before acceptance.

g)

In case of goods put up for sale in lots, each lot is prima-facie deemed to be the
subject of a separate contract of sale.

h)

A right to bid may be reserved expressly by or on behalf of the seller. Where


such right is expressly reserved the seller or any person on his behalf may bid at
the auction.

i)

No seller or any person who has advertised can bid at an auction sale, unless the
right is expressly reserved and notified, otherwise, any such sale may be treated
as fraudulent by the buyer.

j)

Agreements not to bid against each other are called Knockout Agreements and they are
not unlawful. The seller may protect himself by a reserve bid.

k)

If the seller makes use of pretended bidding to raise the price, the sale is voidable at the
option of the buyer.

l)

The sale may be notified subject to a reserve or upset price, i.e. there may be a price below

which the goods will not be sold. The reserve price may be kept a secret.
m)

Where the auctioneer discloses the fact that he is acting as an agent, but does not disclose the
name of his principal and sells specific goods, the principals title to the goods is not lost.

n)

If the sale is through the court, it would be subject to the confirmation of the court.

Notes

Summary
Contract of Sale
A contract of sale of goods is a contract whereby the seller transfers or agrees to transfer the
property in goods to the buyer for a price. Goods here means only movable goods. Price must be
expressed in money.

Sale and Agreement to Sell


In a sale the property in the goods is transferred from the seller to the buyer. In an agreement to sell,
the transfer of the property in the goods is to take place at a future time or subject to some condition
thereafter to be fulfilled. An agreement to sell becomes a sale when the time elapses or the conditions
are fulfilled subject to which the property in the goods is to be transferred.

How a Contract of Sale is Made?


A contract of sale may be made in writing or orally or partly in writing and partly orally or may be
implied from the conduct of the parties. There must be an offer to buy or sell goods for a price and
acceptance of such offer. It may provide for the immediate delivery of the goods or immediate
payment of the price or both, or for the delivery or payment by instalments or that both is done at
a future date. It may be for existing or future goods.

What is a Stipulation?
A Stipulation in a contract of sale with reference to goods which are the subject thereof may be a
Condition or a Warranty.

What is a Condition?
A Condition is a stipulation essential to the main purpose of the contract. Its breach gives a right to
the buyer to repudiate the contract.

What is a Warranty?
A Warranty is a stipulation collateral to the main purpose of the contract. Its breach gives rise to a
claim for damages but not a right to treat the contract as repudiated.

Express and Implied Conditions and Warranties


In a Contract of sale, conditions and warranties may be express or implied. They are express when
they are mentioned in the contract by the parties. Implied conditions and warranties are those
which are implied by law unless the parties stipulate to the contrary.

Self-Learning Material 71

Implied Conditions
Notes

These are conditions. 1. as to title 2. a sale by description 3. in a sale by sample 4. in a sale by


sample as well as description 5. as to fitness or quality 6. to merchantability 7. as to wholesomeness.

Implied Warranties
In a contract of sale, unless there is a contrary intention, there is an impled warranty that 1. the
buyer shall have and enjoy quiet possession of the goods 2. the goods are free from any charge or
encumberances 3. that the seller will disclose the dangerous nature of goods to the ignorant buyer.

What is Caveat Emptor?


This means let the buyer be aware. The doctrine of Caveat Emptor does not apply 1. When there
is custom or usage of trade 2. When there is a fraud by the seller 3. When the buyer intimates the
purpose to the seller and depends upon his skill or judgement 4. In case of implied conditions and
warranties.

Rules for Transfer of Property


Rules for ascertaining when the property in goods passes to the buyer are the following:
1.

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

2.

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.
To ascertain the intention of the parties, relevant issues are; terms of the contract, the conduct
of the parties and the circumstances of the following rules will be relevant.

a)

Specific Goods: 1. When goods are in a deliverable state 2. If the seller has to do something
to make goods deliverable, then when the seller has done such thing, and notice thereof is
given to the buyer.

b)

Unascertained or Future Goods: If such goods are sold by description, property passes,
when goods according to the description are unconditionally appropriated, and the buyer is
given a notice thereof.

c)

Goods Sent on Approval: In such goods, property passes when the buyer signifies his approval
or acceptance or when he does some act adopting the transaction if he retains the goods
without giving notice of rejection, property passes when the time agreed for returning the
goods expires or a reasonable time has expired.

Duty of Seller and Buyer


Sellers duty is to deliver the goods and the buyers duty is to accept and pay for the goods as per the
terms of the contract of sale.

Delivery of Goods
Delivery means voluntary transfer of possession of goods from the seller to the buyer. It may be
actual, symbolic or constructive.

Rules as to Delivery
1. Unless otherwise agreed, delivery of the goods and payment of the price are concurrent conditions.
72 Self-Learning Material

2. A delivery of part of the goods, in progress, of the delivery of whole, amounts to, for the purpose
of passing the property in such goods, as a delivery of the whole. 3 Apart from any express contract,
the seller of goods is not bound to deliver them until the buyer applies for delivery. 4. The place of
delivery is the place at which they are at the time of the sale. 5. If the goods are in possession of a
third party, there is no delivery until such third party acknowledges to the buyer that he holds the
goods on his behalf. 6. Where the seller is bound to send the goods to the buyer but no time for
sending them is fixed, they must be sent within a reasonable time. 7. Expenses of making delivery
are borne by the seller and expenses of obtaining delivery by the buyer. 8. If the seller sends to the
buyer a larger or a smaller quantity of goods than he ordered, the buyer may a) reject the whole, or
b) accept the whole, or c) accept the quantity he ordered and reject the rest. 9. If the seller delivers,
with the goods ordered, goods of a wrong description, the buyer may accept the goods ordered and
reject the rest or reject the whole. 10. Unless otherwise agreed, the goods are not to be delivered by
instalments.

Notes

Rights of an Unpaid Seller


A seller of goods is deemed to be an unpaid seller - 1. When the whole of the price has not been
paid or tendered 2. When a bill of exchange or other negotiable instrument has been received as a
conditional payment, and the condition on which it was received has not been fulfilled by reason of
the dishonour of the instrument, or otherwise. An unpaid seller has the rights:

1.

As Against the Goods


i.

Right of Lien: It is available to the unpaid seller when a) the goods have been
sold without any stipulation as to credit; b) the goods have been sold on credit,
but the term of the credit has expired; c) the buyer becomes insolvent.

ii. Right of Stoppage in Transit: When the buyer of goods becomes insolvent the
unpaid seller who has parted with the possession of the goods has the right of
stopping them in transit. The seller may resume possession of the goods, as
long as they are in the course of transit and may retain them until payment or
tender of the price. The unpaid seller may exercise this right of stoppage in
transit either by taking actual possession of the goods, or by giving notice of his
claim to the carrier or other bailee in whose possession the goods are.
iii. Right of Re-sale: The unpaid seller can re-sell the goods Where the goods are
of a perishable nature- Where he has exercised his right of lien or stoppage in
transit and given notice to the buyer of his intention to re-sell the goods and
where the buyer has not within a reasonable time paid the price; andWhere
the seller expressly reserves a right of re-sale in case the buyer should make
default.

2.

Right of Withholding Delivery

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 similar to and coextensive with his rights of lien and
stoppage in transit where the property has passed to the buyer.

3.

As Against the Buyer Personally


i.

Suit for Price: Where under a contract of sale the property in the 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, the seller may sue him for the
price of the goods.

ii. Damages for Non-acceptance: Where the buyer wrongfully neglects or refuses
Self-Learning Material 73

to pay for the goods, the seller may sue him for damages for non-acceptance.
iii. Repudiation of Contract Before Due Date: Where the buyer in a contract of sale
repudiates the contract before the date of delivery, the seller may either treat
the contract as subsisting and wait till the date of delivery, or he may treat the
contract as rescinded and sue for damages for the breach.

Notes

iv. Suit for Interest: The seller can recover interest on price from the date on
which the payment became due, if there is a special agreement to that effect.

4.

Auction Sale

A sale by auction is a public sale where different intending buyers try to outbid each other. The
goods are ultimately sold to the highest bidder.

Review Questions
True or False
1.

The consideration for the contract of sale can be partly in money and partly in goods.

2.

A stipulation the breach of which gives the aggrieved party a right to terminate the contract
is called a warranty.

3.

The term property in goods and possession of goods means the same thing.

4.

The property in goods passes only when the goods are delivered.

5.

When the goods are sent on sale or return basis, the property in goods passes when the buyer
retains the goods beyond a reasonable time.

6.

Generally, risk follows ownership whether the goods have been delivered or not and whether
price has been paid or not.

7.

An unpaid seller is bound to resell the goods.

8.

In a contract of sale of goods, if goods are destroyed while still in the possession of the
seller, the loss falls on the seller.

9.

In a contract of sale by sample, the bulk of goods supplied may not correspond with sample.

10.

Stipulations relating to time of payment are not of the essence of a contract of sale.

Practical Problems
Attempt the following problems giving reasons:

74 Self-Learning Material

1.

A sold 100 tons of groundnut oil to B. Before it could be delivered to B, the government
requisitioned the whole quantity of A in public interest. Can B sue A for breach of Contract?

2.

Soda Water was supplied by S to B in bottles. B was injured by the bursting of one of the
bottles. Can B claim damages from S?

3.

A contracts to sell B a piece of silk. B thinks that it is Indian silk. A knows that B thinks so
but knows that it is not Indian silk. A does not correct Bs impression. B later discovers that
it is not Indian silk and wants to repudiate the contract. Can he do so?

4.

A purchases a television from B on Bs plea that though it is old, it is in an excellent condition.


A finds later on that the television set does not work at all. Can he reject the set and recover
his money?

5.

A sells goods to B. B pays to A through a cheque. Before B could obtain the delivery of
goods, his cheque is dishonoured by the bank. A, therefore, refuses to deliver the goods until
paid. Is As action justified?

Practical Problems
1.

B cannot sue A for breach of contract as the contract becomes void because of supervening
impossibility.

2.

B can claim damages from S for the injury as the bottle is not of merchantable quality and
there is a sale of goods by description.

3.

No, B cannot repudiate the contract, the rule of Caveat Emptor will apply here.

4.

This is a contract of sale by description. B described the T.V. to be in excellent condition


whereas it was not. Thus, A can reject the T.V. set and recover his money.

5.

Yes, here A is an Unpaid Seller and under the Sale of Goods Act (section 47) can exercise
his right of lien over the goods.

Notes

Test Questions
1.

Explain Sale and give essential elements of a contract of sale.

2.

Differentiate between a) Sale and Hire Purchase Agreement. b) Sale and Agreement to
sell.

3.

Explain the terms Condition and Warranty and distinguish them.

4.

What are Implied Conditions and Implied Warranties?

5.

What is meant by Caveat Emptor? In what circumstances the doctrine does not apply?

6.

Explain the rules governing passing of property.

7.

Delivery does not amount to acceptance of goods. Discuss when a buyer can be said to
have accepted the goods.

8.

Explain rights and duties of the buyer and the seller.

9.

Define Unpaid Seller. What are the rights of an unpaid seller over the goods sold by him?

10.

Write Short notes on: a) Carriage by sea. b) Auction sale.

11.

Define the term goods. What are the different types of goods?

12.

In a contract for the sale of goods there is no implied condition or warranty as to the quality
of the goods or their fitness for any oparticular purpose. Comment.

13.

In a contract for the sale of goods, state when a) the property, b) the risk, in the goods sold
passes from the seller to the buyer.

14.

Summarise the provisions of the Sale of Goods Act in regard to the passing of property in a)
ascertained goods, b) unascertained goods, c) goods sold on approval or on sale or return.

15.

The right or stoppage in transit is an extension of an unpaid sellers right of lien. Comment.

16.

State the rules gegarding sale by auction.

Answers to True or False


1. True 2. False
9. False 10. True

3. False

4. False

5. True

6. True

7. False 8. False

Answers to Check Your Progress


Following are the answers to Check Your Progress, indicating respective paragraphs for reference.
1) 3.3.2 2) 3.3.4 3) 3.5 & 3.5.1 4) 3.8.1 5) 3.9.1 6) 3.8.5 7) 3.10.2 8) 3.10.3 9) 3.11.2.2 10)
3.11.2.2.k 11) 3.11.2.2./ 12) 3.11.2.4.a rule 3 13) 3.11.3 14) 3.13.a.b 15) 3.13.c 16) 3.14.2 17) 3.15
18) 3.15.b
Self-Learning Material 75

References
Notes

76 Self-Learning Material

Section 3
Section 4 (1)
3
Section 2 (11)
4
Section 2 (7)
5
Rash Behari v. Emperor. A.I.R. (1936). Cal.
753
6
Section 2 (10)
7
Section 4 (3)
8
note 7 ibid
9
Section 5
10
note 9 ibid
11
Section 12 (1)
12
Section 12 (2)
13
Section 12 (3)
14
Section 12 (4)
15
Section 14 (a)
16
Rowland v. Divall. (1923), 2 K.B. 500.
17
Section 15
18
Section 17
19
note 17 ibid
20
Nichol v. Godts. (1854), 10 Ex. 191.
21
Section 16 (1)
22
Priest v. Last. (1903), 2 K.B. 148.
23
Section 16 (2)
24
Grant v. Australian Knitting Mills Ltd.
(1936), A.C. 85.
25
Wren v. Halt. (1903), 1, K.B. 610.
26
Section 14 (b)
27
Mason v. Burmingham (1949), 2 K.B.
545.
28
Section 14 (c)
29
Clarke v. Army and Navy Cooperative
Society Ltd. (1903), 1 K.B. 155.
30
Section 16
31
Ward v. Hobbs. (1878), 4 A.C. 13.
32
Section 2 (14)
33
Secton 19 (1)
34
Section 20
35
Section 21
36
Section 22
37
Section 31
38
Section 2 (2)
39
Section 33
40
Section 32
41
note 33 ibid
42
Section 34
43
Section 35
44
Section 36 (1)
45
note 44 ibid
46
Section 35 (2)
47
Section 36 (4)
48
Section 36 (3)
49
Section 36 (5)
50
Section 38 (1)
51
Section 40
52
Section 37
53
Sections 41 to 43
54
Section 41
1

55

56

Section 42
Section 43
57
Section 44
58
Section 39
59
Section 45 (1)
60
Section 46 (1)
61
Section 46 (2)
62
Loon Karan Sethia and ors. v. Ivan E. John
and ors. - AIR 1973 SC 376.
63
Section 64

Law Relating to
Negotiable Instruments
Notes

Section

4
Money speaks sense in a language all nations understand.
Aphra Behn
STRUCTURE
4.1

Introduction

4.2

What is a Negotiable Instrument?

4.3

Characteristics of Negotiable Instruments.

4.4

Laws of Negotiable Instruments.

4.5

Presumptions as to Negotiable Instruments

4.6

Promissory Note.

4.7

Bill of Exchange.

4.8

Cheque.

4.9

Negotiation.

4.10 Parties to Negotiable Instruments.


4.11 Endorsement.

Self-Learning Material 77

4.1 Introduction
Notes

Money is the most common medium of exchange in any advanced society. The reason for this is
that money has the exchange value and is also freely transferable. In trade and commerce the use of
ready cash is desirable, because of its acceptability, but it may cause inconvenience and risk. The
need for some safe and effective substitute for money lead to the development of the use of negotiable
instrument.The law relating to negotiable Instruments is contained in the Negotiable Instruments
Act, 1881 (in short the Act). It came into force on 01-03-1882. It extends to the whole of India.

4.2 What is a Negotiable Instrument?


The term negotiable instrument consists of two words negotiable and instrument.
The word negotiable means transferable by delivery or by endorsement and delivery and the
word instrument means a written document by which a right is created in favour of some person
or entity. Thus, the term negotiable instrument literally means a written document transferable
by delivery. According to the Act, A negotiable instrument means a promissory note, bill of
exchange or cheque payable either to order or to bearer.1 Judge Wills defines a negotiable instrument
as One, the property in which is acquired by anyone who takes it bonafide for value, not withstanding
any defect of title in the person from whom he took it.

4.3 Characteristics of a Negotiable Instrument


An instrument must possess the following characteristics in order to be treated as a negotiable
instrument: In writing, Signed by the maker/drawer, Promise or order to pay, Promise/order must
be unconditional, and Payment in money. For a certain sum, payable at a time certain to arrive,
drawee must be named or described with reasonable certainty.

4.4 Kinds of Negotiable Instruments


Negotiable Instruments may be of two kinds:
a)

Negotiable by Statute: The Act mentions only three kinds of instruments, i.e. Promissory
note, Bill of Exchange and Cheque (These are discussed in paragraphs 4.6, 4.7 and 4.8 ).

b)

Negotiable by Custom or Usage: Though the Act speaks of only three kinds of negotiable
instruments, it does not mean that there cannot be any other negotiable instruments.
For Example: hundis, treasury bills, bankers draft, share warrants, bearer warrants, bearer
debentures, etc. are negotiable instruments recognized by the custom, or usage or the
Companies Act. Money orders, Postal orders, Deposit receipts, Bills of lading, Railway
receipts, Dock warrants, etc. are not negotiable instruments. These documents are transferable
by delivery and endorsement, they cannot give a better title to the transferee.

4.5 Presumptions as to Negotiable Instruments


The Act2 provides the following presumptions as to negotiable instruments:

78 Self-Learning Material

a)

Consideration: Every negotiable instrument was made or drawn, accepted, endorsed,


negotiated for consideration.

b)

Date: Every negotiable instrument was made or drawn on the date it bears.

c)

Time of Acceptance: Every accepted bill was accepted within a reasonable time after its date
and before its maturity.

d)

Transfer: Every transfer of a negotiable instrument was made before its maturity.

e)

Order of Endorsement: The endorsements on a negotiable instrument were made in the


order in which they appear.

f)

Stamping: A lost promissory note or bill of exchange was duly stamped.

g)

Holder in Due Course: The holder of a negotiable instrument is a holder in due course.

h)

Proof of Protest: In a suit upon an instrument which has been dishonoured,


the court shall, on proof of protest, presume the fact of dishonour, unless and
until such fact is disproved, i.e. counter evidence.

Notes

The above presumptions are rebuttable by evidence to the contrary. Moreover, these presumptions
would not arise if an instrument has been obtained by means of fraud (or) for unlawful consideration.

4.6

Promissory Note

4.6.1 Definition
According to the Act, A promissory note is 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.3 Bank
notes and currency notes are not treated as promissory notes. The words or to the bearer of the
instrument in the definition of the promissory note are inoperative in view of the provisions of the
Reserve Bank of India Act, which prohibits the issue of a promissory note payable to bearer by
anybody other than the Reserve Bank of India4 and the Central Government of India.

4.6.2 Essentials of a Promissory Note


From the definition given in the Act, it follows that to be a valid promissory note, an instrument
must fulfill the following essential requirements:
a)

It must be in writing.

b)

It must contain a promise or undertaking to pay.

c)

The promise to pay must be unconditional.

d)

It must be signed by the maker.

e)

The maker must be a certain person.

f)

The payee must be certain.

g)

The sum payable must be certain.

h)

The amount payable must be in legal tender money of India.

i)

Other formalities like proper stamping should be there.

4.6.3 Illustrations
S. No.

Instrument

Check Your Progress


Remarks

1.

I owe B Rs. 500.

Acknowledges debt but no promise


to pay.

2.

I am liable to pay X Rs. 1000.

Acknowledges debt but no promise to


pay.

3.

I have borrowed Rs. 2000 from Y.

Acknowledges debt but no promise to


pay.

1. What is a Negotiable
Instrument?
2. How many types of
negotiable instruments
are there?
3. What is a
Promissory Note?

Self-Learning Material 79

S. No.
Notes

Remarks

4.

I promise to pay B Rs. 1000 after


receiving money from Y.

Promise to pay is contingent on


other factors. It is conditional
promise to pay.

5.

I promise to pay B Rs. 1000 as soon


as I am able to.

Promise to pay is contingent on


other factors. It is a conditional
promise to pay.

6.

I promise to pay B Rs. 1000 after his


successful completion of studies.

Promise to pay is contingent on


other factors. It is a conditional
promise to pay.

7.

I promise to pay B Rs. 500 and other


charges.

The payable sum is uncertain.

8.

I promise to pay Rs. 500 but after


deducting money owed by him.

The payable sum is uncertain.

9.

I promise to pay B or
his orders Rs. 500.

The payable sum is certain and it is


a promissory note.

I acknowledge myself to be indebted


to B in Rs. 1000 to be paid on
demand, for value received.

This instrument is a promissory


note.

10.

4.6.4

4.7

Instrument

Specimen of a Promissory Note

Bill of Exchange

4.7.1 Definition
According to the Act, A bill of exchange is 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.
80 Self-Learning Material

4.7.2 Parties to a Bill of Exchange


Notes

There are three parties to a bill of exchange as under:


a)

Drawer - The person who draws a bill of exchange.

b)

Drawee - The person on whom the bill of exchange is drawn. He is also called as an acceptor
of the bill.

Check Your Progress

c)

Payee - The person named in the instrument to whom or to whose order the money is directed
to be paid by the instrument.

4. What is a Bill of

4.7.3 Distinction Between Bill and Promissory Note

S. No. Point of
Distinction

Bill of Exchange

Exchange?
5. Who are the parties to
a Bill of Exchange?

Promisory Note
(Pro-note)

1.

Numbers of
parties

There are three parties in the


case of a bill of exchange, viz.
Drawer, Drawee and Payee, one
person may assume any of the
two capacities out of the three.

There are only two parties to


a pro-note, viz., Maker and
Payee. Hence, it is a two
party paper.

2.

Order and
promise

A bill contains an
unconditional order.

A pro-note contains an
unconditional undertaking or
promise.

3.

Nature of
relationship

A bill arises usually upon the


basis of a creditor-debtor
relationship, i.e the drawer of a
bill is the creditor and the
drawee is the debtor.

A pro-note is based on a
debtor creditor relationship,
i.e. the maker of a pro-note is
debtor and the payee is
creditor.

4.

Acceptacne

A bill needs to be accepted to


make it valid. The drawee puts
his signature as acceptor (Bills
payable on demand do not
require acceptance).

No such acceptance is
required, a pro-note is signed
by the maker only.

5.

Nature of
liability

The liability of the drawer of a


bill is secondary and
conditional. The drawee or the
acceptor is primarily liable.

The liability of the maker of


a pro-note is primary and
absolute because he himself
is the main debtor.

6.

Immediate
relation

The drawer (maker) of an


acceptance bill stands in
immediate relation with the
acceptor and the payee.

The maker of a note stands


in immdiate relation with
the payee.

7.

Notice to
prior
parties

When a bill is dishonoured


either by non-payment, due
notice of dishonour must be
given by the holder to all prior
parties (including drawer and
intermediate endorsers).

Notice of dishonour need not


be given to the maker of a
pro-note.

Self-Learning Material 81

Notes

S. No. Point of
Distinction

Bill of Exchange

Promisory Note
(Pro-note)

8.

Sets

Foreign bills are drawn in


sets (of three or four).

Pro-notes are not so drawn.

9.

Protest

Foreign bills must be


protested for dishonour when
such protest is required by
the law of the place where
they are drawn.

No such protest for


dishonour is required for
foreign pro-notes.

10.

Conditional
acceptance

A bill may be accepted


conditionally.

The maker of the pro-note


cannot attach any such
condition to it.

11.

Acceptor for
honour

The acceptor for honour can


even make the payment of a
bill.

It cannot be paid for honour.

12.

Payable to the
maker himself

A bill may be payable to the


maker (drawer) himself when
the drawer and the payee are
one and the same person.

A not cannot be made


payable to the market
himself.

4.7.4 Specimen of a Bill of Exchange

4.8 Cheque
4.8.1 Definition
According to the Act A cheque is 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 the electronic form.5

Explanation I For the purposes of this section, the expressions:


82 Self-Learning Material

a)

a cheque in the 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 biometrics signature) and
asymmetric crypto system;

b)

Notes

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 the cheque in writing.

Explanation II For the purposes 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
Reserve Bank of India.

4.8.2 Distinction Between Cheque and Bill of Exchange


A cheque can be distinguished from a bill of exchange as shown below:

S. No. Point of
Distinction

Cheque

Bill of Exchange

1.

Drawee
demand

A cheque is always drawn on


a specified banker only.

A bill may be drawn on any


one including a banker.

2.

Payable on
demand

A cheque is always payable


on demand and may be made
payable to bearer or order.

A bill may be drawn payable


on demand or on the expiry
of a certain period after date
or sight.

3.

Payable to the
bearer on
demand

A cheque is always payable


on demand and may be made
payable to bearer or order.

A bill cannot be drawn


payable to the bearer on
demand.

4.

Acceptance

A cheque requires no
acceptance.

A bill must be accepted


before payment can be
claimed.

5.

Days of grace

No days of grace are allowed.

In the case of time bills three


days of grace are allowed
from the due date for
calculating the maturity of
the bill.

6.

Supposition

It is presumed that the


customer is having an
account with sufficient credit
balance or credit
arrangement.

In case of a bill, there is no


such presumption.

7.

Crossing

A cheque can be crossed


either generally or specially.

A bill cannot be crossed.

8.

Stamping

A cheque does not require


any stamp.

A bill must be properly


stamped (except in the case
of demand bills).

Self-Learning Material 83

Notes

S. No. Point of
Distinction

Cheque

Bill of Exchange

Countermanding

A payment of a cheque can be


countermanded by the
drawer.

The payment of a bill cannot


be countermanded by the
drawer.

10.

Circulation

A cheque is not intended for


circulation but for immediate
payment.

A bill can be discounted and


rediscounted with the banks.

11.

Discounting

A cheque is not generally


discounted.

A bill can be discounted and


rediscounted with the bank.

12.

Failure to
present

If the cheque is not presented


for payment on the due date,
the drawer is not discharged
from liability unless he
suffers any damages by delay
in presentment, e.g. the
liquidation of the bank.

The drawer of a bill is


discharged if it is not duly
presented to the acceptor for
payment or else.

13.

Primary
liability

The drawer of chequie is


primarily liable for payment.

The drawee or the acceptor of


a bill is primarily liable for
it.

14.

Statutory
protection

The banker is protected if he


pays a cheque under a forged
endorsement.

The drawee of a bill has no


such protection.

15.

Noting and
protesting

A cheque need not be noted


and protested when
dishonoured.

A Bill must be noted and


protested when it is
dishonoured.

16.

Sets

Cheques are not issued in


sets.

Foreign bills are generally


drawn in sets of three or
four.

9.

4.8.3 Specimen of a Cheque

84 Self-Learning Material

4.8.4 Crossing of Cheque


A crossed cheque is payable only through a collecting banker and not directly at the counter of the
bank. A cheque is said to be crossed when two parallel transverse lines, with or without any
words, are drawn on the left hand top corner of the cheque. There are the following types of
crossing:
a)

General: Where a cheque bears across its face, two parallel transverse lines either with or
without any words, that shall be deemed to be crossed generally. The words used are &
Co. Not negotialbe or a combination of both. Where a cheque is crossed generally, the
banker on whom it is drawn shall not pay it otherwise than to a banker.

b)

Special: Where a cheque bears across its face an addition of the name of a banker, either
with or without the words not negotiable, and company, the cheque is deemed to be
crossed specially. The payment of a specially crossed cheque can be obtained only through
the particular banker whose name appears across the face of the cheque or between the
transverse lines, if any.

c)

Restrictive: In addition to the two statutory types of crossing (general or special) discussed
above, there is another type which has been adopted by commercial and banking usage. In
this type of crossing the words A/c Payee only are added to general or special crossing.
The words A/c Payee only on a cheque are a direction to the collecting banker that the
amount collected on the cheque is to be credited to the account of the payee. A/c payee
cheques are negotiable.

Notes

Not negotiable crossing (Section 130) - The effect of the words not negotiable on a crossed
cheque is that the title of the transferee of such a cheque cannot be better than that of its transferor.
The addition of the words not negotiable does not restrict the further transferability of the cheque.
The object of crossing a cheque not negotiable is to afford protection to the drawer or holder of
the cheque against miscarriage or dishonesty in the course of transit by making it difficult to get
the cheque so crossed cashed, until it reaches its destination. For example: W drew a cheque not
negotiable in bank and handed it to his clerk to fill in the amount and the name of the payee. The
clerk inserted a sum in excess of her authority, and delivered the cheque to P in payment of a debt
of her own. Held, that the clerk had no title to the cheque and as such P had no better title, and
therefore W was not liable.

4.8.5 Bouncing of Cheques


A drawer of a dishonoured (bounced) cheque shall be deemed to have committed an offence. For
this offence, the punishment provided in the Act is imprisonment upto two years or with a fine
which may extend to twice the amount of the cheque or with both provided the following conditions
are fulfilled:
a)

Cheque should have been dishonoured due to insufficiency of funds. The courts
have held the following amounting to dishounour for insufficiency of funds:
i.

Stop-payment instructions to the payee bank.

ii. Request to the payee not to present the cheque till further intimation.

Check Your Progress

iii. Cheque received back from the payee bank with the remarks Account Closed.
However, remarks Refer to Drawer will not constitute dishonour for insufficiency of funds
because a cheque may be referred to a drawer for reasons other than insufficiency of funds.

6 What is a Truncated

b)

The cheque should be presented within its validity.

c)

The cheque was issued for the discharge of legally enforceable debt or other liability (not
for charity or marriage or birthday presents).

d)

The payee is to give notice demanding payment, within thirty days, from the drawer, on
receipt of information of dishonour of cheque from the bank.

Cheque?
7. What is the effect and
type of crossing?
8. What are the rules
for bouncing of
cheque?

Self-Learning Material 85

Notes

e)

The drawer is liable only if he fails to make payment within fifteen days of such notice
period.

f)

A written complaint to a Metropolitan Magistrate or a Judicial Magistrate of the first class


is made within one month of cause of action arising.

4.8.6 Offences by Companies


For the offence of dishonour of cheque for insufficiency of funds in the account (Section 138) by
a company following rules are note-worthy.
a)

The word Company includes a partnership firm, or any other body corporate, or body of
individuals, and director, in relation to a firm means partner in a firm.6

b)

If the offence under section 138 of the Act is committed by a company, then every person,
who at the time when the offence was committed, was in charge of, and was responsible to,
the company for conducting its business, shall be deemed to be guilty as also the company
itself of the offence.7

c)

The persons who are guilty under Section 138 being in charge of the affairs of the company
can escape the liability if they can prove that:
i.

The offence was committed without their knowledge, or

ii. They had exercised due diligence to prevent the commission of such offence.8
d)

The words in charge of the company must mean In overall conduct of the day-to-day
business of the company or the firm.9

e)

In order to proceed against any director, manager, secretary or other officer of the company,
it has got to be proved that the offence has been committed by the company, and such
offence has been committed with the consent, or connivance of or is attributable to the
neglect on the part of any such director, manager, secretary or other officer of the company.10

f)

The company, and the person in charge of or officer of the company may be prosecuted
independently, or jointly.11

Note: The remedy available to the payee (or any other holder) of a cheque dishonoured for the
reasons mentioned in Section 138 of the Act is an additional remedy. Since the amount of the
cheque dishonoured basically constitutes a debt, the holder of the cheque can sue the drawer
under the civil law to claim his debt.

4.9

Negotiation

4.9.1 Definition
According to the 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.12
Thus negotiation implies a transfer of negotiable instrument so as to constitute the transferee a
holder thereof, who should be entitled in his own name to sue on the instrument and recover the
amount due thereon.
Example: Handing over a bearer instrument to a servant for safe keeping is not negotiation.

4.10 Parties to Negotiable Instruments


The parties to negotiable instrument in case of promissory note, bill of exchange and cheque are
stated below:
a)
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Drawer: The maker of a negotiable instrument is called drawer.

b)

Drawee: He is the person on whom the instrument is drawn.

c)

Acceptor: He is a the person who accepts the instrument of bill of exchange. Generally the
drawee becomes the acceptor after accepting the instrument (but sometimes a stranger may
accept on behalf of the drawee).

d)

Payee: Payee is a person to whom the sum stated in the instrument is payable. The drawer
or any other person may also be the payee. In the latter case, he is called Payee for Honour.

e)

Endorser: When the holder endorses the instrument to any one else, he becomes the endorser.

f)

Endorsee: The person to whom the instrument is endorsed is known as endorsee.

g)

Endorsee in Case of Need: The person to whom resort may be had in case of need (In
English law, he is called referee in case of need), i.e. when the bill is dishonoured either by
non-acceptance or by non-payment.

h)

Acceptor for Honour: Further, any person may voluntarily become a party to a
bill as an acceptor. A person who, on refusal by the original drawee to accept the
bill or to furnish better security when demanded by the notary, accepts the bill in
order to safeguard the honour of the drawer or any endorser is called acceptor for
honour.

i)

Holder: According to the Act, The holder of a negotiable instrument means any
person entitled to the possession of the instrument in his own name and to receive
or recover the amount due thereon from the parties thereto. 13 Where the
promissory note, bill of exchange or cheque is lost or destroyed, its holder is the
person so entitled at the time of such loss or destruction.

j)

Holder in Due Course: According to the Act, Holder in due course means any person
who for consideration became the possessor of a promissory note, bill of exchange or
cheque, if payable to the bearer, or the payee or endorsee thereof, if payable to the order,
before the amount mentioned in it became payable, and without having sufficient cause to
believe that any defect existed in the title of the person from whom he derived his title.14
For example: A bank note sent by post was taken and carried away by a robber. The next
day the same note was received by X. He received it for full and valuable consideration and
in the usual course of his business and without any notice of the bank note being taken out
of the mail. The court held him to be a holder in due course.

Notes

4.10.1 Essentials to Become a Holder in Due Course


The essential requirements for attaining the status of a holder in due course are elaborated below:
a)

He must be a holder.

b)

The holder must have paid a valuable consideration.

c)

He must have become the holder of the negotiable instrument before its maturity.

d)

He must take the negotiable instrument complete and regular on the face of it.

e)

The holder must have obtained the instrument without a sufficient cause to believe that any
defect existed in the title of the person from whom he has derived his title (Good faith).

4.10.2 Privileges of a Holder in Due Course


A holder in due course is given certain other privileges under the Act, which are not available to
a holder.
a)

A person, who signed and delivered to another a stamped but otherwise inchoate (incomplete)
instrument, is stopped from asserting, as against a holder in due course, that the instrument
has not been filled in accordance with the authority given by him provided the amount
filled is covered by the stamp affixed.15

Check Your Progress


9.

Who is holder in due


course?

10. What is endorsement?

Self-Learning Material 87

b)

Every prior party to a negotiable instrument, i.e. the maker or drawer, the acceptor, and all
the intermediate endorsers continue to remain liable to the holder in due course until the
instrument is duly satisfied.16

c)

Where a bill of exchange is drawn by a fictitious person and is payable to his order, the
acceptor cannot be relieved from his liability to the holder in due course. The holder in due
course shall, however, have to prove that the instrument was endorsed by the same hand as
the drawers signature.17

d)

Where as instrument is negotiated to a holder in due course, the parties to the instrument
cannot escape liability on the ground that the delivery of the instrument was conditional or
for a special purpose only.18

e)

Not only that the title of the holder in due course is not subject to the defect in previous
holders title but once the instrument passes through the hands of a holder in due course, it
is purged of all defects. Any person acquiring it takes it as free of all defects, unless he was
himself a party to the fraud.19

f)

No maker of a promissory note and no drawer of a bill of exchange or cheque shall in a suit
thereon by a holder in due course, be permitted to deny the validity of the instrument as
originally made or drawn.20

Notes

a.

Estoppel against denying capacity of payee to endorse.21

b.

Defence that instrument is obtained by unlawful means or for unlawful


consideration is not valid against a holder in due course.22

4.11 Endorsement
4.11.1 Definition
When the maker or holder of a negotiable instrument signs the same, otherwise than such a
maker, for the purpose of negotiation, on the back or face thereof or on a slip of paper annexed
thereto, or so signs for the same purpose a stamped paper intended to be completed as a negotiable
instrument, he is said to endorse the same; and is called the endorser.23
The person who signs the instrument with the intention of transferring its ownership to another is
called the endorser and the person in whose favour the instrument is transferred is called the
endorsee and the procedure is called endorsement.

4.11.2 Who may Endorse?


The following persons may endorse a negotiable instrument:
a)

The payee of the instrument.

b)

The holder of instrument.

c)

The maker signing it otherwise as such maker.

d)

Every sole maker, drawer, payee or endorsee or all of several joint makers, drawers, payees
or endorsees of the instrument.

e)

The holder in due course of the instrument.

4.11.3 Types of Endorsement


a)

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Blank or General Endorsement: An endorsement is said to be blank or general when the


endorser merely signs on the back of the instrument without specifying any person to whom
the payment is to be made.

b)

Full or special Endorsement: When an endorser signs his name and also specifies a person
to whom or to whose order the amount of the instrument is to be said the endorsement is
said to be full or special, and the person so specified is called the endorsee of the
instrument.24

c)

Restrictive Endorsement: An endorsement is said to be restrictive when endorser, by express


words, restricts the right of further negotiation of the instrument.

d)

Partial Endorsement: Where only part of the amount of the instrument is transferred, it is
called partial endorsement. A partial endorsement does not operate as a negotiation of the
instrument, e.g. the holder of a promissory note for Rs. 2,000 writes on it, pay B Rs.
1,000 and endorses the note. The endorsement is invalid for the purpose of negotiation.
But where a instrument has been partly paid, it can be negotiated for the balance, provided
the fact of partpayment is noted on the instrument (Section 56).

e)

Conditional or Qualified Endorsement: Where an endorsement limits or negates the liability


of the endorser, it is called qualified endorsement.25 It differs from a restrictive endorsement
which restricts the negotiability of the instrument but does not in any way limit or negate
the liability of the endorser.

f)

San Recourse Endorsement: An endorsement of a negotiable instrument may be express


words in the endorsement exclude his own liability thereon. Such endorsement is called
Endorsement Sans Recourse or without recourse to me. For example, where X endorses
a cheque as: Pay Y or order Sans Recourse or Pay Y order without recourse to me. X
will not be liable on the instrument if it is dishonoured.

g)

Sans Frais: These words, when added at the end of the endorsement, indicate that no
expenses should be incurred on account of the bill.

h)

Faculative Endorsement: Where such words are added to an endorsement whereby


the endorser waives his right to receive notice of dishonour, the endorsement is
termed as Faculative Endorsement.

Notes

Summary
The law relating to negotiable instruments is contained in the Negotiable Instruments Act, 1881.
A negotiable instrument means a promissory note, bill of exchange or cheque payable to order or
to bearer.

Characteristics of a Negotiable Instrument


An instrument in order to be treated as a negotiable instrument must be 1. in writing, 2. signed by
the maker / drawer, 3. a promise or order to pay, 4. Unconditional, 5. payment in money, 6. for a
certain sum, 7. payable at a time certain to arrive and 8. draweee must be named or described with
reasonable certainity.

Presumptions
The presumptions laid down by the Act in favour of negotiable instruments are as to a) consideration,
b) date, c) time of acceptance, d) time of transfer, e) order of endorsement, f) stamping, g) holder
in due course, and h) proof of interest.

Promissory Note
A promissory note is 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.
Self-Learning Material 89

Bill of Exchange
Notes

A bill of exchange is 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.

Cheque
A cheque is 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 the electronic form.

Crossing of Cheque
When a cheque bears across its face two parallel transverse lines, the cheque is said to be crossed.
The payment of a crossed cheque can be obtained only through another banker. The crossing may
be general, special or restrictive.

Bouncing of Cheque
A drawer of a dishonoured cheque is punishable to imprisonment upto two years or with a fine
upto twice the amount of the cheque, if cerain conditions are fulfilled. These conditions are, 1.
Cheque should have been dishonoured due to insufficiency of funds, 2. cheque should be presented
within its validity, 3. Cheque was issued for the discharge of legally enforceable debt or other
liability, 4. Payee is to give notice demanding payment within thirty days of dishonour, 5. Drawer
is allowed to make payment within fifteen days after receiving the notice, and 6. A written complaint
to a Metropolitan Magistrate or a Judicial Magistrate of the first class is made within one month
of cause of action arising. If the cheque issued by a company is dishonoured, then the company
and the person in charge of or officer of the company may be prosecuted independently or jointly.

Negotiation
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.

Holder
The holder of a negotiable instrument means any person entitled to the possession of the instrument
in his own name and to receive or recover the amount due thereon from the parties thereto.

Holder in due Course


Holder in due course means any person who for consideration became the possessor of a promissory
note, bill of exchange or cheque, if payable to the bearer, or the payee or endorse thereof, if
payable to the order, before the amount mentioned in it became payable, and without having
sufficient cause to believe that any defect existed in the title of the person from whom he derived
his title.

Privileges of a holder in due course


He enjoys the following privileges 1. He gets a better title than that of the transfer, 2. Privileges in
case of inchoate stamped instruments upto the value of the stamps fixed, 3. All prior parties are
90 Self-Learning Material

liable to him, 4. Acceptor of a fictitious bill is liable to a holder in due course provided the latter
can show that the first endorsement on the bill and the signature of the supposed drawer are in the
same handwriting, 5. Privilege when an instrument delivered conditionally is negotiated, 6. Estopped
against denying original validity of instrument, 7. Estopped against denying capacity of payee to
endorse.

Notes

Endorsement
When the maker or holder of a negotiable instrument signs the same, ortherwise than such a
maker, for the purpose of negotiation, on the back or face thereof or on a slip of paper annexed
thereto, or so signs for the same purpose a stamped paper intended to be completed as a negotiable
instrument, he is said to endorse the same, and is called the endorser.

Types of Endorsement
1. Blank or general, 2. Full or special, 3. Restrictive, 4. Partial , 5. Conditional or qualified, 6. San
Recourse, 7. Sans Frais, and 8. Faculative.

Review Questions
True or False
1.

If an instrument contains a promise to pay something in addition to money, it can be a


promissory note.

2.

A cheque is a species of bill of exchange.

3.

The payment of a specially crossed cheque can be obtained only by the particular banker
whose name appears between the crossing.

4.

Every prior party to a negotiable instrument is duly liable thereon to a holder in due course
until the instrument is satisfied.

5.

A minor signing a promissory note for necessaries is personally liable.

6.

The liability of the maker of a note is primary and unconditional.

7.

Noting and protesting are compulsory in the case of all bills.

8.

Generally, every holder of a negotiable instrument is presumed by law to be holder in due


course.

9.

A bill of exchange can be drawn upon bank.

10.

All negotiable instruments are entitled to three days of grace.

Practical Problems
1.

Mr. X promises by way of promissory note to pay Y, his partner, a sum of Rs. 10,000 in the
event of Ys retirement from the partnership firm. Is this a valid promissory note.

2.

A signed as maker, a blank stamped paper and gave it to B and authorized him to fill it as a
note for Rs. 500. B fraudulently filled it up as a note for Rs. 1,000 payable to C, who in
good faith advanced Rs. 1,000. Can C recover Rs. 1,000 from A?

3.

A owes Rs. 1,000 to B. A makes a promissory note for the amount payable to B. A dies and
the promissory note was found by his legal heirs, afterwards among his papers, and delivered
to B. Can B sue upon it?

4.

A cheque payable to bearer is crossed generally and is marked not negotiable. The cheque
Self-Learning Material 91

is lost and comes into possession of Ram, who takes it in good faith and for value. Ram
deposits the cheque in his bank account and the banker collects the same. Can Ram be
compelled to return the money to the true owner of the cheque?

Notes
5.

Amit draws a bill of exchange on Shashi. Arun writes an acceptance on it. Is it a valid
acceptance?

Practical Problems
1.

The promise of X is conditional, and hence it cannot be constituted as a valid promissory


note. Further retirement of Y from the partnership firm is not a certain event.

2.

C, being a holder in due course can recover Rs. 1,000 from A provided the stamp covers the
value of Rs. 1,000.

3.

No, B cannot sue upon it because the instrument was not properly negotiated. Delivery is
essential to complete negotiation. The delivery effected by legal heirs of a deceased is not
considered as a good delivery under the Negotiable Instruments Act.

4.

Yes, the true owner can compel Ram to refund money because the cheque bears not
negotiable crossing as a request of which the transferee cannot get a better title than that of
the transferor.

5.

No, a stranger to the bill cannot accept it unless it is done for the honour of the party liable
on the bill after the bill has been noted or protested for non-acceptance.

Test Questions
1.

What is a Negotiable Instrument? Explain its essential characteristics.

2.

What are the presumptions as to negotiable instruments?

3.

Define a Promissory Note. How does it differ from bill of exchange?

4.

What is a bill of exchange? How does it differ from a cheque?

5.

Define a cheque. In what ways a cheque is different from a promissory note?

6.

What is meant by the term crossing a cheque? Explain the different types of crossings.

7.

Discuss the law relating to bouncing of cheques for insufficiency of funds in the account.

8.

Explain briefly what is meant by negotiation.

9.

Explain the terms holder and holder in due course.

10.

A holder in due course gets a title free from equities. Explain the statement and discuss
the various privileges of a holder in due course.

11.

What do you mean by the term Endorsement? What are the types of endorsement?

12.

What are the types of negotiable instruments?

13.

What is a Promissory Note? What are its essential elements?

14.

Why are bills of exchange, promissory notes and cheques called negotiable instruments?

15.

Dishonour of a cheque for want of funds is an offence under the Negotiable Instrument Act.
Do you agree with this statement?

Answers to True or False


1. False 2. True 3. True 4. True 5. False 6. True 7. False 8. True 9. True 10. False

92 Self-Learning Material

Answers to Check Your Progress


Following are the answers to Check Your Progress, indicating respective paragraphs for reference.

Notes

1) 4.2 2) 4.4 3) 4.6.1 4) 4.7.1 5) 4.7.2 6) 4.8.1b 7) 4.8.4 8) 4.8.5 9) 4.10.1 10) 4.11.1

References
1

Section 13 (1). It may be noted that the Act does not give the meaning of the term negotiable
instrument. Rather it enumerates the class of instruments considered as negotiable by the statute.
2

Sections 118 and 119.

Section 4.

Section 31 (2) of the Reserve Bank of India, Act.

Section 6 as amended by the Negotiable Instrument (Amendment and Miscellaneous Provisions)


Act, 2002 (55 of 2002) (w.e.f. 6.2.2003).
6

Explanation to section 141.

Section 141(1).

Proviso to section 141(1).

Supreme Court decision in Girdhari Lal v. D.N. Mehta 1971 SC 2162.

10
11

Section 141(2).

Sheoratan Agarwal v. State of Madhya Pradesh. AIR 1984 n 4 SCC 352.

12

Section 14.

13

Section 8.

14

Section 9.

15

Section 20.

16

Section 36.

17

Section 42.

18

Sections 46 and 47.

19

Section 53.

20

Section 120.

21

Section 121.

22

Section 58.

23

Section 15.

24

Section 16.

25

Section 52.

Self-Learning Material 93

Notes

94 Self-Learning Material

Consumer Protection Act


1986
Notes

Section

5
Dont
organise.
Moneyagonise;
speaks sense
in a language all nations understand.
FlorynceAphra
R. Kennedy
Behn
STRUCTURE
5.1

Introduction

5.2

Objects of the Act

5.3

Meaning of Some Important and Relevant Terms

5.4

Consumer Disputes Redressal Agencies

5.5

Manner of Making a Complaint

5.6

Procedure on Admission of Complaint

5.7

Findings

5.8

Miscellaneous

5.9

Some Decisions of National Commission / Supreme Court

Self-Learning Material 95

5.1 Introduction
Notes

In India, with industrialisation and economic development, the population of consumers and the
volume of consumption of goods and services increased. The Contract Act, 1872 and the Sale of
Goods Act, 1930 provided remedies but they were time consuming and expensive. Consumer
issues started gaining importance. The interests of consumers were highlighted by media, nongovernment organisations, social activists and even business concerns. The United Nations
organised a session on the need for the protection of consumers. The government of India also
realised that consumers need to be protected by law.The law relating to consumer protection is
contained in the Consumer Protection Act, 1986 (in short the Act). The Act extends to the whole
of India except the state of Jammu and Kashmir.

5.2 Objects of the Act


The objects of the Act are as follows:
a)

Better Protection of Interests of Consumers: The Act seeks to provide consumer councils
and authorities for settlement of consumer disputes.

b)

Protection of Rights of Consumers: The Act seeks to promote and protect the rights of
consumers such as:
i.

The right to be protected: Against marketing of goods and services which are hazardous
to life and property.

ii. The right to be informed: About the quality, quantity, potency, purity, standard and
price of goods and services so as to protect the consumers against unfair trade practices.
iii. The right to be assured: Wherever possible, access to goods and services at competitive
prices.
iv. The right to be heard: And to be assured that consumers interest will receive due
consideration at appropriate forums.
v.

The right to seek redressal: Against unfair trade practices or restrictive trade practices
or unscrupulous exploitation of consumers.

vi. Right to consumer education: By publishing material and magazines for the benefit of
consumers, such as magazine like Upbhokta Jagran.
c)

Consumer Protection Councils: The above said objects are sought to be promoted and
protected by the consumer protection councils established at the central, state and district
levels.

d)

Quasi-judicial Machinery for Speedy Redressal of Consumer Disputes: The Act seeks to
provide speedy and simple redressal to consumer disputes. For this purpose, the following
consumer disputes redressal agencies are envisaged:
i.

District Forums: at district level.

ii. State Commissions: at State level.


iii. National Commission: at Central or National level.

5.3 Meaning of Some Important and Relevant Terms


5.3.1 Consumer
According to the Act, Consumer means any person who:
a)
96 Self-Learning Material

Buys any goods for consideration which has been paid or promised or partly paid and

partly promised, or under any system of deferred payment and includes any user of such
goods other than the person who buys such goods for consideration paid or promised or
partly paid or partly promised or under any system of deferred payment when such use is
made with the approval of such person, but does not include a person who obtains such
goods for resale or for any commercial purpose; or
b)

Notes

Hires or avails of any services for a consideration which has been paid or promised or
partly paid or partly promised, or under system of deferred payment and includes any
beneficiary of such services other than the person who hires or avails of the services for
consideration paid or promised or partly paid and partly promised, or under any system of
deferred payment, when such services are availed of with the approval of the first mentioned
person but does not include a person who avails of such services for any commercial
purpose.

Commercial purpose does not include use by a person of goods bought and used by him and
services availed by him exclusively for the purposes of earning his livelihood by means of selfemployment.1 To put briefly, consumer is a person who buys any goods or hires or avails of any
services for a consideration.

Esamples
1.

Amar bought a pressure cooker for use by his family. In the first use it self, while his wife
Bindu was using it, the pressure cooker burst, hurting her. Is Amar a consumer? Is Bindu a
consumer?

2.

Chander bought a laptop and gifted it to his son Dev, Dev is an advocate and uses the laptop
for his business. Are Chander and Dev Consumers?

Answers to Examples
1.

Amar is a consumer due to the first part of (i) buys any goods for consideration. Bindu is
also a consumer as the provision provides and includes any user of such goods other than the
person who buys such goods for consideration.... ... when such use is made with the approval
of such person.

2.

Chander was a consumer when he bought the laptop, as the purchase was neither for resale
nor for commercial purpose. However, Dev is not a consumer as he is using it for commercial
purpose.

Case A charitable trust was running a diagnostic centre, where patients taking advantage of X-ray, CT
scan etc. were ordinarily required to pay for the same and only 10% of them being provided free
service. It was held that the machines purchased by the Trust for use in the diagnostic centre were
meant for commercial purpose, and therefore the Trust was not a consumer. - Kalpavraksha Charitable
Trust vs Toshniwal Brothers (Bombay) (P) Ltd. - ((2000) I.S.C.C. 512).

Check Your Progress


5.3.2 Goods
As per the Act, Goods mean goods as defined in the Sale of Goods Act, 1930.2 According to the
Sale of Goods Act, Goods means every kind of moveable property other than actionable claims
and money; and includes stocks and shares, growing crops, grass and things attached to or forming
part of land which are agreed to be severed before sale or under the contract of sale.3

1.

Who is a consumer?

2.

What is a service?

3.

What is known as
Unfair Trade
Practice?

Self-Learning Material 97

5.3.3 Services
Notes

According to the Act, Service means service of any description which is available to potential
users and includes, but not limited to, the provision of facilities in connection with banking,
financing, insurance, transport, processing, supply of electrical or other energy, board or lodging
or both, housing construction, entertainment, amusement or the purveying of news or other
information, but does not include the rendering of any service free of charge or under a contract of
personal service.4

Case A customer of a bank is aconsumer entitled to seek compensation under the act, and the bank is
liable for deficiency of service. - Vimal Chandra Grover vs Bank of India ((2002), 110 comp. cas: 499 (SC))

5.3.4 Complainant
According to the Act, Complainant meansa)

a consumer.

b)

any voluntary consumer association registered under the companies act, 1956 or under any
other law for the time being in force.

c)

the central government or any state government.

d)

one or more consumers, where there are numerous consumers having the same interest, in
case of a death of a consumer, his legal heir or representative; who or which makes a
complaint.5

Case Where Insurance company pays and settles the claim of the insured, it can file a complaint for the
loss caused to the insured goods by negligence of goods/service providers. For example, when loss
is caused to such goods because of negligence of transport company, the insurance company can
file a claim against the transport company. - New India Assurance Company Ltd. vs Green Transport Co.
((1991), CPJ(I) Delhi).

5.3.5 Complaint
Complaint means any allegation in writing made by a complainant with a view to obtaining any
relief under the Act.

5.3.6 Restrictive Trade Practice


According to the Act, Restrictive trade practice means a trade practice which tends to bring
about manipulation of price or its conditions of delivery or to affect flow of supplies in the market
relating to goods or services in such a manner as to impose on the consumers unjustified costs or
restrictions and shall include:

98 Self-Learning Material

a)

Delay beyond the period agreed to by a trader in supply of such goods or in providing the
services which has led or is likely to lead to rise in the prices.

b)

Any trade practice which requires a consumer to buy, hire or avail of any goods or, as the
case may be, services as condition precedent to buying, hiring or availing of other goods or
services.6

Case A furniture dealer offers to sell a Sofa at Rs. 20,000 and Double Bed at Rs. 15,000. He has an offer
that whoever will buy Sofa and Bed both he will charge Rs. 30,000 only. Here the choice is open to
the customer to buy the products single or composte. This is not a restrictive trade practice.

Notes

5.3.7 Unfair Trade Practice


Unfair trade practice means a trade practice, which, for the purposes of promoting the sale, use or
supply of any goods or for the provision of any service, adopts any unfair method or unfair or
deceptive practices.7 The Act also lists out some of the practices as unfair trade practice, like
misleading advertisements and making of false statements, permitting publication of any
advertisement for the sale at a bargain price that are not intended to be offered for sale at bargain
price, or permitting the offering of gifts and prizes with the intention of not providing them or with
holding gifts/prizes after declaration of result of the scheme, or not conforming to prescribed
standards or hoarding of goods or manufacturing of spurious goods.

Example Akash sold a second hand computer to Bharat representing it to be a new one. Here Bharat can
make a complaint against Akash for adopting an unfair trade practice.

5.3.8 Defect
A defect is defined to mean any fault, imperfection or shortcoming in the quality, quantity, potency,
purity or standard which is required to be maintained under any law or contract.8

Example Ajit bought a computer from Bimal. It was not working properly since day one. Ajit can make a
complaint against Bimal for supplying a defective computer.

5.3.9 Deficiency
It is defined to mean any fault, imperfection, shortcoming or inadequacy in the quality, nature and
manner of performance which is required to be maintained under any law or contract.9

Case A boarded a train. The compartmet in which he travelled was in ban shape-fans and shutters of
windows were not working, rexin of the berth was badly torn and there were rusty nails which
caused some injury to his wife who was also travelling along with him. A made a complaint against
Railways for deficiency in service. It was held that the faults or short-coming pointed out in the
plaint constituted deficieny in service and teh compensation of Rs. 1500 was awarded to A. General Manager, South Eastern Railway vs Anand Prasad Sinha ((1991), CPJ 10 (12) NC).

5.3.10 Person
The expression person for the purposes of the Act shall include:
a)

A firm whether registered or not

b)

A hindu undivided family


Self-Learning Material 99

Notes

c)

A co-operative society

d)

Every other association of persons whether registered under the Societies Registration Act
or not.

5.3.11 Consumer Dispute


It means a dispute where the person against whom a complaint has been made, denies or disputes
the allegations contained in the complaint.10

5.4 Consumer Disputes Redressal Agencies


S. No. Point of
District Forum
Distinction

100 Self-Learning Material

State
Commission

National
Commission

1.

Territorial

One or more district.

One or more state.

All India.

2.

Composition

President & two


members - one woman.

President &
minimum two
members - one
woman.

President &
minimum seven
members - one
woman.

3.

Qualifications
for President

Serving or retired or
qualified to be a District
Judge.

Serving or retired
judge of High
Court.
(Consultation with
Chief Justice of
the High Court
necessary).

Serving or
retired judge of
Supreme Court.
(Consultation
with Chief
Justice of India
necessary).

4.

Qualifications
of members

Age - 35 yrs. Bachelors


degree 10 yrs experience
in economics, law,
ecommerce, accountancy
etc.

Same as for
District Forum.

Same as for
District Forum.

5.

Disqualifications
of members

a) Convicted & sentenced


to imprisonment for an
offence of moral
turpitude. b)
Undischarged insolvent.
c) Unsound mind. d)
Removed or dismissed
from service. e) Has
financial or other
interest. f) Others as
may be prescribed.

Same as for
District Forum.

Same as for
District Forum.

6.

Selection
Committee

Chairman - President of
State Commission.
Members - Secretary
Law, Secretary
Consumers Affairs of
State.

Same as for
District Forum.

Chairman, S.C.
Judge Members
- Secy. Deptt of
legal affairs Secy. Deptt of
Consumer
Affairs.

S. No. Point of
Distinction

District
Forum

State
Commission

5 years or age of 65 5 years or age of


whichever is earlier. 67 whichever is
earlier.

National
Commission

7.

Term

8.

Eligibility for Yes


reappointment

Yes

9.

Monetary
Jurisdiction

Upto 20 lakhs.

Between 20 lakhs
and one crore.

More than one crore.

10.

Administratove
control

State
commission.

National
Commission.

--------

11.

Limitation

Upto 2 years
from the date on
which the cause
of action arose.

Upto 2 years from


the date on which
the cause of action
arose.

Upto 2 years from


the date on which
the cause of action
arose.

12.

Appeal

State
Commission
within 30 days of
order. 50% of the
amount payable
or Rs. 25000,
whichever is less
to be deposited
by the appellant.

National commission Supreme Court


within 30 days of
within 30 days of
order.
order. 50% of the
amount payable or
Rs. 50000, whichever
is less to be
deposited by the
appellant.

13.

Enforcement
of the order

As if it is a court
order, forwarded to
the appropriate
court.

As if it is a court
order, forwarded to
the appropriate
court.

As if it is a court
order, forwarded to
the appropriate
court.

14.

Penalties

Imprisonment Not less than one


month but may
extend to 3 years.
Fine - not less than
Rs. 2000, but may
extend to Rs.
10,000.

Imprisonment - Not
less than one month
but may extend to 3
years. Fine - not less
than Rs. 2000, but
may extend to Rs.
10,000.

Imprisonment - Not
less than one month
but may extend to 3
years. Fine - not less
than Rs. 2000, but
may extend to Rs.
10,000.

Dismiss the
complaint and
costs upto Rs.
10,000.

Dismiss the
complaint and costs
upto Rs. 10,000.

Dismiss the
complaint and costs
upto Rs. 10,000.

15.

Frivolous or
Vexatious
Complaints

Notes

5 years or age of
70 whichever is
earlier.
Yes

Check Your Progress


4.

Are defects and


deficiencies the
same?

5.

Is a co-operative
society treated on the
basis of separate
individual under law?

6.

Who bears the


laboratory expenses
incurred?

5.5 Manner of Making a Complaint


A complaint can be made by any complainant in relation to any goods sold, delivered or agreed to
be sold or delivered or any service provided or agreed to be provided. Complaint shall be filed
along with fees as prescribed. Fees prescribed is very nominal. Admissibility of the complaint shall

7.

How diligently the


complaint shall be
handled?

Self-Learning Material 101

Notes

ordinarily be decided within twenty one days of the receipt of complaint. A complaint may be
proceeded with or rejected. However before rejection, an opportunity to be given to the complainant
for hearing.

5.6

Procedure on Admission of Complaint

If a complaint relates to any goods, a copy of the admitted complaint should be given to the opposite
party within 21 days for him to give his version within thirty days. If the opposite party denies or
disputes the complaint or fails or omits to take any action within the time given, (Initial 30 days and
can be extended by 15 days) then the complaint shall be proceeded further. If the defect in goods
needs analysis or testing by a laboratory, a sample of the goods shall be sent to the laboratory for a
report within forty five days. The fees for the laboratory test shall be payable by the complainant.
The report of the laboratory test is given to the opposite party. If any of the parties disputes the
correctness of the laboratory test report, the objections to such report shall be made in writing. A
reasonable opportunity of being heard shall be given regarding the objections made in relation to
laboratory test.If the complaint relates to any services or in respect of goods where laboratory
report is not required, then a copy of the complaint is referred to the opposite party directing him to
give his version within a period of thirty days. This can be extended by fifteen days. If the opposite
party does not file any reply the complaint shall be decided exparte. If the opposite party, denies or
disputes the allegations made in complaint, the matter will be decided on the basis of evidence
adduced by the complainant and the opposite party. Every complaint shall be heard expeditiously
and endeavour shall be made to decide the complaint within three months when it does not require
analysis or testing by any laboratory and within five months if it requires analysis or testing of
commodities.11

5.7

Findings

The following orders can be made by the consumer dispute redressal agency:

102 Self-Learning Material

a)

To remove the defect - pointed out by the appropriate laboratory from the goods in question.

b)

To replace the goods - with new goods of similar description which shall be free from any
defect.

c)

To return to the complainant the price - or, as the case may be, the charges paid by the
complainant.

d)

To pay compensation - to the consumer for any loss or injury suffered due to the negligence
of the opposite party. However the consumer disputes redressal agency shall have the power
to grant punitive damages in such circumstances as it deems fit.

e)

To remove the defects in goods or deficiencies in services - in question.

f)

To discontinue the unfair trade practice or the restrictive trade practice - or not to repeat
them.

g)

Not to offer hazardous goods for sale.

h)

To withdraw the hazardous goods - from being offered for sale.

i)

To cease manufacture of hazardous goods - and to desist from offering services which are
hazardous in nature.

j)

To pay such sum - as may be determined by it, if it is of the opinion that loss or injury has
been suffered by a large number of consumers who are not identifiable conveniently. However,
the minimum amount of sum so payable shall not be less than five percent of the value of
such defective gods sold or services provided as the case may be to such consumers. It may
also provide that the amount so obtained shall be credited in favour of such person and
utilised in such manner as may be prescribed.

k)

To issue corrective advertisement - to neutralise the effect of misleading advertisement at

the cost of the opposite party responsible for issuing such misleading advertisement.
l)

To provide for adequate costs - to parties.12

Notes

5.8 Miscellaneous
The act also lays down provisions regarding the following:
a)

Protection of action taken in good faith.13

b)

Power to make rules by the central government or by the state governments,14 and laying of
such rules before parliament/state legislature.15

5.9

Some decisions of National Commission/Supreme Court

a)

Doctors are within the purview of the Act.16

b)

Government hospitals/health centres/dispensaries where services are rendered free of charge


to all the patients, the provisions of the Act do not apply. The Supreme Court did not agree
with the contention that the expenses of running the said hospitals are met by appropriation
from the Consolidated Fund which is raised from the taxes paid by the tax payers.17

c)

Under the Act, damages are payable only if there is negligence of the opposite party.18
Employees of Bank of Baroda, Calcutta, resorted to a strike, in opposition to a scheme of
transfer of its employees. The striking employees created barricades by forming a human
wall before the bank. The customers were prevented from entering the bank for 54 days.
The customers had suffered losses, which included loss of interest. The Supreme Court
ruled that the shortcoming in the service by bank did not arise due to failure on the part of
bank in performing its duty or discharging its obligations as required by law.19

d)

Where the opposite party failed to file written objections within the time allowed, it could
not be denied the privilege of oral submissions before the Forums. The National Commission
gave the reason that the opposite party should not be deprived of its natural and legal right
to put forward its defence.20

e)

Provident fund subscribers are also consumers.21

f)

Wearing of jewellery on body of person included in luggage, being in his charge during
travel in Railway. Gold chain snatched by miscreants while travelling in reserved
compartment. It was held that there was deficiency in service on the part of Railways.22

g)

A Statutory Authority developing land or constructing a house, is like a builder or a contractor,


if the service is defective, then it would be an unfair trade practice.23

h)

When an intra-muscular injection administered intra-venously, caused combolism


of heart as the blood circulation to heart stopped and the patient died within
minutes. The argument that he did not pay for the services was negated as how
a deadman can pay for the services. Negligence was also proved.24

i)

Complainant having confirmed ticket, not provided seat in aircraft and consequently lost
job. It was held that there was deficiency of service on the part of the airlines.25

j)

Nursing home had no proper arrangements to meet emergency and not properly equipped,
it is deficient in service. When forceps delivery was done in haste which caused haemorrhage
and no attempt was made to stop profuse bleeding, it was held that there was negligence
and deficiency in medical care.26

k)

Deceased was insured under the Salary Savings Scheme from L.I.C. Employer failed to
deduct the premium from the salary of the employee. As a result policy lapsed. It was held
that the complainant (wife of the deceased) is entitled to claim the insurance amount from
the employer.27
Self-Learning Material 103

Notes

l)

When there is a delay in delivery of motor vehicle and there is unauthorised escalation in
price, consumer is not liable to pay.28

m)

Complainant applied for allotment of a flat under a scheme of Housing Board and made
full payment. Possession of the flat was not given as per the scheme. The contention of the
Housing Board that the scheme was given up due to unavoidable reasons and the option
given to the complainant to opt for another scheme is not valid. It was held that there was
a deficiency in service on the part of the Housing Board.29

Summary
The law relating to consumer protection is contained in the Consumer Protection Act, 1986. Its
objects are a) better protection of interests of consumers, b) protection of rights of consumers, c)
to provide for consumer protection councils and d) to provide quasi-judicial machinery for speedy
redressal of consumer disputes. The Act also defines terms like a) consumer who buys goods and
services for a price b) goods means every kind of moveable property c) services, d) complainant,
e) complaint f) restrictive trade practices, g) unfair trade practices h) defect, i) deficiency, i)
persons and k) consumer dispute.

Consumer Disputes Redressal Agencies


There are three such agencies a) District Forum b) State Commission and c) National Commission.
District Forum is for one or more district and a consumer can file his claim if the limit of the claim
is upto Rs. 20 lakhs. Appeal from the decision of the District Forum is to be filed within 30 days
of its order to the State Commission. A State Commission is for one or more states. A consumer
can file his claim if the claim is above Rs. 20 lakhs but below one crore. Appeal from the decision
of the State Commission can be filed within 30 days of its order to the National Commission.
National Commission is one for the whole of India. A Consumer can file his claim if it is more
than Rs. 1 crore. Appeal from the decisions of the National Commission can be made in the
Supreme Court of India.

How a Complaint is Made and Dealt With?


A complainant can make a complaint before the appropriate consumer dispute redressal agency in
relation to any defect in goods or deficiency in service. The complaint relating to any goods or
services is given to the opposite party within 21 days to allow him to give his version in 30 days.
If the defect in goods needs analysis or testing by a laboratory, a sample of the goods is sent to the
laboratory for a report within 45 days. The report is given to the opposite party. Complaint shall
be decided within 3 months if no laboratory test is required and within 5 months if the laboratory
test is required.

Findings
The consumer dispute redressal agencies can arrive at any of these findings a) to remove defects,
b) to replace goods, c) to return the price, d) to pay compensation, e) to remove deficiencies in
services, f) to discontinue the unfair trade practice or the restrictive trade practice, g) not to offer
hazardous goods for sale, h) to withdraw hazardous goods, i) to cease manufacture of hazardous
goods, j) to pay such sum as may be determined by such agency k) to issue corrective advertisement,
and l) to provide for adequate costs to parties.

104 Self-Learning Material

Review Questions
Notes

True or False
1.

When a cause of action has arisen, a complaint before a consumer dispute redressal agency
is to be filed within three years.

2.

A patient receiving free medical treatment in a government hospital is a consumer.

3.

A member of the District Forum under the Consumer Protection Act, can hold office upto
the age of 65 years.

4.

A claim of Rs. 50 lakhs under Consumer Protection Act is to be filed before the National
Commission.

5.

A tutor teaches a student for one year and the student fails. The student is a consumer under
the Consumer Protection Act.

6.

A woman is necessary as a member in all the consumer disputes redressal agencies.

7.

A member is not eligible for reappointment in the National Commission.

8.

Consumer Protection Act does not provide any remedy for frivolous and vexatious
complaints.

9.

No appeal can be filed from the orders of the National Commission.

10.

Complainant is required to pay the cost of testing of goods in an appropriate laboratory.

Practical Problems
1.

Mr. Chaluram is a transport contractor and has a proprietory firm in Meerut by the name of
M/s Ram and Sons. He has two trailors of Ashok Leyland make. He purchased a third
trailor for a sum of Rs. 4.75 lakhs. This trailor did not give satisfactory service and started
giving trouble on account of manufacturing defects. He filed a complaint before District
Forum, Meerut against M/s Ashok Leyland for defects in the trailor. Will Mr. Chaluram
succeed?

2.

Sampatilal became a member of a Cooperative Group Housing Society, Ghaziabad. The


Managing Committee of the society did not allot the flat to Sampatilal and he had to wait
over 20 months after making full payment of Rs. 25 lakhs to get the flat. Sampatilal wants
to file a complaint under the Consumer Protection Act. Advise him as to which consumer
dispute redressal agency he can file his complaint and whether he will succeed or not.

3.

Kamjor, a subscriber to the Provident Fund Under Employees Provident Fund and Misc.
Provisions Act, 1952 could not get final provident fund dues amounting to Rs. 5.75 lakhs
within the stipulated period of 20 days. After waiting for twenty months he filed a complaint
in the concerned District Forum against the relevant Regional Provident Fund Commissioner.
Will Kamjor succeed?

4.

Akash a reputed manufacturer of consumer goods advertised a scheme called Hidden


treasure prize offer where prize coupons were placed inside some of the bottles of the
product, by which purchasers of the bottles wherein coupons are placed would get prizes.
Does this amount to an unfair trade practice?

5.

A boy aged 10 years was admitted in a private nursing home with high fever. On account of
negligence and deficiency on the part of nursing home, doctors and nurses the child suffered
irreparable damage. Can childs parents file complaint under the Consumers Protection
Act?

Self-Learning Material 105

Test Questions
Notes

1.

What are the objects which the Consumer Protection Act, 1986, seeks to achieve?

2.

Discuss the main features of the Consumer Protection Act, 1986.

3.

Define the following terms as used in the Consumer Protection Act, 1986.
a. Consumer
b.

Goods

c.

Services

d.

Complainant

e.

Restrictive Trade Practice

f.

Unfair Trade Practice

4.

Which are the Consumer Dispute Redressal Agencies and what are their powers?

5.

How a complaint is made? Describe the procedure for disposal of a complaint.

6.

Explain the rights of a consumer enshrined under the Consumer Protection Act, 1986.

7.

What findings can by given by the Consumer Disputes Redressal Agencies?

Practical Problems
1.

No, as he is not a consumer because trailor was purchased for commercial purpose.

2.

Uttar Pradesh Consumer Disputes Redressal Commission as the claim amount of Rs. 25
lakhs is within the jurisdiction of State Commission. He will succeed as the Cooperative
Group Housing Society comes under Consumer Protection Act.

3.

Yes as the Regional Commissioner to the employees provident fund comes under the purview
of Consumer Protection Act. Non payment of dues within the stipulated period is a deficiency
of service.

4.

No, it does not amount to Unfair Trade Practice under the Consumer Protection Act.

5.

Yes, they come under the definition of consumer under the Act.

Answers to True or False


1. False
8. False

2. False 3. True
9. False 10. True

4. False

5. False

6. True

7. False

Answers to Check Your Progress


Following are the answers to Check Your Progress, indicating respective paragraphs for reference.
1) 5.3.1 2) 5.3.3 3) 5.3.7 4) 5.3.8 & 5.3.9 5) 5.3.10 6) 5.6 7) 5.6

References

106 Self-Learning Material

Section 2 (1) (d).

Section 2 (1) (i).

Section 2 (7) of the Sale of Goods Act, 1930.

Section 2 (1) (o).

Section 2 (1) (b).

Section 2 (1) (nnn).

Section 2 (1) (r).

Section 2 (1) (f).

Section 2 (1) (g).

10
11

Notes

Section 2 (1) (c).

Section 13.

12

Section 14.

13

Section 28.

14

Section 30.

15

Section 31.

16

Indian Medical Association V.P. Shantha & Ors. (1995) 3 CTJ 969 (Supreme Court CP); [1995
(III) CPJ 1 (SC)].

17

See note 16 ibid.

18

Section 14 (1) (d).

19

Consumer Unity and Trust Society, Jaipur v. Chairman and Managing Director, Bank of

Baroda, Calcutta and Another; 1995 (2) SCC 150.


20

South Delhi University Teacher Cooperative Group Housing Society Ltd. v. Dr. Madhu

Rathour; II 1994 CPJ 49.


21

Regional Provident Fund Commissioner, Faridabad v. Shiv Kumar Joshi (1997) 24 CLA NCDRC.

22

Mrs. M. Kanthimathi & Anr v. Government of India, Ministry of Railways; I 2003 CPJ 16

(NC).
23

Lucknow Development Authority v. M. K. Gupta. C. A No. 6237 of 1990 (SC).

24

Dr. Sham Lal & ors. v. Mrs Saroj Rani & Ors; I (2003) CPJ 47 (NC).

25

Manager Air India Ltd. & Anr. v. A Moideen Kutty & Ors., I (2003) CPJ 65 (NC).

26

Dr. Smt. T. Vani Devi & ors. v. T.L.N. Narasa Reddy. I (2003) CPJ 180 (NC).

27

Smt. C. Rajeshwari v L.I.C. of India & Anr. I (2000) CPJ 50 (NC).

28

M/s Vikas Motors Ltd v. Dr. P.K. Jain. II (1999) CPJ 44 (SC).

29

George Thomas & ors. v. G.D.A. & ors. I (1999) CPJ 18 (NC).

Self-Learning Material 107

Notes

108 Self-Learning Material

Introduction to Law of
Partnership

Notes

Section

6
The most enlightened judicial policy is to let people manage their own
Money speaks
in a language all nations understand.
business
in theirsense
own way.
Aphra
Behn
Oliver Wendell
Holmes
STRUCTURE
6.1

Introduction

6.2

Definition of Partnership

6.3

Essential Elements of a Partnership

6.4

Meaning of Partner, Firm and Firm Name

6.5

Nature of a Partnership Firm

6.6

Partnership and other Association

6.7

Registration of Firms

6.8

Rights and Duties of a Partner

6.9

Reconstitution of Firm

6.10 Types of Dissolution of Partnership Firm


6.11 Modes of Dissolution of Firm
6.12 Limited Liability Partnership (LLP)

Self-Learning Material 109

6.1 Introduction
Notes

To carry on a business, a person may choose any form of organization depending upon his needs.
When a person works in his individual capacity, he runs a proprietary organization, also known as
a sole trader. When he works with some person, they are running a partnership. Partnership is the
most common form of organisation . Law relating to partnership is governed by the Indian
Partnership Act, 1932 (the Act). it extends to the whole of India except to the state of Jammu and
Kashmir.

6.2 Definition of Partnership


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.1

6.3 Essential Elements of a Partnership


An analysis of the definition of partnership reveals the following essential elements.
a)

An agreement: partnership is the result of an agreement. It does not arise from status (as in
the case of Hindu Undivided Family) operation of law (as of co-owners) or inheritance.
Agreement may be express or implied. Again it may be oral or in writing. partnership deed
is example, of an agreement in writing.

b)

Two or More Persons: There must be at least two persons to form a partnership. The Act
does not mention any thing about the maximum number of persons who can be partners in
a partnership firm but the Companies Act, 1956 (Section 11) lays down that a partnership
consisting of more than 10 persons for banking business and 20 persons for any other
business would be illegal. Hence these should be regarded as the maximum limits on the
number of partners in a partnership firm.

Note: The term person means any person competent to enter into a contract and includes a
company also. A minor can be admitted as a partner only for the benefits of partnership.
c)

Carrying on a Business: For a partnership to exist, it is essential that there should be a


business. Business includes every trade, occupation and profession.2 It may be for long
term business activities or for a particular venture or for a short duration.

d)

Sharing of Profits: There must be sharing of profits. However, partners may agree to share
profits in any proportion. But whenever the partnership firm runs into losses, the partners
will share it too since a loss represents a negative profit.

e)

Mutual Agency: There must exist a mutual agency relationship among the partners. Mutual
agency implies that each partner acts for the other partners. He, thus, is an agent of other
partners. Also, each partner is a principal for he is bound by the acts of other partners.

6.4 Meaning of Partner, Firm, and Firm name


Persons who have entered into partnership with one another are called individually partners and
collectively a firm, and the name under which their business is carried on is called the firm
name.3

6.5 Nature of a Partnership Firm


A partnership firm is not a person in the eyes of law. It has no separate legal entity apart from the
parners constituting it.
110 Self-Learning Material

6.6 Partnership and Other Association


Notes

6.6.1 Partnership and Joint Hindu Family


A business in Hindu Law is a heritable asset. If an ancestral business descends on the members of
a Joint Hindu Family (also called Hindu Undivided Family), or if they start a common business out
of the Joint funds at any time after the death of the ancestors such a business is called a Joint Family
Business. The members of a Joint Hindu Family carrying on family business as such are not partners
in such business. The points of distinction between the two are as follows :
1.

Mode of creation. Partnership is essentially the result of an agreement. A Joint Hindu Family
arises from status and is not the result of an agreement. It arises by operation of law.

2.

Interest in business. In partnership a person does not acquire interest in partnership business
by birth. It is the result of an agreement In a joint family business, the male members acquire
Interest by birth.

3.

Admission of new members. In partnership, a new partner can be admitted only with the
consent of all the partners. In a joint family business, a male becomes a member by his birth.
a)

Check Your Progress


1.

What is partnership?

2.

What are the


essential elements of
a partnership?

3.

Is it compulsory to
register a partnership
firm?

Female members. A female can become a full-fledged partner in partnership, whereas


in a joint family business, a female does not become its member by birth.

b) Minor members. In partnership, a minor can be admitted to the benefits of partnership


with the consent of the other partners. In a Joint family business, a male minor becomes
its member merely by birth.
c)

Membership fluctuating. In partnership, the number of partners should not exceed ten
in case of a firm carrying on banking business and twenty in case of any other business.
In a joint family business, there is no limit to the maximum number of members.

4.

Authority of members. In partnership each partner has implied authority to bind the firm by
acts done in the ordinary course of the business of the firm. In a joint family business, only
the Karta (usually the eldest male member of the family) has implied authority to contract
debts and pledge the credit and the property of the family for the ordinary purposes of the
family business.

5.

Liability of members. In partnership, the liability of the partners is unlimited. The share of
each partner in the partnership property along with his private property is liable for the
discharge of partnership liabilities. In a joint family business, the Karta is personally liable
for the debts of the family whereas the other members are liable only to the extent of their
Interest in the Joint family business. The other members are personally liable If they are also
contracting parties.

6.

Right of members to demand accounts. In partnership, every partner has a right to have
access to and inspect and copy any of the books of the firm and ask for the account of profits
and losses. The members of a joint family business cannot ask the Karta of the family for
accounts of his past dealings concerning the family business. Similarly, they cannot ask the
Karta for the account of profits and losses.

7.

Registration. In case of partnership, it is not compulsory that it should be registered. But,


indirectly, law has made registration compulsory because an unregistered firm suffers from
certain disabilities. A joint family business does hot require any such registration.

6.6.2 Partnership and co-ownership


Co-ownership means joint ownership of some property which does not necessarily result in
partnership. In partnership the partners are necessarily co-owners of the property of the firm, but In
co-ownership the co-owners are not necessarily partners. The following are the points of difference
Self-Learning Material 111

between the two:


Notes

1.

Mode of creation. Partnership is necessarily the result of an agreement. Co-ownership may


or may not arise from agreement; it may also arise by status.

2.

Business. Business Is necessary for the existence of partnership ; co-ownership can exisf
without it

3.

Nature of interest. Partnership involves community of interest whereas co-ownership may


not necessarily involve any such interest.

4.

Transfer of interest. A partner cannot transfer his share to a stranger without the consent of
the other partners. A co-owner can. When a co-owner transfers his share, the transferee
becomes vis-a-vis the other co- wners a substitute of the co owner who transfers his share.

5.

Number of members. In partnership, the number of members cannot exceed the statutory
limit. In co-ownership there is no limit on maximum number.

6.

Authority of members. A partner is the agent of his co-partners. A co-owner is not the agent
of the other co-owners.

7.

Partition of property. A partner cannot sue for the partition of partnership property in specie
but he can sue his co-partners for the dissolution of the firm and accounts. A co-owner can
sue for the partition of the property.

8.

Lien for expenses. A partner has a lien on the partnership property for expenses incurred by
him on such property on behalf of the firm ; a co-owner has no such lien.

6.6.3 Clubs
A club or a society, such as a cricket club or a debating society or a residents welfare society, is not
a partnership. It is not formed to earn profit and its members are not agents of one another and as
such are not liable for one anothers acts. A member of a club Is not liable to a creditor except so far
as he has assented to the contract in respect of which such liability has arisen. A club Is formed
upon the implied condition that its members are not bound to contribute to its losses beyond the
amount or subscription as laid down in the rules to be paid so long as he remains a member.

6.7 Registration of Firms


According to the Act, it is not compulsory to get a firm registered with the Registrar of Firms.
(Appointed by the State Government). It is, thus, an optional affair. The Act, however, puts an
unregistered firm to certain disabilities thereby making registration of firms desirable. A firm may
get registered anytime, i.e. at the time of formation or anytime thereafter.

6.8 Rights and Duties of a Partner


Check Your Progress
4.

Explain the rights and


duties of a partner.

5.

Under what
circumstances does
reconstitution of a
partnership firm take
place?

112 Self-Learning Material

6.8.1 Relation of Partners to one another


The relations of the partners of a firm to one another are usually governed by the agreement
among them. Such agreement may be express or may be implied from the course of dealing
among them. It may be varied by consent of all them, and such consent may be expressed or may
be implied by a course of dealing [Sec. 11 (1)]. Where there is no specific agreement or where the
agreement is silent on a certain point, the relations of partners to one another as regards their
rights and duties are governed by Sees. 9 to 17 of the Partnership Act.

6.8.2 Rights
1.

2.

Right to take part in business. The partnership agreement usually provides the mode of the
conduct of the business. Subject to any such agreement between the partners, every partner
has a right to take part in the conduct of the business. This is based on the general principle
that partnership business is the common business of all the partners.
Right to be consulted. Every partner has an inherent right to be consulted in all matters
affecting the business of the partnership and express his views before any decision is taken
by the partners.

3.

Right of access to accounts. Subject to contract between the partners, every partner has a
right to have access to and inspect and copy any of the books of the firm. A minor partner
may have access to and inspect any of the accounts of the firm but not books.

4.

Right to share in profits. In the absence of any agreement, the partners are entitled to share
equally in the profits earned and are liable to contribute equally to the losses sustained by
the firm.

5.

Right to interest on capital The partnership agreement may contain a clause as to the right
of the partners to claim interest on capital at a certain rate. Such interest, subject to contract
between the partners is payable only out of profits, if any, earned by the firm.

6.

Right to interest on advances. Where a partner makes, for the purposes of the business of
the firm, any advance beyond the amount of capital, he is entitled to interest on such advance
at the rate of six per cent per annum. Such interest is not only payable out of the profits of
the business but also out of the assets of the firm.

7.

Right to be indemnified. A partner has authority, in an emergency, to do all such acts for the
purpose of protecting the firm from loss as would be done by a person of ordinary prudence,
in his own case, acting under similar circumstances. Such acts of the partner bind the firm.
If as a consequence of any such act, the partner incurs any liability or makes any payment,
he has a right to be indemnified.

8.

Right to the use of partnership property. Subject to contract between the partners, the
property of the firm must be held and used by the partners exclusively for the purposes of
the business of the firm. No partner has a right to treat it as his individual property. If a
partner uses the property of the firm directly or indirectly for his private purpose, he must
account to the firm for the profits which he may have earned by the use of that property.

9.

Right of partner as agent of the firm. Every partner for the purposes of the business of the
firm is the agent of the firm. And subject to the provisions of the Indian Partnership Act the
act of a partner which is done to carry on, in the usual way, business of the kind carried on
by the firm, binds the firm.

10.

No new partner to be introduced. Every partner has a right to prevent the introduction of a
new partner unless he consents to that or unless there is an express term in the contract
permitting such introduction.

11.

No liability before joining. A person who is introduced as a partner into a firm is not liable
for any act of the firm done before he became a partner.

12.

Right to retire. A partner has a right to retire (a) with the consent of all the other partners, or
(b) in accordance with an express agreement between the partners, or (c) where the
partnership is at will, by giving notice to all the other partners of his intention to retire.

13.

Right not to be expelled. A partner has a right not to be expelled from the firm by any
majority of the partners, save in the exercise in good faith of powers conferred by the
contract between the partners.

14.

Right of outgoing partner to share in the subsequent profits. Where a partner has died, or
has ceased to be a partner by retirement, expulsion, insolvency, or any ether cause, the
surviving or continuing partners may carry on the business with the property of the firm

Notes

Check Your Progress


6.

How does the


dissolution of a
partnership firm
takes place?

7.

What is a limited
liability partnership?

Self-Learning Material 113

without any final settlement of accounts as between them and the outgoing partner or his
estate. In such a case, legal representative of the deceased partner or the outgoing partner,
in the absence of a contract to the contrary. Is entitled, at his option, to

Notes

a)

such share, of the profits as is proportionate to his share in the property of the firm, or

b) Interest at the rate of 6 per cent per annum on the amount of his share in the property
of the firm.

6.8.3 Duties
Partnership is a contract of uberrimae fidea. The partners must act with utmost good faith as the
very basis of partnership is mutual trust and confidence. According to Sec. 9, which deals with the
general duties of partners, partners are bound
a)

to carry on the business of the firm to the greatest common advantage,

b)

to be Just and faithful to each other, and

c)

to render true accounts and full Information of all things affecting the firm to any partner or
his legal representative.

The other duties are spread over the Partnership Act These duties are summed up as under:

114 Self-Learning Material

1.

To carry on business to the greatest common advantage. Every partner is bound to carry on
the business of the firm to the greatest common advantage. He is bound, in all transactions
affecting the partnership, to do his best in the common interest of the firm. He must share
with other partners any benefit which he may have been able to obtain from other people and
in which the firm is in honour and conscience entitled to participate.

2.

To observe faith. Partnership is a fiduciary relation. Every partner must be Just and faithful,
and observe utmost good faith towards every other partner of the firm. Good faith requires
that he shall not obtain a private advantage at the expense of the firm. He is bound, in all
transactions affecting the partnership, to do his best In the common interest of the firm.

3.

To indemnijy for fraud. Every partner is bound to indemnify the firm for any loss caused to
it by his fraud In the conduct of the business of the firm. This is an absolute duty of a partner
and no partner can contract himself out of it. The innocent partners of the firm are, however,
liable to third parties for the fraud of any of the partners. But they can proceed to claim
damages against the partner who has committed the fraud.

4.

To attend diligently. Subject to contract, between the partners, it is the duty of every partner
to attend diligently to his duties in the conduct of the business of the firm, and to use his
knowledge and skill to the common advantage of all the partners.

5.

Not to claim remuneration. A partner Is not entitled to receive any remuneration in any form
for taking part in the conduct of the business of the firm. It is, however, usual to allow some
remuneration to the working partners provided there is a specific agreement to that effect.

6.

To share losses. It is the duty of every partner to contribute to the losses of the firm. In the
absence of an agreement to the contrary, the partners are bound to contribute equally to the
losses sustained by the firm. An agreement to share profits implies an agreement to share
losses also.

7.

To indemnify for wilful neglect. Every partner Is, subject to contract between the partners,
bound to indemnify the firm for any loss caused to it by his wilful neglect in the conduct of
the business of the firm. The firm is, however, liable to the third persons for the wilful
neglect or fraud of any of the partners.

8.

To hold and use property of the firm exclusively for the firm. It is the duty of every partner of
the firm to hold and use the property of the firm exclusively for the purposes of the business
of the firm. The partners may agree differently but, in such a case, there should be a specific
agreement to that effect.

9.

To account for personal profits. If a partner derives any benefit, without the consent of the
other partners, from partnership transactions (or from any use by him of the partnership
property, name or business connection), he must account for it and pay it to the firm. This is
because the relationship between partners is a fiduciary relationships and no partner is entitled
to make any personal profit.

10.

To account for profits in competing business. A partner must not carry on any business of
the same nature as competing with that of the firm. If he does that he is bound to account for
and pay to the firm all profits made by him in that business. This is, however, subject to
contract between the partners.

11.

To act within authority. Every partner is bound to act within the scope of his actual or
Implied authority. Where he exceeds the authority conferred on him and the firm suffers a
loss, he shall have to compensate the firm for any such loss.

12.

To be liable jointly and severally. Every partner is liable, jointly with all the other partners
and also severally, for all the acts of the firm done while he is a partner.

13.

Not to assign his rights. A partner cannot assign his rights and interest in the firm to an
outsider so as to make him the partner of the firm. He can, however, assign his share of the
profit and his share in the assets of the firm.

Notes

6.9 Reconstitution of Firm


A firm is reconstituted when there is a change in the composition of its partners without affecting
the continuity of the firm. Such a reconstitution may take place due to:
a)

Introduction of a new partner

b)

Retirement of a partner

c)

Expulsion of a partner

d)

Insolvency of a partner

e)

Death of a partner, or

f)

Transfer of a partners share

6.10 Types of Dissolution of Partnership Firm


The Act contemplates and distinguishes between:
a)

Dissolution of Firm: The term refers to the dissolution of partnership between all the partners
of a firm. Thus, where all the partners in a firm agree to sever their relationship, it is known
as dissolution of firm.

b)

Dissolution of Partnership: The term implies the re-organisation or reconstitution of firm


wherein one or more partners sever their relationship with other partners who decide to
continue with the business under altered conditions but without dissolution of firm. This
may happen when one or more partners in a firm either die, retire or are declared insolvent
and the remaining partners elect to continue with business. Thus, the dissolution of firm
necessarily implies the dissolution of partnership but the dissolution of partnership may not
necessarily lead to the dissolution of firm.

6.11 Modes of Dissolution of Firm


Broadly speaking, the dissolution of a firm may take place:
a)

Without court order: Such a dissolution may take place in the following ways:
i.

Dissolution by agreement
Self-Learning Material 115

ii. Compulsory dissolution by the adjudication of all partners or of all the


partners but one as insolvent, or by the happening of any event which
makes it unlawful for the business of the firm to be carried on or for the
partners to carry it on in partnership.

Notes

iii. Dissolution on happening of certain contingencies. Subject to contract


between the partners a firm is dissolved:
a. If constituted for a fixed term, by the expiry of that term;
b. If constituted to carry out one or more adventures or undertakings by
the completion thereof;
c. By the death of a partner; and
d. By the adjudication of a partner as an insolvent.
iv. Dissolution by notice of partnership at will:
a. Where the partnership is at will, the firm may be dissolved by any partner giving
notice in writing to all the other partners of his intention to dissolve the firm.
b. The firm is dissolved as from the date mentioned in the notice as the date of dissolution,
or if no date is mentioned, as from the date of the communication of the notice.
b)

Dissolution by the Court: At the suit of a partner, the court may dissolve a firm on any of the
following grounds, namely:
i.

That a partner has become of unsound mind, in which case the suit may be brought as
well by the next friend of the partner who has become of unsound mind as by any other
partner;

ii. That a partner, other than the partner suing, has become in any way permanently incapable
of performing his duties as partner;
iii. That a partner, other than the partner suing, is guilty of conduct which is likely to affect
prejudicially the carrying on of the business;
iv. That a partner, other than the partner suing willfully or persistently commits breach of
agreements relating to the management of affairs of the firm or the conduct of its business;
or otherwise so conducts himself in matters relating to the business that it is not reasonably
practicable for the other partners to carry on the business in partnership with him;
v.

That the business of a firm cannot be carried on except at a loss;

vi. That a partner, other than the partner suing, has in any way transferred the whole of his
interest in the firm to a third party, or has allowed it to be sold if the recovery of arrears
of land revenue or of any dues recoverable as arrears of land revenue due by the partner;
or
vii. On any other ground which renders it just and equitable that the firm should be dissolved.

6.12 Limited Liability Partnership (LLP)


A partnership firm entails unlimited liability for its partners, where the chief advantage of forming
a company under the Companies Act, 1956 is the limited liability of its members. A company is
required to carry out a number of legal formalities. To get the advantage of limited liability as well
as that of partnership establishment of limited liability partnership (LLP) has now been given legal
recognition. LLP Act has now been enacted and the professionals can now form partnership firm
with limited liability. This would promote a new era of entrepreneurship.
Forming an LLP has all the advantages of a sole trader or partnership like flexibility in taking
decisions, less legal formalities than that of a joint stock company and the advantage of a limited
liability. A firm of professionals like chartered accountants lawyers and company secretaries may
take benefit of such a partnership under the LLP Act.4
116 Self-Learning Material

Summay
Notes

Law Relating to Partnership


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. Essential elements of a partnership are 1- Agreement,
2- Two or more persons, 3- Carrying on a business, 4- Sharing of profits, and 5- Mutual agency.
Persons who have entered into partnership with one another are called individually partners and
collectively a firm, and the name under which their business is carried on is called the firm name.
A partnership firm is not a person in the eyes of law. A Partnership is different from their associations
like joint hindu family, co-ownership and clubs. Registration of firm is optional.
Rights of a partner are, 1- To take part in business, 2- To be consulted, 3- Access to accounts, 4Share profits, 5- Interest on capital, 6- Interest on advances, 7- To be indemnified, 8- To use
partnership property, 9- Agent of firm, 10- To permit introduction of new partner, 11- To retire, 12Not to be expelled, and 13- Outgoing partner to share subsequent profits. Duties of a partner are: 1General duties like to be just and faithful to other, to render true accounts, to carry on the business
of the firm to the greater common advantage and to provide full information to all partners, 2- To
indemnity for loss caused due to fraud or willful neglect, 3- To attend diligently, 4- Not to claim
remuneration, 5-To contribute to losses, 6- To use firms property for business, 7- To account for
personal profits, 8- To account for profits in competing business, 9- To act with authority, 10- Joint
and several liability for acts of firm, and 11- Not to assign his partnership rights.
A firm is reconstituted when there is a change in the composition of its partners without affecting
the continuity of the firm. There are two types of dissolution, 1- Dissolution of firm, and 2- Dissolution
of partnership. Dissolution of firm may take place in two modes, 1- Without court order, and 2Dissolution by the court. Limited liability partnership (LLP) has been given a legal recognition.

Review Questions
True or False
1.

A money lender getting a share in the profits of the firm for the sum lent is a partner in the
firm.

2.

A partner is an agent of other partners in a partnership firm.

3.

Permanent incapacity of partner is not a ground for dissolution of partnership.

Test Questions
1.

What is parternship?

2.

Give essential elements of a partnership.

3.

Is partnership a person as per law?

4.

Is registration of partnership firm compulsory?

5.

What are the rights of a partner?

6.

Give primary duties of a partner.

7.

What do you understand by the reconstitution of a partnership firm?

8.

A parnership firm can be dissolved by a court order only? Is it true?

Self-Learning Material 117

Practical Problems
Notes

Attempt the following problem giving reasons:


1.

X, the lessee and manager of a theatre enters into an agreement for the performance of a play
at his theatre, with Y, the manager of a theatrical company. The terms of the agreement
provide that X would provide the theatre, pay for the lighting and pay bills and would
receive 60 per cent of the receipts, and Y would receive the remaining 40 per cent. State
whether the aforesaid relationship amounts to partnership between X and Y or not.

2.

A and B are partners of a trading firm. A borrows Rs. 40000 from C in the name of the firm
without the knowledge of B. A spends the amount for his own purpose. Can C hold B liable
for Rs. 40000?

3.

A, B and C carry on partnership business. A dispute about partnership accounts is referred to


arbitration by A and B. Is the reference competent?

Answers to True or False


1. False

2. True

3. False

Answers to Practical Problems


1.

No, the participation in profit is not the decisive test of partnership.

2.

Yes, C can hold B liable.

3.

No, as all the parties interested in the matter of dispute are not ad-idem on the question of
reference, the reference is invalid and the award will not bind even the consenting parties.

Answers to Check Your Progress


Following are the answers to Check Your Progress, indicating respective paragraphs or reference.
1) 6.2

2) 6.3

3) 6.7

4) 6.8

5) 6.9

References
Section 4 of the Indian Partnership Act, 1932.
2

Section 2 (b) of the Indian Partnership Act, 1932.

Section 4 of the Indian Partnership Act, 1932.

Details of LLP can be obtained on Ministry of Company Affairs site http://www.nic.in/dca and
Institute of Company Affairs site www.icsi.edu.

118 Self-Learning Material

The Competition Act,


2002

Notes

Section

7
Free
competition
is worth
more to society
thanunderstand.
it costs.
Money
speaks sense
in a language
all nations
Oliver Wendell
Holmes
Aphra
Behn
STRUCTURE
7.1

Introduction

7.2

Extent and Application

7.3

Prohibition of Certain Agreements, Abuse of Dominant Position and Regulation of


Combination

7.4

Competition Commission of India

7.5

Director General (DG)

7.6

Penalties

7.7

Competition Advocacy

7.8

Finance, Accounts And Audit

7.9

Competition Appellate Tribunal (CAT)

7.10 Miscelianeous

Self-Learning Material 119

7.1 Introduction:
Notes

India has in the pursuit of globalization, responded to liberalization. . The natural corollary of this
is that the Indian market should be geared to face competition from within the country and outside.
The Monopolistic Restrictive Trade Practices Act, 1969 had become obsolete in certain respects in
the light of international economic development relating more particularly to competition laws.
There is a need to shift our focus from curbing monopolies to promoting competition. Competition
in business is like the blood in the body. As without blood, body will perish, similarly without
competition, business will languish and perish. Even giants like Microsoft was slapped a fine of
US$ 613 million by European Union competition authority for its antitrust (anti-competitive)
practices. Microsoft had also lost the Case in US, under anti-trust law. In India the Central
Government constituted a High Level Committee on competition Policy and Law (Under the
chairmanship of Mr. V.S. Raghavan). This committee submitted its report on 22.5.2000. Thereafter
the Central Government consulted all concerned including the trade and industry associations and
the general public. The Central Government after considering the suggestions of all concerned
parties enacted the Competition Act, 2002, hereinafter referred to as the Act. The Act received the
assent of the President on 13.1.2003. The Act was further extensivly amended in 2007.

7.2 Extent And Application1


The Act extends to the whole of India except Jammu and Kashmir. It defines the terms such as
Cartel, enterprise, price, relevant market, relevant geographic market, relevant product market,
acquisition, consumer, goods and service. Certain section of the Act have come into force from
31.3.2003 and some from 19.06.2003.

7.3 Prohibition of Certain Agreements, Abuse of Dominant


Position and Regulation of Combination2
a)

Anti-competitive Agreements: The Act provides for prohibition of agreement, which causes
or is likely to cause an appreciable adverse effect on competition within India. In this
category come agreements relating to bid-rigging or collusive bidding, market - sharing,
control of source of production or services, tie-in agreements or exclusive supply or
distribution agreements. However the right of any person to restrain any infringements of
for protecting any of his rights under Intellectual Property Rights (like Copyright Act 1957,
Patents Act 1970 or such other IPR protection law) is protected.

b)

Abuse of Dominant position: No enterprise or group shall abuse its Dominant position. The
expression dominant position means a position of strength, enjoyed by an Enteiprise, in
the relevant market in India

c)

Regulation of combination: The acquisition of one or more enterprises by one or more


persons or acquiring of control or merger or amalgamation of enterprises under certain
circumstances (exceeding monetary limits of assets or turnover as specified in section 5 of
the Act and given below) shall be construed as combination. Any combination, if entered
into, shall be void. The monetary limits specified for acquisition under the Act are:
i.

The parties jointly have a. In India assets > Rs.1000 crores or turnover>Rs.3000 crores
b. In India or outside India assets >500 million US$ including at least Rs. 500 crores in
India or turnover > 1500 million US$ including at least Rs.1500 crores in India.

ii. The group jointly havea. In India assets > Rs 4000 crores or turnover > Rs 12000 crores .
b. in India or outside India the assets >2billion US$ including at least Ks. 500 crores in
120 Self-Learning Material

India or turnover > 6 billion US$ including at least Rs. 1500 crores in India.
iii. Direct or indirect contract of acquisition if the acquirer has directly or indirectly control
over.

Notes

a. Any other enterprise in India -for the limits as provided in


i (a).
b. A group in India
> Rs. 12000 crores.

assets

>

Rs.

4000

crores

or

turnover

c. In India or outside India the assets > 2 billion US$ including


at least Rs. 500 crores in India or turnover > 6 billion US$.
iv.

Any enterprise after merger/amalgamation a. In India assets > Rs. 1000 crores or turnover > Rs. 3000 crores.
b. In India or outside India assets > 500 million US$ including at least Rs. 500 crores in
India or turnover > 6 billion US$ including at least Rs. 1500 crores in India.

Note:1.

Any person/enterprise entering into a combination shall give notice to the Competition
Commission of India (CCI) within 30 days of approval of the proposal by its board of
directors or execution of any agreement or other document for execution.

2.

No combination shall come into effect until 210 days have passed from the day on
which the notice has been given to CCI, which may deal with the notice in accordance
with the Act.

7.4 Competition Commission of India3


a)

Establishment of Competition Commission (CCI): The Act provides for the establishment
of the CCI which shall consist of the chairperson and not less than 2 and not more than 6
members, to be appointed by the Central Government. Their term shall be of 5 years and are
eligible for re-appointment. Central Government may appoint a Director General for assisting
CCI.

b)

Duties of C.C.I.:
It shall be the duty of CCI:i.

To eliminate practices having adverse effect on competition.

ii. Promote and sustain competition.


iii. Protect the interests of consumers.
iv. Ensure freedom of trade carried on by other participants in markets in India.
v.
c)

d)

To make inquiries into certain agreements and dominant position of enterprise and
about combinations.

Procedure for Inquiry: C.C.I, can direct the Director General (D.G.) to investigate, if primafacie case exists. If there is no prima-facie case, the matter shall be closed D.G. after inquiry
shall submit the report to C.C.I., who shall send the report to the parties, Central Government
or State Government. If DGs report says no contravention, then the complainant or the
relevant authorities shall be given an opportunity to rebut DGs findings. C.C.I, can dismiss
or order further enquiry. No enquiry shall take place after the expiiy of 1 year from the date
on which combination has taken effect.
Powers of CCI: After inquiring into agreements or abuse of dominant position CCI can pass
appropriate orders. It can order division of enterprise enjoying dominant position. CCI has
powers to regulate its own procedure and to rectify its own orders and to make a reference to
the statutory authority. CCI has power to inquire into acts taking place outside India but

Check Your Progress


1.

What are anticompetitive


agreement.

2.

What is abuse of
dominant position?

3.

What do you
understand by
combination?

4.

Explain duties of CCI.

Self-Learning Material 121

having its effect on competition in India.


Notes

7.5 Director General (DG)4


D.G. shall on directions from C.C.I assist CCI in investigating into any contravention of the Act,
DG has all the powers of the court to summon witnesses, discovery and production of documents,
receiving evidence, issuing commission etc. DG has also the powers of an Inspector under the
Companies Act, 1956 (Sec. 240 and 240A) for investigation of the companies.

7.6 Penalties5
Some of the penalties under the Act are as under:
Note:i.

C.C.I, has power to impose a lesser penalty, if any producer, seller,


distributor, trader or service provider has made a full and true disclosure.

ii. Amount of penalties to be credited to the Consolidated Fund of India.

S. No.

Check Your Progress


5.

Does DG have power


of a court?

6.

What penalties are


provided for the
contravention of
orders of CCI?

7.

Is opinion given by
CCI binding on
Central/State
Government.

122 Self-Learning Material

Offences

Penalties

1.

Contravention of orders of C.C.I.

Imprisonment upto 3 years or fine upto


Rs. 25 crore or both

2.

Failure to comply with the directions of


C.C.I and D.G.

Rs.l lakh for each day of default,


subject to a maximum of Rs. One crore.

3.

Non furnishing of information on


combination

Upto one percent of total turnover or


assets whichever is higher.

4.

Making false statements or omission to


furnish material information (being a
party to the combination)

Not less than Rs. 50 lakhs extendable


upto Rs. 1 crore.

5.

Making false statement, omission of


material fact or alteration or destruction
of document (offences in relation to
furnishing of information)

Fine upto Rs. One crore but shall not


be less than Rs. 50 lakhs.

7.7 Competition Advocacy6


The Central or a State Government may in formulating competition policy (including a review of
competition law) or any other matter ask the opinion of the C.C.I. C.C.I, shall give its opinion
within 60 days but the opinion given by C.C.I shall not be binding on the Central/State Government.
CCI shall take suitable measures for the promotion of competition advocacy, creating awareness
and imparting training about competition issues.

7.8 Finance, Accounts And Audit7


Central Government may make grants to C.C.I. There shall be constituted a fund to be called the
Competition Fund to which all incomes and grants shall be credited and from which all expenses
of C.C.I shall, be met. C.C.I shall maintain proper accounts in the form as prescribed by the Central
Government in Consultation with the Comptroller and Auditor-General of India. The audit of accounts
shall be done by the Comptroller and Auditor General of India. The audit report shall be forwarded
annually to the Central Government and shall be laid before each House of Parliament.

Notes

7.9 Competition Appellate Tribunal (CAT)8


a.

Establishment of CAT: The Central Government shall establish CAT to hear and dispose of
appeals against any direction issued or decision made or order passed by CCI. CAT shall
also adjudicate on claims for compensation.

b.

Appeal to CAT: The Central or State Government, a local authority, enterprise or any person
aggrieved by any direction, decision or order of CCI may file an appeal to CAT, Appeal shall
be filed within 60 days of the receipt of the order/decision by the appellant, CAT should
dispose of the appeal within 6 months of its receipts.

c.

Composition of CAT: CAT shall consist of a chairperson and not more than two members.
The term of chairperson or a member of CAT is five years and they are eligible for reappointment.

d.

Procedure and Powers of CAT: CAT shall not be bound by the procedure laid down in the
Code of Civil Procedure. It shall be guided by the principles of natural justice, provisions of
the Act and rules made by the Central Government. CAT shall have power to regulate its
own procedure. CAT shall have the same powers as are vested in a civil court.

e.

Contravention of orders of CAT.: Any person contravening any order of CAT shall be liable
for a penalty upto Rs. 1 crore or imprisonment upto 3 years or both.

f.

Appeal to Supreme Court: Any person/authority/enterprise or Government aggrieved by


any decision or order of CAT may file an appeal to the Supreme court within 60 days from
the communication of the decision/order of CAT.

7.10 Miscellaneous9
This part of the Act provides for:
a.

Power to exempt by government of:


i.

Any enterprise necessary in the interest of security of state or public interest.

ii. Any agreement arising out of treaty, agreement or convention with any country.
iii. Any enterprise performing sovereign function.
b.

Government has power to issue directions or supersede C.C.I.

c.

The chairpersons and members of C.C.I., CAT, D.G., Secretary officers and employees are
public servants.

d.

Protection of action taken in good faith.

e.

The Act to have over-riding effect. The application of other laws is not barred.

f.

The exclusion of jurisdiction of civil court.

g.

Power to make rules and regulations.

h.

Power to remove difficulties upto 2 years.

i.

Monopolistic Restrictive Trade Practices Act, 1969 is repeated.


Self-Learning Material 123

j.
Notes

All pending cases relating to Monopolistic Restrictive Trade Practices shall revert to C.C.i
and of Unfair Trade Practices (except some) to the National Commission under the Consumer
Protection Act, 1986.

Summary
The Competition Act, 2002
Competition is necessary for any business in India. The law regarding competition is contained in
the Competition Act, 2002 as amended in 2007. It extends to the whole of India except Jammu and
Kashmir. The Act prohibits anti-Competitive agreements, abuse of dominant position and regulates
combination by laying down monetary limits for acquisition by one or by a group in or outside
India. The Act also provides for the establishment of Competition Commission of India (CCI) and
its power and duties and the procedure for Inquiry to be conducted by the Director General. From
the orders of CCI, appeal can be filed to the competition Appellate Tribunal (CAT) and from its
orders in the Supreme Court of India. The Act provides for various offences like contravention of
orders of CCI, non furnishing of information on combination making false statements and the
punishment for them. There are provisions for finance, audit and accounts and some miscellaneous
aspects.

Review Questions
True or False
1.

The CCI orders are not appeal-able

2.

From the orders of the CAT appeal is made to the Supreme Court of India.

Choose the Right Answer


3.

The Competition Commission of India (CCI) shall consist of members not more than:
a)

Two

b) Three

c) Five

d) Six

Test Questions
1.

Explain the composition, powers and duties of the CCI.

2.

Discuss briefly the offences and penalties provided in the Competition Act, 2002.

3.

What are the main anti-competitive practices?

4.

What is competition advocacy.

5.

Write a short note on Competition Appellate Tribunal.

Answers to True or False


1. False

2. True

3. Two.

Answers to Check Your Progress


Following are the answers to Check Your Progress, indicating respective paragraphs or reference.
1) 7.3 (a)

124 Self-Learning Material

2) 7.3 (b)

3) 7.3 (c)

4) 7.4 (b)

5) 7.5

6) 7.6

7) 7.7

References
1

Sections 1 to 2 of the Competition Act, 2002

Notes

Sections 3 to 6 of the Competition Act, 2002

Sections 7 to 34 of th e Competition Act, 2002

Section 41 of the Competition Act, 2002

Sections 42 to 48 of the Competition Act, 2002

Section 49 of the Competition Act, 2002

Sections 50 to 53 of the Competition Act, 2002

Sections 53A 53U of the Competition Act, 2002

Sections 54 to 66 of the Competition Act, 2002

Self-Learning Material 125

Notes

126 Self-Learning Material

Highlights of
Information Technology
Act
Notes

Section

Money
speaks
sense inwhen
a language
understand.
Men keep
agreements
it is to all
thenations
advantage
of neither to break them.
Aphra
Behn
Salon
STRUCTURE
8.1

Introdution

8.2

Objectives of the Act.

8.3

Applicability.

8.4

Authentication of Electronic Records.

8.5

Electronic Governance.

8.6

Attribution, Acknowledgement and Despatch of Electronic Records.

8.7

Secure Electronic Records and Secure Digital Signatures.

8.8

Regulation of Certifying Authorities.

8.9

Digital Signature Certificates (DSC)

8.10 Duties of Subscribers.


8.11 Penalties and Adjudication.
8.12 The Cyber Regulation Appellate Tribunal.
8.13 Offences.
8.14 Liability of Network Service Provider.
8.15 Miscellaneous.

Self-Learning Material 127

8.1 Introduction
Notes

Electronic commerce eliminates the need for paper based transactions, therefore to facilitate ecommerce there is a need for legal changes. The United Nations Commission on International
Trade Law (UNCITRAL) adopted the model law on e-commerce in 1996. The General Assembly
of the United Nations by its resolution No. A/RES/51/162 dated 30 January 1997, recommended
that all states should give favourable considerations to the said model law when they enact or revise
their law. Consequently, India enacted Information Technology Act, 2000 (hereinafter referred to
as the Act) which came into force on 17-10-2000.

8.2 Objectives of the Act


The Act is set to revolutionise the technology scenerio in the country. This Act provides for legal
recognition for transactions carried out by 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, 1860, 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.

8.3 Applicability
The Act extends to the whole of India. It shall also apply to any violation or contravention of the
provisions of the Act done by any person any where in the world. The Act is not applicable to:
a)

A negotiable instrument as defined in section 13 of the Negotiable Instruments Act, 1881.

b)

A power-of-attorney as defined in section 1A of the Powers-of-Attorney Act, 1882.

c)

A trust as defined in section 3 of the Indian Trusts Act, 1882.

d)

A will as defined in clause (h) of section 2 of the Indian Succession Act, 1925, including any
other testamentary disposition by whatever name called.

e)

Any contract for the sale or conveyance of immovable property or any interest in such
property.

f)

Any such class of documents or transactions as may be notified by the Central Government
in the Official Gazette.1

8.4 Authentication of Electronic Records2


Any subscriber may authenticate an electronic record by affixing his digital signatures. The
authentication of the electronic record shall be effected by the use of asymmetric crypto system and
hash function, which envelop and transform the initial electronic record into another electronic
record. The entire regime of digital signatures is based upon the concept of public key and private
key. Both these keys are simultaneously generated by the algorithm. While the private key remains
with the subscriber, the public key remains with the Certifying Authority and the public key is used
by other members of the public to verify that the digital signature on a particular document has
been affixed by using the private key of the subscriber. The private key and the public key are
unique to the subscriber. These two keys constitute a functioning key pair.

8.5 Electronic Governance


a)

Legal recognition of electronic records.3


Where any law provides that information or any matter shall be in writing or in the typewritten

128 Self-Learning Material

or printed form, then such requirement shall be deemed to have been satisfied if such
information or matter is:i.

Notes

Rendered or made available in the electronic form.

ii. Accessible so as to be usable for a subsequent reference.


b)

Legal recognition of digital signatures.4


If any information/matter is required by law to be authenticated by affixing the signature,
then such requirement shall be deemed to have been satisfied, if such information/
matter is authenticated by means of digital signature, affixed in the prescribed manner.

c)

Use of electronic records and digital signatures in Government and its agencies.5
This is permitted for filing of any records, issue, grant of licenses/permit or receipt/ payment
of money, as may be prescribed by appropriate Government.

d)

Retention of electronic records.6


If any law provides that documents, records or information are required to be retained for
any specified period, then that requirement shall be deemed to have been satisfied if the
same is retained in electronic form.

e)

Publication of rules, regulations, etc. in Electronic Gazette.7


It provides for the publication of the Official Gazette in the electronic form.

f)

Sections 6,7,8 not to confer right to insist document should be accepted in electronic form.8

g)

Central Govt. has power to make rules in respect of digital signatures.9

8.6 Attribution, Acknowledgement and Despatch of Electronic


Records
a)

Attribution of electronic records.10


An electronic record shall be attributed to the originator:
i.

If it was sent by the originator himself.

ii. By any person who has such an authority.


iii. By an information system programmed by or on behalf of the originator to
operate automatically.
b)

Acknowledgement of receipt.11
This can be given of electronic record in a particular form or by a particular method, if so
desired by the originator.

c)

Check Your Progress

12

Time and place of dispatch and receipt of electronic record.

The dispatch of an electronic record (E.R.) occurs when it enters a computer resource (C.R.)
outside the control of the originator.The time of receipt of an E.R. shall be determined:
i.

If the addressee has designated a C.R. for the purpose of receiving E.R., when
E.R. enters designated C.R. or when E.R. is retrieved by the addressee.

ii. If the addressee has not designated a C.R. along with specified timings, if any,
receipt occurs when the E.R. enters the C.R. of the addressee.

1.

records authenticated?
2.

Are digital
signatures legally
recognised?

3.

What is a secure
digital signature?

8.7 Secure Electronic Records and Secure Digital Signatures


4.
a)

13

Secure E.R.

Where any security procedure has been applied to an E.R. at a specified point of time, then
such record shall be deemed to be a secure E.R. from such point of time to the time of

How are electronic

How are digital


signature certificates
issued?

Self-Learning Material 129

verification.
Notes

b)

Secure digital signature (D.S).14


If it can be verified that a D.S. at the time it was affixed, was (i) unique to the subscriber
affixing it (ii) capable of identifying the subscriber, (iii) created in a manner or using a
means under the exclusive control of the subscriber and is linked to the E.R. to which it
relates in such a manner that if the E.R. was altered, the D.S. would be invalidated, then such
D.S. shall be deemed to be a secure D.S.

c)

Security Procedure.15
The central government shall prescribe the security procedure having regard to commercial
circumstances prevailing at the time when the procedure was used.

8.8 Regulation of Certifying Authorities16


Central government may appoint Controller of Certifying Authorities. The Controller shall be the
repository of all Digital Signature Certificates (DSC). The Controller may issue license to any
person to issue DSC. The Controller or any person authorised by him shall have access to any
computer system and data to find out if any contravention of the Act has been committed.

8.9 Digital Signature Certificates (DSC)17


Any person can make an application to the Certifying Authority for the issue of a DSC by paying
the fees upto Rs. 25000. Application must be accompanied by a certification practice statement or
a statement containing specified particulars. A DSC can be revoked as provided in the Act.

8.10 Duties of Subscribers18


The duties of subscribers are:
a)

Generating key pair (private and public) by applying the security procedure.

b)

Acceptance of DSC once it is published or authorised for publication.

c)

Control of private key corresponding to public key shall be exercised.

8.11 Penalties and Adjudication19


The Act provides for:
a)

Penalties for damage to computer, computer system etc. upto Rs. 1 crore and for failure to
furnish information, return etc. upto Rs. 1.5 lakhs.

b)

Power to adjudicate by adjudicating officer to be appointed by the central government.

8.12 The Cyber Regulation Appellate Tribunal20


The Central Government shall establish one or more Cyber Appellate Tribunal (CAT). The Act
provides for the composition of CAT, conditions of service, qualifications and terms of office of
presiding officer CAT. The appeal shall be disposed of finally within six months. Civil Courts
shall not have any jurisdiction. Appeal from the decisions of CAT shall be filed to the High Court
within sixty days from the date of communication of the decision of CAT.

8.13 Offences21
a)
130 Self-Learning Material

Offences and the punishment provided can be summarised in the following table:

S. No.

Offences

Punishment
Imprisonment
Term upto

Fine upto
Notes

1.

Tempering with computer


source document.

3 years

2 lakhs

2.

Hacking with computer


system.

3 years

2 lakhs

3.

Publishing of Information
which is obscene in
electronic form.
Failure to comply with the
orders of the Controller.

5 years

1 lakh

3 years

2 lakhs

5.

Failure to comply with the


directions
of
the
Controller to extend
facilities to decrypt
information.

7 years

NIL

6.

Securing access to a
protected system.

10 years

No Limit

7.

Misrepresentation or
suppression of fact.

2 years

1 lakh

8.

Breach of confidentiality
and piracy, publishing
false or fraudulent DSC.

2 years

1 lakh

4.

b)

Extra-territorial jurisdiction - The provisions of the Act shall apply also to any offence
committee outside India by any person irrespective of his nationality.

c)

Confiscation - Any computer, floppies, compact discs, tape drive or any other accessories
related thereto, in respect of which any contravention has been committed shall be liable to
confiscation.

d)

Penalties or confiscation not to interfere with other punishments provided in any other law.

e)

Power to investigate offences - This power is vested with police officer not below the rank
of Deputy Superintendent of Police.

8.14 Liability of Network Service Provider22

Check Your Progress

Network service provider shall not be liable if the offence or contravention was committed without
his knowledge or that he had exercised all due diligence to prevent the commission of such offence
or contravention.

5.

8.15 Miscellaneous23
This portion of the Act deals with miscellaneous subjects like power to make rules and regulations
and amendments to Indian Penal Code I860, Indian Evidence Act 1872, Bankers Books Evidence
Act 1891, and the Reserve Bank of India Act, 1934. By an amendment made in 2002 the Act shall
apply to electronic cheques and truncated cheques.24

To what extent, the


penalties may go in
case of noncompliance
with the Act?

6.

Who has the power to


investigate offences
under the I.T. Act?

Self-Learning Material 131

Summary
Notes

Information Technology Act


The United Commission on International Trade Law (UNCITRAL) had adopted the model law on
e-commerce in 1996. In India the law relating to Information Technology is based on this model
law and contained in the Information Technology Act, 2000. The objectives of this Act are ecommerce and e-governance. The Act extends to India and also it has extra-territorial application
even outside India. The Act is not applicable to certain documents like negotiable instruments,
will, trust, power of attorney and any conveyance of immovable property. Authentication of
electronic records is done by digital signature which is based on the concept of private and public
key. E-governance is provided by means of legal recognition of electronic records, of digital
siginatures, retention of electronic records and publication of rules, regulations etc. in electronic
gazette. An electronic record is attributed to the originator when it was sent by himself or by
authorised person. Digital Signatures shall be given by the Controller of Certifying Authority
appointed by the central government. The Act also provides for Digital signatures Certificates,
penalties, adjudication, the Cyber Appellate Tribunal and the liability of network service provider.

Review Questions
True or False
1.

A contravention of Information Technology Act by any person any where in the world is
punishable under the Act.

2.

The digital signatures are generated by one key and not by a set of keys.

3.

There is no provision of appeal in the Information Technology Act.

Multiple Choice Questions


1

Digital signature can be obtained from:


a)

Central Government

b)

State Government

c)

Certifying Authority

d)

Cyber Regulation Appellate Tribunal

Information Technology Act, is not applicable to:


a) Company law
b)
Central Excise
c)

Income Tax

d)

Trust

Test Questions
1.

Write short notes on:


a)

Digital signature

b) Electronic governance

132 Self-Learning Material

2.

Explain the provisions on penalties, adjudication and offences of the Information Technology
Act.

3.

Explain the areas where Information Technology Act 2000 is not applicable.

4.

How are electronic records authenticated?

5.

Give highlights of the Information Technology Act, 2000.

Answers to True or False


1. True

Notes

2. False 3. False

Multiple Choice Questions


1. c

2. d

Answers to Check Your Progress


Following are the answers to Check Your Progress, indicating respective paragraphs for reference.
1) 8.4

2) 8.5.b 3) 8.7 (b)

4) 8.9 5) 8.13 (a)

6) 8.13.e

References
1

Section 1 (4) of the Information Technology Act, 2000.

Section 3 of the Information Technology Act, 2000.

Section 4 of the Information Technology Act, 2000.

Section 5 of the Information Technology Act, 2000.

Section 6 of the Information Technology Act, 2000.

Section 7 of the Information Technology Act, 2000.

Section 8 of the Information Technology Act, 2000.

Section 9 of the Information Technology Act, 2000.

Section 10 of the Information Technology Act, 2000.

10
11

Section 11 of the Information Technology Act, 2000.

Section 12 of the Information Technology Act, 2000.

12

Section 13 of the Information Technology Act, 2000.

13

Section 14 of the Information Technology Act, 2000.

14

Section 15 of the Information Technology Act, 2000.

15

Section 16 of the Information Technology Act, 2000.

16

Sections 17 to 34 of the Information Technology Act, 2000.

17

Sections 35 to 39 of the Information Technology Act, 2000.

18

Sections 40 to 42 of the Information Technology Act, 2000.

19

Sections 43 to 47 of the Information Technology Act, 2000.

20

Sections 48 to 64 of the Information Technology Act, 2000.

21

Sections 65 to 78 of the Information Technology Act, 2000.

22

Sections 79 of the Information Technology Act, 2000.

23

Sections 80 to 94 of the Information Technology Act, 2000.

24

Inserted by Amendment Act, 2002. (55 of2002) w.e.f. 6-2-2003.

Self-Learning Material 133

Notes

134 Self-Learning Material

Important Features of
Copyright Law

Notes

Section

9
Thoughts,
emotions
demand
legal
recognition.
Money speaks
sense and
in a sensations
language all
nations
understand.
Louis
D. Brandeis
Aphra
Behn
STRUCTURE
9.1

Introduction

9.2

Copyright Office and Copyright Board

9.3

Copyright, its Ownership and Term

9.4

Licences

9.5

Copyright Societies

9.6

Rights of Broadcasting Organisations and of Performers

9.7

International Copyright

9.8

Registration of Copyright

9.9

Infringement of Copyright

9.10 Civil Remedies


9.11 Offences

Check Your Progress


1.

What is a Copyright
Board?

2.

Who is the owner of a


copyright?

3.

What is the life of a


copyright?

4.

Does the use of


copyrighted material
for a judicial
proceeding infringe
copyright?

9.12 Miscellaneous
9.13 Some Cases on Copyright

Self-Learning Material 135

9.1 Introduction
Notes

Copyright is about the right to copy. It is based on the principle that people who produce creative
work like poems, novels have a right to decide how their works can be reproduced. It is relevant
to mention that copyright is not related to ideas, but to their expression. Law relating to copyright
is contained in the Copyright Act, 1957 (referred to as the Act). It extends to the whole of India
and came into force on 21-11958. The Act has been amended in 1983, 1984, 1992, 1994 and 1999
primarily to bring the Indian law in conformity with the international conventions like Bern
Convention, Universal Copyright Convention and agreements ofWorld Trade Organization relating
to Trade Related Intellectual Property Rights (TRIPS).

9.2 Copyright Office and Copyright Board1


The Central Government has established a Copyright Office under the control of Registrar of
Copyrights. The Central Government has also constituted a Copyright Board. The Registrar of
Copyrights is the Secretary of the Board. The Copyright Board consists of a Chairman and between
2 to 14 members. The Board functions through Benches consisting of 3 members. The Copyright
Board shall be deemed to be a civil court.

9.3 Copyright, its Ownership and Term2


a)

Works in which Copyright Subsists: Copyright subsists throughout India in the


following classes of work:
i.

Original literary, dramatic, musical and artistic works.

ii. Cinematograph films.


iii. Sound recordings.
Literary works include computer programmes, tables and compilations including computer
databases. The term dramatic works includes any piece of recitation, choreographic work
or entertainment in dumb show or acting. The words musical works mean a work consisting
of music and includes any graphical notation of such work. A painting, sculpture, drawing
or works of architecture and photograph are included in artistic works.

Case 1 Check Your Progress


1.

What is a Copyright
Board?

2.

Who is the owner of a


copyright?

3.

What is the life of a


copyright?

4.

Does the use of


copyrighted material
for a judicial
proceeding infringe
copyright?

Basically for a copyright, there should be a work and not a mere idea. Idea does not have
a copyright protection. To claim copyright, the work should be in a material form which
involves the ideas translated. - Jeffreys vs Bosey (1854, 4 HLC 815).

Case 2 The term literary means anything written or printed such as books on various subjects,
serious and non-serious, novels, drama, poetry, anthology, critique, excerpts with comments,
etc. What is material is that there should be some originality and skill in the work turned
out. Thus the term literary is not confined to works of literature in the commonly understood
sense but would include of what is expressed in writing whether they have inherent or
latent literary merit or not. - Agarwal Publishing House vs Board of Higher Secondary and Intermediate
Education, (UP AIR 1967 (All) 91).

Case 3 It is the original inventive literary work that is entitled to protection under the Act. The

136 Self-Learning Material

word original does not mean that the work must be the expression or inventive thought.
Orginality relates to the expression of thought but the Act does not require that the expression
must be in original or other form. The work must not be copied from another work, that is,
it should not originate from another. - MacMillan & Co. vs Cooper, (AIR 1924 PC 75).

Notes

Case 4 Copyright exists in computer programes (software) and the written requests, punched cards,
magnetic tapes or disks as the case may be. In a television programme also, there exists a
copyright. The Tambola ticket books carry copyright protection as it consists of tables and
numbers of skill and labour as has been bestowed. In the case of question papers, they
enjoy copyright. - Jagdish Prasad vs Parameswar Prasad, (AIR 1966 Pat 33).

Case 5 An exhibition of a film in a television through video tape in which the cinematograph film
is recorded will be the subject matter of copyright protection. A VCR which is used for
playing pre-recorded cassettes of movies similarly will also be subject - matter of copyrights
protection. In respect of cinematographic films the word original is missing in the section.
In a film, a particular actor cannot claim any copyright and hence the actors performance
is not copyrighted. In other words, a cine artiste in a film does not have a copyright protection.
- International Films vs Dev Anand, (AIR 1979, Bom 17).

b)

Meaning of Copyright: The word Copyright means the exclusive right in all the works in
which the copyright subsists (See paragraph 9.3.3 (a))

c)

Ownership of Copyright: The author of the work is the first owner of the copyright therein.
This is, however, subject to some exceptions like an employer can have the ownership on a
work produced by an author, under a Contract of Service or apprenticeship or the ownership
of a computer related work vests in one who pays for it.

d)

Assignment of Copyright: The owner of the copyright may assign to any person the copyright,
either wholly or partially, and either generally or subject to limitation and either for the
whole term of the copyright or any part thereof. The assignment is valid only when it is in
writing.

e)

Term of Copyright:
i.

The term of the copyright in any literary, dramatic, musical or artistic work
(other than a photograph) is:
a. If published with in the lifetime of the author until 60 years from the beginning
of the calendar year next following the year in which the author dies.
b. If published anonymously or pseudonymously, until 60 years from the
beginning of the calendar year next following the year in which the work is
first published. If, however, the identity of the author is disclosed before the
expiry of the said period, then copyright shall subsist as per a above.
c. In posthumous works, until 60 years from the beginning of the calendar year
next following the year in which the work is first published.

ii. The term of the copyright in case of a photograph, cinematograph film,


sound recording, government work, work of public undertaking and the works
of an international organisation, shall subsist until 60 years from the beginning
of the calendar year next following the year in which the work is first
published.

Self-Learning Material 137

9.4 Licences3
Notes

The owner of the copyright in any existing work or the prospective owner of the copyright in any
future work may grant any interest in the right by license in writing signed by him or by his duly
authorised agent. License to produce and publish a translation of a literary or dramatic work in
any language may be applied to the Copyright Board, after a period of 7 years from the first
publication of the work. A License to translate foreign literary or dramatic work, may be applied
after three years from its publication.

Case Many a time there arises a contentious issue whether a deed is one of assignment of copyright or
licensing of copyright may arise. Much of the confusion is because of the manner of drafting the
deed. Particularly whether there is an exclusive licence or a partial licence or non-exclusive licence
or a partial assignment or otherwise of the copyright the problem of interpretation becomes
necessary in the context of the intention expressed in the deed but where the agreement contain
express words indicating a licence or a partial assignment not much difference would areise.
Many times where the agreement provides for royalties for sharing of profits in respect of literary
works, the inference that could be drawn is that there is no assignment of the copyright. Similarly,
where the publishers have been conferred exclusive licence to publish and sell and the authors are
under obligation to revise the work and keep it up-to-date, there would be in law an inference that
there is no assignment of the copyright whatsoever. Where payment of royalty is specified in the
agreement the preponderance of the conclusion that there is no assignment would be right in law.
- Sundaram vs Rattan Prakashan Mandir, (AIR 1983 Del 461).

9.5 Copyright Societies4


No person or association of persons can commence or carry on the business of issuing or granting
licenses in respect of any work in which copyright subsists unless a copyright society is registered
by the Central Government. For example: Phonographic Performance Ltd. (PPL) is a copyright
society which has got licenses from music companies for broadcasting their music in India.

9.6 Rights of Broadcasting Organisations and of Performers5


Every broadcasting organisation shall have a special right known as Broadcasting Reproduction
Right in respect of its broadcasts. The term of this right is 25 years and of performers right
subsists for 50 years.

9.7 International Copyright6


The Central Government can extend copyright protection to foreign works, and works made and
published by certain International Organisations. Accordingly the Central Government has made
the International Copyright Order, 1991 and the Copyright (International Organisations) Order,
1958.

9.8 Registration of Copyright7


Registration of copyright is optional. A register of copyright is kept in the copyright office. All
details of works in which registration is applied for is entered in that register. Register of copyrights
is a prima-facie evidence of the particulars entered there in. The register is open for inspection
and extracts of it can be obtained. The entries in the register can be corrected or rectified and shall
be published. A certificate of registration becomes a crucial prima-facie evidence before a court
138 Self-Learning Material

in the ownership of the material and other facts recorded therein.

Case -

Notes

The copyright exists whether the registration is done or not, and the registration is merely a piece
of evidence as to when a certain author started claiming copyrights in some artistic or some other
work. - Glaxo Operations UK Ltd. vs Samrat Pharmaceuticals (AIR 1984 Del 265).

9.9 Infringement of Copyright8


Some of the acts which are considered as no infringement of copyright are:
a)

Private use including research.

b)

Criticism or review.

c)

Computer programme - making copies for the purpose for which it was supplied or make
backup copies.

d)

Reporting current events in a newspaper, magazine or by broadcast or in a cinematograph


film, or by means of photographs.

e)

For judicial proceedings.

f)

In any work prepared by the Secretariat of a Legislature exclusively for the use of its
members.

g)

Copy made in accordance with any law.

h)

Reading in public of any reasonable extract from a published literary or dramatic


work.

i)

Along with non-copyright matter, for the bonafide use of educational institutions.

j)

By a teacher or pupil in the course of instruction or as a part of question or answer in


examination.

k)

Recording to be heard in public by utilising it in an enclosed room.

l)

Any bonafide religious ceremony held by the Central or State Government or any Local
Authority.

Case Mr. Anand wrote a play entitled Hum Hindustani in 1953. The play was enacted in the next few
years, in Delhi and Calcutta. It got good reviews in newspapers like the Indian Express, Hindustan
Times, The Times of India and other papers. The play was based on the theme of provincialism and
its baneful and divisive effects on the society. A film maker, Mr. Mohan Sehgal, become interested
in making a film based on the play. He heard the play from Mr. Anand, in his office. Mr. Mohan did
not receive any further communication from Mr. Sehgal. Thereafter, Mr. Sehgal announced the
production of a film New Delhi. The picture was released in Delhi in September, 1956. From
comments in the press, Mr. Anand felt that the film was very much like his play, Hum Hindustani.
Thereafter, Mr. Anand himself saw the picture and felt that the film was entirely based on his play.
He felt that Mr. Sehgal had dishonestly imitated the play in the film and violated his copyright. He,
therefore, moved the court and the case finally came before the Supreme Court.
The opposite party (Delux Films) claimed that they had communicated to Mr. Anand that the play
might have been all right for the amateur stage, but it was too inadequate for the purposes of
making a full length commercial motion picture. The key argument of the opposite party was that
there could be no copyright on the subject or idea of provincialism. Any one can adopt it in his own
way. They claimed that the motion picture was quite different from the play. Hum Hindustani in
its content, spirit and climax. Some similarities could be explained by the fact that both were based
Self-Learning Material 139

on the idea of provincialism.


Notes

Thus the position appears to be that an idea, principle, theme, or subject matter or historical or
legendary facts being common property, cannot be the subject matter of copyright of a particular
person. It is always open to any person to choose an idea as a subject matter and develop it in his
own manner and give expression to the idea by treating it differently from others. Where two
writers write on the same subject, similarities are bound to occur because the central idea of both
are the same but the similarities or coincidences by themselves cannot lead to an irressistible inference
of plagiarism or piracy. The court found that there had been no copyright violation in that case. - R.
G. Anand vs M/s Delux Films and others (AIR 1978 SC 1613).

9.10 Civil Remedies9


The owner of copyright can sue in the district court having jurisdiction and shall be entitled to
remedies such as injunction, damages.

9.11 Offences10
Any infringement of copyright is punishable with imprisonment of not less than 6 months but may
extend to 3 years or fine not less than Rs. 50 thousand but may extend to Rs. 2 lakhs. For infringement
of copyright in computer programme punishment provided is imprisonment of not less than seven
days but may extend to 3 years and fine of not less than Rs. 50 thousand but may extend to Rs. 2
lakh. If the infringement is not for gain or commercial purpose punishment can be less. If any
person is aggrieved by any order made by the court, then he can file appeal within 30 days of the
date of the order to the higher appellate court.

9.12 Miscellaneous11
This provides for the Central Government to make rules and also that all the actions taken by
officials under the Act, if done in goods faith are protected.

9.13 Some Cases on Copyright

140 Self-Learning Material

a)

Ratnasagar Pvt. Ltd. v. Trisea Publications and others (citation: (1997) 24 CLA (SNR) 1
Delhi) Ratnasagar Pvt. Ltd. had published a book titled Living Science and claimed rights
of literary work in that book. Trisea Publications brought out another book titled Unique
Science. Ratnasagar Pvt. Ltd. urged that their copyright has been infringed by Trisea
Publications and prayed for an injunction which was granted.

b)

Nagoti Venkataramana Case (Citation: 1996, (6) Scale 417 and 1996, (6) Sec 409)Nagoti
Venkataramana was owning a Video parlour named Video City in Andhra Pradesh. He
was sentenced to 3 months R.I. and fine of Rs. 3000 for keeping 90 pirated Telugu, Hindi
and English movies video cassettes. He used to give these pirated cassettes to customers on
hire. On the point that the police should have produced the evidence of the copyright owners,
the Supreme Court ruled that It is unnecessary for the prosecution to track on and trace out
the owner of the copyright to come and adduce evidence of infringement of the copyright.

c)

Phonographic Performance Ltd. (PPL) (As reported in the Times of India, Delhi edition
1st Jan. 2004). PPL is a copyright society registered under the Copyright Act. It is the sole
authority to administer the broadcasting, telecasting and public performance rights and to
collect licence fees on behalf of the music industry. Music Companies are members of PPL
and have assigned it the right to issue licenses to event organisers for playing music at
public performance. In a petition filed by PPL in Bombay High Court against the hotels of
Mumbai for not paying license fee to PPL for playing music in respect of the companies
with PPL on New years eve parties, the High Court of Bombay directed hotels of Mumbai

to pay license fee to PPL for the music they play.


d)

P. N. Krishnamurthys Case Shri P. N. Krishnamurthy, 70 year old author of


Childrens literature won a copyright case against CARE after battling in court
for 27 years. CARE was imposed a fine of Rs 5000 for a copyright violation. An
appeal filed by CARE was dismissed as Without any merit.

Notes

Summary
Copyright
The law relating to Copyright is contained in the Copyright Act, 1957. The Indian law is in
conformity with our obligations in International Conventions. The Registrar of Copyright controls
Copyright office and above him is the Copyright Board. The copyright subsits in 1 - original
literary, dramatic, musical and artistic works, 2 - cinematograph films, and 3 - sound recordings.
Copyright means the exclusive right in all the works in which the copyright subsists. The author of
the work is the first owner of the Copyright therein. The owner of the copyright may assign to any
person the copyright, either partially or wholly. The term of the copyright in any literary, dramatic,
musical or artistic work is 60 years. The term of broadcasting reproduction right is 25 years and of
performers right in 50 years. The Act provides for international copyright and for optional
registration of copyright. Some of the acts which are considered as no infringement of copyright
are, a - private use including research, b - criticism or review, c - making back-up copies of
computer programme, d - reporting current events, e -for judicial proceedings, f- work prepared
by secretariat of a legislature for its members, g - copy made in accordance with law, h - reading
in public of any extract from a published literary or dramatic work, i - for the bonafide use of
educational institutions, j - in the course of instructions or as a part in examination, k - recording
to be heard in an enclosed room, or l - any bonafide religious ceremony held by the Central, State
or Local Government. The infringement of copyright gives rise to civil remedies such as injunction
or damages and penalties of imprisonment upto 3 years and fine upto Rs. 2 lakhs.

Review Questions
True or False
1.

Registration of copyright is compulsory under the Copyright Act.

2.

Granting license of copyright can only be done to a copyright society registered by the
Central Government.

3.

The assignment of copyright is valid only when it is in writing.

4.

Making back-up copies of a computer programme is no infringement of copyright.

Multiple Choice Questions


Tick the Right Answer:
1.

The term of Performers Right is for a period of:


a. 50 years

2.

b. 40 years

c. 30 years

The term of copyright is for a period of:


a. 20 years b. 40 years c. 60 years

d. 20 years
d. 80 years

Self-Learning Material 141

Test Questions
Notes

1.

Elaborate on the meaning of Copyright.

2.

How infringements of Copyright are dealt under the copyright Act, 1957? What acts are
considered as no infringement of copyright?

3.

Give highlights of the Copyright Act, 1957?

Answers to True or False


1. False

2. True 3. True

4. True

Answers to Multiple Choice Questions


1. a

2. c

Answers to Check Your Progress


Following are the answers to Check Your Progress, indicating respective paragraphs for reference:
1) 9.2

2) 9.3 c

3) 9.3 e

4) 9.9 c

References
Sections 9 to 12 of the Copyright Act, 1957.
Sections 13 to 29 of the Copyright Act, 1957.
3
Sections 30 to 32 B of the Copyright Act, 1957.
4
Sections 33 to 36 A of the Copyright Act, 1957.
5
Sections 37 to 39 A of the Copyright Act, 1957.
6
Sections 40 to 43 of the Copyright Act, 1957.
7
Sections 44 to 50 A of the Copyright Act, 1957.
8
Sections 51 to 53 A of the Copyright Act, 1957.
9
Sections 54 to 62 of the Copyright Act, 1957.
10
Sections 63 to 73 of the Copyright Act, 1957.
11
Sections 74 to 79 of the Copyright Act, 1957.
1
2

142 Self-Learning Material

Important Aspects of
Patent Law

Notes

Section

10
Art and law are as different as chalk from cheese. But the dreamer also
needs support.
Money speaks sense in a language all nations understand.
Anonymous
Aphra Behn

STRUCTURE
10.1 Introduction
10.2 What is a Patent?
10.3 Inventions not Patentable
10.4. Application for Patents
10.5 Publication and Examination of Application
10.6 Oppositoin Proceedings to Grant of Patents
10.7 Provisions for Secrecy of Certain Inventions
10.8 Grant of Patents and Rights Conferred Thereby
10.9 Patents of Addition
10.10 Amendment of Applications and Specifications
10.11 Restoration of Lapsed Patents
10.12 Surrender and Revocation of Patents

Check Your Progress

10.13 Register of Patents


10.14 Ratent Office and its Establishment and Powers of Controller 1.
10.15 Working of Patents, Compulsory Licences and Revocation

Which Act governs the


law related to patents?

2. Inventions
Who makes
the
10.16 Use of Inventions for Purposes of Government and Acquisition of
by Central
applications
for
Government
patents?
10.17 Suits Concerning Infringement of Patents
10.18 Miscellaneous
Self-Learning Material 143

10.1 Introduction
Notes

The fundamental principle of patent law is that a patent is granted only for an invention which must
be new and useful. That is to say, it must have novelty and utility. It is essential for the validity of a
patent that it must be the inventors own creation as opposed to mere verification of what was
already known before the date of the patent. Mere collection of more than one integers or things,
not involving the exercise of any inventive faculty does not qualify for the grant of a patent. The
law relating to patents is contained in the Patents Act, 1970, hereinafter referred to as the Act. It
extends to the whole of India. The Act describes the procedure for the grant of patent and protects
the rights of the patentee against infringement. The Act came into force from 21-91970. It has been
amended in 1999, 2002 and again in 2005.

10.2 What is a Patent?


The Act states that a patent means a patent for any invention granted under the Act.1 It can also be
defined as a grant from the government, which confers on the grantee, for a limited term, the
exclusive privilege of making, selling and using an invention and also authorising others to do so.
Thus a patent is a protection given to a patentee for his invention for a limited term by the Government
in consideration of his disclosing the invention.

10.3 Inventions not Patentable2


Some of the inventions which are not patentable under the Act are:
a)

Frivolous inventions or which claim anything obvious or contrary to well established natural
laws.

b)

Inventions which are contrary to public order or morality, or which caused serious prejudice
to human, animal or plant life or health or to the environment.

c)

Mere discovery of a new form of a known substance which does not result in the enhancement
of the known efficacy of that substance.

d)

Mere discovery of any new property or mere use of a known process, machine or apparatus
unless such known process results in a new product or employs at least one new reactant.

e)

A method of agriculture or horticulture.

f)

A mathematical or business method or a computer programme per se or algorithms.

g)

A mere scheme or rule or method of performing mental act or method of playing


game.

h)

A presentation of information.

i)

Topography of integrated circuits.

j)

An invention which, in effect, is traditional knowledge.

k)

An invention relating to atomic energy.

Case Mere arrangement or rearrangement or duplication of a known device cannot be patented. - Standipack
Pvt. Ltd. vs Oswal Trading Co. Ltd. ((19) PTC 479 (Del)).

10.4 Application for Patents3


A patent application can be made by any of the following persons either alone or jointly:
a)
144 Self-Learning Material

True and first inventor

b)

Assignee of (a)

c)

The legal representative of (a) or (b) after their death

Notes

Every application for a patent shall be for one invention only and on a prescribed form. It shall be
filed in the patent office with provisional or complete specifications. The Act also provides for
international application under the Patent Cooperation Treaty, for a patent.

10.5 Publication and Examination of Application4


Every application of patent shall be published. When a request for examination is made by the
applicant, the Controller shall refer the application and the specifications to an examiner for making
a report to him. The examiner can come to the conclusion whether the invention has already been
published or claimed or is the subject matter of existing patent. Controller can make objections,
which the applicant shall rectify.

Case Prior registration of patent in another country prima facie constitutes prior publication and is liable
to be rejected. - Lintech Electronics (P) Ltd. vs Marvel Engineering Co. (1995 (35) DRJ 11).

10.6 Opposition Proceedings to Grant of Patents5


Where an application for a patent has been published but a patent has not been granted, any person
may, in writing on specified grounds give, notice of opposition to the Controller against the grant of
patent. At any time after the grant of patent but before the expiry of one year from the date of
publication of grant of a patent any person interested may give notice of opposition to the Controller
on certain specified grounds only. Where any notice of opposition has been given, the Controller
shall constitute an Opposition Board for examination and submission of its recommendations to
the Controller. Thereafter the Controller may, if so desired, give to both the applicant and the
opponent an opportunity to be heard before ordering either to maintain or to amend or to revoke the
patent.

10.7 Provisions for Secrecy of Certain Inventions6


Where in respect of an application for a patent, it appears to the Controller that the invention is one
of a class notified to him by the Central Government as relevant for defense purposes, then he may
give directions for prohibiting or restricting the publication of information with respect to the
invention or the communication of such information. Such directions shall be periodically reviewed
at intervals of six months or on a request made by the applicant.

10.8 Grant of Patents and Rights Conferred Thereby7


Check Your Progress
a)

Grant of Patent: Where the application for the patent is accepted, then the Controller shall
grant the patent. The date of the grant of patent is entered in the register when the patent is
granted, the application, specification and other documents related to the patent shall be
open for public inspection.

3.

When the secrecy


shall be maintained
with regard to patents?

b)

Date of Patent: Every patent shall be dated as of the date on which the application for patent
was filed.

4.

c)

Rights of Patentee: The patentee has exclusive right to prevent third parties from the act of
making, using, selling or importing for these purposes the patented product in India.

What are the rights


related to the
patentee?

5.

d)

Term of Patent: The term of every patent shall be 20 years from the date of filing of the
application for the patent.

How long a patent is


valid?

Self-Learning Material 145

10.9 Patents of Addition8


Notes

An application may be for a patent in respect of any improvement in or modification of a patented


invention (known as main invention). The Controller may grant the patent for the improvement or
modification as a patent of addition. The term of the patent of addition shall run concurrently and
terminate with the main patent. A patent of addition shall not be granted before grant of the patent
for the main invention.

10.10 Amendment of Applications and Specifications9


The Controller is empowered to allow the application for the patent or the complete specification
or any document relating thereto to be amended. Every such application shall state the reasons and
nature of the proposed amendment. If such application is made after the grant of the patent then the
nature of the proposed amendment shall be published.

10.11 Restoration of Lapsed Patents10


Where a patent has ceased to have effect by reason of failure to pay any renewal fee within the
prescribed period, then an application may be made to the Controller within 18 months for the
restoration of the patent.

10.12 Surrender and Revocation of Patents11


A patentee may at any time by giving notice to the Controller, offer to surrender his patent. This
offer shall be published. Opposition can be made and settled and then only the Controller shall
revoke the patent. The Appellate Board may also revoke the patent on a petition of any person
interested or of the Central Government. The High Court may also revoke the patent on a counter
claim in a suit for infringement of the patent. The Act also provides revocation of patent by the
Central Government in public interest.

10.13 Register of Patents12


A register of patents shall be kept at the patent office. The particulars regarding the patent, patentee,
assignment, transfer, license shall be entered in the register. The Controller can keep the register in
computer floppies, diskettes, or any other electronic form. This register shall be open to inspection
by the public. Any person can take extracts of the register on payment of prescribed fee. The
register shall be prima-facie evidence of any matters required or authorised to be entered therein.
The Appellate Board may, on the application of an aggrieved person make such order for the
making, variation or deletion of any entry therein as it may think fit.

10.14 Patent Office and its Establishment and Powers of


Controller13
The head office and the branch offices of the patent office shall be specified by the Central
Government. Presently it has branch offices at Mumbai, New Delhi and Chennai and head office at
Kolkata. The Controller General of Patents, Design and Trade Marks is the Controller of Patents.
There shall be a seal of the patent office. The Controller shall have powers of Civil Court. The
Controller has powers to correct clerical errors, take evidence either orally or by affidavit. Three of
the patent offices in Kolkata, Chennai, Mumbai and New Delhi have been modernised. The
modernisation of patent offices helps fast track patent processing, apart from linking them with
Patent Cooperation Treaty network in Geneva.14
146 Self-Learning Material

10.15 Working of Patents, Compulsory Licenses and


Revocation15
a)

Working of Patents: The patents are granted to encourage inventions, and to make the benefit
of the patented inventions available at reasonably affordable prices to the public. They are
not granted merely to enable patentees to enjoy a monopoly. The patents granted do not
impede protection of public health and nutrition. The Central Government is working on a
fast track solution to ease the burden of ever growing patent applications in India. Once the
system is in place, the procedure of completing a patent application will take six months to
five years. At present the government needs at least 11 years to handle one patent application.
Till a couple of years ago, only 4000 patent applications were filed annually. In 2004-05,
there were about 17000 applications which further went upto 25000 during 2005-06.16

b)

Compulsory Licenses and Revocation: At any time after the expiration of 3 years from the
date of the grant of a patent, any person interested may make an application to the Controller
for the grant of compulsory license on patent. The Controller, may grant a license on such
terms as he may deem fit. The Controller may grant compulsory license for export of patented
pharmaceutical products in certain exceptional circumstances like public health. Any license
of the patent can also be terminated by the Controller.

Notes

10.16 Use of Inventions for Purposes of Government and


Acquisition of Inventions by Central Government17
At any time after the application for a patent had been filed or the patent has been granted, the
Central Government may use the invention for government purposes. The Central Government can
acquire an invention for a public purpose, before or after the grant of a patent. Adequate compensation
for the acquisition shall be paid.

10.17 Suits Concerning Infringement of Patents18


The court can grant relief in cases of groundless threats of infringement, including an injunction
and damages. In any suit of infringement, the Court may grant an injunction, or seizure of goods or
damages.

Case Where the defendant neither claims to be the owner of the patent nor has it filed any petition or
counter claim, it cannot plead that the plaintiff has no locus standi to institute proceeding for
infringement of patent, merely raising the plea that the plaintiffs registration is improper. - Schnieder
Electric Industries SA vs Telemecaniqne and Controls (I) Ltd. ((IA no 8522) 2000 (20) PTC 20 (Del)).

10.18 Miscellaneous
The Act also provides for:
a)

Appeals to the Appellate Board.19

b)

Penalties.20

c)

Patent agents.21

d)

International arrangements.22

e)

Fees for grant, renewal etc. of patents.23

f)

Power of High Courts and Central Government to make rules.24

Check Your Progress


6.

How can the


modifications be made
to an existing patents?

7.

What is the time


allowed to patentee for
restoring a lapsed
patent?

Self-Learning Material 147

Summary
Notes

Patent
The law relating to patents is contained in the Patents Act, 1970. Patent is granted only for inventions
which are new and useful. Patent is a grant from the government, which confers on the grantee, for
a limited term, the exclusive privilege of making, selling and using an invention and also authorising
others to do so. Some of the inventions which are not patentable are 1 - frivolous, 2 - contrary to
public order or morality, 3 - mere discovery of any new property or a known substance, 4 - methods
of agriculture or horticulture, 5 - mathematical or business methods, 6 - method of playing games,
7 - presentation of information, 8 - topography of integrated circuits, 9 - which in effect is traditional
knowledge, and 10 - relating to atomic energy. A patent application can be made by true and first
inventor, his assignee or their legal representative. Every application shall be for one invention and
accompanied by provisional or complete specifications. Every application shall be published and
sent to an examiner for a report. If any opposition to the grant of patent is made, it shall be decided
by the controller. If the invention is relevant for defense purposes, then the Central Government
may give directions as to prohibiting the publication of information. The term of the patent shall be
20 years from the date of filing of the application for the patent. The patentee has exclusive right to
prevent third parties from making, using or importing the patented product in India. The Controller
may grant the patent for the improvements or modification as a patent of addition.
The Controller has powers 1 - to allow the application for the patent or complete specifications, 2
- for the restoration of a lapsed patent and 3 - to allow surrender or to revoke the patent. A register
of patent is kept in the patent office. All the particulars regarding the patent are entered in the
register. The register is prima-facie evidence of entries made in the register. The head office of the
patent office is at Kolkata and branch offices are at Mumbai, New Delhi and Chennai. The Central
Government may use the invention for government purposes and also can acquire an invention for
a public purpose for adequate compensation. For any infringement of patent, the court may grant
injunction, seizure of goods or damages.

Review Questions
True or False
1.

A method of agriculture cannot be patented.

2.

The Central Government can acquire a patent for public purpose without paying any
compensation.

3.

A patent application can be made by true and first inventor.

4.

The Controller is empowered to allow the application for the patent to be amended.

Multiple Choice Questions


Tick the Right Answer:
1.

The term of patent under the Patent Act, 1970 is:


a. 7 years
b. 14 years c. 20 years d. 50 years

2.

The head office of the patent office is:


a. New Delhi b. Chennai

148 Self-Learning Material

c. Mumbai

d. Kolkata

Test Questions
Notes

1.

What is a patent?

2.

Explain the procedure for grant of patent?

3.

What inventions can not be patented under the Patents Act, 1970?

Answers to True or False


1. True

2. False 3. True

4. True

Answers to Multiple Choice Questions


1. C

2. D

Answers to Check Your Progress


Following are the answers to Check Your Progress, indicating respective paragraphs for reference:
1) 10.1

2) 10.4

3) 10.7

4) 10.8 c

5) 10.8 d

6) 10.9

7) 10.11

References
1

Section 2 (1) (m) of the Patents Act, 1970.

Section 3 and 4 of the Patents Act, 1970.

Section 6 to 11 of the Patents Act, 1970.

Section 11 A to 21 of the Patents Act, 1970.

Section 25 to 28 of the Patents Act, 1970.

Section 35 to 42 of the Patents Act, 1970.

Section 43 to 53 of the Patents Act, 1970.

Section 54 to 56 of the Patents Act, 1970.

Section 57 to 59 of the Patents Act, 1970.

10
11

Section 60 to 62 of the Patents Act, 1970.

Section 63 to 66 of the Patents Act, 1970.

12

Section 67 to 72 of the Patents Act, 1970.

13

Section 73 to 81 of the Patents Act, 1970.

14

Ajay Dua, Secretary, Department of Industrial Policy and Promotion as told to Economic Times
and published in Economic Times (Delhi edition) dated 9th April 2006.

15

Section 82 to 94.

16

Economic Times (Delhi edition) dated 9th April 2006.

17

Sections 99 to 103 of the Patents Act, 1970.

18

Sections 104 to 115 of the Patents Act, 1970.

19

Sections 116 to 117 H of the Patents Act, 1970.

20

Sections 118 to 124 of the Patents Act, 1970.

21

Section 125 to 132 of the Patents Act, 1970.

22

Sections 133 to 139 of the Patents Act, 1970.


Self-Learning Material 149

Notes

150 Self-Learning Material

23

Section 142 of the Patents Act, 1970.

24

Sections 158 and 159 of the Patents Act, 1970.

Introduction to FEMA

Notes

Section

11
Obey the law, whoever you be that made the law
Money speaks sense in a language all nations understand.

STRUCTURE

Pittacus
Aphra Behn

11.1 Introduction
11.2 Extent and Application
11.3 Regulation and Management of Foreign Exchange
11.4. Authorised Person
11.5 Contravention and Penalties
11.6 Adjucdication and Appeal
11.7 Directorate of Enforcement
11.8 Miscellaneous

Self-Learning Material 151

11.1 Introduction
Notes

The Foreign Exchange Management Act, 1999 (FEMA) replaces the Foreign Exchange Regulation
Act, 1972 (FERA). FERA aimed at having stringent controls to conserve Indias foreign exchange.
FERA was amended in 1993 to bring about certain changes, as a result of introduction of economic
reforms and liberalisation of the Indian economy. It was soon realized that FERA has outlived its
utility and was replaced by FEMA. FEMA has been brought into force with effect from1-6-2000.1
The objective of FEMA is to facilitate external trade and payments and to promote the orderly
development and maintenance of foreign exchange market in India.

11.2 Extent and Application2


FEMA extends to the whole of India. It applies to all branches, offices and agencies outside India
owned and controlled by a person resident in India and also to any contravention committed
outside India by any person to whom this Act applies.

11.3 Regulation and Management of Foreign Exchange3


a)

Dealing in Foreign Exchange:


No person, except with the general or special permission of the Reserve Bank of India,
shall deal in or transfer any foreign exchange, or make any payment to any person resident
outside India, or receive any payment from outside India or enter into any financial
transaction in India, to acquire any asset outside India. Dealing in foreign exchange can be
done only by authorised person.

b)

Holding of Foreign Exchange etc.:


No person resident in India shall hold, own, possess or transfer any foreign exchange or
acquire any immovable property outside India without the sanction of the Reserve Bank of
India. Foreign exchange may be drawn from an authorised person for current account
transactions and for capital account transactions to such restrictions as may be imposed by
the Reserve Bank of India in consultations with the central government.

c)

Export of goods and services:


Every exporter of goods and services shall furnish to the Reserve Bank of India or to such
other authority a declaration containing true and correct particulars representing full export
value or payment for services.

d)

Realisation and Repatriation of Foreign Exchange:


Persons resident in India shall take all reasonable steps to realise and repatriate the foreign
exchange due or accrued within such period and in such manner as may be prescribed.
However, certain category of persons are exempt from realisation and repatriation.

11.4 Authorised Person4


The Reserve Bank of India appoints in writing any person as authorised dealer, person or money
changer to deal in foreign exchange or in foreign security. The Reserve Bank of India has powers
to issue directions to and inspect authorised person.

11.5 Contravention and Penalties6


a)

Penalties for Contravention:


For any contravention under FEMA the penalty is thrice the sum involved when the amount

152 Self-Learning Material

is quantifiable otherwise upto Rs. 2 lakhs. If the contravention continues, the penalty of Rs.
500 per day shall be imposed. Any adjudicating authority, may in addition to the penalty,
direct confiscation of money, security, currency or property involved.
b)

Notes

Enforcement of orders of Adjudicating Authority (A.A).


If a person fails to make payment of penalty within 90 days, he is liable to civil imprisonment.
No order for civil imprisonment will be made unless the A.A. has issued a show cause
notice. Detention order or arrest warrant may be issued by the A.A. The defaulter shall be
detained in civil prison upto 3 years where the demand exceeds Rs. 1 crore and in any other
case upto 6 months. He can be released from detention if amount is subsequently paid. Any
contravention can be compounded within 180 days from the date of application for this
purpose.

11.6 Adjudication and Appeal7


a)

Adjudicating Authority:
The central government is empowered to appoint Adjudicating Authorities (A.A) for holding
inquiries in their respective jurisdiction on a complaint made in writing. The A.A. has
powers of a civil court. All complaints are to be disposed off finally within one year, otherwise
reasons are to be given in writing.

b)

Appeal to Special Director (Appeals):


The central government is empowered to appoint Special Director (Appeals) to hear appeal
from the orders of A.A. The appeal shall be filed within 45 days from the receipt of the
order. The Special Director (Appeals) shall have the powers of the civil court.

c)

Appellate Tribunal:
The central government can establish Appellate Tribunal to hear appeals against the orders
of A.A. and Special Director (Appeals). The person appealing has to deposit the levied
penalty. The appeal is to be filed within 45 days of the receipt of the order. It is to be
disposed off within 180 days, otherwise reasons in writing are to be given. The Appellate
Tribunal shall have the powers of the civil court. The Appellate Tribunal and the Special
Director (Appeals) shall not be bound by the procedure laid down by the Code of Civil
Procedure. They shall be guided by the principles of natural justice and shall have powers
to lay down their own procedure. No civil court shall have jurisdiction in respect of matters
to be dealt with by A.A., Special Director (Appeals) or Appellate Tribunal. From the orders
of the Appellate Tribunal, appeal can be filed in the High Court within 60 days.

11.7 Directorate of Enforcement8


The central government shall establish a Directorate of Enforcement with a Director and other
officers as it thinks fit. Other officers not below the rank of Under Secretary to Government of
India can also investigate. The officer so appointed shall exercise the like powers which are
conferred on the income tax authorities under the Income-Tax Act, 1961, subject to such conditions
and limitations as the central government may impose.

Check Your Progress


1.

When did FEMA


come into force?

2.

Does FEMA also leave


the state of J&K in the
terms of
enforceability?

3.

Can an individual hold


foreign exchange in
India?

4.

What is the duty of


person residing in
India, related to the
realisation of foreign
exchange?

5.

What is the Directorate


of Enforcement?

11.8 Miscellaneous9
Under this chapter FEMA provides for:
a)

Power to make rules and regulations.

b)

Power of central government to give directions and suspend the operations of this Act.

c)

Death or insolvency shall not abate the action. Liability is only to the extent of inheritance
Self-Learning Material 153

or estate of the deceased.


Notes

d)

There are certain presumptions as to documents in certain cases.

e)

Contravention by companies.

f)

FERA has been repealed.

Summary
The Foreign Exchange Management Act, 1999
The Foreign Exchange Management Act, 1999 (FEMA) replaces the Foreign Exchange Regulation
Act, 1949. FEMA extends to the whole of India and to all branches, offices outside India owned
and controlled by person resident in India. Dealing in foreign exchange can be done only by
authorised persons who are appointed by the Reserve Bank of India. Current account transactions
are fully convertible whereas there are some restrictions in respect of capital account transactions.
For any contravention of the Act, the penalty is thrice the sum involved when the amount is
quantifiable otherwise upto Rs. 2 lakhs. In addition to the penalty, Adjudicating Authority (AA)
may order confiscation of money, security or property involved. If penalty is not paid within 90
days, a person is liable for civil imprisonment. If the default in payment of penalty exceeds Rs. 1
crore detention in civil prison shall be upto 3 years and in other case upto 6 months. Person is
released from detention if amount is subsequently paid. A.A. is appointed by the Central Government.
A.A is required to dispose of complaint within one year. Appeal against the orders of AA is made to
the Special Director (Appeals) within 45 days of the receipt of the order. Thereafter appeal can be
made to Appellate Tribunal established by the central government. The Appellate Tribunal is required
to dispose of appeals within 180 days. No civil court shall have jurisdiction. From the orders of
Appellate Tribunal, appeal can be filed in the High Court within 60 days. The central government
shall establish a Directorate of Enforcement with a Director and other officers. These officers
investigate the matter under the Act and have powers like income tax authorities under the Income
Tax Act, 1961.

Review Questions
True or False
1.

Foreign Exchange Management Act (FEMA) applies to a branch in England of a


company registered in India.

2.

A person resident in India can purchase a house in Singapore only after getting
permission from the Reserve Bank of India.

3.

Director of Enforcement under FEMA has powers of the police officers.

Multiple Choice Questions


1.

2.

154 Self-Learning Material

Foreign Exchange can be obtained from:


a)

Central Government

b)

State Government

c)

Authorised person

d)

Any travel agent

Authorised persons are appointed by:


a)

Foreign Exchange Appellate Tribunal

b)

Adjudicating Authority

c)

Reserve Bank of India

d)

Central Government

Test Questions
1.

How is regulation and management of foreign exchange done under the Foreign Exchange
Management Act?

2.

Who is an authorised person?

3.

Discuss briefly the provisions ofcontravention, penalties, adjudication and appeal in the
Foreign Exchange Management Act?

Notes

Answers to True or False


1. True

2. True 3. False

Answers to Multiple Choice Questions


1. B

2. C

Answers to Check Your Progress


Following are the answers to Check Your Progress, indicating respective paragraphs for reference:
1) 11.1

2) 11.2

3) 11.3.b

4) 11.3 d

5) 11.7

References
1

Vide GSR 371 (E), dated 1-5-2000.

Section 1 of the Foreign Exchange Management Act, 1999 (FEMA).

Sections 3 to 9 of FEMA.

Sections 10 to 12 of FEMA.

Sections 13 to 15 of FEMA.

Sections 16 to 35 of FEMA.

Sections 36 to 38 of FEMA.

Sections 39 to 49 of FEMA.

Self-Learning Material 155

Notes

156 Self-Learning Material

Company Law

Notes

Section

12
Corporations cannot commit treason, nor be outlawed, nor excommunicated,
for they have no souls
Money speaks sense in a language all nations understand.
Sir Edward Coke
Aphra Behn

STRUCTURE
12.1 Meaning and Nature of a Company
12.2 Formation and Incorporation of a Company
12.3 Memorandum of Association
12.4. Articles of Association
12.5 Prospectus
12.6 Membership
12.7 Share and Share Capital
12.8 Borrowings, Loans, Debentures and Investments
12.9 Company Management and Administration
12.10 Company Meetings and Resolutions
12.11 Accounts and Audit

Check Your
Your Progress
Progress
Check

12.12 Prevention of Oppression and Mismanagement

1.
12.13 Compromises, Arrangements, Reconstruction and Amalgamation1.
2.
2.
12.14 Winding Up of a Company
12.15 Corporate Governance
3.
3.

Define a company.
Define a company.
What do you
What do you
understand by an
understand by an
Artificial Legal
Artificial Legal
Person?
Person?
What is a Common
What is a Common
Seal?
Seal?

Self-Learning Material 157

12.1 Meaning and Nature of a Company


Notes

12.1.1 What is a Company?


The word Company has no strictly technical or legal meaning. It implies an association of persons
for some common object. The law relating to companies in India is contained in the Companies
Act, 1956, as amended up to date. This Act runs into 658 sections and 15 schedules. The text of
the law alone occupies more than 700 pages. Endeavour is, therefore, to present some aspects of
company law which are relevant for managers.

12.1.2 Definitions of a Company


Section 3(1) (i) of the Companies Act, 1956 (the Act) merely states that a company means a
company formed and registered under this Act or an existing company as defined in Section 3(1)
(ii). Section 3(1) (ii) lays down an existing company means a company formed and registered
under any of the previous companies law. This definition neither gives the meaning of a company
clearly, nor defines a company in terms of its features. To understand the meaning of a company,
let us see the definition as given by different authorities.
a)

A company is an association of many persons who contribute money or monies worth to a


common stock and employed in some trade or business and who share the profit and loss
arising there-from. The common stock so contributed is denoted in money and is the capital
of the company. The persons who contribute to it or to whom it pertains are members. The
proportion of capital to which each member is entitled is his share. The shares are always
transferable although the right to transfer is often more or less restricted.
Lord Justice Lindley

b)

According to Chief Justice Marshall, A corporation is an artificial being, invisible, intangible


existing only in contemplation of the law. Being a mere creation of law, it possesses only
the properties which the charter of its creation confers upon it, either expressly or as incidental
to its very existence.

c)

As per Prof. Haney, A company is an artificial person created by law, having separate
entity, with a perpetual succession and common seal.

12.1.3 Characteristics of a Company


The characteristic features of a company are as follows:
a)

Incorporated Association: The company must be incorporated or registered under the Act.

b)

Artificial Legal Person: The company, being a juristic person, does not possess the body of
a natural being. It exists only in contemplation of law.

c)

Separate Legal Entity: Unlike partnership, the company is distinct from the persons who
constitute it. In the famous case of Salomon V. Saloman Co. Ltd1., Salomon was leather
merchant. He converted his business into a limited company -Salomon and Co. Ltd. The
company so formed consisted of Salomon, his wife and five of his children as members.
The company purchased the business of Salomon for 39,000, the purchase consideration
was paid in terms of 10,000 debenture conferring a charge over the companys assets,
20,000 in fully paid 1 share each and the balance in cash. The company within a year ran
into difficulties and liquidation proceedings commenced. The assets of the company were
not even sufficient to discharge the debentures (held entirely by Salomon himself). And
nothing was left for the unsecured creditors. It was held by the House of Lords that the
company was validly constituted. The business belonged to the company and not to Salomon.1

d)

Perpetual Succession: A company being an artificial person does not die. Its life is not

Check Your Progress


1.

Define a company.

2.

What do you
understand by an,
Artificial Legal
Person.

3.

What is a Common
Seal?

158 Self-Learning Material

dependant on its members. Prof. Gower aptly puts that no hydrogen bomb could have
destroyed a company.
e)

Limited Liability: The members of a company are only liable to contribute towards payment
of its debts to a limited extent, e.g. in a company limited by shares, a members liability is
limited to the nominal value of the share. However, the Act provides for unlimited liability
company as well.

f)

Transferable Shares: The companys shares are capable of being easily transferred. They
are traded in a stock exchange market.

g)

Common Seal: A company can be held bound by only those documents which bear its
signature. Common seal is the official signature of a company.

h)

Separate Property: Share holders are not, as per law, part owners of the company or its
property. A company being a legal person can hold and own property in its own name.

i)

Capacity to Sue and Being Sued: A company, has a distinct legal personality and hence can
sue and being sued.

Notes

12.1.4 Kinds of Companies


Companies can be classified on various basis, which are as follows:
a)

On the basis of mode of incorporationi.

Chartered Companies: Like East India Company. This type of company is generally
not found in India presently.

ii. Statutory Companies: Which are created by a special Act like Life Insurance
Corporation, State Bank of India, Unit Trust of India, Reserve Bank of India.
iii. Registered Companies: Are companies registered under the Act.
b)

On the basis of Liability of Membersiv. Limited by Shares: Where the liability of the members of a company is limited to the
amount unpaid on the shares.2
v.

Limited by Guarantee: Where the liability of the members of a company is limited to


a fixed amount which the members undertake to contribute to the assets of the company
in the event of its being wound up.3

vi. Unlimited: Every member is liable for the debts of the company, as in an ordinary
partnership, in proportion to his interest in the company.4
c)

On the basis of Number of Membersvii. Private: Where the minimum number of member is two and maximum fifty.
viii. Public: Where the minimum number of member is seven and maximum number is
limited by number of shares.

d)

Other types of Companiesi.

Government Companies: Means any company in which not less than 51% of the paid
up share capital is held by the central government and partly by one or more state
governments.5

ii. Foreign Company: Means a company incorporated outside India but having a place of
business in India.6
iii. Holding and Subsidiary Company7: These are relative terms. A company is a holding
company of another, if the other is its subsidiary. A company shall be deemed to be a
subsidiary of another if:
a.

That other company controls the composition of its board of directors, or

b.

The other company holds more than half in nominal value of its equity share capital.
Self-Learning Material 159

c.
Notes
e)

It is a subsidiary of a third company which itself is a subsidiary of the controlling


company.

Producer Companies8The companies (Amendment) Act, 2002, has introduced a new type of company known as
Producer Companies. Any ten or more individual producers or any two or more producer
institutions may form and incorporate a company as a producer company. This type of
company shall have special provisions regarding membership and voting rights and its
administration.

12.1.5 Distinction Between Private and Public Company


S. No.

160 Self-Learning Material

Private Company

Public Company

1.

Minimum numbers of members to


form a company is 2.

Minimum numbers to form a


company is 7.

2.

Maximum numbers of members


should not exceed 50.

No restriction.

3.

Right to transfer share is restricted.

Freely transferable.

4.

Prospectus can not be issued.

Through prospectus general public is


invited to subscribe for shares,
debentures or deposits.

5.

Number of directors must be at least 2.

Must have at least 3.

6.

Commence business immediately after


getting the certificate of incorporation.

Can only start after receiving the


certificate to commence business
from Registrar of Companies.

7.

Directors consent to work, as a director


with Registrar is not necessary.

Necessary.

8.

Directors can be approved by a single


resolution.

Each directors appointment requires


separate resolution.

9.

Number of directors may be increased


to any number.

Not more than 12 without the


approval of central government.

10.

Directors are not required to retire


by rotation.

At least 2/3 of directors must retire


by rotation.

11.

Managerial remuneration no
restriction.

Not more than 11% of net profit (Not


more than 5% to single Manager/
Director).

12.

Quorum for general meeting 2

Five members.

13.

Can be registered with a paid up


capital of Rs. 1 lakh.

Rs. 5 lakh.

14.

Exempted from filing of various returns.

Not so exempted.

15.

Cannot accept deposits from the


public.

Can accept public deposits (Subject


to Secs 58A, AA, AAA & B)

16.

Need not hold a statutory meeting or


file a statutory report.

Must do so.

12.1.6 Lifting the Corporate Veil


The main advantage of forming a company is to have a separate legal entity. At times, the facade
of corporate personality might have to be removed to identify the persons who are really guilty.
This is known as lifting the corporate veil. Generally, courts do not interfere and essentially go
by the principle of separate entity as laid down in the Salomons case, it may be in the interest of
members and in public interest to identify and punish the persons who misuse the medium of
corporate personality. The circumstances under which the courts may lift the corporate veil may
broadly be grouped under the following two heads:
a)

Notes

Check Your Progress


4.

What are different


types of companies
on the basis of
liability?

5.

What do you
understand by a

Under Statutory Provisions: The advantage of distinct entity and limited liability may
not be allowed in certain circumstances. Such cases are:
i.

Reduction of Membership: When the number of members of a company is reduced


below the statutory minimum, and the company carries on business for more than six
months, every member who is aware of that fact shall be severally liable for the payment
of companys debts, contracted during that time.9

ii. Misrepresentation in Prospectus: In such a case, every director, promoter and every
other person, who authorises such issue of prospectus incurs liability towards those
who subscribed for shares on the faith of untrue statement.10
iii. Fraudulent Conduct of Business: During winding up of a company, when any business
of a company has been carried on with intent to defraud creditors of the company or
any other person, those who are knowingly parties to such conduct of business may, be
made personally liable.11

Foreign Company?
6.

Under which two


categories, lifting
the corporate veil is
possible?

iv. Failure to Return Application Money: When a company issues shares to the public,
and minimum subscription as stated in the prospectus has not been received within
sixty days of the closure of the issue, directors shall be personally liable to return the
money with interest @ 15% per annum, in case application money is not repaid within
10 days of the closing of issue.12
v.

Mis-description of Name: When the companys name is not mentioned, or not properly
mentioned in any document, then any person signing such document shall be personally
liable.13

vi. Non-payment of Tax: Under the Income Tax Act, where any private company is wound
up and any tax arrears could not be recovered, then every director of such a company
shall be jointly and severally liable for payment of tax.
vii. Liability of Ultra-vires Acts: Directors and other officers of a company will be personally
liable for all those acts which they have done on behalf of a company if the same are
ultra-vires the company.
viii. Liability of Promoters For Pre-incorporation Contracts: Prior to passing of Specific
Relief Act, 1963, would not be borne by the company and promoters are liable for
such contracts.
ix. Directors With Unlimited Liability: Shall be personally responsible for the debts of
the company.
x.

b)

Holding-subsidiary Company: Every holding company shall attach to its balance sheet
copies of balance sheet, profit and loss account, directors reports and auditors report
in respect of each subsidiary company.

Under Judicial Interpretations: It is difficult to deal with all the cases in which courts have
lifted or might lift the corporate veil. Some such cases are:
i.

For Determining the Enemy Character of a Company: Famous case establishing this
point is Daimler Company Ltd. v. Continental Tyre and Rubber Co. (Great Britain)
Ltd.14 The brief facts of this case are that a company was incorporated in London for
Self-Learning Material 161

the purpose of selling tyres manufactured in Germany by a German company. Its


majority shareholders and all the directors were Germans. On declaration of war between
England and Germany in 1914, it was held that since both the decision making bodies,
the Board of Directors and the general body of shareholders were controlled by
Germans, the company was a German company and hence an enemy company.
Accordingly, the suit filed by the company to recover a trade debt was dismissed on
the ground that such payment would amount to trading with enemy.

Notes

ii. For the Benefit of Revenue: In Sir Dinshaw Maneckjee Petil, Re,15 An assessee was
receiving huge income by way of dividend and interest income, transferred his
investments to four private companies formed for the purpose of reducing his tax
liability. These companies transferred the income to D as a pretended loan. Held, the
companies were formed by D purely and simply as a means of avoiding tax obligation
and the companies were nothing more than the assessee himself.
iii. For Prevention of Fraud and Improper Conduct: In Jones v. Lipman16 L agreed to sell
a certain land to J. He subsequently changed his mind and to avoid the specific
performance of the contract, he sold it to a company which was formed specifically for
this purpose. The company had L and a clerk of his solicitors as the only members. J
brought the action for specific performance against L and the company. The court
looked to the reality of the situation, ignored the transfer, and ordered that the company
should convey the land to J.
iv. Others: Like where company is used to avoid welfare legislation, or where company is
a mere sham or cloak. In Delhi Development Authority V. Skipper Construction
company (P) Ltd.17 the Supreme Court held that the fact that the director and members
of the family of Tejwant Singh had created several companies and these companies
were mere cloaks and that the device of incorporation was really a ploy adopted for
committing illegalities and / or to defraud people.

12.2 Formation and Incorporation of a Company


12.2.1 Stages of Incorporation
The complete process of formation of a company may be divided into four stages namely:
a)

Promotion.

b)

Registration/Incorporation.

c)

Floatation/Raising of Capital.

d)

Commencement of Business.

12.2.2 Promotion
Promotion means the preliminary steps taken for the purpose of registration and floatation of the
company. Gerstenberg has defined the term promotion as the discovery of business opportunities
and the subsequent organization of fund, property and managerial ability into a business concern
for the purpose of making profits therefrom. Persons who perform the task of promotion are
called promoters. The word promoter has not been defined in the Act, although this term has been
used in various sections of the Act. Justice Cockburn described a promoter as one who under takes
to form a company with reference to a given project and to set it going, and who takes the necessary
steps to accomplish that purpose.18 L.J. Bowen observed that the term promoter is a term not of
law but of business, usefully summing up in a single word-promotion, a number of business operations
familiar to the commercial world by which a company is brought into existence.19
162 Self-Learning Material

12.2.3 Registration/Incorporation of Company


Notes

The promoter of the company will submit the following documents with the Registrar of Companies
for the registration of the company:
a)

The memorandum of association.

b)

The articles of association.

c)

A list of persons who have consented to act as directors of the proposed company.

d)

A statutory declaration of compliance.

e)

Any agreement with the relevant persons of the proposed company.

The Registrar of Companies is to allot a Corporate Identity Number (CIN) to each company
registered on or after November 1, 2000. After scrutiny of all these documents and if they are in
order, the Registrar of Companies shall issue a certificate of incorporation. This certificate of
incorporation given by the Registrar shall be conclusive evidence that all the requirements of the
Act have been complied with. In the case of Jubilee Cotton Mills Ltd v. Lewis20, the Registrar
issued a certificate of incorporation on January 8, but dated it January 6th, which was the date he
received the documents. On January 6th the company made an allotment of shares to Lewis. It
was held that the certificate was conclusive evidence of incorporation on Jan 6th and that the
allotment was not void on the ground that it was made before the company was incorporated.

12.2.4 Floatation/Raising of Capital


A private company is prohibited from inviting public to subscribe to its share capital. Therefore,
when a private company is formed, the requisite capital is obtained from friends and relatives by
making its own arrangement. A public company can take either of the following steps:
a)

Issue a prospectus in case public is to be invited to subscribe to its capital, or

b)

Deliver a statement in lieu of prospectus where the company has either not issued a prospectus
or though it has issued a prospectus it has not proceeded to allot any of the shares offered
to the public for subscription.

12.2.5 Commencement of Business


Every private company and a company not limited by shares can commence business immediately
on receipt of certificate of incorporation. But a public company limited by shares is debarred from
commencing business or borrowing money without the certification of commencement of business.
a)

Where the company has issued a prospectus it has to satisfy the following conditions:
i.

The minimum subscription in cash has been received,

ii. Every director of the company has paid on his shares in cash, a proportion equal to the
proportion payable on application and allotment on the shares payable in cash.
iii. A statutory declaration duly verified by one of the directors or the secretary in the
prescribed form, that the above conditions have been complied with, is filed with the
Registrar. When the company has complied with the aforesaid conditions, the Registrar
will issue a certificate to commence business.
b)

Where the company has not issued a prospectue - it has to satisfy the following conditions:
i.

Check Your Progress

A statement in lieu of prospectus has been filed with the Registrar,

ii. Every director of the company has paid on his shares in cash, a proportion equal to the
proportion payable on application and allotment on the shares payable in cash.

7.

What are the stages in


incorporation of a
company.

8.

Who is a promoter?

9.

Who allots a
Corporate Identity
Number?

10. What is the


significance of
certificate of
incorporation?

iii. A statutory declaration duly verified by one of the directors or the secretary in the
Self-Learning Material 163

Notes

prescribed form, that the above conditions have been complied with, is filed with the Registrar.
When the company has complied with the aforsaid conditions, the Registrar will issue a certificate
to commence business.

12.3 Memorandum of Association


12.3.1 Meaning and Importance
For the formation of a company one of the first steps is to prepare a document called the
memorandum of association. According to the Act, memorandum means the memorandum of
association of a company as originally framed or altered from time to time in pursuance of any
previous companies law or of this Act.21 This definition however, does not state the nature of this
document nor is indicative of its importance. According to Lord Cairns, the memorandum of
association of a company is its charter and defines the limitations of the powers of a company. It
contains the fundamental condition upon which alone the company is allowed to be incorporated.
Thus the memorandum of association is the charter of the company, but it is not unalterable. The
memorandum shall be drawn up in such a form as is given in Tables B,C,D and E in Schedule I to
the Act. It has to be printed, divided into paragraphs, numbered consecutively and signed by at
least 7 persons (2 in the case of private company) in the presence of at least one witness, who will
attest the signature(s). Each of the subscribers shall at least take one share.

12.3.2 Contents
The memorandum of a limited company is to contain the following clauses:
a)

Name of the Company With limited or private limited as the last word(s) of the name.

b)

Registered Office The name of the state in which the registered office is to be situated.

c)

Objects of the Company Stating separately:


i.

The main objects.

ii. Incidental or ancillary objects.


iii. Other objects not included in (i) and (ii) above.
d)

Liability A declaration is made that the liability of the member is limited.

e)

Capital The amount of authorised share capital divided into shares of fixed amounts.

f)

Association or Subscription The initial members are called subscribers, who sign the
memorandum in the presence of one witness.

The above clauses of the memorandum are called compulsory clauses. In addition to these, the
memorandum may contain other information, for example, rights attached to various classes of
shares. The memorandum cannot contain anything contrary to the provisions of the Act.

12.3.3 Doctrine of Ultra-vires


The word ultra means beyond and the word vires means the powers. Therefore the term ultravires means beyond the powers. In case of a company, it means beyond the powers of the company.
The powers of a company are contained in the statute constituting it and the memorandum of
association.

164 Self-Learning Material

The rule of ultra-vires was for the first time laid down in the case of Ashbury Railway Carriage
and Iron Company Ltd. v. Riche.22 In this case the company was formed with the object to make
and sell, or lend or hire railway carriage and wagons and all kinds of railway plants, to carry on
the business of mechanical engineers and general contractors. The company contracted with
Riche to finance the construction of railway line in Belgium. The company repudiated the agreement

and was sued for breach of contract. Riche contended firstly, that the contract in question came
well within the meaning of the words general contractors, and, was therefore, within the powers
of the company, Secondly, that the contract was ratified by the majority of the shareholders. The
court (House of Lords) held that the term general contractors must be taken to indicate the
making generally of such contracts as were connected with the business of mechanical engineers,
otherwise it would authorise the making of contracts of any kind and every description and would,
therefore, be altogether un-meaningful. Hence the contract was entirely beyond the objects in the
memorandum of association. The effects of ultra-vires transactions are:
a)

Void abinitio - The ultra-vires acts are null and void abinitio (The company is not bound by
these acts).

b)

Injunction - A member can get an order of restraint (injunction) from the court against such
an act (ultra-vires) of the company.

c)

Personal liability of directors - For ultra-vires acts of the company, directors will be
personally liable.

d)

Acquisition of property that is ultra-vires - In such a case companys right over such property
is held secured.

e)

Directors are personally liable to third parties.

Notes

12.3.4 Alteration of Memorandum


The contents of a memorandum can be altered only in the manner and to the extent provided in the
Act. All the clauses of the memorandum, except the subscription clause can be changed. The
provisions regarding alteration of clauses can be summarized as follows:
a)

Alteration of name clause.24


i.

For the change of name special resolution by a company and written approval of the
central government is required. However no approval of the central government is
necessary if the change of name involves only the addition or deletion of the word
Private.

ii. When name is identical or too closely resembles the name of an existing company then
change of name can be done by passing an ordinary resolution and the written approval
of the central government.
b)

Change of registered office.25


i.

From one premises to another premises in the same city, town or village, by passing a
resolution of the Board of Directors.

ii. From one town or city or village to another town or city or village in the same state, by
passing a special resolution. Confirmation of Regional Director is required if the
jurisdiction of the Registrar of company is changed. A copy of the special resolution
and the confirmation of the Regional Director, if required, is to be filed with the Registrar
who is also given notice of new location within thirty days.
iii. From one state to another state special resolution and confirmation of the central
government is required. This change is permissible only for certain purposes as given
in Section 17 of the Act (see paragraph 12.3.4 (c) ii).
c)

Alteration of objects clause:


i.

Special resolution is passed by the company and a copy of the same is filed with the
Registrar within 30 days.

ii. Alteration is sought on any of these grounds.26

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11. How the capital can be
raised by a public
company?
12. When can a private
company commence
its business?
13. What is a
Memorandum of
Association?
14. What is ultra vires?
15. Which clause of the
memorandum cannot
be changed?

a. To carry on its business more economically and more efficiently.


b. To attain its main purpose by new or improved means.
Self-Learning Material 165

c. To enlarge or change the local areas of its operations.


Notes

d. To carry on some business which under existing circumstances may conveniently


or advantageously be combined with the business of the company.
e. To restrict or abandon any of the objects specified in the memorandum.
f. To sell or dispose off the whole or any part of the undertaking.
g. To amalgamate with any other company.
d)

Alteration of liability clause:27


i.

The liability of a member of a company cannot be increased unless the member agrees
in writing.

ii. From unlimited liability, it can be made limited by re-registration of the company.
e)

Alteration of capital clause:28

If the articles authorise a company limited by share capital may by an ordinary resolution alter the
capital so as:
i.

To increase the authorised share capital.

ii. To consolidate and subdivide share.


iii. To convert shares into stock and vice versa.
iv. To cancel shares not taken up.

12.4

Articles of Association

12.4.1 Meaning
According to the Act, articles means the articles of association of a company as originally framed
or as altered from time to time in pursuance of any previous company laws or of this Act....29 The
articles of association of a company are its bye laws or rules and regulations that govern the
management of its internal affairs and the conduct of its business. They define the powers of its
officers. They also establish a contract between the company and the members and between the
members inter se.

12.4.2 Contents of Articles


Articles usually contain provisions relating to the following matters like:

166 Self-Learning Material

a)

Different classes of shares and their rights.

b)

Procedure of making an issue of share capital and allotment there of.

c)

Procedure of issuing share certificates and share warrants.

d)

Forefeiture of shares and the procedure of their reissue.

e)

Procedure for transfer and transmission of shares.

f)

The time lag in between calls on shares, conversion of shares into stock.

g)

Directors, their appointment, remuneration, qualifications, etc.

h)

Accounts and audit.

i)

Lien of shares.

j)

Payment of commission on shares and debentures to underwriters.

k)

Rules for adoption of preliminary contracts if any.

l)

Re-organisation and consolidation of share capital.

m)

Alteration of share capital and buyback of shares.

n)

Borrowing power of directors.

o)

General meeting, proxies and polls.

p)

Voting rights of members.

q)

Dividend and reserves.

r)

Winding up.

Notes

12 .4.3 Alteration of Articles


a)

Procedure for alteration:


i.

Passing of a special resolution.

ii. Copy of resolution should be sent to the registrar within 30 days.


iii. Copy of altered articles to be registered within 3 months of passing of resolution.
b)

Limitations regarding alteration of articles:


i.

Alteration should not be inconsistent with the provisions of the Act or any other statute,
and conditions contained in memorandum.

ii. Alteration must not constitute a fraud on the majority.


iii. Alteration must not deprive any person of his rights under a contract.
iv. Alteration must be bonafide for the benefit of the company as a whole.
v.

Alteration must not be contrary to the order of National Company Law Tribunal
(Tribunal).

vi. An alteration of articles to effect a conversion of a public company into a private


company cannot be made without the approval of the central government.
vii. No retrospective operation of articles.
Note:
The Act has been amended and the National Company Law Tribunal (in short Tribunal or NCLT)
has been provided in the Act. The central government has not yet constituted NCLT and Company
Law Board or the High Court powers are continuing. But NCLT has been used.

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12.4.4 Binding Force of Memorandum and Articles


The following are the legal implications:
a)

The company is bound to its members.

b)

Each member is bound to the company.

c)

Each member is bound to other members so far as rights and duties arising out of the
articles are concerned.

d)

Neither the company nor the members are bound to outsiders.

16. When does the


company require the
confirmation from
Regional Director to
change its registered
office?
17. What do you
understand by the
Article of
Association?
18. What is the procedure
regarding alteration of
articles?

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Notes

12.4.5 Difference Between Memorandum of Association and Articles of


Association
S. No.

Memrandum

Articles

1.

Charter of company.

Regulations for Internal Management.

2.

Defines the scope of the activities.

Rules for carrying out the objects of


company.

3.

Supreme document.

Subordinate to the memorandum.

4.

Must for every company.

Company limited by shares need not


have it. (Table A of Schedule 1 may
be adopted).

5.

Strict restrictions, some alterations may


require sanction of central government.

Can be altered by special resolution.

6.

Act ultra-vires is wholly void and


cannot be ratified.

Act ultra-vires (but intra-vires the


memorandum) can be ratified.

12.4.6 Doctrine of Constructive Notice


The memorandum and articles when registered with the Registrar become public documents and
accessible to all. They can be inspected on payment of a nominal fee. Therefore, there is a
presumption that any outsider dealing with company has read and understood these documents.
This is known as doctrine of constructive notice. It is a negative doctrine, acting only against the
outsiders and not the company. In Kotla Venkataswamy v. C. Ramamurthy30 the facts were that the
articles of association of a company included a clause that all documents and deeds of the company
shall be signed by the managing director, the secretary and working director on behalf of the
company. A mortgage deed was signed by the secretary and a working director only. It was held
that the mortgage was invalid in spite of the fact that the plaintiff acted in good faith and the
money was utilised for the company. The mortgagee should have consulted the articles of association
before executing the mortgage deed.

12.4.7 Doctrine of Indoor Management


The rule of constructive notice proved too inconvenient for business transactions, particularly
where the directors or other officers of the company were empowered under the articles to exercise
certain powers subject only to certain prior approvals or sanctions of the shareholders. Whether
those sanctions and approvals had actually been obtained or not could not be ascertained. This is
the Doctrine of Indoor Management. Persons dealing with the company in good faith have a
right to assume that the internal requirements prescribed in public documents (memorandum and
articles) have been observed. In other words, persons are not bound to enquire into regularity of
internal proceedings. There are certain exceptions to this doctrine and they can be summarised as:

168 Self-Learning Material

a)

Where the outsider had knowledge of irregularity.

b)

In case of forgery.

c)

Negligence on the part of the outsider.

d)

Acts outside scope of apparent authority.

The doctrine of indoor management was propounded in the case of Royal British Bank v.
Turquand.31 In this case the directors of a company were authorised by the articles to borrow on
bonds, as authorised by the shareholders. The directors gave a bond without the authority of any
resolution. It was held that the company was liable on the bond, as T was entitled to assume that
the resolution of the company in general meeting had been passed.

Notes

12.5 Prospectus
12.5.1 Definition
According to the Act, prospectus means any document described or issued as a prospectus and
includes any notice, circular, advertisement or other document inviting deposits from the public
or inviting offers from the public for the subscription or purchase of any shares in, or debentures
of a body corporate.32

12.5.2 Essentials of Definition


The definition of prospectus gives the following essential features:
a)

Document.

b)

Subscription.

c)

Invitation to public.

d)

Offer to public. 50 or more persons constitute public as per the amendment of the Act in
2000.

12.5.3 Necessary Pre-Requisites of Prospectus


a)

Prospectus must be Dated: There are two dates relevant-one is the date of issue and the
other is the date of publication.

b)

Prospectus must be Signed: It must be signed by the director(s) or proposed director(s) or


by their agents who have such authority in writing.

c)

Prospectus must be Registered: It must be registered with the registrar of companies.


Prospectus must be issued within 90 days from delivery date for registration.

12.5.4 Contents of Prospectus


Prospectus is the window through which an investor can look into the soundness of a companys
ventures. It consists of the following:
a)

Matters specified in Part I of Schedule II-It includes general information like name and
address of the company, its objects, number and classes of shares, particulars of directors,
and auditors, underwriters, details regarding the securities being issued, outstanding
litigation, management perception of risk factors and details of any issue within past 3
years.

b)

Matters listed in Part II of Schedule II - It contains reports by the auditors and the
accountants, consent of directors, auditors etc. and some other statutory information.

c)

Matters given in Part III of Schedule II- This would include :


i.

For a company carrying on business for less than 5 financial years, then the reference
is to the number of financial years for which the business has been carried on.

ii. If the prospectus is issued more than 2 years after the date at which the company is
Self-Learning Material 169

entitled to commence business, particulars of the signatories to the memorandum and


shares subscribed for by them and details of preliminary expenses need not be given.

Notes

iii. Statements by experts - Prospectus also contains statements made by experts like
engineer, valuer, or an accountant. Experts need to give their consent in writing. Experts
not connected with the formation of the company are included in the category of experts.

12.5.5 Golden Rule of Prospectus


There should be full frank and honest disclosure of all facts in the prospectus. These facts should
be scrupulously accurate. There should not be any error of commission (mis-statements) nor any
error of omission (non disclosure of relevant facts). Thus the golden rule of prospectus is that the
true nature of the companys venture to be disclosed.

12.5.6 Mis-statements in Prospectus and Liability


There should not be any mis-statements in the prospectus. Mis-statements are, saying that something
is expected when in reality it is not or saying that the directors have an intention to do something
when they have no such intention. Any mis-statements lead to the following liability:
a)

Civil: This consists of liability against the company and against the directors, promoters
and experts. This may include rescission of contract, damages or compensation.

b)

Criminal: Fine upto Rs. 50,000 or imprisonment upto 2 years or both. If there is a fraud,
penalty is increased to fine upto Rs. 1 lakh, or imprisonment upto 5 years or both. In case
of allotment on fictitious names imprisonment can extend upto 5 years.

12.5.7 Deemed Prospectus

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When a company allots shares or debentures to the public through the medium of issue houses,
then the issue houses invite subscription from the public through their own offer documents. Such
an offer document by the issue houses is treated as a prospectus by the company and known as a
deemed prospectus or prospectus by implication.

19. Who should sign the


prospectus?

12.5.8 Statement in lieu of Prospectus

20. What is the


stipulated time period
for registering the
prospectus?
21. When is a deemed
prospectus issued?

Where a public company does not invite public to subscribe for its shares, but arranges to get
money from private sources, it need not issue a prospectus to the public. In such a case the promoters
are required to prepare a draft prospectus known as statement in lieu of prospectus. It should
contain the information required to be disclosed by Schedule-III of the Act. The statement In lieu
of prospectus must be filed with the Registrar at least three days before any allotment of shares or
debentures are made.

22. What is an error of


omission?

12.5.9 Shelf Prospectus and Information Memorandum

23. Who is the


administrating
authority with regard
to prospectus?
24. When should a
promoter prepare a
statement in lieu of
prospectus?

170 Self-Learning Material

Shelf Prospectus means a prospectus issued by any financial institution or bank for one or more
issues of the securities or class of securities specified in the prospectus. This is valid for a period
of one year from the date of opening of the first offering of the shelf prospectus. For subsequent
offering, information memorandum updating the information under the various heads will have to
be filed and entire set comprising of shelf prospectus and the information memorandum shall
constitute the prospectus and have to be circulated to the general public. This will help to reduce
the expenses of preparation and issue of prospectus on the part of the issuer and will inform the
investors up-to-date position of the issue.

12.5.10 Red Herring Prospectus


A red-herring prospectus is a prospectus, which does not have complete particulars on the price of
securities offered and quantum of securities offered. Examples - when companies have resorted to
red herring prospectus are Jet airways, Maruti Udyog, Suzlon, and Oriental Bank of Commerce.

Notes

12.5.11 Services and Exchange Board of India (SEBI) -The Administrative


Authority
The Companies (Amendments) Act, 2000, in relation to prospectus, has made SEBI as the
administrative authority. Any complaint about violations regarding the prospectus should be made
to SEBI which is now vested with powers to inquire into such complaints and punish those who
are found guilty.

12.6 Membership
12.6.1 Introduction
Persons who collectively constitute the company as a corporate entity are members or shareholders.

12.6.2 Definition
a)

The subscribers to the memorandum.

b)

Who agrees in writing to become member and whose name appears in the register of
members.

c)

Who holds equity share capital and whose name is entered as beneficial owner in the records
of the depository.

12.6.3 Pre-Requisites for Becoming a Member


a)

The agreement in writing to take shares of the company.

b)

The registration of name in the register of members.

12.6.4 Distinction between Member and Shareholder


The words member, shareholder and holder of shares are used interchangeably and at times called
synonymous. But there are some differences between member and shareholder and they can be
summarised as follows:

S. No.

Shareholder

Member

1.

Is a member.

May not be a shareholder because the


company may not have a share capital.

2.

Person who owns a bearer share


warrant is a share holder.

He is not a member as his name is


struck off the register of members.

3.

A legal representative of a member is a


shareholder.

Does not become a member until he


apples for registration.

4.

No shares are allotted to a subscriber


to the memorandum.

a subscriber to the memorandum is


member.
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12.6.5 Who may become a Member?


Notes

Subject to the provisions of the Act, the memorandum and articles the position of certain persons
who may become a member of a company is as follows:
a)

Minor: As a minor is not competent to contract, an agreement by a minor to take shares is


void, and hence he cannot be a member of a company. In case of fullypaid shares, minor can
become member, if he acquires the shares by transfer or transmission.33

b)

Insolvent: An insolvent may be a member of a company so long as his name appear in the
register of members, he is a member and is entitled to vote even though his shares vest in the
Official Receiver or Assignee.

c)

Partnership Firm: A partnership firm is not a legal person and as such it cannot be a member
of a company. However, the partnership firm may hold shares in a company in the Indvidual
or joint names of partners.

d)

Foreigner: A foreigner may become a member of a company subject to the provisions of the
Foreign Exchange Management Act, 1999.

e)

Company: A company may, if so authorised by its articles, become a member of any company.

f)

Trade Union or Society: A registered trade union or a society can become member of a
company.

g)

President of India, Governor of a State or Collector of a District: Whereas President of


India and Governor of a state may hold shares in their official position but the Collector of
a district cannot become a member of a company.

12.6.6 Modes of Acquiring Membership


A person may become a member of a company in any of the following ways:
a)

Membership by Subscription: The subscribers to the memorandum of association are deemed


to have agreed to become its members.

b)

Membership by Application and Registration: A person who agrees in writing to become a


member and whose name is entered in the register of members is a member of the company.
A persons name may be registered in any of the following ways:
i.

By application and allotment

ii. By transfer
iii. By transmission

12.6.7 Rights of a Member


The various rights of a member can be grouped under the following categories:
a)

Statutory - Given by various provisions of the Act.

b)

Contractual or otherwise - Given by virtue of the contract as provided in the memorandum


or articles.

12.6.8 Register of Members34


A company shall keep a register of members and enter therein the following particulars:

172 Self-Learning Material

a)

Name, address and the occupation of each member.

b)

Shares held by each member and the amount paid up on those shares.

c)

Date at which each person was entered in the register as a member.

d)

Date at which any person ceased to be a member.


Notes

12.6.9 Index of Members35


A company with more than fifty members shall keep an index of members.

12.6.10 Termination of Membership


A persons membership ceases when he/his:
a)

Transfers his shares.

b)

Shares are forfeited by the company.

c)

Surrenders his shares.

d)

Shares are sold by the company to enforce its lien.

e)

Dies.

f)

Is adjudged insolvent.

g)

Shares have been redeemed by the company.

h)

Rescinds the contract of membership on fraud or misrepresentation.

12.7 Share and Share Capital


12.7.1 Meaning of Share
The capital of a company is divided into certain indivisible units of a fixed amount. These units are
called shares. According to the Act Share means a share in the share capital of a company, and
includes stock except where a distinction between stock and share is expressed or implied.36 Share
may also be defined as Interest in the company entitling the owner thereof to receive proportionate
parts of profits, if any, and of a proportionate part of the assets of the company upon liquidation.

12.7.2 Meaning of Share Certificate


A share certificate is issued by a company under its common seal. It specifies the shares held by a
member and is prima-facie evidence of the title of member to the shares. Each share is distinguished
by an appropriate number.

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12.7.3 Meaning of Stock


Stock is the aggregate of fully paid up shares, consolidated and divided for the convenient holding
into different parts. It may be transferred or split up into fraction of any amount, without regard to
the original face value of share. Stock can be validly issued only when shares are fully paid up.

12.7.4 Difference Between Share and Stock


S. No.

25. What is a Red Herring


Prospectus?
26. What are the
prerequisites for
becoming a member?

Share

Stock

1.

Has a nominal value.

Has no nominal value.

2.

May not be fully paid up.

Always fully paid up.

3.

Transferable in round numbers.

Transferable in fractions.

27. Who all are competent


to become a member?
28. What are the
contractual rights of a
member?

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S. No.
Notes

Share

Stock

4.

Can be issued directly.

Cannot be issued directly.

5.

Has a distinctive number.

No such number.

6.

All shares of a class are of


denomination.

May be different equal denomination.

12.7.5 Types of Shares


There are two types of shares:
a)

Preference share.

b)

Equity or ordinary share. This type of share can be further divided into:
i.

With voting rights; or

ii. With differential right as to dividend, voting or otherwise.

12.7.6 Characteristics of Preference Shares


Preference shares have two characteristics:
a)

They have preferential rights to be paid dividend during the life time of company.

b)

They have preferential right to the return of capital when the company goes into liquidation.

12.7.7 Types of Preference Shares

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a)

Cumulative or non-cumulative: With regard to the payment of dividends, preference shares


may be cumulative or non-cumulative. A cumulative preference share confers a right on its
holders to claim fixed dividend of the past and the current year out of future profits. The
fixed dividend keeps on accumulating until it is fully paid.

b)

Participating or non-participating: Participating preference shares are those shares which


are entitled to a fixed preferential dividend and, in addition carry a right to participate in
the surplus profits along with equity shareholders.

c)

Redeemable or irredeemable: Redeemable preference shares are issued by a public limited


company, to be redeemed either at a fixed date or after a certain period of time during the
lifetime of the company. Conditions for issue of such shares are laid down in Section 80 of
the Act.

d)

Convertible or non convertible: Convertible preference shares are those which would be
convertible into equity shares after a specified period.

12.7.8 Share Warrant


29. Can a foreigner
become a member of a
company?
30. What is a stock and
how it differs from a
share?
31. How many types of
shares are there?

174 Self-Learning Material

A public company limited by shares, if so authorised by its articles, may issue, with the previous
approval of the central government, with respect to any fully paid up shares, a warrant stating that
the bearer of the warrant is entitled to share specified therein. The shares become transferable by
mere delivery of the share warrant.37

12.7.9 Distinction Between Share Warrant and Share Certificate


Notes

S. No.

Share Warrant

Share Certificate

1.

Issued only by public companies.

Issued by public and private


companies.

2.

Provision in articles and approval from


central government.

It is a statutory obligation and none is


necessary.

3.

Only for fully paid up shares.

For all shares.

4.

Holder is not a member of a company,


unless the articles so provide.

He is a member.

5.

Transferred by mere delivery.

For transfer of shares.

6.

No stamp duty payable on transfer.

Stamp duty is payable on tranfer of


shares.

7.

By usage-a negotiable instrument.

Not so considered.

8.

Does not constitute share qualification


of a director.

It does.

9.

Holder cannot present a petition for


winding up.

Holder can present such a petition.

10.

Dividend is payable to the holder of


share warrant on presentation of the
relevant coupon attached to the share
warrant.

Dividend is paid to the holder of a share


certificate by the issue of a dividend
warrant.

12.7.10 Transfer of Shares


One of the important features of a company is that its shares are transferable. Some of the important
aspects of the Act relating to transfer of shares are:
a)

Time Within Which Transfer Must be Registered: Is within two months of the application of
transfer.

b)

Refusal of Transfer: Where the articles of a company give power to the board to refuse
registration of a transfer of shares; such power must be exercised by a resolution of the
Board. The Board must act in the interest of the company and bonafide.

c)

d)

e)

Transfer Instrument Must be Valid and Proper: A proper instrument of transfer is lodged
with the company by the buyer with valid signature of the seller. The company after satisfying
the validity of instrument of transfer, shall record the transaction. Appropriate stamps are
to be affixed on the transfer deed.
Appeal Against Refusal to Register: The transferor or transferee may appeal to the Tribunal
(NCLT) against any refusal of the company to register the transfer or against any failure on
its part within a period of 2 months, either to register the transfer or to send notice of its
refusal to register the same. This period of two months shall reckon from the receipt of the
notice of such refusal.
Forged Transfer: An instrument on which the signature of the transferor is forged is called
a forged transfer. A forged transfer can never confer ownership upon the transferee thereof,

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32. What is a share
warrant.
33. How can the transfer
of shares be refused by
the company?
34. When the transfer of
shares is called Forged
transfer?

Self-Learning Material 175

however genuine the transaction may appear.


Notes

f)

Transfer of Shares Under Depository System: Is governed by the provisions of the


Depositories Act, 1996.

12.7.11 Transmission of Shares


Transmission of shares takes place:
a)

When the registered shareholder dies.

b)

When he is adjudicated an insolvent.

c)

Where the shareholder is a company, and it goes into liquidation.

12.7.12 Nomination of Shares


Every holder of shares or debentures may, at any time, nominate, a person to whom his shares or
debentures shall vest in the event of his death. The nomination shall be in the prescribed form and
lodged with the company.

12.7.13 Forfeiture of Shares


A companys articles usually contain a power for it to forfeit the shares of a member who fails to
pay calls within a certain time after they fall due. Forfeiture of shares must be exercised:
a)

In accordance with articles.

b)

After giving a proper notice.

c)

After passing a resolution for forfeiture.

d)

Bonafide and in good faith.

12.7.14 Surrender of Shares


Surrender of shares means voluntary return of shares by the shareholder to the company for
cancellation. There is no provision for surrender of shares either in the Act or in Table A. However,
the articles of some companies may allow surrender of shares as a short cut to the long procedure
of forfeiture.

12.7.15 Buy-Back of Shares by a Company

Check Your Progress


35. Does a company have
a power to forfeit the
shares?

Section 77(1) of the Act provides that a company limited by shares or a company limited by
guarantee having a share capital cannot buy its own shares except when reduction of capital is
effected. The Companies (Amendment) Act, 1999, vide sections 77A, 77AA and 77B (effective
from 31-10-1998) and as amended by the Companies (Amendment) Act 2002 (effective from 2310-2001) and the guidelines issued by SEBI and the Department of Company Affairs allow
companies to purchase their own shares. The relevant provisions are:
a)

i.

36. What can be the


sources of a buyback?
37. Is a register mandatory
to be maintained by a
company in buyback?

Free Reserves: In case shares are bought back out of free reserves then an equal sum
shall be transferred to capital redemption reserve account. This can be used for issue
of fully paid bonus shares.

ii. Securities Premium Account.


iii. Proceeds of Any Shares or Other Specified Securities: However no buy back shall be
made out of the proceeds of an earlier issue of the same kind of shares/securites.
b)

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Sources to Buy Back

Conditions for Buy Back: No company shall purchase its own shares unless:

i.

The buy back is authorised by its Articles.

ii. A special resolution is passed.

Notes

a. Not applicable if the buy back is less than 10% of the total paid up capital and
free reserves of the company.
b. Such buy back is authorised by a Boards resolution. No offer of buy-back is
made within one year of the preceding year.
iii. The buy-back is or less than 25% of the total paid up capital and free reserves
of the company. In any financial year not to exceed 25% of its total paid up
equity capital in that financial year.
iv. The ratio of debt owed by the company is not more than twice the capital and
its free reserves. The central government may prescribe a higher ratio for a
class or classes of companies.
v.

Shares/securities are fully paid up.

vi. For listed shares of companies, as per guidelines issued by SEBI.


vii. For unlisted shares guidelines can be prescribed by the central government.
c)

Notice of the Meeting: The notice of the meeting at which special resolution is
proposed to be passed shall be accompanied by an explanatory statement stating:
i.

A full and complete disclosure.

ii. The necessity for the buy back.


iii. The class of security of buy back.
iv. The amount to be invested.
v.
d)

The time limit for completion of buy back.

Sources of Buy-Back: The buy back may be:


i.

From the existing security holders on a proportionate basis.

ii. From the open market.


iii. From odd lots.
iv. By purchasing the securities issued to employees of the company pursuant
to a scheme of stock option or sweat equity.
e)

Declaration of Solvency: A declaration of solvency is to be filed with the Registrar and


SEBI (for listed companies only). The declaration of solvency states that the company is
capable of meeting its liabilities and will not be rendered insolvent within one year of the
date of declaration adopted by the Board. This declaration is to be signed by at least two
directors of the company one of whom shall be the Managing Director, if any.

f)

Destruction of the Securities: The company shall extinguish and physically destroy the
securities so bought back within seven days of completion of buy back.

g)

Further Issue of Shares: On completion of buy back of shares/securities, the company


shall not make further issue of the same kind of shares/securities within a period of six
months except:

e)

i. Bonus shares.
ii. Conversion of warrants.
iii. Stock option schemes or sweat equity.
iv. Conversion of preference shares or debentures into equity shares.

h)

Maintenance of Register: The company shall maintain a register of the:


i.

Securities so bought.
Self-Learning Material 177

ii. Consideration paid.


iii. Dates of cancellation, extinguishing and physically destroying of the securities.

Notes

iv. Other particulars as prescribed.


i)

Filing a Completion Return: A company shall file a completion return within


thirty days of completion of buy back with the Registrar and SEBI (for listed
companies) with particulars as prescribed.

j)

Penalties: In case of any default, a person is imposed a fine upto Rs. 50,000 or imprisonment
upto to 2 years or both.

k)

Prohibition for Buyback: No company shall directly or indirectly purchase its own shares/
securities.
i.

Through any subsidiary company including its own subsidiary company.

ii. Through any investment company or group of investment companies.


iii. If a default by the company in repayment of deposit or interest payable thereon,
redemption of debentures or preference shares or payment of dividend to any
shareholder or repayment of any term loan, or interest payable thereon to any bank or
any financial institution is subsisting.
iv. In case such company has not complied with provisions of: Section 159, (Annual return
to be made by company having share capital) Section 207, (Penalty for failure to pay
dividend within 30 days) and Section 211, (Form and content of balance sheet and
profit and loss a/c)

12.7.16 Sweat Equity Shares38


a)

Meaning: The expression sweat equity shares means equity shares:


i.

Issued by the company to employees or directors at a discount.

ii. For consideration other than cash for providing know how.
iii. Making available rights in the nature of intellectual property rights or value
additions.
b)

Conditions for Issue:


i.

Is authorised by special resolution

ii. The resolution specifies the number of shares, current market price, the
consideration, if any, and the class of directors or employees to whom such
equity shares are to be issued.

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38. How long shall a
company wait, after
commencement of
business, to issue
sweat equity shares?
39. How many types of
share capital are there?
40. What is alteration the
capital?

178 Self-Learning Material

iii. Not less than one year has at the date of the issue elapsed since the date on
which the company was entitled to commence business.
iv. The sweat equity shares of a company whose equity shares are listed on a
recognised stock exchange, are issued in accordance with the regulations
made by SEBI.

12.7.17 Classification of Share Capital


Share capital can be classified, based on usage as follows:

Classification of Share Capital Based on Usage


Nominal, Authorised, Registered Capital

Notes

Issued Capital
Subscribed Capital
Called-up Capital
Paid-up

12.7.18 Kinds of Share Capital


a)

Preference share capital

b)

Equity or ordinary share capital

12.7.19 Alteration of Capital


a)

Increase: By issuing new shares.

b)

Consolidation: By division into shares of larger amount.

c)

Conversion: Of fully paid shares into stock.

d)

Sub-division: Into shares of smaller amount.

e)

Cancellation: Of shares which have not been taken up.

12.7.20 Reduction of Capital


A company limited by shares, if so authorised by its articles, may by special resolution, which is
to be confirmed by the Tribunal (NCLT) reduce its share capital in any of the following manner:
a)

By reducing or extinguishing the liability of members for uncalled capital.

b)

By paying off or returning capital which is in excess of the wants of the company;

c)

Pay off paid-up capital on the understanding that it may be called up again.

d)

A combination of the preceding methods.

e)

Write off or cancel capital which has been lost or is not represented by available assets.

a)

The creditors are entitled to object where the reduction of share capital is involved.

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12.8 Borrowings, Loans, Debentures and Investments


Notes

12.8.1 Borrowing Powers of a Company


a)

Introduction: A company needs money to finance its activities. A part of this requirement is
met by issue of shares; for the rest the company has to resort to public borrowing. Borrowing
is incidental to trading. The exigencies of commerce render such a power necessary. A
trading company has implied power to borrow unless prohibited by its memorandum or
articles. A non-trading company requires express powers to borrow. This power is taken in
its memorandum or articles. Where the memorandum authorises the company to borrow,
the articles provide as to how and by whom these powers will be exercised. A public company,
having a share capital, cannot exercise borrowing power unless certificate to commence
business is obtained by it.

b)

Exercise of Borrowing Power and Limitations: The power to borrow is exercised by the
directors. Directors act as agents and this power is subject to two limitations:
i.

Statutory Limits: No borrowing is permissible beyond the aggregate of the


paid up capital of the company and its free reserves (i.e. reserves not set
apart for any specific purpose) unless prior sanction is obtained in general
meeting.

ii. As contained in the memorandum or articles.

12.8.2 Meaning of Loan


Loan includes debentures or any deposit of money made by one company with another company,
not being a banking company.

12.8.3 Debenture
a)

Definition: According to the Act, debenture includes debenture, stock, bonds, and any
other securities of a company, whether constituting a charge on the assets of the company
or not.39

b)

Characteristic Features of a Debenture Are:


i.

It is issued by the company and is in the form of a certificate of indebtedness.

ii. It is of a series but can be a single debenture.


iii. It usually specifies the date of redemption. It also provides for the repayment
of principal and interest at specified date(s).

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iv. It generally creates a charge.


41. Who has the power to
borrow?

v.

vi. A debenture holder has no right of voting in companys meetings.

42. What is a Loan?


43. What do you
understand by
investments?
44. What is the
significance of a
unanimous board
resolution?

It is a movable property.

c)

Kinds of debentures: Debentures may be of the following kinds:


i.

Bearer or unregistered

ii. Registered
iii. Secured
iv. Unsecured or naked
v.

Redeemable

vi. Irredeemable or perpetual.


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vii. Convertible or non-convertible. Convertible debentures can be fully or partly


convertible.

Notes

12.8.4 Investments
a)

Meaning: The word investments in its natural connotation, would include any property or
right in which money or capital is invested. The word investments in a limited sense
would mean the investing of money in shares, stock, debentures or other securities.

b)

Rules for Investments: Some of the rules for investments are:


i.

Investments are to be held in companys own name, except an investment


company.

ii. Qualification shares are to be in respect of nominee director or nominee


holders.
iii. Holding shares in a subsidiary company may be in the name of nominee.
iv. Certificates or letters of allotment are to be in the custody of the company.
v.

Register of investments not held in companys own name is to be maintained.

12.8.5 Inter Corporate Loans and Investments40


a)

Ceiling on Loans, Guarantees, Investments, etc.: No company shall, directly or indirectly:


i.

Make any loan to any other body corporate.

ii. Give any guarantee, or provide security, in connection with a loan made by
any other person to, or to any other person, by any body corporate.
iii. Acquire by way of subscription, purchase or otherwise the securities of any
body corporate, exceeding 60% of its paid up share capital and free reserves
or 100% of its free reserves, whichever is more.In case the limit is exceeded
special resolution is required.
b)

Guarantee by the Board: The Board may give guarantee, without being previously authorised
by a special resolution, if:
i.

A resolution is passed in the meeting of the Board authorising to give guarantee.

ii. There exist exceptional circumstances which prevent the company from obtaining
previous authorisation by a special resolution passed in a general meeting for giving a
guarantee.
iii. The resolution of the board under (i) is confirmed within 12 months, in a general
meeting of the company or the annual general meeting held immediately after passing
of the board resolution, whichever is earlier.
c)

Notice: Of such resolution shall indicate clearly.


i.

The specific limits.

ii. The particulars of the body corporate where loan, guarantee or security to
be given.
iii. The purpose of the investment, loan, security or guarantee.
iv. Special sources of funding and such other details.
d)

Unanimous Board Resolution: No loan or investment shall be made or security given by


the company unless the resolution sanctioning it is passed at the meeting of the board with
the consent of all the directors present at the meeting and the prior approval of the public
financial institution where any term loan is subsisting, is obtained.

e)

Loan at Bank Rate: No loan to any body corporate shall be made at a rate of interest lower
Self-Learning Material 181

than the prevailing bank rate.


Notes

f)

Not Applicable to a Company in Default of Public Deposits: No company which has


defaulted in complying with Section 58A (Public deposits) shall directly or indirectly:
i.

Make any loan to any body corporate.

ii. Give any guarantee, or provide a loan made by any person to, or to any
other person by any body corporate.
iii. Acquire, by way of subscription, purchase or otherwise the securities of any
other body corporate till such default is subsisting.
g)

Keeping of a Register: Every company shall keep a register showing the following particulars
in respect of every investment or loan made, guarantee given or security provided by it in
relation to any body corporate namely:
i.

The name of the body corporate.

ii. The amount, terms and purpose of the investment or loan or security or
guarantee;
iii. The date on which the investment or loan has been made.
iv. The date on which the guarantee has been given or security has been
provided in connection with the loan.
h)

Other Rules About Register:


i.

Entries to be made chronologically within seven days of transaction.

ii. Register shall be kept at registered office and open for inspection as the
register of members.
iii. Extracts or copies can be taken.
i)

Guidelines: Central government may prescribe guidelines for the purpose of this section.

j)

Not Applicable: Nothing contained in this section (372A) shall apply:


i.

To any loan made, any guarantee given or any security provided for any investment
made by:
a. A banking company, or an insurance company, or a housing finance company
in the ordinary course of its business, or a company established with the
object of financing industrial enterprise, or of providing infrastructural
facilities.
b. A company whose principal business is the acquisition of shares, stock,
debentures or other securities.
c. A private company, unless it is a subsidiary of a public company.

ii. To any investments made in shares allotted in pursuance of Section 81 (1)(A) (Rights
issue).
iii. To any loan made by a holding company to its wholly owned subsidiary.
iv. To any guarantee given or any security provided by a holding company to its wholly
owned subsidiary.
v.
k)

Penalties:
i.

182 Self-Learning Material

To acquisition by a holding company by way of subscription, purchase or otherwise,


the securities of its wholly owned subsidiary.
If default is made in complying with the provisions of this section, other than the
provision relating to keeping of a register, the company and every officer of the company
who is in default shall be punishable with imprisonment which may extend to two
years or with fine which may extend to Rs. 50,000.

ii. If default is made in complying with the provisions relating to keeping of a


register, the company and every officer of the company who is in default
shall be punishable with fine which may extend to Rs. 5,000 and also with a
further fine which may extend to Rs. 500 for every day after the first day
during which the default continues.

Notes

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iii. No punishment of imprisonment, if loan is repaid in full.


iv. Imprisonment is proportionately reduced, when loan is paid in part.

12.9

Company Management and Administration

12.9.1 Definition of Director


According to the Act, director includes any person occupying the position of director, by
whatever name called.41 A company is an artificial legal person and the directors as a body
endow the artificial legal person with human face that can act and react.

45. What penalties may be


attached to the
company and its each
officer, who is found of
violating legal
provisions relating to
intercorporate loans
and investments?
46. Who cannot become
a director?

12.9.2 Who are Directors?


The persons, through whom a company acts and does its business, are termed as directors. They
are collectively known as board of directors. They are the brains of the company. A director is a
person having control over the direction, conduct of a company. Board of directors or Board in
relation to a company, means the board of directors of the company.

12.9.3 Who may be Appointed as Director?

47. Are there any


professional
qualifications required
to become a director?
48. What is the nominal
value of qualification
shares?

No body corporate, association or firm can be appointed director of a company. Only an individual
can be appointed.

12.9.4 Minimum and Maximum Number of Directors


Private Company
Minimum *

Public Company
3

Maximum *
* Both minimum and maximum number of directors may be as provided in the articles. For
example, the articles may fix 6 as the minimum and 10 as maximum.

12.9.5 Number of Directorships


A person cannot hold office at the same time as a director in more than 15 companies.

12.9.6 Qualifications for Directors


a)

The Act prescribes no academic, professional or share qualifications.

b)

Articles may provide for any qualifications.


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c)

Where share qualification is fixed by articles then the Act42 provides:


i.

Notes

Qualification shares must be taken within 2 months after appointment.

ii. Nominal value of qualification shares must not exceed Rs. 5000 or one share
where its value exceeds Rs. 5000.
iii. Share warrants will not count for this purpose.

12.9.7 Disqualifications of Director


The following persons are disqualified for appointment as director of a company:
a)

A person of unsound mind;

b)

An undischarged insolvent;

c)

A person who has applied to be adjudged as an insolvent and his application is pending;

d)

A person who has been convicted by a court of an offence involving moral turpitude and
sentenced to imprisonment for six months, and a period of five years has not elapsed from
the date of the expiry of the sentence;

e)

A person whose calls in respect of shares of the company held for more than 6 months have
been in arrears;

f)

A person who is disqualified for appointment as directed by an order of the Tribunal (NCLT)
under section 203 of the Act (which deals with power of the Tribunal to restrain fraudulent
person from managing company);

g)

A person who is a director of a public company which:


i.

Has not filed the annual accounts and annual returns for 3 financial years commencing
on and after 1.4.1999.

ii. Has failed to repay its deposit or interest thereon on due date or redeem its debentures
on due date or pay dividend and such failure continues for one year or more.
Note:
1.

The disqualifications mentioned in (d) and (e) above may be removed by the central
government by a notification in the Official Gazette.

2.

A private company which is not a subsidiary of a public company may, by its articles,
provide for additional grounds.

3.

A director who has been removed by the central government shall not be a director for five
years.

4.

A director disqualified under (g) above shall be ineligible for appointment as a director of
any other public company only and this disqualification shall last for 5 years.

12.9.8 Appointment of Directors


Directors can be appointed in the following ways:

184 Self-Learning Material

a)

First Director: The first directors are usually appointed by name in the articles, or in the
manner provided therein. When the articles do not provide for the appointment of first
directors, the subscribers to the memorandum, shall be deemed to be the first directors of
the company.

b)

Appointment of Directors by Company: The directors must be appointed by the company


in general meeting. Two-third of the total number of directors must retire by rotation. In
other words only one-third of the total number of directors can be non-rotational directors.

c)

Appointment of Directors by the Board: The board of directors can exercise the power to
appoint directors in the following three cases:

i.

Additional directors.

ii. Filling up the casual vacancy.


iii. Alternate directors.
d)

Appointment of Directors by Third Parties (Nominee Directors): When the government,


foreign collaborators, holding companies, financial institutions, or other lenders, etc.,
nominate a director to represent their interest on the board, he is called a nominee director.

e)

Appointment of Directors by Proportional Representation: Ordinarily, directors are


appointed by simple majority vote. As a result, shareholders controlling 51% or more votes
may elect all directors and the minority as high as 49% may find no representation on the
board. To enable the minority shareholders to have a proportionate representation on the
board, the Act43 gives an option to companies to appoint directors through a system of
proportionate representation by any of the following methods:
i.

Notes

Single Transferable Vote: A quota of votes is fixed. A person gets elected if he gets the
required number of votes fixed as quota. Suppose votes cast are 600 and there are 5
seats. Thus the quota will be 101 calculated as follows:

600
+1 = 101 Votes
5+1
ii. Cumulative Voting: The total number of votes cast would be equal to the total number
of shares multiplied by the number of directors to be elected. Thus, if there are 1000
shares and five directors to be elected, the total number of votes cast would be equal to
5000. A candidate getting 1000 votes should be declared elected. Now assuming that
the minority holds 20% of shares, i.e. 200 shares, the total votes which the minority
can cast in favour of one or more candidate would be equal to 200 x 5 = 1000. Thus
this minority shareholder can elect one director.
f)

Appointment by Central Government: The central government can appoint directors on an


order passed by the Tribunal (NCLT).

g)

Appointment by Small Shareholders: A public company having a paid-up capital of 5 crore


rupees or more, and one thousand or more small shareholders may have a director elected
by such small shareholders. The term small shareholder means a shareholder holding
shares of nominal value of Rs. 20,000 or less.

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12.9.9 Consent for Appointment
Before a person is appointed as a director, his prior written consent is required to be signed and
filed with the Registrar and the Company.

12.9.10 Removal of Directors


Directors can be removed in the following ways:
a)

By Shareholders: Shareholders have the option to remove the directors by passing an


ordinary resolution. Company receives a special notice for the removal of the director
before the expiry of his term of office. The notice must disclose the ground on which the
director is proposed to be removed. Director has a right to make representations.

b)

By Central Government: The central government has the power to make reference to
the Tribunal (NCLT) against any managerial personnel, with a request to inquire into
as to whether or not such a person is fit and proper person to hold the office of director.
On the findings of the Tribunal, the central government may remove the director.

c)

By Tribunal (NCLT): Where an application has been made to the Tribunal (NCLT) against
oppression and mismanagement of companys affairs, the Tribunal (NCLT) may order the

49. Can a person of


unsound mind become
the director of a
company?
50. When can board of
directors appoint the
directors of a
company?
51. Who is a small
shareholder?
52. Does central
government have the
power to remove a
director? If yes, then
how?

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termination of the agreement of the company with the director.


Notes

12.9.11 Resignation by Directors


There is no express provision in the Act relating to resignation of directors. The Act, however,
indirectly acknowledges this right as the Act stipulates that no director is entitled to any
compensation if he resigns his office.44 Articles of a company may provide for resignation of
directors. Resignation to be valid must be addressed to the company. A director cannot withdraw
his resignation without the consent of the company. When a director resigns, two formalities are
to follow: First, this fact is to be entered in the register of directors. Second, a return to be filed
with the Registrar within 30 days of the resignation becoming effective. When the company does
not comply with the second formality, the affected director may face some difficulty.

12.9.12 Legal Position of Directors


It is difficult to state the exact legal position of a director. The Act does not define their position
clearly. A director acts as an agent, a trustee, managing partner or as employee but he is none of
them. M.R. Jessel has succinctly put the position of a director in these words: Directors have
sometimes been called as trustees or commercial trustees, and sometimes they have been called
managing partners; it dos not matter much what you call them so long as you understand what
their real position is, which is that they are really commercial men managing a trading concern for
the benefit of themselves and of all the shareholders in it. They stand in a fiduciary position
towards the company in respect of their powers and capital under their control.

12.9.13 Powers of the Board of Directors


The Board of Directors of a company shall be entitled to exercise all such powers, and to do all
such acts and things, as the company is authorised to exercise and do. However, the board cannot
exercise any power or do any act or thing which is directed or required, whether by the Act, or any
other Act, or by the memorandum or articles, to be exercised by the company in general meeting.

12.9.14 Power to be Exercised by Resolutions Passed at Boards Meeting


The board shall exercise the followings powers by means of resolution passed at boards meeting:
a)

The power to make calls.

b)

The power to issue debentures.

c)

The power to borrow money otherwise than on debentures.

d)

The power to invest funds.

e)

The power to make loans.

f)

The power to buy-back of shares.

g)

Others - This will cover the following:


i.

To fill casual vacancy in board.

ii. Sanctioning of a contract in which a director is interested.


iii. Recommend rate of divided at the Annual General Meeting.
iv. To make political contribution.

186 Self-Learning Material

12.9.15 Powers to Be Exercised by the Company in General Meeting


a)

Sale, lease or disposal of the undertaking.

b)

Showing any concession regarding payment of debts.

c)

Make investment of the amount of compensation received.

d)

Contribution to charitable and other funds.

e)

Borrowing monies exceeding the aggregate of the paid-up capital and free reserves of the
company.

12.9.16 Duties of Directors


Some of the duties of directors are:
a)

Duty of good faith.

b)

Duty to take reasonable care.

c)

Duty to disclose interest.

d)

Duty to participate in committees of the board like Audit Committee or Investors Grievance
Committee.

e)

Duty to attend board meetings.

Notes

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53. Can a director choose
to withdraw his/her
resignation?
54. What power does the
board possess through
resolutions?
55. What are the
limitations with regard
to a directors power?

12.9.17 Limitation on the Powers of Director


a)

Where the directors actions are found to be malafide.

b)

Where the Board becomes incompetent to act.

c)

Deadlock in the board.

12.9.18 Managing Director


a)

Meaning: A director who is entrusted with substantial powers of management which would
not otherwise be exercisable by him.

b)

Number of companies: Of which one person may be appointed Managing Director is two.

c)

Tenure of appointment: Is five years but eligible for re-appointment for another term of
five years.

12.9.19 Managerial Remuneration


The total managerial remuneration payable by a public company or a private company which is
subsidiary of a public company to its directors (or manager) in respect of any financial year must
not exceed eleven per cent of the net profits of any financial year. For a whole time director or a
managing director, the remuneration shall not exceed five per cent of the net profits for one such
director, or if there is more than one such director, ten per cent for all of them taken together.

12.10 Company Meetings and Resolutions


12.10.1 Introduction
A company being an artificial legal person, can only act through some human intermediary. The
various provisions of the Act and rules empower members to do certain things. All decisions of
Self-Learning Material 187

the company are taken in meetings.


Notes

12.10.2 General
a)

Requisites of a Valid Meeting: It must be duly convened, legally constituted and properly
conducted.

b)

Notice of Meeting Must be Proper and Adequate: For general meetings at least 21 clear
days notice must be given to every member and auditor of the company. It must specify the
date, time and place of meeting.

c)

Chairman of the Meeting: Every meeting is presided over by the chairman who is to conduct
the proceedings of the meeting properly. The chairman is either the chairman of the board
or elected for every meeting. His main role is to maintain order and decorum in the meeting.

d)

Quorum: The quorum is generally laid down in the articles. In the absence of any provision
in the articles, the quorum is 5 members for public and 2 members for private company.
The articles can not provide for a smaller quorum.

e)

Voting: To ascertain the sense of the house the chairman of the meeting can use any of the
following:
i.

Acclamation (By cheering or clapping)

ii. Voice vote


iii. Division
iv. Show of hands
v.

Ballot (which can be open or secret)

vi. Poll (According to the number of shares held by a member. A proxy can only
vote on a poll, unless the articles may provide otherwise, say permitting a
proxy to vote on a show of hands also)
f)

Agenda: Every general meeting has an agenda to be sent to every member. An agenda is the
statement of business to be conducted in a meeting.

g)

Minutes: The decisions taken in a meeting are recorded as minutes of the meeting. These
minutes shall be evidence of the proceedings recorded therein.

12.10.3 Kinds of Meetings


The kinds of meetings of a company are shown below:

Meetings of a Company
Shareholders

General Meetings

Statutory Meetings

188 Self-Learning Material

Directors

Creditors and Debenture


Holders

Class Meetings

Annual General Meetings

Extra-ordinary Meetings

12.10.4 Statutory Meeting


a)

Object: The main purpose is to enable the members to know at an early date the financial
position and prospects of the company and also to provide them an opportunity of discussion
on various matters arising out of promotion and formation of a company.

b)

When Held: Only Once in the life time of the company. It is to be held within a period of
not less than one month but not more than six months from the date the company is entitled
to commence business. This is the first meeting of the shareholders.

c)

Not Required to be Held: A private company is not required to hold a statutory meeting.
This meeting is also not required to be held by a public company not having share capital
or has unlimited liability or a government company.

d)

Notice: At least 21 days notice is to be given.

e)

Statutory Report: Is presented in this meeting. Its contents include, total shares allotted,
total amount of cash received, an abstract of receipts and payments, details of contract,
directors, brokerage and commission.

f)

In case of default: Penalty is Rs. 5000 and is also a ground for winding up.

Notes

12.10.5 Annual General Meeting (AGM)


a)

Which company to hold: Every company either public or private.

b)

When to be held: Every calender year, i.e. once annually.

c)

Gap between two AGM:


i.

First AGM: May be held within 18 months from the date of incorporation.
First AGM must be held not later than 9 months from the date of closing of
financial year.

ii. Subsequent AGM: There must be one meeting held in each calendar year.
The gap between two AGMs must not be more than 15 months. This period
can be extended to 18 months by the Registrar. Meeting must be held not
later than 6 months from the close of the financial year.
iii. Extension of time: Registrar can give extension time upto a maximum of 3
months.
iv. Business to be transacted: Ordinary business like consideration of annual
accounts, declaration of dividend, appointment of directors and auditors or
any special business may be transacted.
v.

Notice: 21 days.

vi. Default: Central government can give directions as it thinks expedient. Penalty
provided is Rs. 50,000 or in case of continuing default Rs. 2500 per day.

Check Your Progress


56. What is the maximum
number of companies
a person can associate
with as MD?
57. Who presides the
meeting in a company?

12.10.6 Extraordinary General Meeting (EGM)

58. In what ways a


member can vote?

All general meetings other than the AGM shall be EGMs. Some of the points relating

59. What is the notice


period for a statutory
meeting?

to EGM are:
a)

When to be convened: For transacting some urgent or special business that may arise between
two AGMs, e.g. removal of a director/auditor.

60. What business has to


be transacted in AGM?

b)

Business to be transacted: All business transacted in EGM is called special business and
accompanied by an Explanatory Statement.

61. What is a Motion?

Self-Learning Material 189

c)

Who may call: An EGM may be called by:


i.

Notes

The board on its own.

ii. The directors on requisition, if the requisitionists are the holders of 1/10 of
total voting power.
iii. The requisitionists themselves, if the board does not call the meeting within
45 days of the deposit of a valid requisition. Meeting must be held within 3
months of the date of deposit of requisition.
iv. The Tribunal (NCLT).
d)

An institutional shareholder can requisition an EGM.45

e)

All reasonable expenses incurred by the requisitionists by reason of the failure of the board
to call a meeting shall be repaid to the requisitionist by the company.

12.10.7 Board Meeting


a)

When to hold: Atleast once in every three calendar months and 4 meetings every year.46

b)

Notice: To be given to every director in writing. No form or period of notice is laid down.
Usually a weeks notice is sufficient. The notice must state, the date, time and place of
meetings.

c)

Quorum: 1/3 of the total strength or two, whichever is higher.

d)

Passing of resolution by circulation is permissible.

12.10.8 Motion
a)

Meaning: A proposal under consideration by members in a meeting before it is voted upon.

b)

Rules as to Motion: The following are the rules as to motion:


i.

Should be positive in terms and should always be in writing.

ii. Within power, scope and relevant to business.


iii. Comply with the provisions of the Act, memorandum and articles.
iv. Duly proposed by any member in a meeting.
v.

Should not be withdrawn before consent.

12.10.9 Resolution
a)

Meaning: Any motion voted upon and agreed to in a meeting and entered in minutes. In
other words, a motion when passed, with or without amendment, is called a resolution.

b)

Types of Resolution:
i.

Ordinary resolution

ii. Special resolution


iii. Resolutions requiring special notice

190 Self-Learning Material

c)

What is an Ordinary Resolution: A motion passed by simple majority of the members


voting at a general meeting.

d)

Special Resolution: The votes cast in favour, by whatever means, by members present
should not be less than three times the votes cast against the resolution. Intention as special
resolution should be specified in the notice or intimation of the meeting. Some of the matters
for which special resolution is required are to alter objects clause of memorandum or to
alter articles.

e)

Resolution Requiring Special Notice: Notice of the intention to move the resolution should
be given to the company not less than 14 clear days before the meeting at which it is to be
moved. Examples - appointing an auditor other than the retiring one, removing a director
before expiry of period of his office.

Notes

12.10.10 Passing of Resolutions by Postal Ballot47


a)

Conditions of Applicability:
i.

Listed public company shall get any resolutions passed by postal ballot on
subjects so declared by the central government. Some of the subjects so declared
are, alteration in the object clause of the memorandum, buy-back of own shares,
sale of the undertaking of the company.

ii. Send a notice to shareholders along with the draft resolution and shareholders
to send their vote within 30 days of posting of the letter.
iii. Notice to be sent by registered post. A.D. or by any other method as prescribed
with a pre-paid postage envelope.
b)

Penalties:
i.

For fraudulently defacing or destroying the ballot paper, or declaration of identity


of the shareholder, imprisonment upto 6 months or fine or both.

ii. For any other default fine upto Rs. 50,000.


Note: Postal ballot includes voting by electronic mode.

12.11 Accounts and Audit


12.11.1 Introduction
The Act contains a number of provisions relating to accounts and audit designed to ensure that
members of a company are furnished with all the necessary information relating to its affairs,
without giving away any information which would be detrimental to the interests of the company.

12.11.2 Books of Account


Every company is required to maintain proper books of account with respect to:
a)

All receipts and expenditure of money.

b)

All sales and purchases of goods by the company.

c)

The assets and liabilities of the company.

d)

Every three months summarised accounts of all branch offices-in or outside India.

e)

In case of a company engaged in production, processing, manufacturing or mining activities,


such particulars relating to utilisation of material, labour or other items of cost as may be
prescribed by the central government.

Note:
1.

Books of accounts should necessarily give a true and fair view of the state of affairs of the
company.

2.

Books are to be kept on accrual basis and as per double entry system of accounting.

3.

Books are to be kept at the registered office. However, a company may keep books at any

Self-Learning Material 191

other place in India as the board of directors may decide. In such an event, the company has
to file full particulars with the Registrar within 7 days of such decision.

Notes

12.11.3 Inspection of Books of Account


Check Your Progress
62. How many types of
resolutions are there?
63. Who can inspect the
books of account?
64. How long the books of
accounts shall be
preserved?
65. Who can be an
auditor?

Books of account and other books are open for inspection by:
a)

Any director

b)

The Registrar

c)

Authorised officers of the central government.

d)

Authorised officers of SEBI (for listed companies only).

A shareholder has no statutory right to inspect books of account. However, if the articles specifically
provide for such a right then he can inspect.48

12.11.4 Preservation of Books of Account


Books of account of every company are to be preserved for a period of eight years.

12.11.5 Authentication of Accounts


Every balance sheet and profit and loss account of a company (except a banking company) shall
be signed on behalf of the board, by its manager or secretary, if any, and by not less than two
directors, one of whom shall be the managing director, where there is one. They are approved by
the board, before signing. After approval and signature, they are handed over to the companys
auditor for his report.

12.11.6 Circulation and Adoption of Annual Accounts


A copy of annual accounts (Balance sheet and profit and loss account) auditors report, and directors
report, shall be sent to every member of the company, not less than 21 days before the meeting
(AGM). They are adopted in the AGM.

12.11.7 Filing of Annual Accounts


Every company is required to file with the Registrar three copies of annual accounts within thirty
days from the date they were laid before the company at the AGM.

12.11.8 Who can be an Auditor?


A person is qualified to be an auditor of a company if he is a practicing chartered accountant
within the meaning of the Chartered Accountants Act, 1947.

12.11.9 Disqualifications of an Auditor


The following entities or persons are disqualified to be appointed as an auditor of a company:

192 Self-Learning Material

a)

A body corporate.

b)

An officer or employee of the company.

c)

Partner/employee of an officer or employee of the company.

d)

Indebted to the company for an amount exceeding Rs. 1000 or guarantor or who had given
security in connection with the indebtedness of any third person.

e)

Disqualified for appointment as auditor of any body corporate which is:


i.

The companys subsidiary,

Notes

ii. Its holding company, or


iii. A subsidiary of its holding company.
f)

A person holding any security carrying voting rights of that company after a period of one
year from the date of commencement of the Companies (Amendment) Act, 2000 (viz., 1412-2000).

12.11.10 Appointment of Auditor


a)

First Auditor: Is appointed by the board, if not then by the company in general meeting.

b)

Subsequent Auditor: Is appointed every year by the members in AGM by passing an ordinary
resolution.

12.11.11 Tenure of Appointment


An auditor is appointed from the conclusion of one AGM until the conclusion of the next AGM.

12.11.12 Rights of Auditor


The rights of an auditor are:
a)

Access to books, accounts and vouchers.

b)

To obtain information and explanation.

c)

To visit branch offices and right to access to books, accounts etc.

d)

To receive notice of general meeting and to attend.

e)

To receive remuneration on completion of his work.

12.11.13 Duties of Auditor


His duties are:
a)

Acquaintance with the Act, memorandum and articles;

b)

To make report to members;

c)

Others:
i.

Statutory report.

ii. Prospectus.
iii. Assistance in investigation.
iv. Following accounting standards.

12.11.14 Auditors Report


a)

Obligations to make an inquiry relating to:


i.

Loans and advances made by the company.

ii. Transactions of the company.


iii. Personal expenses charged to revenue account.
iv. Receipt of cash for shares allotted.
Self-Learning Material 193

b)

Matters that are to be stated in the auditors report:


i.

Notes

Obtained all information and explanations.

ii. Proper books of account have been kept by the company and report from
branches received.
iii. Auditors report of branch office, not audited by him.
iv. Accounts render true and fair view of the affairs of the company.
v.
vi.

Balance sheet and profit and loss account are in agreement with books of
account.

Compliance of accounting standard.

12.11.15 Cost Audit49


It is also a part of audit to verify the costs of manufacture or production of an article on the basis
of accounts as regards utilisation of material or labour or other items of cost, maintained by the
company. Such an audit shall be conducted by a cost accountant within the meaning of the Cost
and Works Accountant Act, 1957.

12.11.16 National Advisory Committee on Accounting Standard (NACAS)50


The central government may constitute NACAS, to advise the central government on the
formulation and laying down of accounting policies and accounting standards for adoption by
companies. The central government has already constituted NACAS.

12.11.17 Audit Committee51


Some of the provisions relating to audit committee are:
a)

Applicable to every public company having paid up capital of not less than Rs. 5 crores.

b)

This is a committee of the board.

c)

It shall consist of not less than three directors.

d)

The terms of reference shall be specified by the board.

e)

Its composition shall be disclosed in the annual report.

f)

It shall have authority to investigate into any matter specified in section 292A of the Act or
referred to by the board. It shall have full access to information kept by the company.

g)

The recommendations on any matter relating to financial management including the audit
report, shall be binding on the board. If the board does not accept the recommendation, it
shall record the reasons there for and communicate such reasons to the shareholders.

h)

The chairman of the audit committee shall attend AGM.

12.12 Prevention of Oppression and Mismanagement


12.12.1 The Principle of Majority Rule
The management of companies is based on the rule by majority, like any democratic set up. The
principle of majority rule is often described as the rule in Foss v. Harbottle.52 Briefly the facts in
this case were that two minority shareholders alleged that directors and solicitors of the company
were guilty of fraudulent acts which resulted in loss to the company. They decided to take action
for damages against the directors. The court dismissed the suit of the minority shareholder on the
194 Self-Learning Material

ground that the acts of the directors were capable of confirmation by the majority of shareholders
and held that the proper plaintiff for wrongs done to the company is the company itself, and not
the minority shareholders, and as such the company could act only through its majority shareholders.
The majority rule has many inherent advantages like:
a)

If a company has suffered any financial loss, it is the company and not the minority
shareholders who can sue.

b)

If every individual member were given unfettered right to decide there would be endless
litigation.

c)

There is a need to preserve right of majority to decide.

Notes

Check Your Progress


66. How are the auditors
appointed?

12.12.2 Exceptions to the Majority Rule

67. What is NACAS and


what does it do?

There are many exceptions to the majority rule. One of them is - where prevention of oppression
and mismanagement is applicable.53

68. What are the main


provisions for the audit
committee?

12.12.3 Meaning of Oppression

69. What is termed as


oppression?

The term oppression has not been defined in the Act. Lord Cooper has given the meaning of the
term as The essence of the matter seems to be that the conduct complained of should, at the
lowest, involve a visible departure from the standards of their dealing and a violation of the
conditions of fair play on which every shareholder who entrusts his money to the company is
entitled to rely.54 The complaining member must show that he is suffering from oppression in his
capacity as member and not in any other capacity. The oppression must be of continuing nature.

12.12.4 Conditions Precedent for Mismanagement


The affairs of the company are being conducted or such affairs are likely to be conducted in a
manner which is:
a)

Prejudicial to public interest.

b)

Prejudicial to the interest of the company.

12.12.5 Relief from Oppression and Mismanagement


In case of oppression of members and mismanagement of company, a requisite number of
shareholders can apply for appropriate relief to:
a)

The Tribunal (National Company Law Tribunal (NCLT)) for winding up.

b)

The Tribunal (National Company Law Tribunal (NCLT)).

c)

The central government.

Note:
The powers of the court or Company Law Board are transferred to the National Company Law
Tribunal (in short NCLT) by the Companies (Amendment) Act 2002. The central government is in
the process of formation of NCLT. As on date, the powers are exercised by courts or Company
Law Board. Hence, in this section NCLT or Tribunal has been used.

12.12.6 Application to NCLT and Relief by it


A requisite number of shareholders can apply for appropriate relief to NCLT. NCLT may give
relief if it is of the opinion that the companys affairs are being conducted:
a)

In a manner prejudicial to public interest.


Self-Learning Material 195

b)
Notes

In a manner oppressive to any member(s).

12.12.7 Who can Apply for Relief55


Requisite number of members should sign on the application:
a)

Company having share capital:


i.

Not less than 100 members or 1/10 of the total number of its members,
whichever is less.

ii. By any member(s) holding not less than 1/10 of the issued share capital.
b)

Company not having share capital: 1/5 of the total number of member of the company.

c)

Besides members the following can also apply:


i.

The central government or any person authorised by the central government.

ii. Trustees of a shareholder/member.


iii. A legal representative of a deceased member.

12.12.8 Notice of Application to be Given to the Central Government


The notice of every application made to the Tribunal (NCLT) under sections 397/398 of the Act
for the prevention of oppression or mismanagement must be given by the Tribunal (NCLT) to the
central government. The central government can make any representation which the Tribunal will
consider before making a final order.

12.12.9 Acts held as Oppressive


The court has held following acts as oppressive:
a)

Not calling a general meeting and keeping shareholders in dark.

b)

Non-maintenance of statutory records and not conducting affairs of the company in


accordance with the Act.

c)

Depriving a member of the right to dividend.

d)

Transfer of shares held by company to some shareholders otherwise than by making an


offer to all.

e)

Allotment of shares by directors in a manner by which majority of shareholders is reduced


to minority.

f)

Failure to distribute the amount of compensation received on nationalisation of business of


company among the members, where required to be distributed.

g)

Countermanding decision of the board who controls majority voting power, and not allowing
board to perform its functions.

h)

If sale of assets is made by a company to some of its directors and simultaneously


giving them loan to purchase the same.

i)

Issue of further shares benefiting a section of the shareholders.

12.12.10 Acts held as not Oppressive


The court has held the following acts as not oppressive:

196 Self-Learning Material

a)

An unwise, inefficient careless conduct of a director.

b)

Not declaring dividend when company is making loss.

c)

Non-holding of the meeting of the directors.

d)

Failure to maintain proper records of the company.

e)

Drawing remuneration by a director to which he is not legally entitled.

f)

Negligence and inefficiency in managing the affairs of the company.

g)

Increasing the voting rights of the share held by the management.

Notes

Check Your Progress


12.12.11 Majority can also Apply for Relief
Relief can be granted if the application is made by majority shareholders who have been rendered
completely ineffective by the questionable acts of a minority group.

70. Which authorities deal


with oppression &
mismanagement?

12.12.12 Acts Held As Mismanagement

71. Who can apply for


relief from oppression
& mismanagement?

a)

Serious in-fight between the directors.

b)

Illegal constitution of the board of directors.

c)

Gross neglect of interest of the company by sale of its only assets.

d)

Diversion of the funds to benefit the majority.

e)

Operation of bank account by an unauthorised person.

f)

Advance of loans without execution of a document.

g)

Continuation of managing director in office after the expiry of his term.

h)

Sale of assets at low price and without compliance with the Act.

i)

Violation of statutory provisions and those of articles.

j)

Violation of the condition of the companys memorandum.

72. What is known as


amalgamation?

12.12.13 Acts held as not Mismanagement


a)

Building up of reserves.

b)

Merely because company incurs loss, it cannot be that it is mismanaged.

c)
Removal of secretary by majority decision of the board unless it is shown that the removal
has prejudicially affected the interest of the company or public interest.
d)

Removal of the director and termination of the works managers service.

e)

Arrangement with creditors in companys bonafide interest.

12.12.14 Powers of the Tribunal (NCLT)


The Tribunal (NCLT) has all the necessary powers to end oppression as well as mismanagement.
Some of the powers are:
a)

The regulation of conduct of the companys affairs in future.

b)

Purchase of shares or interest of any member of the company by other member or by the
company.

c)

Reduction of the share capital.

d)

Termination, setting aside or modification of any agreement between the company and the
managing director/director/manager.

e)

Termination, setting aside or modification of any agreement between the company and any
third party.

f)

Setting aside of any transfer, delivery of goods, payment, execution or other acts relating to
Self-Learning Material 197

property.
Notes

g)

Any other matter considered just and equitable.

h)

Prevent the change in the board.

12.12.15 Power of the Central Government


The central government has also the following powers:
a)

Power to prevent oppression or mismanagement.

b)

Power to remove managerial personnel.

12.13 Compromises, Arrangements, Reconstruction and


Amalgamation
12.13.1 Meaning of Compromise
Compromise is a term which implies existence of a dispute such as relating to rights. It means
settlement or adjustment of claims in a dispute by mutual concessions. If the members are required
to give up their rights entirely, it will not be a compromise.

12.13.2 Meaning of Arrangement


The term arrangement is of very wide import. An arrangement embraces a far wider class of
agreements than a compromise. All modes of re-organising share capital, can properly form part
of an arrangement with members. According to the Act, the expression arrangement includes a
reorganisation of the share capital of the company by the consolidation of shares of different
classes, or by the division of shares into shares of different classes or by both these methods.56 An
arrangement may also involve:
a)

Debenture holders being given an extension of time for payment.

b)

Creditors agreeing to receive in part payment of the claims and the balance in shares or
debentures of the company.

c)

Preference shareholders giving up their rights to arrears of dividends or agreeing to accept


a reduced rate of dividend in the future.

12.13.3 Compromise and Arrangement


When a company has a dispute with members or creditors, a scheme of compromise may be
drawn up. But, where there is no dispute and there is need for readjusting the rights or liabilities of
members or creditors the company may resort to a scheme of arrangement with them. A company
has an implied power to compromise/ arrangement. Compromises/arrangements can be discussed
under the following two heads:
a)

198 Self-Learning Material

Compromise/arrangement when the company is a going concern - This can be done between
a company and its creditors or any class of them or between a company and its members or
any class of them. When a proposal is made, the company or any creditor or member may
apply to the NCLT (Tribunal) for compromise. NCLT then calls a separate meeting of each
class of creditors/ members. Meeting is held and conducted as NCLT directs. Proper notice
of meeting and full particulars of the scheme is given to all interested parties, including
shareholders and the central government. NCLT sanctions the compromise if it is approved
by a majority representing 3/4th in value of creditors/members at the meeting. Any scheme
which is fair and reasonable and made in good faith will be sanctioned. A certified copy of

NCLTs order is filed with the Registrar, then only the order has any effect. An appeal lies
to the Appellate Tribunal. NCLT has the power to supervise the carrying out of the
compromise/arrangement. If the NCLT is satisfied that the compromise/arrangement cannot
be worked satisfactorily it may make an order for the winding up of the company. The
procedure to be followed is summarised below:
i.

Notes

Application to the Tribunal.

ii. Meeting of members or creditors.


iii. Resolution by three-fourth majority.
iv. Tribunals sanction.
v.

Binding on all members and creditors.

vi. Copy of the Tribunals order to be filed with the Registrar.


vii. Stay of suit, if applied for.
viii. Appeal.
b)

Compromise / arrangement during the winding up of company - Liquidator may apply to


the NCLT for compromise/arrangement. He may exercise the powers of compromise/
arrangement with the sanction of the NCLT. In case of voluntary winding up the sanction of
a special resolution of the company is necessary.

Note:
The powers of court are transferred to the National Company Law Tribunal (NCLT), in short
Tribunal by the Companies (second amendment) Act, 2002. The central government is in the
process of formation of the Tribunal. As on date, the powers are exercised by courts. Hence in this
section Tribunal or NCLT is used.

12.13.4 Reconstruction and Amalgamation


Arrangements and compromises can take place for the purposes of reconstruction and amalgamation
of companies.
a)

Meaning of Reconstruction: When a company transfers the whole of its


undertaking and property to a new company, under an arrangement by which
the shareholders of the old company are entitled to receive some shares or other
similar interest in the new company. A reconstruction is made for any of the two
purposes:
i.

To enlarge the operations of the company.

ii. For reorganisation.


b)

Meaning of Amalgamation: This term is not defined in the Act. It implies combination of
two or more companies or the business of two or more companies into one company or into
the control of one company.

c)

Difference Between Amalgamation and Reconstruction: Amalgamation involves the


blending of two or more concerns, and not merely the continuance of one concern;
reconstruction implies the carrying on of an existing business in some altered form, so that
persons interested in the business may remain substantially the same.

d)

Take-over and Merger: Distinction - amalgamation/reconstruction may take the form of


take-over or merger. In a take-over the direct or indirect control over the assets of the
acquired company passes to the acquirer, in a merger the shareholding in the combined
enterprise will be spread between the shareholders of the two companies.

e)

Forms of Reconstruction/Amalgamations: A reconstruction/amalgamation may


take any of the following forms:
Self-Learning Material 199

i.

By sale of undertaking.

ii. By sale of shares.

Notes

iii. By a scheme of arrangement.


f)

Duties of the Tribunal (NCLT) with respect to Reconstruction/Amalgamation:


i.

To see that the scheme is reasonable and fair.

ii. To ascertain the wishes of the members.


iii. To see that the scheme is designed to overcome difficulties and re-establish
the business.

12.13.5 Amalgamation of Companies in National Interest (Section 396)


Where the central government is satisfied that it is essential in the public interest that two or more
companies should amalgamate, then the central government may order the amalgamation of those
companies into a single company with such constitution, with such property, powers, rights, interests,
authorities and privileges and with such liabilities, duties and obligations as may be specified in
the order.
Any member or creditor who stands to lose by the amalgamation is to be given compensation. The
amount of compensation is to be assessed by the central government and has to be published in
the Official Gazette.
The books and papers of a company which have been amalgamated with, or whose shares have
been acquired by, another company, must not be disposed of without the prior permission of the
central government.

12.14 Winding up of a Company


12.14.1 Meaning of Winding up

Check Your Progress


73. What are the modes of
winding up?
74. What is the stipulated
period for
commencing business
activities after
incorporation, and its
effect?
75. Who presents the
petition for
compulsory winding
up of a company?

200 Self-Learning Material

Winding-up of a company represents the steps for the last stage in its life. It means a proceeding
by which a company is dissolved. According to Prof. L.C.B Gower, Winding-up of a company is
a process whereby its life is ended and its property administered for the benefit of its creditors and
members. An administrator, called liquidator, is appointed and he takes control of the company,
collects its assets, pays its debts and finally distributes any surplus among the members in accordance
with their rights.57 Winding up of a company differs from insolvency of an individual in as much
as a company cannot be made insolvent under the insolvency law. Besides, even a solvent company
can be wound-up.

12.14.2 Modes of Winding up


There are two modes of winding-up. These modes are:
a)

Compulsory winding-up under orders of the National Company Law Tribunal


(NCLT)*.

b)

Voluntary winding-Up.

*Note:
The powers of court are transferred to the National Company Law Tribunal by the Company
(Amendment) Act, 2002. The central government is in the process of formation of this Tribunal.
As on date, the powers are exercised by courts. Hence in this section Tribunal/NCLT has been
used.

12.14.3 Grounds for Winding up by the Tribunal (NCLT)58


A company may be wound up by the Tribunal on the following grounds:
a)

By the company passing a special resolution: This ground may not be resorted to very
much as the members may prefer to go for voluntary winding up as the same may be more
economical and speedier.

b)

Default in holding statutory meeting or in delivering statutory report to the Registrar:


This clause is not applicable for a private company. The NCLT may instead of making a
winding up order direct that the statutory meeting be held or the statutory report be delivered.

c)

Failure to commence business within a year from the date of incorporation or suspension
of business for a whole year: The suspension must be of entire business and not a part of it.

d)

Reduction in membership below the minimum required: The minimum number is 7 for a
public company and 2 for a private company. The company carries on business for more
than 6 months while the number is so reduced.

e)

Inability to pay its debts of Rs. 1 lakh : What is important to note that the company must be
commercially insolvent.

f)

Tribunal is of the opinion that it is just and equitable: The Tribunal may order winding up
under this clause in the following cases:
i.

Notes

When the main object of the company has substantially failed.59

ii. When there is a complete deadlock in the management of the company.60


iii. Where there is a mismanagement and there is no practical possibility of
remedying it.61
iv. When the company is a bubble, i.e. it never had any business - such
companies are commonly called as fly-by-night companies.
v.

When there is oppression of minority shareholders.

g)

Default of companys filing its balance sheet and profit and loss account on annual
return for any five consecutive financial years.

h)

If the company has acted against the interests of sovereignty and integrity of
India, the security of the state, friendly relations with foreign states, public order,
decency or morality.

i)

If the Tribunal is of the opinion that the company should be wound up as it has
become sick and is unlikely to become viable in future.

12.14.4 Who may Petition for Winding-up62


A petition for the compulsory winding-up of a company may be presented by:
a)

The company.

b)

Any creditor.

c)

Any contributory.

d)

Any combination of creditor, company or contributory acting jointly or separately.

e)

The Registrar.

f)

Any person authorised by the central government.

g)

The official liquidator.

h)

The central government or state government.

The Supreme Court of India has ruled that the workers of a company cannot prefer a winding-up
petition against a company. They are entitled to appear and be heard in support of or in opposition
Self-Learning Material 201

to the winding-up petition.63


Notes

12.14.5 Statement of Affairs to be Filed on Winding-up64


Every company is to file with the Tribunal a statement of its affairs along with the petition for
winding up. When the company is opposing a petition for winding up, a statement of affairs is to
be filed by the company. The statement of affairs shall include details like names and addresses of
directors, company secretary, location of assets of the company and their value, debtors and creditors
with their addresses, workmen and other employees and any outstandings to them and such other
details as the Tribunal may direct.

12.14.6 Consequences of Winding-up Order by the Tribunal


The important consequences of the winding up order by the Tribunal are as follows:
a)

Intimation to be sent to the official liquidator and the Registrar.

b)

Filing of winding up order with the Registrar within 30 days.

c)

Notification of order in the Official Gazette.

d)

Winding-up order is deemed to be notice of discharge for employees.

e)

Suits stayed unless the Tribunal gives leave to continue.

f)

Order operates in the interests of all creditors and contributories.

g)

Official liquidator is normally the liquidator, If not, then liquidator is selected from a panel.

h)

Boards powers come to an end.

i)

On the commencement of winding-up, the limitation remains suspended in favour


of the company till one year after the winding-up order is made.

12.14.7 Action by the Tribunal


a)

Statement of Affairs to be made available to the liquidator;

b)

Tribunal may direct for the constitution of a Committee of Inspection.

12.14.8 General Powers of the Tribunal in Compulsory Winding-up

202 Self-Learning Material

a)

To stay winding-up.

b)

To settle the list of contributories.

c)

To require delivery of property to the liquidator.

d)

To set-off claims.

e)

To make calls.

f)

To order payment into bank of moneys due to the company.

g)

To exclude creditors not proving on time.

h)

To adjust the right of contributories.

i)

To order costs.

j)

To summon persons suspected of having the property of the company.

k)

To order public examination of promoters, directors, etc.

l)

To arrest an absconding contributory.

m)

To order the dissolution of the company.

12.14.9 Duties of Liquidator


Liquidator has the following duties:
a)

To conduct proceedings in winding-up.

b)

To make a report.

c)

To take custody of companys property.

d)

To comply with directions of the creditors or contributories or the Committee of Inspection.

e)

To summon meetings of creditors and contributories.

f)

To obtain directions from the Tribunal.

g)

To keep statutory books.

h)

To get accounts audited.

i)

Central governments control of liquidator.

j)

Information as to a pending winding up.

Notes

12.14.10 Powers of the Liquidator


a)

Exercisable with the sanction of the Tribunal:


i.

To institute or defend any suit in the name and on behalf of the company;

ii. To carry on the business of the company;


iii. To sell the immovable/movable property of the company;
iv. To raise money on the security of the company;
v.

To do all such other things as may be necessary for the winding-up of the
company;

vi. To pay, compromise or settle with any class of creditors;


vii. To appoint advocate, attorney.
viii. To compromise any call, liability or debt.
b)

Exercisable without the sanction of the Tribunal:


i.

Do all acts, execute all deeds, receipts and other documents;

ii. Inspect the records and returns of the company with the Registrar;
iii. Claim in the insolvency of any contributory;
iv. Draw, accept, make any bill of exchange in the name of the company;
v.

Appoint any agent.

12.14.11 Voluntary Winding-up


a)

Kinds - There are two types of voluntary winding up:


i.

Members voluntary winding-up

ii. Creditors voluntary winding-up


b)

Effects of voluntary winding-up - Voluntary winding-up has the following effects:


i.

On status of company.

ii. Corporate powers to continue until dissolution.


iii. Boards powers to cease on liquidators appointment.
iv. Effect on companys employees.
Self-Learning Material 203

v.
Notes

c)

Avoidance of transfer of shares.

Members voluntary winding-up, conditions to be satisfied: The following two


conditions are to be satisfied in members voluntary winding-up:
i.

Check Your Progress

Declaration of solvency to be made.

ii. Shareholders resolution to be passed.


d)

Provisions applicable to members voluntary winding-up:


i.

76. What power does a


liquidator can exercise
irrespective of sanction
by the Tribunal?

Appointment of liquidator.

ii. Boards powers to cease on appointment of a liquidator.


iii. Power to fill a vacancy in the office of liquidator.
iv. Notice of appointment of liquidator to be given to the Registrar.

77. How many types of


voluntary winding up
are there?

v.

Power of liquidator to accept shares etc. as consideration sale of companys


property.

vi. Duty of liquidator to call creditors meeting in case of insolvency.

78. Give differences


between members and
creditors voluntary
winding-up.

vii. Duty of liquidator to call a general meeting at the end of each year.
viii. Final meeting and dissolution.
ix. Alternative provisions as to annual and final meeting in case of insolvency.
e)

Provisions applicable to creditors voluntary winding-up:


i.

Meeting of creditors.

ii. Notice of resolution to be given to the registrar.


iii. Appointment of liquidator.
iv. Appointment of a Committee of Inspection.
v.

Fixing of liquidators remuneration.

vi. Boards power to cease on appointment of a liquidator.


vii. Powers to fill a vacancy in the office of a liquidator.
viii. Power of liquidator to accept shares etc. as consideration for sale of company property.
ix. Duty of a liquidator to call meeting of a company and creditor at the end of
each year.
x.

Final meeting and dissolution.

12.14.12 Difference Between Members and Creditors Voluntary


Winding-up
Sl. No.

204 Self-Learning Material

Members Voluntary
Winding-up

Creditors Voluntary
Winding-up

1.

Directors declaration of solvency is a


must.

No such declaration is required.

2.

Meeting of members and passing a


resolution is required.

No meeting of members is necessary.

3.

No Committee of Inspection.

Such a Committee may be constituted.

4.

Members have dominating control.

Creditors have dominating control.

5.

Members appoint the liquidator.

Creditors have choice over members.

Sl. No.

6.

Members Voluntary
Winding-up
Liquidator exercises some of his powers
with the sanction of a special resolution
of members.

Creditors Voluntary
Winding-up

Notes

Sanction of the tribunal of the committee


of inspection or of meeting of creditors.

12.15 Corporate Governance


12.15.1 Introduction
Corporate governance was a relatively unknown subject to the public till about 1980s. In the last
two to three decades it has become a buzzword. With outbreak of corporate scams in various
countries the need for corporate governance has come to the fore.

12.15.2 Historical Evolution of Corporate Governance


A spate of scandals and corporate collapses in the late 1980s and 1990s led shareholders and
banks to express concern about the safety of their investments. Corporate failures of Bank of
Credit and Commerce International (BCCI), Robert Maxwells Mirror Groups News International
arose out of poor governance practices. With a view to prevent the recurrence of business failures,
London Stock Exchange in May 1991 set up Cadbury Committee under the Chairmanship of Sir
Adrian Cadbury. Cadbury Committee was constituted to draft a Code of Best Practices for the
U.K. Corporations. This committee submitted its report and associated Code of Best Practices
in December 1992. It was for Sir Ronald Hampel (the chairman of ICI) Committee on Corporate
Governance to assess the import of Cadburys recommendations and developing further guidance.
Thereafter there was Richard Greenbury (Mark and Spencer chief) Committee on Directors
remuneration. All these developments with regard to corporate governance led Turnbull Guidelines
in September 1997.
These developments in U.K. had significant influence on India. Confederation of Indian Industries
(CII) appointed a National Task Force headed by Rahul Bajaj, who submitted a Desirable Corporate
Governance in India - a Code in April 1998 containing 17 recommendations. Thereafter Securities
and Exchange Board of India (SEBI) appointed a Committee under the chairmanship of Kumar
Mangalam Birla. This committee submitted its report on 7 May 1999, Containing 19 Mandatory
and 6 non-mandatory recommendations. SEBI implemented the report by requiring the Stock
Exchanges to introduce a separate clause 49 in the Listing Agreements. In April 2002 Ganguly
Committee report was made for improving corporate governance in Banks and Financial
Institutions. The central government (Ministry of Finance and Company Affairs) appointed a
Committee under the chairmanship of Mr. Naresh Chandra on Corporate Audit and Governance.
This committee submitted its report on 23 December 2002. Finally SEBI appointed another
committee on Corporate Governance under the chairmanship of N. R. Narayan Murthy. This
committee submitted its report to SEBI on 8 Feb. 2003.65 SEBI thereafter revised clause 49 of the
Listing Agreement, which has come into force with effect from 01 January 2006.
Some of the recommendations of these various committees were given legal recognition by
amending the Companies Act in 1999, 2000 and twice in 2002. With a view to gear company law
for competition with business in developed countries, the central government (Ministry of Company
Affairs) appointed an expert committee under the chairmanship of Dr Jamshed J Irani in December
2004. The Committee submitted its report to the Central Government on 31 May 2005.66 The
Central Government had announced that the company law would be extensively revised based on
Self-Learning Material 205

Notes

Dr Iranis Committee Report. Corporate world is awaiting the changes to be made in company
law. Parliament had passed the Companies (Amendment) Act, 2006 which envisages
implementation of a comprehensive e-governance system through the much-touted MCA-21 project.

12.15.3 Meaning of Corporate Governance


The concept of corporate governance has been used in different perspectives. It started as
maximising shareholders wealth and then expanded to maximising all stakeholders wealth.
Corporate governance has been defined in many different ways by scholars and agencies. Some of
these definitions/meanings are given below:
a)

Simply stated, corporate governance is about performance as well as conformance.

b)

According to Ada Demb and Friedrich Neubauer, Corporate governance is the process by
which corporation is made responsive to the rights and wishes of stakeholders.

c)

As per James D. Wolfensohnn, President of World Bank, Corporate governance is about


promoting corporate fairness, transparency and accountability.

d)

OECD has defined the corporate governance to mean a system by which business
corporations are directed and controlled.

e)

Cadbury Committee (U.K) has defined corporate governance as (it is) the system by which
companies are directed and controlled.

f)

According to Y C Deveshwar, chairman of ITC, corporate governance refers to the structure,


systems, and processes in a corporation, that are considered most appropriate to enhance
its wealth generating capacity.

g)

Salim Sheikh and William Ress in their treatise Corporate Governance and Corporate
Control stated that corporate governance is also concerned with the ethics, values and
morals of a company and its directors.A review of various definitions and views brings
out that in its simplistic form corporate governance is an umbrella term encompassing
various issues concerning senior management, board of directors, shareholders and other
corporate stakeholders.

12.15.4 Objectives of Corporate Governance


Good governance is integral for the existence of a company. The main objectives of good corporate
governance are:

Check Your Progress


79. What is transparency?
80. What does oversight
mean?
81. What is the principal
of corporate
governance say about
External audit?

a)

To promote a healthy environment for long-term investment.

b)

To create a trust in the corporate and in its abilities.

c)

To promote business development.

d)

To improve the efficiency of the capital markets.

e)

To enhance the effectiveness in the service of the real economy.

f)

To exercise effective control on corporate affairs by the board at all times.

12.15.5 Fundamental Principles of Corporate Governance


Governance style may be as different as the nature of companies. For this reason, both Cadbury
Committee and Rahul Bajaj Committee had stated that there is no unique structure of corporate
governance in the developed world. There is no one size fits all structure for corporate governance.
Every company may have its own governance style. Despite uniqueness of styles, there are some
fundamental principles of corporate governance. These principles are given below:
a)

206 Self-Learning Material

Ethics: A company must observe ethical standards. Deviation from ethical principles corrupts
organisational culture and undermines stakeholder value.

b)

Transparency: It involves the explaining of companys policies and action to those to whom
it owes responsibilities. Transparency leads to appropriate disclosures without endangering
companys interest. In the case of Enron, the shareholders value was destroyed because it
did not share its setbacks with the shareholders.

c)

Accountability: It signifies that the Board of Directors are accountable to shareholders and
management is accountable to the Board of Directors, and shareholders. Accountability
provides impetus to performance.

d)

Trusteeship: There exists the principle of trusteeship on the Board of Directors who must
act to protect and enhance shareholders and other stakeholders value. Mahatma Gandhi
had advocated this principle.

e)

Empowerment: It unleashes creativity and innovation throughout the organization by truly


vesting decision-making powers at the most appropriate levels in the organisational hierarchy.

f)

Fairness to all Stakeholders: It involves a fair and equitable treatment of all stakeholders
who participate in the corporate governance structure.

g)

Oversight: It means the existence of a system of checks and balances. It should prevent
misuse of power and facilitate timely management response to change and risks.

h)

External Audit: It must be independent and penetrating.

i)

Regulatory Regime: There must be an appropriate regulatory regime to back


these obligations.

j)

Whistle Blower Policy: Companies should adopt a policy for Whistle blowers. This was
specifically recommended by Narayan Murthy Committee.

Notes

12.15.6 Conclusions
a)

Practice prevalent in different modes: Corporate governance is a practice which is being


followed by the corporates all over the world. Each country may adopt its own form of
corporate governance.

b)

No single definition: It is a dynamic concept and can be defined in many ways. It is not
defined in only one manner.

c)

Drawn from diverse fields: Corporate governance is drawn from diverse fields like laws,
economics, ethics, politics, management, finance, etc.

d)

Mere law is not sufficient: Corporate governance goes far beyond company law. In India
company law has been amended to include better corporate practices like audit committee,
directors responsibility statement, voting by postal ballot. Strict implementation of the
law is essential.

e)

Accounting standard: In all the developed countries accounting standards have been devised
and followed. India has also evolved its own accounting standards which are required to be
followed by all companies.

f)

Professional and competent directors: The key to good corporate governance is a well
functioning, informed Board of Directors. The board should have a core group of
professionally acclaimed and accredited non-executive directors.

g)

Evaluation: Corporate governance can now be evaluated and corporate governance rating
has come to stay. Many Indian companies like ITC, Infosys, Grasim have been evaluated
and awarded corporate governance rating by agencies like CRISIL or ICRA.

In conclusion, it can be said that minimal corporate governance can be achieved by following the
law, better governance by having a professional management but best corporate governance is
achieved by following ethical practices and principles.

Self-Learning Material 207

Summary
Notes

Meaning and Nature of a Company


A Company implies an association of persons for some common object(s). A Company under
the Act is defined to mean a company formed and registered under the Companies Act, 1956 or
under any of the previous company law. A company is characterised by the features like 1Incorporate association, 2- Artificial legal person, 3- Separate legal entity, 4- Perpetual succession,
5- Limited liability, 6- Transferable shares, 7- Common seal, 8- Can hold separate property, 9Capacity to sue and being
Companies can be classified on the basis of mode of incorporation into chartered companies,
statutory companies and registered company. On the basis of liability of members companies are
classified into limited by shares, limited by guarantee and unlimited. Based on number of members,
a private company has minimum two and maximum fifty whereas the minimum number in a
public company is seven and maximum is limited by number of shares. Other type of companies
are government companies, foreign company, holding and subsidiary company and producer
company.

Lifting the Corporate Veil


At times, the facade of corporate personality might have to be removed to identify the persons
who are really guilty. This is known as lifting the corporate veil. The court may lift the corporate
veil under a) statutory provisions, and b) judicial interpretation. Under statutory provisions these
are included i) Reduction in membership, ii) Misrepresentation in prospectus, iii) Fraudulent
Conduct of business, iv) Failure to return application money, v) Mis-description of name, vi)
Non-payment of tax, vii) Liability of Ultra-vires act, viii) Liability of promoters for preincorporation contracts, ix) Directors with unlimited liability, and x) Holding subsidiary company.
Under judicial interpretations, courts have lifted corporate veil, i) For determining the enemy
character of a company, ii) For the benefit of revenue, iii) For prevention of fraud and improper
conduct, and iv) others like where company is avoiding welfare legislation or where company is
mere sham or cloak.

Formation of a Company
The whole process of formation of a company may be divided into four stages namely
i) promotion, ii) registration, iii) floatation, and iv) commencement of business.Promotion denotes
preliminary steps taken for the purpose of registration of the company. The persons who undertake
these steps are called promoters. The promoters of the company prepare memorandum and articles
of association and other necessary documents. These documents are filed with Registrar of
Companies (ROC). ROC after scruitinising these documents and on being satisfied that they are
in order, issues the certificate of incorporation. This certificate is conclusive as to all the
requirements of the Act with respect to registration have been duly complied with. A private
company can commence its business on receipt of certificate of incorporation. A public company
has to raise capital and for this purpose issue a prospectus if subscription of capital is sought from
public or issue a statement in lieu of prospectus when share capital is sought to be arranged
through friends and relatives. To get the certificate to commence business, a public company must
have received the minimum subscription viz. 90% of the entire issue on complying with some
other formalities, ROC grants the certificate to commence business. Now, a public company can
commence its business.

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Memorandum of Association
Memorandum of association of a company is an important document. It defines as well as confines
the powers of the company. The memorandum of a limited company is to contain its name, the
name of the state in which registered office is to be situated; the objects, the liability, and the
subscription clause. A company can only act as per the objects given in the memorandum of
association. Any action beyond this are Ultra-vires (beyond the powers of the company) and
hence void. All the clauses of the memorandum, except the subscription clause can be changed by
following the procedure provided in the Act.

Notes

Articles of Association
The articles of association of a company are its bye-laws or rules and regulations. It controls the
internal management of the company and defines the powers of its offices. It also establishes a
contract between the company and the members and between members inter se. Articles are
subordinate to memorandum. Articles contain provisions relating to share capital, rights of
shareholders, shares and stock, meetings, directors. Articles may be altered by passing a special
resolution. Alterations must not be inconsistent with the Act, or any other statute; or it must not be
illegal or opposed to public policy and must be in the interest of the company. The memorandum
and articles when registered are public documents and can be inspected by anyone on payment of
a nominal fee. Thus there is a presumption that any person dealing with company has read and
understood these documents. This is known as doctrine of constructive notice. This doctrine is
subject to another doctrine namely indoor management. This doctrine of indoor management
provides that the persons dealing with the company are not bound to inquire into the regularity of
internal proceedings. This relief under indoor management is not available where the outsider has
knowledge of irregularity or in case of forgery or even negligence.

Prospectus
A public company normally invites public to subscribe to its share capital. For this purpose a
prospectus is required to be issued. A prospectus means any document described or issued as
prospectus and includes any notice, circular, advertisement or other documents inviting deposits
from the public or inviting offers from the public for the subscription or purchase of any shares or
debentures of a body corporate. The prospectus must be dated, signed and registered with the
registrar. Prospectus must contain the information as per Parts I, II and III of Schedule II to the
Act. The golden rule of prospectus is that there must be full, frank and honest disclosure of all
facts. There should not be any errors of commission or omission i.e. no mis-statements. Any misstatements in prospectus entails civil and criminal liability. Civil liability may include rescission
of contract, damages or compensation. Criminal liability entails imprisonment upto 2 years or
fine upto Rs 50,000 or both. An offer document by the issue houses offering shares to the public
is known as deemed prospectus. Where a public company does not invite public to subscribe for
its shares, but arranges to get money from private sources, it need not issue a prospectus. The
promoters, in such a case are required to prepare a draft prospectus known as statement in lieu of
prospectus. This is also required to be filed with the Registrar. Public financial institutions and
scheduled banks have been allowed to file shelf prospectus which will remain valid upto one
year. Thus, such institutions and banks need not issue a prospectus every time they offer securities
to public. They only need to file an Information memorandum with respect to changes in the
financial position, etc. A red herring prospectus is a prospectus which does not have complete
particulars on the price of securities offered and quantum of securities offered. SEBI acts as the
administrative authority in relation to any complaints relating to prospectus.

Self-Learning Material 209

Membership
Notes

A member means a person who has either subscribed to the memorandum or who agrees in writing
to become member and whose name appears in the register of members. A member does not
include a bearer of a share warrant. A member is also called a shareholder except in some cases
like the legal heir of a member is a shareholder but not member till his name is entered in the
register of the members. A company, a foreigner, a registered society or trade union can become
members but a partnership firm (although partners in their individual capacity can become
members), official receiver or liquidator cannot become a member. A persons membership can be
terminated in many ways like on transfer forfeiture, or surrender of shares or when he is adjudged
insolvent or when the contract is rescinded.

Share and Share Capital


The capital of a company is divided into a number of indivisible units of a fixed amount. Each of
these units is known as a share. A share certificate issued by a company specifies the shares
held by a member and is prima-facie evidence of the title of member to the shares. Stock is the
aggregate of fully paid shares, consolidated and divided for the convenient holding into different
parts. It may be transferred or split up into fractions of any amount. There are two types of shares
namely preference shares or ordinary shares. Ordinary or equity shares can now be issued with
disproportionate rights as to voting or dividend. Preferenceshares have preferential rights as to
dividend or return of capital when the company goes into liquidation. Preference shares can be of
many types like cumulative or non cumulative, participating or non-participating, redeemable or
irredeemable, convertible or non-convertible . A public company limited by shares, if so authorised
by its articles, with previous approval of the central government, with respect to fully paid shares
may issue share warrants. This is a bearer document of title to shares specified therein. Share
transfer must be effected within two months of the application of transfer. The transfer instrument
must be valid and proper. A company has power to refuse transfer against which appeal can be
filed within a period of 2 months. There are provisions in the Act for nomination, forfeiture and
surrender of shares. A company limited by shares or a company limited by guarantee having a
share capital is prohibited from buying its own shares. The Companies (Amendment) Act, 1999
has, however, allowed purchase of its own shares by a company subject to the conditions laid
down in the Act. The Act divides share capital into two kinds namely preference and equity or
ordinary. Share capital can be altered or reduced subject to the conditions provided in the Act.

Borrowings, Loans, Debentures and Investments


Every trading company has an implied power to borrow. A non-trading company, must, in its
memorandum or articles, contain an express power to borrow. A public company cannot exercise
borrowing power unless certificate to commence business is obtained by it. No borrowing is
permissible beyond the aggregate of the paid up capital of the company and its free reserves
unless prior sanction is obtained in general meeting. Loan includes debentures or any deposit of
money by one company with another company. Debentures may be of many types like registered
or unregistered, secured or unsecured, redeemable or irredeemable, convertible or non-convertible.
Investments for the purposes of the Act means the investing of money in shares, stock, debentures
or other securities. Investments made by a company must be made and held in companys own
name. All certificates or letters of allotment must be in the custody of the company. Inter corporate
loans and advances are subject to various provisions of the Act.

Company Management and Administration


The Act defines a director as including any person occupying the position of a director by whatever
name called. The persons through whom a company acts and does its business are termed as
210 Self-Learning Material

directors, collectively known as Board of Directors. Only an individual can be appointed as a


director. Minimum number of directors in a private company is two and in a public company
three. Maximum number is as provided in the articles. A person can hold directorship, at the same
time, in upto 15 companies. The Act provides no qualifications but enumerates certain
disqualifications for directorship like insolvency, unsound mind etc. First directors are appointed
by subscribers to memorandum. Subsequent directors are appointed by shareholders or by third
parties or by the central government. Casual, additional and alternate directors are appointed by
the Board. The Act also provides appointment of director by small shareholders. Before appointing
a director, his prior consent is required to be signed with the Registrar and the company. Directors
can be removed by shareholders, central government or the Tribunal (NCLT). It is difficult to
state the exact legal position of a director. Although a director acts as agent, trustee, managing
partner or employee, yet he is none of them. The board shall be entitled to exercise all such
powers and to do all such acts and things, as the company is authorised to exercise and do. However,
the board cannot exercise any power or do any act or thing which is exercisable by the company
in general meeting. Directors duties include to act in good faith, to take reasonable care and to
disclose interest. Managing director is a director who is entrusted with substantial powers of
management and his tenure is five years and eligible for reappointment.

Notes

Company Meetings and Resolutions


Company can only act through persons who take various decisions in meetings.
A valid meeting must be duly convened, legally constituted and properly conducted. General
aspects of meetings relate to chairman, notice, voting, agenda and quorum. Meetings of company
can be of a) shareholders, b) directors, and c) creditors and debenture holders. Shareholders
meetings include statutory meeting, annual general meeting, extraordinary general meeting and
class meetings. A motion is a proposal under consideration by members in a meeting before it is
voted upon. A resolution is any motion voted upon and agreed to in a meeting and entered in
minutes. Resolutions are of two types - ordinary or special. When a motion is passed by simple
majority of the members voting at a general meeting, it is called ordinary resolution. Special
resolution is when the votes cast in favour, should not be less than three times the votes cast
against. Resolutions requiring special notice mean that the notice of intention to move the resolution
should be given to the company not less than 14 clear days before the meeting at which it is to be
moved. The Act also provides passing of resolutions by postal ballot.

Accounts and Audit


Every company is required to maintain proper books of account with respect to all receipts and
expenditure, sales and purchases, assets and liabilities and summarised account of all branch
offices. These books are to be kept on accrual basis and as per double entry system of accounting.
Books of account can be inspected by any director, registrar, authorised officers of central
government and of SEBI. These books are to be preserved for 8 years. Balance sheet and profit
and loss account are required to be authenticated (signed by atleast two directors). Annual accounts
(Balance sheet and profit and loss account) are to be sent to every member, filed with the registrar
and adopted in the AGM. An auditor of a company is a practising chartered accountant.
Disqualifications for an auditor entail a body cooperate, an officer/employee, indebted to the
company for over Rs 1000 or disqualified for appointment as auditor of any body corporate which
is the companys subsidiary or its holding company or a subsidiary of its holding company. First
auditor is appointed by the board and subsequent auditor by shareholders. Under the Act, the
auditor has certain rights and duties and he is required to submit an auditors report. The Act also
has provisions for cost audit, National Advisory Committee on Accounting Standard and for Audit
Committee.

Self-Learning Material 211

Prevention of Oppression and Mismanagement


Notes

The management of companies is based on the rule of majority. One of the exceptions to this rule
is where prevention of oppression and mismanagement is applicable. Oppression has not been
defined in the Act. It means visible departures from the standards and a violation of the conditions
of fair play. The term mismanagement would mean that the affairs of the company are being
conducted or such affairs are likely to be conducted in a manner which is prejudicial to public
interest or prejudicial to the interests of the company. In case of oppression of members and
mismanagement of company, a requisite number of shareholders can apply for appropriate relief
to the Tribunal for winding-up, or the Tribunal / central government for appropriate relief. Requisite
number of members who should sign such an application in respect of company having share
capital is not less than 100 members or 1/10 of the total number of its members, which ever is less,
or by any member(s) holding not less than 1/10 of the issued share capital. In case of a company
not having share capital, requisite number is 1/5 of the total number of members of the company.
The notice of every application made to the Tribunal for the prevention of oppression and
mismanagement must be given by the Tribunal to the central government. The central government
can make any representation which the Tribunal will consider before making a final order. Relief
can be granted if the application is made by majority shareholders who have been rendered
completely ineffective by the questionable acts of a minority group. The Tribunal has all the
necessary powers to end oppression as well as mismanagement. Some of the powers are a) the
regulation of conduct of the companys affairs in future, b) purchases of shares by another member,
c) reduction of share capital, d) termination or modification of any agreement with the director or
any third party, e) setting aside of any transfer of any property, f) prevent the change in the board,
or g) any other matter considered just and equitable. The central government has also the powers
to prevent oppression or mismanagement and to remove managerial personnel.

Compromises, Arrangements, Reconstruction and Amalgamation


Compromise means settlement or adjustment of claims in a dispute by mutual concessions. The
expression arrangement includes a re-organisation of the share capital of the company by the
consolidation of shares of different classes, or by the division of shares into shares of different
classes or by both these methods. Compromise/arrangement when the company is a going concern
involve the procedure for an application to the Tribunal, meeting of creditors/ members, resolution
by 3/4th majority, sanction by the Tribunal, binding on all members and creditors, Tribunals
order to be filed with the registrar and is appealable. Compromise/arrangement during the winding
up ofcompany entails that the liquidator may apply to the Tribunal. Reconstruction means when
a company transfers the whole of its undertaking and property to a new company, under an
arrangement by when the shareholders of the old company are entitled to receive some shares or
other similar interest in the new company. A reconstruction is made to enlarge the operations of
the company or for reorganization. The Term amalgamation implies combination of two or more
companies or the business of two or more companies into one company or into the control of the
company. Where the central government is satisfied that it is essential in the public interest that
two or more companies should amalgamate, then the central government may order the
amalgamation of those companies into a single company.

Winding up of a Company
Winding up of a company is a process whereby its life is ended and its property administered for
the benefit of its creditors and members. An administrator, called liquidator is appointed and he
takes control of the company, collects its assets, pays its debts and finally distributes any surplus
among the members in accordance with their rights. There are two modes of winding up:

212 Self-Learning Material

a)

Compulsory winding up or under order of the Tribunal.

b)

Voluntary winding up.

A company may be wound up by the Tribunal on these grounds namely a) By the company passing
a special resolution, b) Default in holding statutory meeting or in delivering statutory report to the
registrar, c) Failure to commence business within a year from the date of incorporation, d) Reduction
in membership below the minimum required, e) Inability to pay debt of Rs. one lakh, f) When in
the opinion of the Tribunal it is just and equitable, g) Default of companys filing its balance sheet,
h) If the company has acted against the interests of sovereignty and integrity of India, and i) When
the company has become sick and is unlikely to become viable in future. A petition for winding up
may be made by the company, any creditor, any contributory, the registrar, any person authorised
by the Central Government, the official liquidator or the central or state government. Every company
is to file with the Tribunal a statement of affairs along with the petition for winding up. When the
company is opposing a petition for winding up, a statement of affairs is to be filed by the company.
The consequences of the winding up order by the Tribunal are i) Intimation is sent to the official
liquidator and the registrar, ii) Winding up order is filed with the registrar within 30 days, iii) The
order is notified in the Official Gazette, iv) Winding-up order is deemed to be notice of discharge
for employees, v) Suits stayed unless the Tribunal gives leave to continue, vi) Order operates in
the interests of all creditors and contributories, vii) Official liquidator is the liquidator, and viii)
Boards powers come to an end.

Notes

The Tribunal hands over the statement of affairs to the liquidator and may direct the constitution
of a Committee of Inspection. Besides this the Tribunal has general powers like, to stay winding
up, to settle the list of contributories, to set off claims, to make calls, to order payment into bank
of money due to the company, to exclude creditors not proving on time, to adjust the right of
contributories, to summon persons suspected of having the property of the company, to order
public examination of promoters, directors etc., to arrest an absconding contributory, to order
costs and to order the dissolution of the company.
Liquidators main duty is to conduct the winding-up process. He discharges all the functions of
the board so long as the company is not dissolved/liquidated. For discharge of his duties he has
certain powers. His powers can be divided into two parts - one exercisable with the sanction of the
Tribunal - like to carry on business of the company, to sell the property of the company, to raise
money, to compromise etc., and second exercisable without the sanction of the Tribunal like
inspect the records and returns of the company with the registrar, or appoint any agent.
Voluntary winding-up is of two kinds a) Members voluntary winding-up, and b) Creditors voluntary
winding-up. Voluntary winding-up has effects i) On status of company, ii) Corporate powers to
continue until dissolution, iii) Boards power to cease on liquidators appointment iv) On companys
employee, and v) Avoidance of transfer of share. In members voluntary winding up two conditions
are to be satisfied - firstly a declaration of solvency is made and secondly shareholders resolution
is to be passed. In both types of voluntary winding-ups a meeting of shareholders or creditors is
held. Liquidator is appointed and notice of his appointment is given to the registrar. Boards
powers cease on appointment of the liquidator. Any vacancy in the office of liquidator is filled and
a final meeting is held where a resolution for the dissolution of the company is passed. Although
both members and creditors can resort to voluntary winding up of a company, yet there are some
differences in these two types of voluntary winding up.

Corporate Governance
This term has gained importance in the last two to three decades. A spate of scandals and corporate
collapses in the late 1980s and 1990s led shareholders and banks to think about the safety of
their investments. In U.K. first Cadbury Committee, followed by Hampel and finally Greenbury
Committee were constituted. In India also there were a number of committees which submitted
their reports from 1998 to 2005. First Rahul Bajaj Committee by CII in April 1998, then Kumar
Mangalam Birla Committee by SEBI in May 1997. Thereafter, in April 2002, Ganguly Committee
for Banks and Financial Institutions. The central government appointed Naresh Chandra Committee
which submitted its report on 23 Dec. 2002. Finally SEBI appointed Narayan Murthy Committee
which submitted its report to SEBI on 8 Feb. 2003. As a result SEBI revised clause 49 of the
Self-Learning Material 213

Notes

listing agreement which is effective from 1 Jan 2006. To amend company law, central government
appointed an Expert Committee under the chairmanship of Dr. J. J. Irani. This Committee submitted
its report on 31 May 2005. The changes in company law are awaited.
The concept of corporate governance has been used in different perspectives. Many authors have
defined this term in different ways. It is an umbrella term - encompassing the system by which
companies are directed and controlled. The main objectives of good corporate governance are i)
to promote healthy environment for long term investment, ii) to create a trust in the corporate, iii)
to promote business development, iv) to improve the efficiency of the capital markets, v) to enhance
the effectiveness in the service of the real economy, and vi) to exercise effective control on corporate
affairs by the board at all times. There are some fundamental principles of corporate
governance like i) ethics, ii) transparency, iii) accountability, iv) trusteeship v) empowerment vi)
fairness to all stakeholders viii) oversight, viii) external audit, ix) regulatory regime and x) whistle
blower policy.
In conclusion it can be said that good corporate governance is a must but its models vary from
country to country and company to company. There is no one cap which fits all sizes. Law alone
can bring minimal corporate governance, for a better corporate governance the management has
to be professional but the best corporate governance is possible only when ethical principles and
practices are adopted.

Review Questions
True or False
1.

The property of the company is the property of its members.

2.

One man company is a perfectly valid company

3.

Promoter is neither a trustee nor an agent of the company he promotes but stands in a
fiduciary position towards it.

4.

The memorandum of association is an unalterable charter of a company.

5.

A prospectus must state truth and nothing but truth.

6.

Companies are prohibited from buying their own shares.

7.

In a company all shareholders are members but all members need not be shareholders.

8.
9.

All investments made by a company must be held by it in its own name.


Only members can be appointed directors of a company.

10.

Every meeting, in order to be valid, must be duly convened, properly constituted and
conducted.

11.

A board of directors meeting must be held once every two months.

12.

Every year the auditors are appointed by the board of directors.

13.

A majority, who has been rendered completely ineffective by the questionable acts of a
minority group, cannot complain of oppression or mismanagement.

14.

Compromise implies existence of dispute such as relating to rights.

15.

Every company is required to file, along with the petition for winding-up, with the Tribunal,
a statement of its affairs.

Practical Problems
1.
214 Self-Learning Material

Akhil and Bharat were only two members of a private limited company. Both of them have
been killed in an air crash. Does this company cease to exist?

2.

All the seven signatures on a memorandum of association were forged by a person and a
certificate of incorporation was duly obtained. Is the certificate of incorporation valid?

3.

The directors of a company were authorised by the articles to borrow on bonds such sums
of money as should from time to time, by a resolution of the company in general meeting,
be authorised to be borrowed. One director gave a bond to Tara without the authority of
any such resolution. Is the company liable on the bond?

4.

Amar purchased from Dalal 1000 shares of a company on the basis of prospectus containing
wrong statement. What remedies are available to Amar against the company?

5.

Madhur, a director of ABC Ltd, died in a bomb blast. It has been decided to appoint Murali
in his place. Will the company be required to call extraordinary general meeting to approve
the latters appointment as a director?

6.

One general meeting was called by a company in December 2003. The meeting was
adjourned to March 2004 and then held. Subsequently meeting was held in February 2006.
Is the company liable for any irregularity?

7.

A company has 100 members. It sends notice of the general meeting to all of them. 20
members do not attend the meeting. Out of 80 members who are present 20 abstain from
voting. How many members should vote in favour of a resolution if it is to be passed as a
special resolution?

8.

X,Y,Z, Directors of a company were the major shareholders of the company. X was
the chairman of the company. At a meeting of the Board of Directors, it was decided to
increase the share capital. Y and Z did not have the money to take up additional shares and
feared that in consequence, X would corner all shares and become predominant in the
company. So a general meeting was called and it was resolved that the present members
alone shouldnot benefit from the prosperity of the company, but others also should share,
and a special resolution was passed that the new shares may be offered to about a dozen
persons who were not members of the company. X rushed to the Tribunal, complaining
of oppression, saying that Y and Z wanted to throw him out as director and chairman of the
company and they had passed a special resolution to bring about a change in management.
Will X succeed?

9.

After a scheme of amalgamation was approved by majority of shareholders and creditors,


some of the members requisitioned an EGM to challenge the exchange ratio, which according
to them was not fair and reasonable. The scheme was pending in the Tribunal (NCLT). Can
the directors refuse to call EGM?

10.

There are only two members of a company and both of them are not on speaking terms.
Can the company be wound up on this ground?

Notes

Test Questions
1.

Define a company and explain the features of a company.

2.

Explain the concept of Corporate veil and state the circumstances when it can be lifted.

3.

Distinguish between a public limited company and a private limited company.

4.

Describe various stages of incorporation of a public limited company.

5.

A Joint stock company is an artificial person created by law with a perpetual succession
and a common seal. Do you agree with this definition of a company?

6.

A company is a legal entity distinct from its members. In what cases do the courts
ignore this principle?

7.

Explain what is meant by a holding company and a subsidiary company. Give examples.

8.

Briefly describe the documents to the filed with the Registrar of Companies prior to
incorporation.
Self-Learning Material 215

Notes

9.

Who is a promoter? Discuss his legal position in relation to a company he promotes.


Explain.

10.

What are the clauses of the memorandum of association of a company? Comment


on the memorandum of association is an unalterable charter of a company.

11.

Write a short note on Doctrine of ultra-vires.

12.

Differentiate between memorandum and article of association.

13.

Write short notes on:


a.

Doctrine of indoor management.

b.

Doctrine of constructive notice.

14.

The Memorandum of Association is the fundamental law or a charter defining the objects
and limiting the powers of a company. Explain.

15.

Why is it necessary for a company to have a registered office? Can the registered office of
a company be changed?

16.

The doctrine of ultra vires is an illusory protection to the shareholders and a pitfull for
third parties. Discuss.

17.

What are Articles of Association? How can they be altered? Discuss the limit upon the
powers of a company to after or add to the Articles of Association.

18.

A prospectus must state truth and nothing but truth. Do you agree? Explain.

19.

Write short notes on:


a.

Shelf prospectus and information memorandum.

b.

Statement in lieu of prospectus.

20.

Define prospectus. When is a company not required to issue a prospectus?

21.

What is a prospectus? What are its contents? Is it obligatory for a company to file prospectus
or a statement in lieu of prospectus with the Registrar of Companies?

22.

In a company all shareholders are members but all members need not be shareholders.
Explain.

23.

In what ways may a person i) become, ii) cease to be, a member of company?

24.

Distinguish between:
a.

Share and stock.

b.

Share warrant and share certificate.

25.

What are the conditions required to be complied with for a company to buy-back its shares?

26.

Give various classifications of capital and discuss the procedure for reduction of share
capital.

27.

Define share, What are the different types of shares that may be issued by a company?

28.

What are preference shares? Explain what is meant by i)

Cumulative and non-cumulative preference shares and

ii) Participating and non-participating preference shares.

216 Self-Learning Material

29.

What are the legal requirements which a company must comply with while borrowing?

30.

Discuss the provisions of company law regarding inter-corporate loans and investments.

31.

What is the statutory limitation to the borrowing power of the directors of a company?

32.

Define director. What are the qualifications and disqualifications of a director?

33.

How are directors appointed and removed?

34.

What is the legal position of a director in a company? Explain the powers of the Board of
Directors.

35.

A casual vacancy has occured in a public company due to a director vacating his office
before his term expires. How is the vacancy to be filled?

36.

The exact position of directors with regard to a company is hard to define. They are not
servants of the company but are rather in the position of managing partners. Discuss this
statement and bring out the exact position of directors in a company.

37.

Explain various meetings of shareholders.

38.

What is a motion? Explain types of resolutions.

39.

Write short note on passing of resolution by postal ballot.

40.

What books of accounts are required to be kept by a company? Explain the law relating to
authentication, adoption and filing of annual accounts.

41.

Who can be an auditor of a company and what are his disqualifications, rights and duties?

42.

The will of majority must prevail Is the principle of a company management. Are there
any exceptions to this rule?

43.

Majority will have its way but the minority must be allowed to have its say. Discuss this
proposition with reference to prevention of oppression and mismanagement in a company.

44.

A, B and C own respectively 50%, 30% and 20% of the issued share capital of a company
and A and B are its directors. The company has made good profits but the directors refuse
to recommend the declaration of dividend and A and B, as majority shareholders, pass a
resolution at a general meeting to the effect that their remuneration as directors shall be
90% of the profits. To wind up the company would, in this case, unfairly prejudice the
minority shareholder. What alternative remedy is available to C and how may it be appled?

45.

What is meant by oppression? How does the Companies Act, 1956 attempt to prevent
oppression and mismanagement?

46.

Explain the terms Compromise, Arrangements, Reconstruction and Amalgamation.

47.

What do you understand by winding-up of a company? What are the various modes of
winding-up?

48.

Explain duties and powers of the liquidator.

49.

What is corporate governance? Explain its historical evolution.

50.

Explain principles of corporate governance.

Notes

Answers to True or False


1. False
8. True
15. True

2. False 3. True
9. False 10. True

4. False
11. False

5. True
12. False

6. False
13. False

7. True
14. True

Answers to Practical Problems


1.

No, a company is an entity distinct from its members. Death, insolvency or retirement of its
members, therefore, leave the company unaffected.

2.

Yes, the certificate of incorporation given by the registrar in respect of any company shall
be conclusive evidence that all the requirements of the Act have been complied with in
respect of registration and matters precedent thereto.

3.

Yes, the company was liable on the bond, as Tara was entitled to assume that the resolution
of the company in general meeting has been passed. (Doctrine of Indoor-Management).
Self-Learning Material 217

Notes

4.

Amar shall have no remedy against the company, there being no privity of contract between
Amar and the company.

5.

The vacancy being a casual vacancy can be filled by the board of directors at its meeting.
It may also be filled in a general meeting. Thus, there is no need to call an extra-ordinary
general meeting for this purpose.

6.

The Act (Sec. 166) requires a company to hold its annual general meeting every calendar
year. So there should be one meeting per year and as many meetings as there are years.
Thus in this case the meeting held in March 2004 is actually the meeting of December
2003. Since, next meeting is held only in Feb. 2006, the meeting of2004 has been missed.
Under these circumstances, unless permission of the registrar was obtained for extension
of time which may be granted upto a period of 3 months under certain special circumstances,
the company shall be proceeded against.

7.

For a valid special resolution, votes cast in favour must at least be 3 times the votes cast
against the resolution, if any. Those who abstain are not to be counted. Thus, 3/4th of 60
i.e. at least 45 members must vote in favour of the resolution.

8.

No, seeking change in management does not, prima-facie, amount to oppression. The conduct
of majority does not show any lack of probity, unfair conduct, or prejudice in the exercise
of legal and proprietary rights as a shareholder.

9.

No, director cannot refuse to call EGM requisitioned by members in this case. The Tribunal
cannot prevent a company from holding an EGM for considering the proposed modification
of a scheme.

10.

Yes, company can be wound up on just and equitable ground as there was a deadlock in
management.

Answers to Check Your Progress


1)
6)
12)
18)
24)
30)
36)
41)
47)
52)
57)
62)
67)
72)
77)

12.1.1, 2) 12.1.3(b), 3) 12.1.3(g), 4) 12.1.4(b), 5) 12.1.4(d)(ii),


12.1.6(a&b), 7) 12.2.1, 8) 12.2.2, 9) 12.2.3, 10) 12.2.3, 11) 12.2.4,
12.2.5, 13) 12.3.1, 14) 12.3.3, 15) 12.3.4, 16) 12.3.4(b)(ii),
17) 12.4.1,
12.4.3, 19) 12.5.3(b), 20) 12.5.3(c), 21) 12.5.7, 22) 12.5.5, 23) 12.5.11,
12.5.8, 25) 12.5.10,
26) 12.6.3, 27) 12.6.5, 28) 12.6.7, 29) 12.6.5(d),
12.7.4, 31) 12.7.5, 32) 12.7.8, 33) 12.7.10(b), 34) 12.7.10(e), 35) 12.7.13,
12.7.15(a), 37) 12.7.15(h), 38) 12.7.16(b)(iii), 39) 12.7.18,
40) 12.7.19,
12.8.1(b), 42) 12.8.2, 43) 12.8.4, 44) 12.8.5(d), 45) 12.8.5(k),
46) 12.9.2,
12.9.6(a),
48) 12.9.6(c)(ii), 49) 12.9.7(a), 50) 12.9.8(c), 51) 12.9.8(g),
12.9.10(b), 53) 12.9.11,
54) 12.9.14,
55) 12.9.17,
56) 12.9.18(b),
12.10.2(c), 58) 12.10.2(e), 59) 12.10.4(d), 60) 12.10.5(c)(iv), 61) 12.10.8(a),
12.10.9(b), 63) 12.11.3,
64) 12.11.4,
65) 12.11.8,
66) 12.11.10,
12.11.16,
68) 12.11.17,
69) 12.12.3,
70) 12.12.5,
71) 12.12.7,
12.13.4(b), 73) 12.14.2,
74) 12.14.3(c), 75) 12.14.4,
76) 12.14.10(b),
12.14.11(a), 78) 12.14.12

References

218 Self-Learning Material

(1895) AII. E.R. Rep. 33

Section 12 (2) (a) of the Companies Act.

Section 12 (2) (b) of the Companies Act

Section 12 (2) (c) of the Companies Act

Section 617

Section 591

Section 4

Sections 581 A to 581 ZT

Section 45

10
11

Notes

Section 62

Section 542

12

Section 69

13

Section 147

14

[1916] 2 AC 307

15

AIR 1927 Bom. 371

16

[1962] AII. E.R. 442.

17

[1996] A SCALE 202 (SC)

18

In Twycross v. Grant 1872. 2 C.P.D. 496 at page 541

19

In Whaley Bridge Printing Company v. Green [1880] 5 B.D. 109 at page 111

20

[1924] A.C. 1958

21

Section 2 (28)

22

[1875] LR 7 HL. 653 23Section 16

24

Sections 21 and 22 25Section 146 26Section 17 27Section 38 28Section 94 29Section 2(2)

30

(1934) 4 Comp. Cas. 289 = AIR 1939 Mad. 579

31

(1856) 6 E. and B. 327

32

Section 2(36)

33

Nandita Jain v. Bennett Coleman and Co. Ltd., Appeal No. 27 of 1972

34

Section 150

35

Section 151

36

Section 2(46)

37

Section 114

38

Section 79A - Inserted by the Companies

(Amendment) Act, 1999 w.e.f. 31.10.1998 39Section 2(12)


40

Section 372 A - inserted by the Companies

(Amendment) Act, 1999 w.e.f. 31.10.1998 41Section 2(13) 42Section 270 43Section 265 44Section
318
45

Life Insurance Corporation of India v. Escorts

Ltd. [1986] Tax LR 1826(SC) 46Section 285 47Section 192A


48

Lalita Rajya Lakshmi v. Indian Motor Co.

Ltd[1962] 32 Comp. Cas. 207 49Section 233B 50Section 210A


51

Section 292A inserted by the

Companies (Amendment) Act 2000 based on the recommendations of Kumar Mangalam Birla
Committee Report
52

[1843] 2 Hare 461 53Sections 397, 398

54

Lord Cooper in the Scottish case of Elder v. Elder and Watson Ltd 1952 SC 49 Scotland. It was
cited with approval by Justice Wanchoo, (afterwards chief justice) of the Supreme Court of India
in Shanti Prasad Jain v. Kalinga Tubes [1965] 1 Comp LJ 193, 204 = AIR 1965 SC 1553 = [1965]
Self-Learning Material 219

1 SC A 556
Notes

55

Section 397.

56

Section 390(b)

57

Modern Company Law, 4th ed., p. 789

58

Section 433

59

German Date Coffee Co. Re (1882) 20 Ch. D. 169

60

Yendje Tobacco Co. Ltd. Re (1916) 2 Ch. 426

61

Rajamundary Electric Supply Corp. Ltd. v. Nageshwara Rao, AIR (1956) S.C. 213

62

Section 439

63

National Textile Workers Union v. P.R Ramakrishnan [1983] 53. Comp. Cas. 184 (SC)

64

Section 439A - Vide Companies (Second Amendment) Act, 2002

65

Summary of all these Committees Reports can be seen in Corporate Governance- Global
Concepts and practices by Dr S.Singh (Excel Books) 1st Ed. 2005 in Part IV (from Page 285 to
page 419)
66

Expert Committee Report on Company Law is published in Corporate Law Advisor June (2)
2005 from page 112 to 204 = 200566 CLA (st) 112

220 Self-Learning Material