Fahad Sattar

SZABUL
UBA-LLB,
NIVERSIT CIV-E
ONTRACT LAW; FINAL EXAMINATION
Y OF LAW
BL-1398
Q.NO.1 (a) (Marks 7.5)

CASE LAW: NO BAILMENT CONTRACT WHEN NO

DELIVERY OF GOODS
The main claim in this case was that Plaintiff had alleged breach of bailment
contract by the Defendant, whereby performance of contract comprised of
handling of rice on the ‘Book Balance’ basis without any physical verification
of the stock of rice, which was lying in the Plaintiff’s godown in dumped
position, and that the claim as to shortage in stock was raised post
satisfactory performance of the given contract. Discuss in your own words in
detail.

Introduction
The first important characteristic of bailment is ‘the delivery of possession’ by one person to another.
‘Delivery of possession’ for this purpose should be distinguished from a mere ‘custody’. ‘One who has
custody without possession, like a servant, or a guest using his host’s goods is not a bailee. The goods
must be handed over to the bailee for whatever is the purpose of bailment. Once this is done, a
bailment arises, irrespective of the manner in which this happens.

Constructive Delivery
‘Constructive Delivery’ takes place when there is no change of physical possession, goods remaining
where they are, but something is done which has the effect of putting them in the possession of the
bailee. i.e. delivery of a railway receipt amounts to delivery of the goods. Similarly, where a person
pledged the projector machinery of his cinema under an agreement which allowed him to retain the
machinery for the use of cinema.

Delivery should be upon Contract

Delivery of goods should be made for some purpose and upon a contract that when the purpose is
accomplished the goods shall be returned to the bailor. When a person’s goods go into the possession
of another without any contract, there is no bailment within the meaning of its definition in Section
148.

Delivery should be upon some purpose

Bailment of goods is always made for some purpose and is subject to the condition that when the
purpose is accomplished the goods will be returned to the bailor or disposed of according to his
mandate.

Conclusion
However, the claim for the breach of Bailment could not arise because this condition does not meets
the requirement of bailment and to raise contract of bailment. If there does not raise the contract of
bailment, it means there is not breach. So, the claim for the breach of bailment shall fail.
Q.NO.1 (b) (Marks 2.5)

i) Who may Pledge?

Ordinarily goods may be pledged by the owner or by any person with the owner’s authority. A
pledge made by any other person may not be valid. Thus, for example, where goods were left in
the possession of a servant, while the owner was temporarily absent, a pledge made by the
servant was held to be invalid. Similarly, where certain goods are left in the care of a person for
some special purpose, he cannot pledge them. In a case before the court, the railway company
delivered goods on a forged railway receipt. The goods were then pledged with the defendants.
In a suit b the railways to recover the goods, the defendants contended that the railways were
too negligent in delivering the goods to a wrong person. But the court held that his would not
constitute an Estoppel against the company and that pledge was not valid. The principle in
necessary to protect the individual interest in the ownership of property. But interest acquired in
the course of lawful commercial transactions equally deserves to be protected. Accordingly,
sections 178 and 179 provide for certain circumstances in which a person, being left in
possession with the consent of the owner, any make is valid pledge though without the owner’s
authority.

ii) Discuss whether the pledge is a special type of contract of

bailment?
In terms of S. 172 of the contract act a pledge is defined as the bailment of goods as security
for payment of debt or the performance of a promise. [PLJ 2007 Lah. 1209] A pledge is he
delivery of goods by the pledger to pledgee by way of security upon a contract that they shall
when the debt is paid or the promise is performed, be returned or otherwise disposed of
according to the direction of the pledger. The essential ingredients of the pledge are;

i. There must be bailment of goods as defined in section 148 of the contract act i.e.
delivery of goods;
ii. Bailment must be by way of security;
iii. Security must be for payment of debt of performance of promise.

In order to constitute a valid pledge, what is essential is that there must be delivery of the
article, either actual or constructive, to the pawnee. Possession is an equivocal term, it may
mean either mere manual possession or the mere right to possession. Constructive delivery
will be adequate to constitute a pledge, and it applied to all those cases, where the pledger
remains in possession of the goods under the specific authority of the pledge or for limited
purposes. [2004 CLD 1490]
Q.NO.2 (Marks 10)
Case 1: A parked his cycle at cycle stand. He lost his token given by B. B
refuses to return the cycle. To get the cycle A promises to compensate B
against the loss he may suffer if any other person claims the cycle from B.
Later on Mr. C claimed for cycle from B which was not compensated by Mr.
A. Discuss its consequence referring the law please.
Generally, once the contract is raised then all its terms shall be amounts to essential to the
agreement. However, in this case, as A parked his cycle at cycle stand and lost the his token
given by B. consequently, he get back his cycle in return of the promise that if any of the
person claims the cycle he shall be entitled to for compensation from him (A). Moreover, here
contract is concluded.

As a result if the claim is for that cycle and he proves that it is his cycle then he is bound to
compensate for it.

Case 2: The owner of a commercial property has been paying an insurance

premium to an insurance company so that she can recover the costs for any
loss or damage if a future bad event were to happen to the establishment. If
the building sustains significant structural damages from fire, then the
insurance company will indemnify the owner for the costs to repair by way of
reimbursing the owner or by reconstructing the damaged areas using its own
authorized contractors. Discuss the case referring the law please.
The law on the insurance is general that if anything exists in the terms of their contract and
that term was proposed by them (insurance company) then they (insurance Company) cannot
avoid or render that contract void merely because of its unfair terms etc. The exception is that
if the other party does not slip from the requirements.

So it is here clearly defined that if anything happened bad in the future then the company will
indemnify from all forms of loss. So, the company is liable to for that purpose.

Case 3: A wheelchair manufacturer enters into an agreement with a large

hospital to provide 500 wheelchairs at a discount price. The manufacturer
asks that an indemnity clause be included in the contract, in which the
hospital agrees to protect the company from any losses or lawsuits should
patients be injured while using any of the wheelchairs. In doing this, the
hospital indemnifies the wheelchair company, or the hospital guarantees
indemnity for any losses or injuries that may occur. Discuss the case
referring the law please.
The law regarding this is that if one indemnifies from any form of loss and make contract of
indemnity. So, he will be held liable under such contract law.
Here the hospital indemnifies from such types of losses or injuries. Moreover, in any of the
bad event he shall be held liable for the loss or injury.

Case 4: Lola has a homeowner’s insurance policy on her home in Texas. The
insurance company has agreed to indemnify Lola against damages to her
home and the personal property kept there, from many types of damage,
including fire, burglary, and liability if someone gets injured on Lola’s
property. A visiting neighbor trips on a crack in the walkway and falls,
breaking her arm. Lola’s insurance company would protect Lola from the
medical bills and other losses claimed by the neighbor by paying the claim.
Discuss the case referring the law please.
Here is a matter of privity of contract law. The neighbor is a third party to the contract.
Generally the neighbor cannot claim under the contract law. This case relates to the tort law
case Donoghue v. Stevenson.

Moreover, the case shall be failed under the privity of contract. No claim like this generally
shall amount to proper reward.
Question 6
Bailment
Bailment implies a sort of relationship in which the personal property of one person temporarily goes
into the possession of another. The ownership of the articles or goods is in one person and the
possession in another. The circumstances in which this happens are numerous. Delivering a cycle,
watch or any other article for repair, or leaving a cycle or car et. At a stand, depositing luggage or
books in a cloakroom, delivering gold to a goldsmith for making ornaments, delivering garments to a
dry cleaner, delivering goods for carriage, warehousing or storage and so forth, are all familiar
situations which create the relationship of bailment. Thus bailment is a subject of considerable public
importance.

Essential Features
There are essential features of ‘bailment’ which are being emphasized by this definition and
below are summarized in the cases.

1) Delivery of Possession
It must be noted that ‘Delivery of Possession’ must be distinguished from a mere ‘Custody’.
“The one who has custody without possession, like a servant or guest using his host’s goods is
not a bailee”. The goods must be handed over to the bailee for whatever is the purpose of
bailment.

Ultzen v. Nicoll’s (1894)

Fact: An old customer went into a restaurant for the purpose of dining there. When he
entered the room a waiter took his coat, without being asked, and hung it on a hook behind
him. When the customer rose to leave the coat was gone.

Held: What the waiter did might be no more than an act of voluntary courtesy towards the
customer, yet the restaurant – keeper was held liable as a bailee. Further was held that the
waiter by taking the coat into his possession had relieved the plaintiff of its are and had thus
assumed the responsibility of a bailee. The principle was established by saying that he was
who selected the place where the coat should be put. On the other hand, it would be
different, if the customer had instructed the servant where and how the coat should be put.

Kaliaperumal Pillai v. Visalakshmi (1938)

Fact: A lady handed over to a goldsmith certain jewels for the purpose of being melted and
utilized for making new jewels. Every evening as soon as the Goldsmith’s work for the day ws
over, the lady used to receive half-made jewels from the Goldsmith and put them into a box in
Goldsmith’s room and keep the key in her possession. The jewels were lost one night.

Held: The woman’s action against the goldsmith failed, the court held “Any bailment that
could be gathered from the facts must be taken to have come to an end as soon as the
plaintiff was put in possession of the melted gold. Delivery is necessary to constitute bailment.
The mere leaving of box in a room in the defendant’s house, when the plaintiff herself took
away the key, cannot certainly amount to delivery within the meaning of the provision in
Section 149 of Contract Act, 1872.

Note: There are two types of delivery, Constructive delivery and Actual delivery.

Actual delivery;
When the bailor hands over to the bailee physical possession of the goods that is known as
Actual delivery.

Constructive delivery;
This type of delivery takes place when there is no change of physical possession, goods
remaining where they are, but something is done which has the effect of putting them in the
possession of the bailee. The good illustration of constructive delivery is shown in the
following case.

Fazal v. Salamat Rai (1928)

Fact: The defendant was holding the plaintiff’s mare under the execution of a decree. The
plaintiff satisfied the decree and the court ordered redelivery of the mare to the plaintiff. The
defendant, however, refused to do so unless his maintenance charges were also paid . the
mare was stolen from his custody.

Held: The court holding him liable that after the delivery order had been passed, the relation
of bailor and bailee was established by virtue of the Explanation to section 148.

Insurance Company Case

In the case before the Supreme Court of India, the owner of an accidental car delivered it
under the policy on behalf of the insurer to the nearest garage for repair. This delivery was
regarded as sufficient to constitute the insurance company as bailee and the garage as a sub-
bailee. They became responsible for the loss of the car in a fire on the premises. 1

1
N.R. Srinivasa Iyer v. New India Ins. Co. (1983)
2) Delivery should be upon contract
Delivery of goods must be upon some purpose and a contract and when such purpose is
accomplished the goods shall be returned to the bailor. When a person’s goods go in the
possession of another person without any contract, there is no bailment.

Ram Gullam v. Government of U.P. (1950)

In this case, the plaintiff’s ornaments, having been stolen, were recovered by the police and
while in police custody, were stolen again. The plaintiff’s action against the State for the loss
was dismissed. Here the opinion of Seth J is note worthy who said “….the obligation of a bailee
is contractual obligation and springs only from the contract of bailment. It cannot arise
independently of a contract. In this case the ornaments were not made over to the
Government under any contract whatsoever… The Government, therefore, never occupied
the position of bailee and is not liable as such to indemnify the plaintiffs.” To the same effect is
Mohammad Murad v. Govt. of U.P. (1956), property deposited in court under orders, no
bailment because there was no contract.

Non-Contractual bailment
This assumption has been described unjustifiable by the most jurists such as Pollock and
Mulla. However, English law recognizes bailment without contract. In the words of Cheshire
and Fifoot “At the present day, no doubt, in most instances where goods are lent or hired or
deposited for safe custody, or as security for a debt, the delivery will be the result of a
contract. But this ingredient, though, is not essential.” Referring to this, Shelat J2 observed as
follows, “Bailment is dealt with by the Contract Act only in cases where it arises from a
contract, but it is not correct to say that there cannot be a bailment without an enforceable
contract.

Lasalgaon Merchants Co-operative bank Ltd. v. Prabhudas Hathibhai

Facts: Certain packages of tobacco lying in the godown of a partnership firm were pledged to
the plaintiff bank. Some of the partners, having failed to clear their income-tax dues, the
Income Tax Officer ordered seizure of the goods. He officials of the collectorate accordingly
locked the godown and handed over the key to the police. Then came heavy rains. The roof of
the godown leaked and the tobacco was damaged.

Opinion: In the opinion of the court, as expressed by the Naik J, where certain goods
belonging to an individual are seized by the Government the latter becomes the bailee
2
State of Gujarat v. Memon Mohamed
therefore even if there is no suggestion of a contract between the government and the
individual.

Held: the Court said that heavy rains don not (necessarily) amount to an act of God. It was
the duty of Government officers to take such care as every prudent manager would take of his
own goods. The Government stood in the position of bailees and it was for them to prove that
they had taken s much care as was (reasonably) possible for them and that the damage was
due to reasons beyond their control.

Duty of Bailor
Bailors are of two kinds, namely; a) Gratuitous bailor and b) bailor for reward.

Duty of Gratuitous bailor

A person, for example, who lend his cycle or horse to a friend, and if he knows that the cycle is
without brakes or that the horse is unsound. He should disclose this fact and his duty ends
there.

Duty of bailor for reward

The duty of a bailor for consideration is much greater. He is making profit from his profession
and, therefore, it is his duty to see that the goods which he delivers are reasonably safe for the
purpose of the bailment. It is no defense for him to say that he was not aware of the defect.

Hyman & Wife v. Nye & Sons

Fact: The plaintiff hired from the defendant for a specific journey a carriage, a pair of horses
and a driver. During the journey a bolt in the under-part of the carriage broke. The splinter bar
became displaced, the carriage was upset and the plaintiff injured.

Held: Holding the defendant liable Lindley J said: “A person who lets out carriages is not
responsible for all defects discoverable or not; he is not an insurer against all defects. But he is
an insurer against all the defects which care and skill can guard against. His duty is to supply a
carriage as for the purpose for which it is hired as care and skill can render it.

Reed v. Dean (1949)

Fact: The plaintiff hired a motor launch from the defendant for a holiday on the river
Thames. The launch caught fire, and the plaintiffs were unable to extinguish it, the fire-fighting
equipment being out of order. They were injured and suffered loss.
Held: The court held that there was an implied undertaking that the launch was as fit for the
purpose for which it was hired as reasonable care and skill could make it. The defendant was
accordingly held liable.

Principle: where a bailor delivers goods to another for carriage or for some other
purpose, and if the goods are of dangerous nature, the fact should be disclosed to the bailee.

Duties of Bailee
1) Duty of reasonable care
Originally in English law “liability in bailment was absolute. It was no excuse for the bailee to
say that the damage or failure to return was due to no fault of his own, he was liable in any
case.3 However, the modern trend is towards a simple principle of liability for negligence in all
cases.

Blount v. The War Office (1953)

Fact: A house belonging to the plaintiff as requisitioned by the War Office. The plaintiff was
allowed to store certain articles in a strong room in the house, which he locked. Of the troops
stationed there, who were not kept under proper control, some broke into the room and stole
a quantity of silver plates.

Held: The War Office was held liable. The court said: “There was a voluntary bailment of the
goods to the defendants in the way of deposit and the standard of care required of them was
reasonable care which a man, who had valuable property of his own stored in those
circumstances, would leave it to the tender mercies of seventy or eighty displaced persons of
that type without taking any precaution. The Ministry was negligent.”

Martin v. London County Council (1947)

Fact: The plaintiff was brought to a paid hospital as patient. On her entry, the hospital
officials took charge of two pieces of jewellery and a gold cigarette case. They were
subsequently stolen y a thief who broke into the rook I which they were kept.

Held: it was held that the defendants were bailees for reward and were liable for the loss as
they had failed to exercise a care which the nature and quality of the articles required.

3
The king v. Viscount Hertford (1601)
Loss due to act of bailee’s servant
Where the loss has been due to the act of the bailee’s servant, he would be liable if the
servant’s act is within the scope of his/her employment.

Cheshire v. Bailey (1905)

In this case, Collins Mr. said: “The bailee is bound to bring reasonable care to the execution of
every part of the duty accepted. He may perform that duty by servant or personally, and if he
employs servants he is as much responsible for all acts done by them within the scope of their
employment.”.

Sanderson v. Collins (1904)

Fact: The defendant sent his carriage to the plaintiff for repair and the latter lent his own
carriage to the defendant while the repairs were going on. The defendant’s coachman,
without his knowledge, took away the carriage for his own purpose and damaged it.

Held: The defendant was held not liable as the coachman at the time when the injury ws
done to the carriage was not acting within the course of his employment. “If a burglar broke
into the coach house and took away the carriage and caused damage to it and brought it back,
no liability would attach to the bailee. The act of the servant was not different.

Involuntary bailee
A person who has come into the possession of a chattel through no act of his own and without
his own consent is known to be involuntary bailee.

Newman v. Bourne & Hollingsworth

Fact: The plaintiff went to the defendant’s shop to buy a coat. She was wearing a coat
fastened with a diamond brooch and she took the coat off and put it on a glass case with the
brooch by the side of it. When leaving she forgot the brooch and it was handed by an assistant
to the shopwalker who put it in his desk, from where it was lost.

Held: The defendant was held liable. He had not exercised that degree of care which was due
from one who had found an article and had assumed possession of it. The degree of
negligence must be measured by the apparent value of the article.

Moreover, if an involuntary bailee, without negligence, does something which results in the
loss of the property, he will not be liable for conversion. 4

4
Elvin & Powell Ltd. v. Plummer Raddis Ltd. (1933)
2) Duty to return
When the purpose of bailment is accomplished or the time for which the goods were bailed
has expired, the bailee should return the goods to the bailor without demand. 5

Shaw & Co. v. Symmons & Sons (1917)

Fact: The plaintiff entrusted books to the defendant, a book binder, to be bound, the latter
promising to return them within a reasonable time. The plaintiff having required the
defendant to deliver the whole of the books then bound, the defendant failed to deliver them
within a reasonable time and they were subsequently burnt in an accidental fire on his
premises.

Held: The defendant was held liable in damages for the loss of the books. When the loss
takes place while the bailee’s wrongful act is in operation, there is no question of any defence
like “act of God” or “inevitable accident” being set up. He is liable in any case.

Rights of Bailee

Right of Lien
If the bailee’s lawful charges are not paid he may retain the goods. The right to retain any
property until the charges due in respect of the property are paid, is called the right of lien.

Particular Lien
As a general rule a bailee is entitled only to particular lien, which means the right to retain
only that particular property in respect of which the charge is due.

If a man has an article delivered to him on the improvement of which he has to bestow
trouble and expense. He has a right to detain it until his demand is paid. 6

Hutton v. Car Maintenance Co. (1915)

Fact: The owner of a motor car gave it to a company to maintain it for three years on a fixed
annual payment. An amount having become due for maintenance charges, the company
claimed lien on the car.

Held: It was held that in as much as what the company did was not to improve the car, but
only to maintain it in its former condition, the company had no lien on the car.

5
Dhian Singh Sobha Singh v. Union of India (1958)
6
Bevan v. Waters (1828)
However, in the case of Chand Mal v. Ganda Singh (1885) it was held that lien not allowed for
mere storage of fertilizers.

Possessory right
The right depends on possession and is lost as soon as possession of the goods is lost.

Eduljee v. Café John Bros. (1944)

Fact: The plaintiff purchased an old refrigerator, the vendor agreeing to repair it for a fixed
charge. When the repair was over and the condition of the machine was found satisfactory, it
was delivered to the plaintiff but a part of the repair money was still unpaid. The machine
broke down again and the vendor carried its engine and another part for further repair and
claimed lien on these parts until the outstanding charges of repair were paid.

Held: The court held that delivery of possession after repairs are effected puts and end to the
lien which the repairer has for the charges repair and cannot be revived because the repairer
undertakes further repairs merely out of grace and not as a matter of fresh contract. The court
cited Lord Ellenborough as saying; the defendant after the repairs were completed,
relinquished his possession, and could not afterwards detain for the amount of the repairs.

Principle: It established that the lien is a possessory right which continues only so long as
the possessor holds the goods.

General Lien
The right of “general lien” means the right to hold the goods bailed as security for a general
balance of account. General lien entitled the bailee to detain any goods bailed to him for any
amount due to him whether in respect of those goods or any other goods. If, for example, two
securities are given to a banker but a loan has been taken only against one of them, the
banker may detain both securities until his dues are paid.

Parties entitled to general lien

The right of general lien is a privilege and conferred under section 171 on certain kinds of
bailee only. They are;

i. Bankers,
ii. Factors,
iii. Wharfingers,
iv. Attorneys of a High Court, and
 v. Policy brokers

Types of Lien covered by the Act

The Act provides for the following types of lien:

i. Lien of finder of goods [S. 168]

ii. Bailee’s Lien;
a. Particular {S. 170}
b. General {S. 171}
iii. Lien of pledge or pawnee {Ss. 173-174}
iv. Lien of agents {S. 221}
Question 4
Conditions
Until fairly recently, judges recognized only two classes of term. The most important of these
was the condition, which can be considered in two ways.

Firstly, a condition is a term of a contract which is so important to the contract that a failure to
perform the condition would render the contract meaningless and destroy the whole purpose
of the contract. As a result, anything that is accepted as being a condition is said to ‘go to the
root of’ a contract.

Secondly, as a result of the significance of the term to the contract, the court allows the
claimant who has suffered a breach of the term to the contract; the court allows the claimant
who has suffered a breach of the tem the fullest range of remedies available. When a
condition is unfulfilled the claimant will not only be able to sue for damages but will also be
entitled lawfully to repudiate his own obligations under the contract, or indeed do both.
Repudiation used in this way, as remedy, is the right of the victim of the breach to consider
the contract ended as a result of the other party’s breach of contract. This may be particularly
appropriate as it may mean that the claimant can contract with an alternative party and treat
himself as relieved of his obligations under the contract, without fear of the defendant
successfully alleging a breach by the claimant instead.

An illustration
Here, an actress was contracted to appear in the lead role in an operetta for a season. The
actress, who was taken ill, was unable to attend for the early performances, by which time the
producers had given her role to the understudy. The actress sued for breach of contract but
lost. The court held that she had in fact breached the contract by turning up after the first
night. As the lead singer, her presence was crucial to the production and so was a condition
entitling the producers to repudiate and terminate her contract for her non-attendance at the
earl performances.

Warranties
Warranties are regarded as minor terms of the contract or those where in general the contract might
still continue despite their breach. Almost by default, then, a warranty is any other term in a contract
and specifically one that does not go to the root of the contract.

Warranties are a residual category of terms dealing with obligations that are either ancillary or
secondary to the major purpose of the contract. As a result, the remedy for a breach of warranty is
merely an action for damages. There is no right to repudiate for a breach of a warranty. If the party
who is the victim of the breach of a warranty tries to repudiate his obligations then this itself is an
unlawful and actionable repudiation.
Question 5
Introduction
The consumer has an action against the supplier where the goods are not of acceptable quality.

The supplier is not responsible for defects pointed out to the consumer before sale. This may be done
by way of a notice displayed the goods. Nor is the supplier responsible for defects caused by the
consumer’s carelessness. Finally, where the consumer examines the goods prior to sale the supplier is
not responsible for any defects that the examination out reasonably to have revealed.

The scope of protection provided to consumers by this statutory guarantee is similar to the previous
law, which implied a contractual promise of ‘merchantable quality’. The case below illustrates facts in
which a consumer might argue that the goods were not of acceptable quality.

The decision in Grant v Australian Knitting Mills

In relation to the claim against the retailer, John Martin, the Privy Council held that the goods, as sold,
were not of merchantable quality.

Whether it has now become normal practice for purchasers to wash newly purchased clothing prior to
wearing it. A prudent manufacturer would, of course, include a warning on the packet, and this could
protect both the manufacturer and the retailer.

Credit additionality
Credit or financial additionality refers to the extra loans that would not have come about without the
credit guarantee scheme. Measuring additionality is difficult (Levitsky and Prasad, 1987). In fact, only a
few cases of additionality have been “proven”, and thus experts remain skeptical as to whether CGSs
actually cause additionality. However, Levitsky has argued that additionality is possible if a CGS is
properly designed and implemented. He estimates that in such cases CGSs create, on average, 30 to 35
percent financial additionality (Levitsky, 1997). Since general additionality is hard to determine, this
report will present some empirical evidence illustrating additionality in specific cases, e.g. Chile.

Risk sharing
An improperly designed guarantee scheme can increase moral hazard among borrowers by reducing
the default risk they otherwise would incur (i.e. by providing part of the collateral required to obtain
the loan). This can lead to more “strategic defaults” from borrowers – because part of the collateral
does not belong to the borrower, he has a higher incentive to default. However, a properly designed
guarantee scheme can limit moral hazard. For this to occur, it is important than the loan risk is shared
amongst the lender, the borrower and the guarantors.

The extent to which each party should share in the risk is a delicate balancing act. The guarantor
should accept enough risk to be able to persuade banks to participate in the scheme. In fact, 100
percent coverage exists in countries such as Canada, Japan, and Luxembourg. A World Bank study from
2008 revealed that among the 76 schemes in 46 developed and developing countries, 40 percent of
them offer this option (World Bank, 2008). However, a 100 percent coverage rate is subject to greater
moral hazard. Not only does it increase the strategic default option of borrowers, but it also reduces
banks’ incentives to properly assess and monitor risk.

Coverage rates below 50 percent reduce the potential for moral hazard and encourage the adequate
assessment and monitoring of loans. On the other hand, a coverage rate below 50 percent reduces
banks’ incentives to participate in the guarantee programme, especially because loan administration
costs can be quite high. Some countries with low coverage rates have been able to maintain the
attractiveness of their scheme by using other financial incentives. The national guarantee fund in
Egypt, despite having a low coverage rate, still managed to guarantee USD 85 million in loans in 1995
after only four years in operation. In part, this was achieved by offering other financial incentives in
addition to guarantees. In Thailand, however, a similar scheme with the same coverage rate as that
offered in Egypt only managed to secure USD 51 million in loans after 10 years in operation. One
reason contributing to their lower usage levels was a lack of other financial incentives (Levitsky, 1997).

Such experiences suggest that coverage rates should generally be between 60 and 80 percent
(Levitsky, 1997). Rates in this interval are high enough to encourage lender participation and yet low
enough to limit moral hazard. From the 76 schemes studied by the World Bank, the median coverage
rate was 80 percent. The study also found no correlation between a country’s economic and financial
development and maximum coverage ratios (World Bank, 2008).

Some countries offer more complex coverage rates. For example, Italy and Mexico offer an array of
guarantee rates. Rate levels depend on the risk assessment and the type of loan. In another interesting
example, the Chilean fund FOGAPE determines coverage rates based on an auction.

Types of loans
Another important element that policy makers must take into account is whether a scheme should
provide individual or portfolio loans. A loan-level or individual model applies when applications are
approved by the guarantor. In this case, there is a direct link between the borrowers and the lend.

Since the application assessment is done on case-by-case basis. This allows for a more careful risk
management and likely reduces the probability of moral hazard. Such a scenario probably results in a
higher quality loan portfolio. However, this method can also be more costly for the fund to manage.
According to the World Bank, 72 percent of credit guarantee schemes use this selective or individual
loan approach (World Bank, 2008).

If the objective of the scheme is to increase guarantee and credit volume, the portfolio model might be
a better approach. Under this approach, the guarantor negotiates the criteria of the portfolio. For
example, a fund can specify that loans made with its guarantees are targeted to the SMEs sector, a
particular location or a specific loan size. However, the portfolio model does have some disadvantages.
Because the screening process is less meticulous, default rates tend to be higher. Moreover, since the
portfolio is based on specific lending objectives, there is less risk diversification. Managers are thus
confronted with a trade-off between lending volume and portfolio quality.

International experience has shown that only 14 percent of the 76 schemes studied by the World Bank
use the portfolio model. 9 percent of schemes use a combination of the loan-level/individual model
and portfolio model. The study did not find any indication that country income level or financial
development played a role in determining which model was used by the guarantee schemes in
different countries.
Question 3
What is agent?
Broadly speaking, an agency exists wherever the agent has the power to affect the legal rights
and obligations of the principal.

The primary, but not sole, function of an agent is to make contracts on behalf of the principal.
An independent dealer is not an agent. The facts may need to need to be examined closely to
determine the true nature of the legal relationship between the parties.

Its Functions
While the most common function of an agent is to bring about a contractual relationship
between the principal and a third party, it is not an agent’s only function, nor is it a necessary
function. A person who has no authority to make contracts on behalf of his or her principal may
nevertheless be an agent if he or she has authority to:

 Receive moneys on behalf of the principal and give a valid receipt

 Pay moneys on behalf of the principal
 Make representation for which the principal will be responsible;
 Receive representation on behalf of the principal.

These are only some of the more common examples of what an agent may do in appropriate
circumstances. The common factor is that in each case, the agent has authority to affect the
legal position of the principal vis-à-vis third parties.

An agent may make contracts on behalf of the principal

The most important task of an agent is to make contracts on behalf of the principal. This is an
exception to the rule of privity of contract.

An agent may receive moneys on behalf of the principal

In appropriate circumstances, an agent can have power to receive moneys on behalf of the
principal and to give a valid discharge (receipt). If a debtor pays the debt to the principal’s
agent, the principal cannot sue the debtor for non-payment.

However, just because a person receives money does not make him or her agent. For example,
the general rule in respect of estate agents is that they receive the deposit from the purchaser
as a stakeholder and not as agent for the vendor. If, therefore, the agent disappears with the
money, the purchaser will suffer, not the vendor.
An agent may pay moneys on behalf of the Principal
An agent can have power to pay moneys on behalf of the principal and to receive a valid
discharge. For example, home buyers often use a solicitor to arrange final settlement of the
purchase and to pay the balance of the moneys due under the contract.

An agent may make representations on behalf of the principal

In appropriate circumstances, an agent will have power to make representations on behalf of
the principal which will be legally enforceable against the principal. This may apply even
thought the agent does not have the power to create contractual relations between the
principal and those third parties. For example, a real estate agent will normally have the power
to make representations binding on the principal, but generally does not have the power to
make a contract, or even to receive moneys for the vendor.

This is a particularly important function of an employee. Employers ought to be aware that their
potential legal liability is not curtailed by merely ensuring that their employees cannot make
contracts on their behalf.

An agent may receive representations on behalf of the principal

Just as an agent may have the power to make representation on behalf of another person, an
agent may have the power to receive representations on behalf of another. This means the
principal can enforce representations made to the agent.

Some common commercial relationship and agency

There are numerous varieties of special agents, such as mercantile agents, stock brokers and
solicitors. The powers of the agent in each case will depend on the facts of the case. It should
be noted that an agency relationship may coexist with another legal relationship.

Here is the list of names, some common relationships;

 Employer/Employee
 Independent contractor
 Bailor/bailee
 Partnership
 Supplier/Buyer
 Franchisor/Franchisee

How is an agency created?

The relationship of principal and agent may be created by deed, by agreement in writing or
orally, or by operation of law. There are no formal requirements, except in the following
situation;
  An agent can only execute a deed on behalf of the principal if the authority to do so is
contained in a deed. This deed is called a power of attorney and is widely used within
the community. The power of Attorney may be limited to one matter or it may be
extremely wide, entitling the agent (attorney) to do most things that the principal could
do in person. The usual wording for the wider power would be as follows; ‘I authorize
my attorney to do on my behalf anything that I ma lawfully authorize an attorney to do’.
Being a deed, the power of attorney must be signed, sealed and delivered by the
principal in the presence of witnesses.

Agency may be created by express agreement

The simplest way in which an agency may be created is by express agreement between the
principal and the agent. The agreement does not have to be a binding agreement. For instance,
it is not necessary that the principal provide any consideration. It is sufficient if the principal
instructs or requests the agent to do something and the agent agrees to carry out that request
or instruction.

Agency may be created by implied agreement

Just as contract may be inferred from the conduct of the parties, so also may an agency be
implied form conduct. This will occur where it is reasonable to infer form all the circumstances
that the parties have conducted themselves in such a ay that principal-agent relationship exists.
The test is objective. In the next case, the issue was whether an insurance consultant was an
agent for the insurance company, or an agent for the insurer, or neither.