Indian Contract Act basics

Commerce (General / Accounting and Finance / Banking and Insurance) (B.Com) · Law and audit · free study notes for exams, placements and interviews

In short

The Indian Contract Act, 1872 (Act IX of 1872) is the general law of agreements in India: it says when a promise becomes legally enforceable, when it is void or voidable, and what remedies follow a breach. Sections 1-75 cover general principles (offer, acceptance, consideration, consent, performance, breach, quasi-contracts) and Sections 124-238 cover specific contracts (indemnity, guarantee, bailment, pledge, agency); the law of sale of goods and partnership was carved out into separate Acts in 1930 and 1932. It is tested in every B.Com business-law paper, in CA/CS/CMA foundation and intermediate law papers, and in bank PO/clerk and SSC general-awareness sections. On the job it underlies every vendor agreement, loan document, guarantee, employment letter and purchase order an accountant, auditor or banker handles.

Explained

Formation: offer, acceptance and agreement

Proposal/offer (s.2a): one person signifies willingness to do or abstain from doing something, to obtain the assent of another. Must be communicated, certain, and intend to create legal relations.
Invitation to offer is not an offer: price lists, catalogues, tenders invited, auction notices, prospectus, goods displayed in a shop. The customer makes the offer; the shop accepts.
Acceptance (s.2b): absolute and unqualified (s.7), in the mode prescribed, within reasonable time. A conditional or qualified acceptance is a counter-offer and kills the original offer.
Silence is not acceptance; nor can an offeror impose acceptance by inaction. Performance of conditions in a general offer is acceptance (Carlill-type general offers; in India, *Harbhajan Lal v Harcharan Lal*).
Communication (s.4): a proposal is complete when it comes to the offeree's knowledge. Acceptance is complete against the proposer when the letter is posted, and against the acceptor when it reaches the proposer — hence revocation of acceptance is possible before it reaches the proposer (s.5).
Lapse/revocation of offer (s.6): notice of revocation, lapse of time, failure of a condition precedent, death or insanity of the offeror (if known to the offeree), or rejection/counter-offer.
Agreement (s.2e) = every promise and every set of promises forming the consideration for each other (in exam shorthand, offer + acceptance). Contract (s.2h) = an agreement enforceable by law. So *all contracts are agreements, but not all agreements are contracts*.
E-contracts: click-wrap, shrink-wrap and browse-wrap agreements are valid; the Information Technology Act, 2000 (ss.10A, 11-13) validates electronic offer and acceptance and fixes dispatch/receipt rules, but excludes negotiable instruments, powers of attorney, trusts and wills.

Essentials of a valid contract (s.10)

Offer and acceptance — lawful, communicated, mirror-image.
Intention to create legal relations — social or domestic arrangements (*Balfour v Balfour*) are outside.
Lawful consideration (s.2d, 23, 25) — "something in return": past, present or future; done at the desire of the promisor; need not be adequate but must be real and lawful. Privity of consideration is not needed in India — a stranger to consideration can sue (*Chinnaya v Ramayya*) — but privity of contract is still the rule (a stranger to the contract cannot sue, subject to exceptions: trust, family settlement, acknowledgement, estoppel, marriage settlement).
- Exceptions where no consideration is needed (s.25): natural love and affection between near relations, in writing and registered; promise to compensate a past voluntary service; promise in writing to pay a time-barred debt; completed gift; agency (s.185); bailment (s.148).
Capacity (ss.11-12): parties must be of the age of majority (18 under the Indian Majority Act, 1875 — uniformly 18 since the Indian Majority (Amendment) Act, 1999 deleted the old 21-year rule for persons under a court-appointed guardian), of sound mind, and not disqualified by law (alien enemy, insolvent, convict, foreign sovereign).
- A minor's agreement is void ab initio (*Mohori Bibee v Dharmodas Ghose*) — it cannot be ratified on majority, and the minor cannot be ordered to repay, though s.33 of the Specific Relief Act, 1963 allows restoration of traced benefit. A minor can be a promisee/beneficiary, a partner by agreement only for benefits (s.30, Partnership Act), and is liable under s.68 for necessaries supplied — out of the minor's estate, not personally.
- Sound mind (s.12): capacity to understand the contract and form a rational judgement as to its effect. A usually-sane person may contract when sane; a usually-insane person may contract during lucid intervals.
Free consent (ss.13-22) — see next sub-heading.
Lawful object (s.23) — not forbidden by law, not defeating any law, not fraudulent, not injurious to person or property, not immoral or against public policy (trading with enemy, stifling prosecution, trafficking in public office, marriage brokage, interference with justice).
Not expressly declared void — ss.26-30 and s.56.
Legal formalities — writing, registration, stamping or attestation where a statute requires it (e.g., Transfer of Property Act, Registration Act, Stamp Act).

Free consent and the vitiating factors

Factor	Section	Effect on contract	Burden/remedy
Coercion — committing/threatening an act forbidden by the IPC (now BNS, 2023) or unlawful detaining of property	15	Voidable at the option of the party coerced (s.19)	Money/thing received must be repaid or returned (ss.64, 72)
Undue influence — one party in a position to dominate the will of the other and uses it to get an unfair advantage	16	Voidable; court may set aside absolutely or on terms (s.19A)	Burden of proving fairness shifts to the dominant party where the transaction is unconscionable
Fraud — active concealment, false statement known to be false, promise without intention to perform, any act fitted to deceive	17	Voidable; also damages	Mere silence is not fraud unless there is a duty to speak or silence is equivalent to speech
Misrepresentation — innocent false statement believed to be true	18	Voidable; no damages	Rescission, or insist on performance
Mistake of fact, bilateral and essential	20	Void	—
Mistake of Indian law (s.21) / unilateral mistake (s.22)	21, 22	Contract valid	Mistake of foreign law is treated as mistake of fact

Exception to s.19: if the party's consent was caused by misrepresentation or by silence amounting to fraud, and that party had the means of discovering the truth with ordinary diligence, the contract is not voidable.
Unfair/unconscionable terms in standard-form contracts are controlled by s.16, s.23 (public policy), the doctrine of fundamental breach, and consumer law (handled in its own note).

Classification of contracts and void agreements

By enforceability: valid; void agreement (s.2g — void ab initio, never enforceable); void contract (s.2j — valid when made, later becomes unenforceable); voidable (s.2i — enforceable at the option of one party); illegal (unlawful object; collateral agreements also fail); unenforceable (good in substance but defective in form — unstamped, unregistered, time-barred).
By formation: express, implied (s.9), quasi-contract, and e-contract.
By performance: executed, executory, unilateral, bilateral.
Expressly void agreements: in restraint of marriage (s.26); in restraint of trade (s.27 — stricter than English law; only exception in the Act is sale of goodwill, plus statutory exceptions under the Partnership Act ss.11, 36, 54. Service-period negative covenants are valid; post-employment restraints are generally void, though confidentiality and non-solicitation clauses are often upheld); in restraint of legal proceedings (s.28, subject to exceptions for arbitration); agreements whose meaning is uncertain (s.29); wagering agreements (s.30 — void, and in Maharashtra and Gujarat illegal under the Bombay Wagers (Amendment) Act, 1865; insurance is not a wager because of insurable interest); impossible acts (s.56); and agreements without consideration (s.25).
Contingent contract (ss.31-36): performance depends on a collateral uncertain future event (e.g., insurance, guarantee). Enforceable only when the event happens (s.32); void if the event becomes impossible (s.32, s.34) or if it is impossible at the time of making (s.36).
Quasi-contract (ss.68-72): obligation without agreement, resting on unjust enrichment — necessaries to an incapable person (68), payment by an interested person (69), non-gratuitous act (70), finder of goods (71, duties mirror those of a bailee), money/goods received by mistake or coercion (72).

Performance, discharge and breach

Who performs (ss.37-42): the promisor, their representative (legal representatives are bound unless the contract involves personal skill), or an agent. Joint promisors are jointly and severally liable in India (s.43) and may claim contribution.
Tender (attempted performance): a valid tender of performance that is refused discharges the promisor from liability but not from rights under the contract (s.38).
Time and place (ss.46-50, 55): where time is of the essence, failure makes the contract voidable; where it is not, the party gets compensation only. In commercial sales, time of delivery is usually of the essence; time of payment usually is not.
Appropriation of payments (ss.59-61): debtor's express direction first; then circumstances implying intention; otherwise the creditor may apply it to any lawful debt, including a time-barred one.
Discharge of contract by: performance; mutual agreement (novation, rescission, alteration, remission, waiver — s.62, 63); operation of law (death, insolvency, merger); impossibility/frustration (s.56) — destruction of subject matter, death or incapacity in personal-service contracts, supervening illegality, non-occurrence of the contemplated state of things; and breach.
- Frustration does not cover commercial hardship, rise in cost, strikes or partial difficulty (*Satyabrata Ghose v Mugneeram Bangur*). The doctrine of frustration in India rests on s.56 as a positive rule, not on implied terms (*Energy Watchdog v CERC*, 2017 — a rise in Indonesian coal prices did not frustrate a power purchase agreement). Force majeure clauses, when present, govern instead of s.56.
Breach: actual (on the due date or during the course of performance) or anticipatory (repudiation before performance is due — the aggrieved party may sue at once or wait, s.39).

Remedies for breach

Rescission of the contract (s.39, and Specific Relief Act ss.27-30).
Damages (s.73) — compensation for loss "naturally arising in the usual course of things" or which the parties knew would result (the rule in *Hadley v Baxendale*, adopted in s.73). Remote and indirect loss is not compensated. Types: ordinary/general, special (only if communicated), nominal, vindictive/exemplary (only for breach of promise to marry and wrongful dishonour of a cheque), and liquidated. The claimant has a duty to mitigate (explanation to s.73).
Liquidated damages and penalty (s.74): Indian law makes no rigid distinction — the court awards reasonable compensation not exceeding the named amount, whether the sum is a genuine pre-estimate or a penalty. Proof of actual loss is normally required unless loss is impossible to prove (*Kailash Nath Associates v DDA*, 2015; *ONGC v Saw Pipes*, 2003).
Quantum meruit — payment for the part performed where the contract is discharged by the other party's fault.
Specific performance and injunction under the Specific Relief Act, 1963 as amended in 2018: specific performance is now the general rule and not a discretionary remedy (s.10), with substituted performance available (s.20) and special provisions for infrastructure contracts.
Interest and costs under the Interest Act, 1978; commercial debts also attract the MSMED Act, 2006 interest regime where the supplier is a registered micro or small enterprise.

Specific contracts (ss.124-238)

Indemnity (s.124): promise to save another from loss caused by the conduct of the promisor or any other person. Two parties; liability is contingent; the indemnity-holder can recover damages, costs and sums paid under compromise (s.125).
Guarantee (s.126): three parties — surety, principal debtor, creditor; the surety's liability is secondary and co-extensive with the principal debtor's (s.128). Types: specific and continuing (s.129, revocable as to future transactions by notice, s.130, or by the surety's death, s.131). Surety is discharged by variance in terms (s.133), release or discharge of the principal debtor (s.134), compounding or giving time (s.135), creditor's act impairing the surety's remedy (s.139), or loss of security (s.141). Surety gets rights of subrogation (s.140) and contribution between co-sureties (ss.146-147).
Bailment (s.148): delivery of goods by one person to another for a purpose, to be returned or disposed of as directed; ownership does not pass. Bailee must take care as a prudent owner of his own goods (s.151), is not liable for loss without negligence (s.152), and has a particular lien for services (s.170); bankers, factors, wharfingers, attorneys and policy brokers have a general lien (s.171).
Pledge/pawn (s.172): bailment of goods as security for a debt. The pawnee may retain (s.173), sue and sell after notice (s.176); a pledge by a person in possession under a voidable contract is good if made in good faith (s.178A).
Agency (ss.182-238): agent acts for and binds the principal. Created by agreement, ratification (ss.196-200) or operation of law (agency by necessity, estoppel, holding out). Classes: special, general, universal; sub-agent (s.191) and substituted agent (s.194). Agent's duties: follow instructions, reasonable skill, account, no secret profit, no delegation (*delegatus non potest delegare*). Rights: remuneration, lien, indemnity. Termination (ss.201-210): revocation, renunciation, completion, death/insanity, insolvency of the principal; an agency coupled with interest is irrevocable (s.202). Undisclosed principal and personal liability of the agent (ss.230-233) are frequently examined.

Key points

Contract (s.2h) - an agreement enforceable by law; agreement + enforceability.
Offer vs invitation to offer - a catalogue, tender notice or shop display invites offers; it is not an offer.
Postal rule (ss.4-5) - acceptance binds the proposer on posting, the acceptor only on receipt; so acceptance can be revoked before receipt.
Consideration (s.2d) - at the promisor's desire, may be past/present/future, need not be adequate but must be real and lawful.
Privity of consideration - not required in India; privity of contract is required, with recognised exceptions.
No consideration, no contract - exceptions in s.25: natural love and affection (written and registered), past voluntary service, time-barred debt in writing, agency, bailment, completed gift.
Minor's agreement - void ab initio, no ratification, no estoppel; liable only for necessaries out of their estate (s.68).
Coercion, undue influence, fraud, misrepresentation - make the contract voidable; bilateral mistake of fact makes it void.
Mistake of Indian law does not excuse; mistake of foreign law is treated as a mistake of fact.
Section 27 - all agreements in restraint of trade are void in India except sale of goodwill and statutory partnership exceptions; English "reasonableness" test does not apply.
Wagering agreement (s.30) - void; collateral transactions remain valid (except in Maharashtra and Gujarat, where wagers are illegal).
Contingent contract (s.31) - performance depends on a collateral uncertain event; insurance and guarantee are examples.
Quasi-contract (ss.68-72) - liability imposed by law on unjust enrichment, with no agreement at all.
Frustration (s.56) - impossibility or supervening illegality discharges the contract; commercial hardship and price rise do not.
Anticipatory breach (s.39) - the aggrieved party may sue immediately or keep the contract alive and sue at the due date.
Section 73 / 74 - damages for loss naturally arising or communicated; for a named sum, only reasonable compensation up to that sum.
Indemnity (2 parties) vs guarantee (3 parties) - indemnity liability is primary and contingent; a surety's liability is secondary and co-extensive.
Pledge is bailment for security - the pawnee may retain, sue and sell after reasonable notice (ss.173-176).

Formulas and examples

Damages under s.73 = (Loss naturally arising in the usual course) + (Special loss actually communicated at the time of contracting) − (Loss avoidable by reasonable mitigation). Remote or indirect loss = nil. Amounts in ₹.
Damages on a seller's failure to deliver goods = (Market price on the date of breach − Contract price) × Quantity; on a buyer's refusal to accept = (Contract price − Market price on the date of breach) × Quantity.
Compensation under s.74 = min(Reasonable compensation proved, Sum named in the contract). The named sum is a ceiling, never an automatic entitlement.
Surety's maximum liability = min(Amount guaranteed, Amount outstanding from the principal debtor), reduced by securities realised by the creditor.

1. Seller's non-delivery — ordinary and special damages. A Ludhiana mill contracts to deliver 500 quintals of cotton yarn at ₹9,200/quintal on 1 August. It does not deliver; market price on 1 August is ₹9,750/quintal. The buyer had told the mill that failure would cost it a ₹3,00,000 penalty on an export order; it also lost an uncommunicated ₹5,00,000 resale profit.

Ordinary damages = (9,750 − 9,200) × 500 = ₹550 × 500 = ₹2,75,000.
Special damages = ₹3,00,000 (communicated at the time of contracting, so within the second limb of s.73).
Uncommunicated resale profit = nil (remote under the *Hadley v Baxendale* rule).
Total recoverable = ₹5,75,000.

2. Section 74 — named sum as a ceiling. A contractor forfeits earnest money of ₹10,00,000 under a clause fixing that amount for delay. Actual proved loss is ₹4,20,000.

Named sum = ₹10,00,000; reasonable compensation proved = ₹4,20,000.
Award = min(₹4,20,000, ₹10,00,000) = ₹4,20,000; the balance ₹5,80,000 is not awarded merely because the clause names it (*Kailash Nath Associates v DDA*).
If the contract had instead named ₹2,50,000 and the proved loss were ₹4,20,000, the award would be capped at ₹2,50,000.

3. Surety's liability and securities. B borrows ₹20,00,000 from a bank; S guarantees ₹8,00,000 of it. B repays ₹6,00,000 and defaults; the bank sells B's hypothecated stock for ₹5,00,000.

Outstanding after repayment = 20,00,000 − 6,00,000 = ₹14,00,000.
Less security realised = 14,00,000 − 5,00,000 = ₹9,00,000 still due.
S's liability = min(₹8,00,000, ₹9,00,000) = ₹8,00,000 (co-extensive but capped by the guarantee). On paying, S is subrogated to the bank's rights against B for ₹8,00,000 (s.140).
If the bank had, without S's consent, released the stock, S would be discharged to the extent of ₹5,00,000 (s.141), leaving liability of ₹3,00,000.

4. Mitigation and anticipatory breach. On 1 March, a buyer repudiates a contract to take 1,000 litres of edible oil at ₹140/litre deliverable 1 June. Market price is ₹132 on 1 March and ₹118 on 1 June. The seller sues on 1 March.

Suing immediately: damages = (140 − 132) × 1,000 = ₹8,000.
Keeping the contract alive to 1 June: damages = (140 − 118) × 1,000 = ₹22,000, but the seller carries the risk of further price movement and of the contract being frustrated meanwhile.
Either course is open under s.39; a seller who unreasonably refuses an available resale at ₹132 may have the claim reduced to the mitigated figure.

5. Quasi-contract, s.70. A transporter, finding consignee premises shut, pays ₹18,000 of statutory demurrage to save the goods, non-gratuitously and with the consignee's knowledge.

No agreement exists, so there is no contractual claim.
Under s.70, the consignee enjoyed the benefit of a lawful, non-gratuitous act and must restore ₹18,000 (compare s.69, where payment of another's legal liability by an interested person is recoverable).

Basis	Void agreement (s.2g)	Voidable contract (s.2i)	Illegal agreement
Validity	Void from the start	Valid until rescinded	Void and unlawful
Option with a party	No	Yes, the aggrieved party	No
Collateral agreement	May be valid	Valid	Also void
Example	Minor's agreement, wager	Consent by coercion or fraud	Agreement to smuggle
Restitution	s.65 where it becomes void later	On rescission, s.64	Generally no relief

Where it is used

Banking and NBFC credit: loan agreements, deeds of guarantee, hypothecation and pledge of gold or stock, letters of continuity — bank PO and credit-officer roles apply ss.126-147 and 172-176 daily.
Insurance: policies are contingent contracts needing insurable interest (not wagers); claim settlement turns on misrepresentation and non-disclosure under ss.17-19 read with s.45 of the Insurance Act, 1938.
Procurement, vendor and SLA management: purchase orders, liquidated-damages clauses, force majeure, indemnity caps, arbitration clauses — reviewed by finance and commercial teams in L&T, Reliance, Infosys, TCS and PSU tendering.
Audit and assurance: engagement letters (SA 210) are contracts; auditors test contingent liabilities from guarantees, penalty and LD clauses, and revenue recognition against contract terms under Ind AS 115.
HR and employment: appointment letters, bonds for training costs, notice-period and non-solicitation clauses tested against s.27 and s.74.
Company secretarial and legal compliance roles: agency and authority questions (who can bind the company), board resolutions, powers of attorney, and e-contract validity under the IT Act, 2000.

Interview questions

Q: Are all agreements contracts? A: No. Every contract is an agreement, but an agreement becomes a contract only if it satisfies s.10 — consent, consideration, capacity, lawful object and enforceability.
Q: Can a stranger to consideration sue in India? A: Yes — privity of consideration is not required (*Chinnaya v Ramayya*), but a stranger to the contract generally cannot sue, except in cases like trust, family settlement, estoppel or acknowledgement.
Q: What happens if a minor misrepresents their age and takes a loan? A: The agreement is still void ab initio; the lender cannot enforce repayment, though a court may order restoration of the identifiable benefit under s.33 of the Specific Relief Act, 1963.
Q: Difference between fraud and misrepresentation? A: Fraud is a false statement made knowingly or recklessly with intent to deceive and allows rescission plus damages; misrepresentation is innocent and allows rescission only.
Q: When does a contract become void instead of voidable? A: When consent is caused by a bilateral mistake of an essential fact (s.20), or when the object is unlawful, or performance becomes impossible under s.56; voidability arises from coercion, undue influence, fraud or misrepresentation.
Q: Is a non-compete clause enforceable in India? A: During employment, yes; after employment it is normally void under s.27, which admits no reasonableness test, although confidentiality and non-solicitation obligations are often upheld.
Q: Does a liquidated-damages clause guarantee the full named amount? A: No. Under s.74 the court awards reasonable compensation not exceeding the named sum, and actual loss must usually be proved.
Q: Difference between indemnity and guarantee? A: Indemnity has two parties and the indemnifier's liability is primary and contingent on loss; guarantee has three parties and the surety's liability is secondary but co-extensive with the principal debtor's.
Q: How is a pledge different from a bailment or hypothecation? A: A pledge is a bailment specifically as security for a debt with possession passing to the pawnee; ordinary bailment has no security purpose, and in hypothecation the borrower keeps possession.
Q: Will a rise in raw-material prices frustrate a contract? A: No. Commercial hardship is not impossibility under s.56 (*Satyabrata Ghose*; *Energy Watchdog v CERC*); only an express force majeure clause can give relief.
Q: What are a buyer's options on anticipatory breach? A: Under s.39, sue immediately treating the contract as rescinded, or keep it alive and sue on the due date — accepting the risk of market movement and intervening frustration.
Q: Are click-wrap online terms binding? A: Yes — the IT Act, 2000 (ss.10A, 11-13) validates electronic offer and acceptance, though unconscionable terms can be attacked under ss.16 and 23.

Common mistakes

Writing "void" for contracts caused by coercion, fraud, undue influence or misrepresentation — they are voidable, and only bilateral mistake of fact is void.
Confusing privity of consideration (not required in India) with privity of contract (required).
Applying the English reasonableness test to restraint-of-trade clauses; s.27 is absolute except for sale of goodwill and partnership exceptions.
Saying majority is 21 where a guardian has been appointed — that exception was removed in 1999; it is 18 for everyone.
Treating the sum named in a penalty clause as automatically recoverable, ignoring the s.74 ceiling and the need to prove loss.
Claiming remote or uncommunicated losses under s.73, or forgetting the duty to mitigate.
Saying a minor can ratify the agreement on turning 18, or that estoppel can be used against a minor who lied about age.
Mixing up a general lien (bankers, factors, wharfingers, attorneys, policy brokers — s.171) with a bailee's particular lien (s.170), and treating hypothecation as a pledge.