CMA Foundation Study Material Business Laws Paper 1 Lesson 2.1

Prepare for your CMA Foundation Paper 1 Business Laws and Business Communication. using our CMA Foundation Study Materials. Here is Lesson 2.1 Essential Elements of a Contract, Types of Contract, Offer and Acceptance.

In Lesson 2.1 of the CMA Foundation Paper 1, you will learn the fundamental principles of contract law under the Indian Contracts Act, 1872, which governs commercial agreements and legal relationships in India.

Lesson 2.1 Essential Elements of a Contract, Types of Contract, Offer and Acceptance

Historical Background

• Pre-1872: Courts applied English Common Law adapted to Indian conditions
• Challenges: Difficulties with English laws led to application of Hindu and Muslim personal laws
• Solution: Indian Contract Act, 1872 was enacted based on English Common Law principles

Structure of the Act

The original act was divided into four parts:

1. Sections 1-75: General principles of contract
2. Sections 76-123: Sale of goods (now repealed – replaced by Sale of Goods Act, 1930)
3. Sections 124-238: Special contracts
4. Partnership provisions: Repealed and replaced by Partnership Act, 1932

Key Definitions

Contract [Section 2h]

Definition: “An agreement between two or more parties enforceable by law”

Agreement [Section 2e]

Definition: “Every promise and every set of promises forming consideration for each other”

Important Formula

• Agreement = Offer + Acceptance
• Contract = Agreement + Enforceability by Law

Other Key Terms

Consideration [2d]: Act, abstinence, or promise in return for a promise

Offer/Proposal [2a]: Expression of willingness to do/abstain from doing something

Acceptance [2b]: Signifying assent to a proposal

Promisor [2c]: Person making the proposal

Promisee [2c]: Person accepting the proposal

Agreement vs Contract

Agreement (Sec 2e)

• “Every promise and every set of promises forming the consideration for each other.”
• In short: Offer + Acceptance = Agreement
• When an agreement is backed by law, it becomes a contract.

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

Examples:

1. Agreement not a contract: “I will meet you for coffee tomorrow.” – No legal obligation.
2. Contract: A agrees to sell his bike to B for ₹50,000. If A doesn’t deliver, B can sue.

Essentials of a Valid Contract

For an agreement to become a valid contract under the Indian Contract Act, 1872, it must satisfy the following conditions:

(1) Agreement

To form a contract, there must first be an agreement. An agreement consists of an offer by one party and an acceptance by another. For it to be valid, the terms of the offer must be clear and definite, and the acceptance must be absolute and unconditional.

(2) Free Consent

A valid contract requires the free consent of the parties (Sec. 14, Indian Contract Act, 1872). Consent is said to be free when it is not obtained by coercion, undue influence, fraud, misrepresentation, or mistake. If consent is not free, no valid contract comes into existence.

(3) Lawful Consideration

A contract must be supported by consideration, i.e., “something in return.” Consideration can be an act, a promise, or an abstinence (not doing something). But it must be real and lawful, otherwise the contract will not be valid.

(4) Competency of Parties

The parties entering into a contract must be legally capable. A person is competent if he/she is:

1. At least 18 years of age,
2. Of sound mind, and
3. Not disqualified from contracting by any law.

If these conditions are not met, the contract is not valid. Also, the consent given by the parties must be genuine and not caused by coercion, undue influence, fraud, or misrepresentation.

(5) Legality of Object

The object of the agreement must be lawful. If the object or the consideration is illegal or against public policy, the contract becomes void. A contract must not violate the provisions of law or regulations of the country.

(6) Intention to Create Legal Relationship

The parties must intend that their agreement should create a legal obligation. Social or domestic agreements are not enforceable as contracts.

Examples:

• A husband promising to buy his wife a necklace is not a contract.
• Balfour vs. Balfour: A husband promised to pay his wife a household allowance of ₹5,000. When they separated, the wife sued for allowance. The court held that such agreements are purely domestic and not legally enforceable.
• A film actor promises to attend a dinner party but fails to turn up. The host cannot sue for expenses made, because it was only a social arrangement, not a legal one.
• A father promising to pay his son money if he passes an exam is also not enforceable.

(7) Agreements Not Expressly Declared Void

The agreement must not belong to the category of agreements that are expressly declared void by law (such as agreements in restraint of marriage, restraint of trade, or wagering agreements).

(8) Consensus ad Idem (Meeting of Minds)

• Both parties must understand the agreement in the same sense
• Example: A has Alto and Maruti 800, intends to sell 800 but B thinks he’s selling Alto – no contract

(9) Certainty and Possibility of Performance

• Terms must be certain and capable of being performed
• Vague or impossible terms make contract void

(10) Legal Formalities

• Compliance with required formalities (writing, registration if required)
• Oral contracts have same effect as written contracts unless law requires writing

Types of Contracts

Contracts can be classified into different types depending on their enforceability, method of formation, performance, and obligations.

A. Based on Enforceability

1. Valid Contract

A valid contract is one which satisfies all the essential elements of a contract. It creates legal obligations and is fully enforceable by law.

2. Void Agreement [2g]

An agreement not enforceable by law is a void agreement. Such agreements have no legal effect and cannot be enforced in a court.

Examples:

• An agreement to marry in exchange for dissolving an existing marriage.
• An agreement where the subject matter has already been destroyed (e.g., selling a house which had already collapsed).

3. Voidable Contract [2i]

A contract which is enforceable by law at the option of one party only. The other party has no choice but to follow.

Example: A contract obtained through fraud or undue influence → the victim can either enforce it or declare it void.

4. Void Contract [2j]

A contract that was valid when made, but later becomes unenforceable due to supervening reasons.

Example: A trade agreement between two countries becomes void if war breaks out between them.

5. Unenforceable Contract

• A contract that is good in substance, but cannot be enforced because of technical defects (such as lack of writing, registration, or proper stamping) is an unenforceable contract.
• Once these defects are corrected, the contract can be enforced.
• Example: An oral agreement that is legally required to be in writing.

6. Illegal Contract

An illegal contract is one that is forbidden by law. Illegal contracts are void from the beginning and may also attract penalties. Importantly, all illegal contracts are void, but not all void contracts are illegal.

B. Based on Method of Formation

1. Express Contract

An express contract is formed by spoken or written words where the terms are clearly stated. Example: A written agreement for sale of goods.

2. Implied Contract

An implied contract is formed through the conduct of parties Example: When a person boards a bus, an implied contract is created that he will pay the fare.

3. Tacit Contract

A tacit contract is one inferred from circumstances. Example: Contract formed when a person withdraws cash from an ATM.

4. E-Contract

Contracts formed through electronic means such as e-mails, websites, and digital platforms are e-contracts. Though the medium is different, they must still satisfy all the essential requirements of a valid contract.

C. Based on Performance

1. Executed Contract

An executed contract is one where both parties have completely fulfilled their obligations. Example: Cash purchase with immediate delivery

2. Executory Contract

An executory contract is one where some or all of the promises remain to be performed by either party, such as an agreement to deliver goods at a future date. Example: Agreement to deliver goods next month.

D. Based on Obligation

1. Unilateral Contract

A unilateral contract creates an obligation on only one party. Example: a railway ticket where the passenger has paid and only the railway company is bound to provide transport.

2. Bilateral Contract

A bilateral contract involves mutual obligations, such as a typical contract of sale where one party is bound to deliver goods and the other to pay the price.

3. Multilateral Contract

A multilateral contract involves more than two parties and is usually complex in nature, often used in international trade agreements or joint ventures.

Offer and Acceptance

Offer (Proposal)

The law of contract begins with the concept of an offer, also called a proposal. An offer is the expression of a person’s willingness to enter into a contract on certain definite terms, with the intention that it shall become binding once accepted by the other party.

Types of Offers

An offer may be express, when it is made in spoken or written words, or implied, when it is inferred from conduct or circumstances.

For example, a bus service offering to carry passengers makes an implied offer to anyone boarding the bus.

Offers may also be specific, made to a particular person or group of persons, or general, made to the public at large.

A famous case on general offers is Carlill v. Carbolic Smoke Ball Co., where a company promised to pay a reward to anyone who used its product as directed and still contracted influenza; the court held that such an offer could be accepted by anyone from the public who fulfilled the conditions.

Offer vs Invitation to Offer

It is important to distinguish between an offer and an invitation to offer.

An offer shows willingness to be bound by acceptance, whereas an invitation to offer merely invites others to make an offer.

Examples of Invitation to Offer:

• Job advertisements
• Auction advertisements
• Goods displayed with price tags
• Tender notifications

The leading case on this point is Pharmaceutical Society v. Boots, where it was held that goods displayed in a self-service store with price tags were only invitations to offer, and the contract was formed when the customer brought the goods to the cashier and the cashier accepted payment.

There are other forms of offers as well.

Cross Offer

A cross offer occurs when two persons make identical offers to each other in ignorance of the other’s offer. Since neither has accepted, no contract arises.

Counter Offer

A counter offer takes place when the offeree accepts the offer but with modifications or conditions. This has the effect of rejecting the original offer and creating a new one.

Example: If A offers to sell his car to B for ₹3.8 lakhs and B replies that he will buy it for ₹3.5 lakhs, this is not acceptance but a counter offer.

Legal Rules for Valid Offers

For an offer to be valid, certain legal rules must be followed.

1. An offer may be expressed or may be implied from the conduct of the parties or circumstances of the case.
2. Offer may be specific or general
3. It must create a legal obligation
4. The terms must be definite and certain
5. It must be distinguished from an invitation to offer
6. It must be communicated
7. Any special terms must be communicated
8. It must be made to obtain consent
9. It should not impose unnecessary obligation for non-acceptance
10. An offer to make offer is not an offer

Acceptance

Once an offer has been made, it has to be accepted to make a valid contract.

Definition [Section 2B]

An acceptance is defined under Section 2(b) of the Indian Contract Act as the assent given by the person to whom the proposal is made. When the offeree signifies consent, the proposal becomes accepted and the agreement turns into a promise. For acceptance to be valid, it must be absolute and unqualified, meaning it should fully correspond with the terms of the offer. A qualified acceptance amounts to a counter offer and not acceptance. In Neale v. Merret, for example, an acceptance with altered payment terms was held not to be valid acceptance.

Essentials of Valid Acceptance

For an acceptance to be legally valid under the Indian Contract Act, 1872, it must satisfy certain essential conditions.

1. Must be Absolute and Unqualified

An acceptance must be absolute and unqualified. This means the offeree must accept all the terms of the offer exactly as they are, without any changes or conditions. If the offeree modifies the terms while accepting, it becomes a counter offer rather than true acceptance.

For example, if A offers to sell his car for ₹3 lakhs and B replies that he will pay ₹2.8 lakhs, this is not acceptance but a counter offer. The case of Neale v. Merret illustrates this principle, where conditional acceptance of payment terms was not treated as valid acceptance.

2. Must be Communicated

Acceptance must be communicated to the offeror. Until the offeror knows of the acceptance, no contract is formed. Silence on the part of the offeree cannot amount to acceptance.

In Felthouse v. Bindley, it was held that silence is not acceptance. Similarly, in the case of Lalman Shukla v. Gauri Dutt, the court held that a reward cannot be claimed unless the person performing the act knew about the offer and accepted it.

3. Must be in Prescribed/Reasonable Mode

Acceptance must be made in the prescribed mode if one has been specified by the offeror. If the offeror has not prescribed a mode, then acceptance must be made in a reasonable manner. Acceptance may also be signified through conduct, provided it clearly conveys assent.

4. Must be Within Time Limit

Acceptance must be made within the prescribed time limit. If no time has been fixed, it should be within a reasonable time, otherwise the offer lapses.

In Ramsgate Victoria Hotel v. Montefiore, an acceptance made after a long delay was held invalid because it was not within a reasonable time.

5. Cannot Precede Offer

Acceptance must always follow an offer. A person cannot accept an offer before it is actually communicated to him. Similarly, only the person to whom the offer was made can give acceptance, unless there is prior consent to the contrary.

6. Only by Person to Whom Offer is Made

Only the person to whom the offer was made can give acceptance, unless there is prior consent to the contrary.

7. Rejected Offer Needs Renewal

Once an offer has been rejected, it cannot be accepted later unless the offeror renews it.

8. Revocation Rules

Once an acceptance has been communicated in the prescribed manner, it becomes irrevocable. The offeree cannot withdraw his acceptance once it has reached the offeror.

Thus, for a valid acceptance, it must be absolute and unconditional, communicated properly, made in the prescribed or reasonable mode, within the proper time, and by the right person, and it cannot be revoked once effectively communicated.

Communication of Offer, Acceptance & Revocation

The Indian Contract Act lays down clear rules regarding the communication of an offer, its acceptance, and the revocation of either. These rules are mainly provided under Sections 4, 5, and 6 of the Act.

Section 4 – When Communication is Complete

For Offers

The communication of an offer is considered complete when it comes to the knowledge of the person to whom it is made.

For example, if A posts a letter offering to sell his house to B, the communication of the offer is complete only when B receives the letter and reads its contents.

For Acceptance

The communication of acceptance has two aspects:

• As against the proposer (the person who made the offer), it is complete when the acceptance is put into a course of transmission so that it is out of the power of the acceptor. For instance, if B posts a letter of acceptance to A, the moment the letter is posted, the acceptance is complete as against A.
• As against the acceptor, communication is complete only when the acceptance actually comes to the knowledge of the proposer. So in the same example, the acceptance is complete against B only when A receives the letter.

For Revocation

The communication of revocation also follows a dual rule:

• Against the person who makes the revocation, it is complete when the revocation is put into the course of transmission.
• Against the person receiving it, the communication is complete when it actually comes to his knowledge.

Section 5 – Revocation Rules

When Offer Can Be Revoked

An offer can be revoked at any time before the communication of its acceptance is complete as against the proposer. Once the acceptance is dispatched, the offeror cannot revoke the offer. Similarly, acceptance can be revoked at any time before the communication of acceptance is complete as against the acceptor. But once it has reached the proposer, the acceptance becomes final and cannot be withdrawn.

Section 6 – Modes of Revocation

The law also specifies various situations in which an offer comes to an end. An offer may be revoked in the following ways:

• By communication of a notice of revocation from the offeror to the offeree.
• By the lapse of the time prescribed in the offer, or if no time is prescribed, then by the lapse of a reasonable time.
• By failure of the acceptor to fulfill a condition precedent to acceptance.
• By the death or insanity of the proposer, provided this fact is known to the acceptor before acceptance.
• By the making of a counter-offer, which automatically terminates the original offer.
• By the acceptance not being made in the prescribed mode.
• By a change in the law that renders the contract illegal.

Thus, communication and revocation rules are vital because they determine the exact point at which a contract is formed or an offer comes to an end.

Important Case Studies for Exams

Case laws form the backbone of understanding the Indian Contract Act because they illustrate how principles are applied in real situations. Let us look at some of the most important ones that are frequently asked in exams.

Contract Formation Cases

Carlill vs Carbolic Smoke Ball Co.

One of the landmark cases is Carlill vs Carbolic Smoke Ball Co. In this case, the company advertised that anyone who used their smoke ball product as directed and still contracted influenza would be entitled to a reward of £100. Mrs. Carlill used the smoke ball as prescribed but still caught influenza. The company argued that the advertisement was a mere invitation to treat, not a binding offer.

The Court, however, held that it was a general offer made to the public and Mrs. Carlill’s conduct amounted to valid acceptance. Thus, she was entitled to the reward. This case illustrates that offers can be made to the public and can be accepted by performance.

Balfour vs Balfour

Another important case is Balfour vs Balfour, which explains the principle of intention to create legal relations. Here, a husband promised to pay his wife a monthly allowance while working abroad. Later, when he stopped payments, the wife sued him. The Court held that agreements between husband and wife made in domestic or social contexts do not ordinarily have legal force, as the parties do not intend to create legal obligations.

Pharmaceutical Society vs Boots

The case of Pharmaceutical Society vs Boots also highlights the difference between an offer and an invitation to offer. In this case, Boots introduced a self-service system in their store where goods were displayed on shelves. The Court ruled that the display of goods with price tags was not an offer but merely an invitation to offer. The actual offer was made when a customer brought the goods to the cashier, and acceptance occurred when the cashier approved the sale.

Communication Cases

Lalman Shukla vs Gouri Dutt

The case of Lalman Shukla vs Gouri Dutt emphasizes that acceptance without knowledge of an offer is not valid. In this case, a servant found his master’s missing nephew without knowing that a reward had been announced. Since he was unaware of the reward offer at the time of his actions, he could not claim it.

Felthouse vs Bindley

Similarly, in Felthouse vs Bindley, an uncle wrote to his nephew offering to buy a horse and added, “If I hear no more about it, I will consider the horse mine.” The nephew did not reply, and the horse was mistakenly sold to someone else. The Court ruled that silence cannot amount to acceptance, and therefore no valid contract was formed.

Brogden vs Metropolitan Railway

In Brogden vs Metropolitan Railway, the Court reinforced the principle that acceptance must be communicated. A contract remained incomplete until the acceptance was brought to the notice of the proposer.

Revocation Cases

Ramsgate Victoria Hotel vs Montefiore

A notable case is Ramsgate Victoria Hotel vs Montefiore. Here, Montefiore applied for shares in June but was only allotted them in November. By then, the value of shares had fallen, and he refused to take them. The Court held that the acceptance was not within a reasonable time and thus was invalid. This case highlights the importance of time in contract acceptance and that undue delay can lead to the lapse of an offer.

Conclusion

In this lesson, we explored the different types of contracts, the rules of offer and acceptance, and the importance of proper communication in forming valid agreements. We also studied how acceptance must be absolute, communicated, and within time, and how offers can be revoked under certain conditions.

Finally, we reviewed landmark case laws that illustrate these principles in practice. Together, these concepts will give you a strong understanding of how contracts are created, enforced, or declared void under Indian law. Once you are thorough with lesson 2.1, you can move on to the lesson 2.2, which deals with void and voidable agreements.

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