Essentials of a Contract & Remedies for Breach

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Businesses both individual and corporate enter into business relationships with either individuals or businesses to enable them to carry on their day-to-day commercial transactions. Most of these relationships result in “contracts” that have legal consequences. Most contracts do not have to be in writing to be enforceable. This article aims to provide an overview of the basic principles of contracts law and the consequences and relief’s available for their breach

DEFINITION OF A CONTRACT

 

A contract is a legally enforceable agreement between two or more parties. The core of most contracts is a set of mutual promises (in legal terminology, “consideration”). The promises made by the parties define the rights and obligations of the parties. For every contract there must be an agreement.

 

An agreement is defined as every promise and every set of promises forming the consideration for each other and a promise is an accepted proposal

 

Contracts are enforceable in the courts. If one party meets its contractual obligations and the other party doesn’t (“breaches the contract”), the non-breaching party is entitled to receive relief through the courts.

 

Generally, the non-breaching party’s remedy for breach of contract is monetary damages that will put the non-breaching party in the position it would have enjoyed if the contract had been performed. Under special circumstances, a court will order the breaching party to perform its contractual obligations.

 

Because contracts are enforceable, parties who enter into contracts can rely on contracts in structuring their business relationships.

 

In this country and most others, businesses have significant flexibility in setting the terms of their contracts. Contracts are, in a sense, private law created by the agreement of the parties. The rights and obligations of the parties are determined by the contract’s terms, subject to limits imposed by relevant statutes.

 

ESSENTIALS OF A CONTRACT

 

The Indian Contract Act -1872 defines “contract” as an agreement enforceable by law. The essentials of a (valid) contract are:

 

(a) intention to create legal relations;

 

(b) offer and acceptance;

 

(c) consideration;

 

(d) capacity to enter into a contract

 

(e) free consent of the parties

 

(f) lawful object of the agreement

 

Writing is not essential for the validity of a contract, except where a specific statutory provision requires writing. An arbitration clause must be in writing.

 

CREATION OF A CONTRACT

 

A deal done on a handshake - “You do X for me, and I’ll pay you Y” - is a contract, because it is a legally enforceable agreement involving an exchange of promises. Most contracts are enforceable whether they are oral or written. Nonetheless, one should always have written contracts for all your business relationships.

 

There are several reasons why written contracts are better than oral contracts:

 

The process of writing down the contract’s terms and signing the contract forces both parties to think about - and be precise about - the obligations they are undertaking. With an oral contract, it is too easy for both parties to say “yes” and then have second thoughts.

 

With an oral contract, the parties may have different recollections of what they agreed on (just as two witnesses to a car accident will disagree over what happened). A written agreement eliminates disputes over who promised what.

 

Some types of contracts must be in writing to be enforced. The Indian Copyright Act –1957 requires a copyright assignment or exclusive license to be in writing.

 

If you have to go to court to enforce a contract or get damages, a written contract will mean less dispute about the contract’s terms as the burden of proof lies with you.

 

OFFER AND ACCEPTANCE

 

A contract is formed when one party (the “offeror”) makes an offer which is accepted by the other party (the “offeree”). An offer - a proposal to form a contract - can be as simple as the words, “I’ll wash your car for you for 10 Rupees.”

 

When an offer has been made, no contract is formed until the offeree accepts the offer. When you make an offer, never assume that the offeree will accept the offer. Contractual liability is based on consent.

 

Except for the simplest deals, it generally takes more than one round of negotiations to form a contract. Often, the offeree responds to the initial offer with a counter-offer. A counter-offer is an offer made by an offeree on the same subject matter as the original offer, but proposing a different bargain than the original offer.

 

Consideration, is what one party to a contract will get from the other party in return for performing his contracted obligations. Accordingly, if one party makes a promise and the other party offers nothing in exchange for that promise, the promise is unenforceable. Such a promise is known as a “gratuitous promise.” Gratuitous promises are “unenforceable for lack of consideration.”

 

Lack of consideration is rarely a problem for promises made in the context of business relationships. In most business contracts, there is consideration for both parties (“mutual consideration”, in legal terminology).

 

When one person signifies to another his willingness to do or abstain from doing anything with a view to obtaining the assent of the other to such act or abstinence, he is said to make a proposal.

 

When the person to whom the proposal is made signifies his assent thereto, the proposal is said to be accepted.

 

In order to convert a proposal into a promise, the acceptance must be

 

Absolute and unqualified – Any departure from the terms of the offer or any qualification vitiates the acceptance unless it is agreed to by the person from whom the offer comes. An acceptance with a variation is no acceptance; it is simply a counter proposal.

 

PARTIES TO A CONTRACT

 

Minors and the mentally incompetent lack the legal capacity to enter into contracts. All others are generally assumed to have full power to bind themselves by entering into contracts. The legal age for entering into contracts is 18. The test for mental capacity is whether the contracting party has understood the nature and consequences of the transaction in question.

 

Companies have the power to enter into contracts. They make contracts through the acts of their agents, officers, and employees. Whether a particular employee has the power to bind the corporation to a contract is determined by an area of law called agency law or corporate law. If you doubt whether an individual with whom you are dealing has authority to enter into a contract with you, either ask to see the authority, failing which, insist that the contract be reviewed and signed by the head of the company.

 

A corporation has a separate legal existence from its founders, officers, and employees. Generally, the individuals associated with a corporation are not themselves responsible for the corporation’s debts or liabilities, including liability for breach of contract.

 

ESSENTIALS OF A VALID CONRACT

 

All agreements are contracts if they are made by the free consent of parties competent to contract – Consent is said to be free if it is not caused by

 

Coercion – Consent is said to be caused by coercion when it is obtained by pressure exerted by either committing or threatening to commit an act forbidden by the Indian Penal Code.

 

Undue influence – A contract is said to be induced by “undue influence” where the relation 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 – Means and includes the following acts done with the intention to deceive or to induce a person to enter into a contract. (a) the suggestion that a fact is true when it is not true and the person making the suggestion does not believe it to be true

 

(b) active concealment of a fact by a person who has knowledge or belief of the fact,

 

(c) promise made without the intention of performing it.

 

Misrepresentation – When a person positively asserts that a fact is true when his information does not warrant it to be so, though he believes it to be true, it is misrepresentation.

 

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

 

STANDARDCONTRACT PROVISIONS: Many contracts include special types of provisions to meet the specific needs of the contracting parties. However the following provisions should form part of every contract.

 

Duties and Obligations: The duties and obligations section of a contract is a detailed description of the duties and obligations of the parties and the deadlines for performance. If one party’s obligation is to create a multimedia work, software, or content for a multimedia work, detailed specifications should be stated.

 

Representations and Warranties

 

A warranty is a legal promise that certain facts are true. Typical representations or warranties in contracts concern such matters as ownership of the contract’s subject matter (for example, real estate) and the right to sell or assign the subject matter. In multimedia industry contracts, warranties of ownership of intellectual property rights and non infringement of third parties’ intellectual property rights are common.

 

For contracts involving the sale of goods, certain warranties are implied under state law unless specifically disclaimed by the parties.

 

Termination Clauses

 

These clauses ensure that either or both parties have the right to terminate the contract under certain circumstances. Generally, termination clauses describe breach of contract events that trigger the right to terminate the contract (for example, nonpayment of royalties). Termination clauses also describe the methods of giving notice of exercise of the termination right, and whether the breaching party must be given an opportunity to cure the breach before the other party can terminate the contract.

 

Remedy Clauses

 

These clauses state what rights the non-breaching party has if the other party breaches the contract. In contracts for the sale of goods, remedy clauses are usually designed to limit the seller’s liability for damages.

 

Arbitration Clauses

 

An arbitration clause states that disputes arising under the contract must be settled through arbitration rather than through court litigation. Such clauses generally include the name of the organization that will conduct the arbitration, the city in which the arbitration will be held, and the method for selecting arbitrators.

 

Merger Clauses

 

Merger clauses state that the written document contains the entire understanding of the parties. The purpose of merger clauses is to ensure that evidence outside the written document will not be admissible in court to contradict or supplement the terms of the written agreement.

 

BREACH OF CONTRACT

 

The parties to a contract must either perform or offer to perform, their respective promises, unless such performance is dispensed with or excused under the provisions of the Act, or any other law.

 

Promises bind the representatives of the promisor in the case of death of such promisor before performance, unless a contrary intention appears from a contract.

 

In a contract the agreement being enforceable by law, each party to the contract is legally bound to perform his part of the obligation. Non-performance of the duty undertaken by a party in a contract amounts to breach of contract, for which he can be made liable.

 

Remedies for breach of contract

 

The legal remedies for breach of contract are:

 

(a) damages; (b) specific performance of the contract; and (c) injunction.

 

In practice damages constitute the main remedy.

 

When a contract has been breached, the party who suffers by such breach is entitled to receive, from the party who has breached the contract, compensation for any loss or damage caused to him thereby, being loss or damages which naturally arose in the usual course of things from such breach or which the parties knew, when they made the contract, to be likely to result from the breach of it.

 

Such compensation is not to be given for any remote and indirect loss of damage sustained by reason of the breach.

 

A person who rightfully rescinds a contract is entitled to compensation for any damage, which he has sustained through non-fulfillment of the contract.

 

Liquidated damages and penal stipulations

 

If a sum is named in the contract as the amount to be paid in case of breach of contract, or if the contract contains any other stipulation by way of penalty, the party complaining of the breach is entitled, whether or not actual damage of loss is proved to have been caused thereby, to receive, from the party who has broken the contract, reasonable compensation, not exceeding the amount so named or the penalty stipulated for.

 

A stipulation for increased interest from the date of default may be regarded as a stipulation by “way of penalty”. The court is empowered to reduce it to an amount which is reasonable in the circumstances.

 

Specific performance

 

In certain special cases (dealt with in the Specific Relief Act, 1963), the court may direct against the party in default “specific performance” of the contract, that is to say, the party may be directed to perform the very obligation which he has undertaken, by the contract. This remedy is discretionary and granted in exceptional cases. Specific performance means actual execution of the contract as agreed between the parties.

 

Specific Performance of any contract may, in the discretion of the court be enforced in the following situations

 

l When there exists no standard for ascertaining the actual damage caused by the non-performance of the act agreed to be done; or

 

l When the act agreed to be done is such that monetary compensation for its non-performance would not afford adequate relief.

 

Instances where compensation would be deemed adequate relief are:

 

l Agreement as a consequence of a breach by a landlord for repair of the rented premises;

 

l Contract for the sale of any goods, for instance machinery or goods.

 

EXCEPTIONS:

 

A contract which runs into such minute or numerous details or which is so dependent on the personal qualifications or volition of the parties, or otherwise from its nature is such, that the court cannot enforce specific performance of its material terms, cannot be specifically enforced.

 

Another situation when a contract cannot be specifically enforced is where “the contract is in its nature determinable”. A contract is said to be determinable, when a party to the contract can put it to an end.

 

A contract the performance of which involves the performance of a continuous duty, which the Court cannot supervise, cannot be specifically enforced.

 

PERSONS WHO CANNOT OBTAIN SPECIFIC PERFORMANCE

 

The specific performance of a contract cannot be obtained in favour of a person who could not be entitled to recover compensation for the breach of contract.

 

Specific performance of a contract cannot be enforced in favor of a person who has become incapable of performing the contract that on his part remains to be performed, or who violates any essential term of the contract that on his part remains to be performed, or who acts fraudulently despite the contract, or who willfully acts at variance with, or in subversion, of the relation intended to be established by the contract.

 

I hope this gives you a relevant overview into the key aspect of business contracts and if one takes adequate care when drafting contracts, needless to say relationships will be better and probably more profitable.

 

(The article was contributed by Chandrapal Singh, a leading legal professional based out of Bangalore. Feedback can be mailed to legalese@businessgyan.com)

Issue BG20 Nov02