Corporate Legal Environment

Self Learning Material

Corporate LegalEnvironment

(MBA-302)

Course: Master Business Administration

Semester-III

Distance Education Programme

I.K. Gujral Punjab Technical University

Jalandhar

SyllabusCorporate Legal Environment (MBA 302)

Objective: The objective of this paper is to acquaint the students with the corporate legalframework prevalent in the country.

Unit I

Law of Contract: Definition, offer and Acceptance, Consideration, Capacity of parties, FreeConsent, Legality of Object, Performance and Discharge of Contract and Remedies for Breach ofContract. Introduction to the concept of agent and different types of mercantile agents Bailmentand Pledge, Indemnity and Guarantee

Unit II

Sale of Goods Act: Meaning, Formation of contract, Meaning of condition and warranties.Difference between Transfer of Property and Possession, Right of an Unpaid SellerNegotiable Instrument: Bills of Exchange, Promissory Note, Cheque and Rules Regarding theCrossing of Cheques. Dishonour of cheques and liability of banker and drawer.Law of Insurance: Fundamentals Elements of Insurance. Basic features of law relating to carriers(Air, Road, Rail and Shipping)

Unit III

Company Law Incorporation of companies Memorandum of Association and Articles ofAssociation Membership of a company Prospectus, Issue of capital, Loans, investments, depositsand charges, Meetings, Accounts and Auditors, Amalgamation, reconstructions, arrangements andcompromises Provision with respect to appointment and removal of Director, Meeting, Winding upby court

Unit IV

Taxation: Constitutional framework of taxation. Direct and indirect taxes. Basic features ofCentral excise, Customs, Central, state sales tax and VAT.

Note : Relevant Case Studies should be discussed in class.

Suggested text Books:

1. Majumdar A. K. and Kapoor G. K. ‘Company Law’ Taxmann Publishers2. Bansal C. L. ‘Business Laws’ Taxmann Publishers3. Singhania V. K. and Singhania K. ‘Direct Tax Laws and Practice’ Taxmann Publishers.4. Chawla, Garg and Sarin ‘Mercantile Law’ Kalyani Publishers.5. K. R. Bulchandani ‘Law and corporate law’ Himalya Publishing

Table of ContentsLesson No. Title Written by Page No.

1 Law of Contract-1 Ms. Manpreet Kaur, I.K.G.PunjabTechnical University, Jalandhar

1

2 Law of Contract-2 Ms. Manpreet Kaur, I.K.G. PunjabTechnical University, Jalandhar

17

3 Law of agency-I Ms. Deepali Soni, I.K.G. PunjabTechnical University, Jalandhar

35

4 Law of agency-II Ms. Deepali Soni, I.K.G. PunjabTechnical University, Jalandhar

50

5 Indemnity and Guarantee Ms. Deepali Soni, I.K.G. PunjabTechnical University, Jalandhar

67

6 Sale of Goods Act Ms. Manpreet Kaur, I.K.G. PunjabTechnical University, Jalandhar

81

7 Conditions and Warranties Ms. Deepali Soni, I.K.G. PunjabTechnical University, Jalandhar

98

8 Negotiable Instrument Ms. Deepali Soni, I.K.G PunjabTechnical University, Jalandhar

116

9 Law of insurance Ms. Manpreet Kaur, I.K.G. PunjabTechnical University, Jalandhar

133

10 Basic Features of Law to Carriers Ms. Manpreet Kaur, I.K.G. PunjabTechnical University, Jalandhar

148

11 Company Law Ms. Deepali Soni, I.K.G. PunjabTechnical University, Jalandhar

164

12 Prospectus, Issue of capital, Loans,investments, deposits and charges

Ms. Deepali Soni, I.K.G. PunjabTechnical University, Jalandhar

184

13 Meetings Ms. Deepali Soni, I.K.G. PunjabTechnical University, Jalandhar

200

14 Provision With Respect ToAppointment and Removal of Director

Ms. Manpreet Kaur, I.K.G. PunjabTechnical University, Jalandhar

218

15 Taxation Ms. Manpreet Kaur, I.K.G. PunjabTechnical University, Jalandhar

242

Reviwed by:Dr. Savita, Assistant Professor

Deptt. of Commerce, Maharaja Agarsen University Baddi

© IK Gujral Punjab Technical University JalandharAll rights reserved with IK Gujral Punjab Technical University Jalandhar

LESSON – 1

Law of Contract-1

Structure

1.1 Objectives

1.2 Definition

1.3 Essential of valid contract

1.4 offer

1.4.1 Essential of valid offer

1.5 Acceptance

1.5.1 Essential of valid acceptance

1.5.2 Revocation of acceptance

1.6 Consideration

1.6.1 Essentials of valid acceptance

1.7 Legality of object

1.7.1 Meaning of object and consideration

1.7.2 Meaning of legality

1.8 Capacity of parties

1.9 Free Consent

1.9.1 Meaning of consent

1.10 Summary

1.11 Glossary

1.12 Answer to Check Your Progress

1.13 Suggested Readings

1.14 Terminal and Model Questions

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1.1 Objectives:

After reading this lesson, you should be able:

To understand the meaning of law

To understand meaning of contract

To understand essentials of valid contact

To differentiate between offer and acceptance

To understand consideration, capacity of parties, free consent and legality of object etc.

1.2 Definition of contract

The word contract owes its origin to the Latin word ‘contractum’ which means drawn together.

Contract is an agreement creating and defining obligations between parties.

Anson defines a contract as “A legally binding agreement made between two or more persons by

whom rights are acquired by one more to act or forbearance on the part of the other or others”

A contract is defined in the contract act, (section 2h) as “an agreement enforceable by law”

The concept of a contract consists of two elements, i.e. obligation and agreement. Obligation is

understood ‘as a legal tie, which impose upon a person or persons. When two or more parties

reach in identity of minds regarding a particular subject matter and express to each other that

identity of minds in some understandable manner, we call it an agreement.

Agreement = Offer+ Acceptance

The requirements of an obligation are:

a. There must be two persons

b. The obligation must relate to definite act or acts

c. The obligation must relate to legal matters and not social or domestic affairs

d. Consensus ad idem or identity of minds

An agreement is necessarily the outcome of consenting minds. This means parties to

agreement must have agreed about the subject matter of the agreement in the same sense

and at the same time.

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(e) Mutual communication

There should be communication of their respective intentions.

1.3 Essentials of a valid contract

Contracts arise under various circumstances. They may arise from face to face conversations

over telephone or by any other means of communication. All contracts are agreement, but all

agreements are not contracts.

According to the section 10 of the contract act “all agreements are contracts if they made by the

free consent of parties competent to contract, for lawful consideration and with a lawful object,

and are not hereby expressly declared to be void”.

According to above definition a valid contract must have the following elements:

1. Consensus Ad Idem: there must be identity or meeting of minds. Parties are said to

consent when they agree upon the same thing in the same sense.

For example, if A who owns two estates, one at Mumbai and another at Delhi, offers to

sell B one estate, A intending it to be the one Mumbai and B accepts the offer, thinking

that it is the estate at Delhi, there is no consensus, and hence no contract. Such a contract

is void

2. There should be no flaw in the consent of the parties: consent is said to be free when it

is not caused by coercion, undue influence, fraud, mispresentation or mistake. The

existence of any these vitiating elements would make the contract a voidable one.

3. Competency of parties: the parties of the agreement must have the capacity to contract.

Secs. 11 and 12 of the act deal with this aspect. Every parson of full age and sound mind

is competent to contact. Flaw in capacity to contract may arise from minority, idiocy,

drunkenness, etc., and status. If either party has suffered incapacity to contract, the

contract is rendered void.

4. Lawful consideration: an agreement without consideration is void. Consideration means

an advantage or benefit moving from one person to the other. In other words, it is

something in return.

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5. Lawful object: the object of the agreement must not be illegal, immoral or opposed to

public policy. The rule is that, an agreement is the object of which is unlawful is void

6. Agreement not declared to be void: the agreement should not have been expressly

declared void by any law in force of the land. Thus the agreement in restraint of trade, in

restraint of marriage is all void.

1.4 Offer

The process of making an agreement commences with offer. Offer is a proposal by one party

to another to enter into a legally binding agreement with him. A proposal is an expression of

will or intention. A person is said to have made a proposal, when he signifies to another his

willingness in order to obtain the assent of another to such act. The word proposal is

synonymous with the English word offer. The person who makes the offer is called the

offeror, proposer or promisor and the person to whom it is made is known as the offeree or

promise.

1.4.1 Essentials of a valid offer

1. Express and implied offer: an express offer is one which is made by words, spoken or

written.

Example: an offer to sell his pen to b for Rs 20

An implied offer is one which is gathered from the conduct of the parties or the

circumstances of the case.

2. Specific and general offer: an offer is said to be specific when it is addressed to a

definite person or body of persons. A general offer is one which is addressed to the world

at large even though it may be accepted by a definite person. General offers are termed as

offers at large or offers to public, and specific offers to the individual.

3. Offer and standing offer or tender: an offer for the continuous supply of certain goods

at a certain rate over a definite period is called a standing offer. Such offers though

accepted do not give rise to a contract unless an actual order is placed. The offeror can

withdraw his offer at any time, before an order is placed with him. But when a particular

order is placed for goods the person who made the tender cannot refuse to supply those

goods.

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4. Offer and invitation to treat: an invitation to treat is sometimes called an invitation to

offer. Every expression of willingness to enter into a contract may not amount to an offer.

It is only an initial step in the formation of a contract. So, quotations, catalogues,

advertisement in a newspaper for sale of an article or goods displayed by the shopkeeper

in a shop window or on shelves do not constitute an offer.

5. Offer must be capable of creating legal relations: to constitute an offer the offeror

must intend to create a legal obligation. Social invitation, even though it is accepted, does

not create legal relations. To offer a friend a dinner, does not involve a legal action.

6. Offer must be definite: section 29 states “agreement, the meaning of which is not

certain, or capable of being made certain, are void”. So the notice of revocation is

complete as against the person making it when it is in transit. As against the person to

whom the revocation is made, it is complete when it comes to is knowledge.

1.5 Acceptance

The assent given to a proposal may be understood as acceptance. A proposal when accepted

becomes a promise. In other words, offer+ acceptance=contract. An application for the shares

in a company is in the nature of offer while the allotment of the shares by the company is an

acceptance resulting in a contract. An acceptance once completed cannot be revoked.

An acceptance may be express or implied. It is express when it is communicated by words

spoken or written or by doing some required act. It is implied when it is to be gathered from

the surrounding circumstances or the conduct of parties.

1.5.1 Essentials of valid acceptance

For a valid acceptance, the following are the elements

1. Acceptance must be by the offeree.

2. Acceptance must be absolute and unconditional.

3. Acceptance should be before an offer lapses. Acceptance should be communicated.

1. Acceptance must be by the offeree: when an offer is made to a specified person it can

be accepted by him alone. No person can give himself a contractual right by inter posing

in an offer which was not intended for him.

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2. Acceptance must be absolute and unconditional: the acceptance of the offer should

correspond to the terms of the offer, and the acceptor should not impose any condition

while accepting the offer. Acceptance must be without any condition.

3. Acceptance should be before the offer lapses: an offer in order to ripen into a contract

by acceptance should continue to exist at the time of acceptance. Until an offer is

accepted, it creates no legal obligations, and it may be terminated at any time.

4. Acceptance should be communicated: just as the communication of the offer,

acceptance also should be communicated. The communication need not be of a particular

kind, but silence can never be prescribed as a mode of communication.

Activity-1

Explain essentials of a valid offer with examples------------------------------------------------------

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1.5.2 Revocation of acceptance

An acceptance may be revoked at any time before the communication of acceptance is complete

as against the acceptor, but not afterwards.

1.6 Consideration

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Consideration can be dined as “it is the price of a promise”

According to section 2(d) of the Indian Contract Act, "When at the desire of the promisor, the

promisee or any other person has done or abstained from doing, or does or abstains from doing,

or promises to do or abstain from doing something, such act or abstinence is called a

consideration for the promisee."

It is clear from the above definition that consideration consists of either some benefits to the

promiser or some detriment to the promise. Moreover, consideration is:

a) An act, i.e. doing of something. In this sense consideration is an affirmative form.

Example: X promises Y to guarantee payment of price of the goods which y sells on

credit to Z. here sates by Y to Z is a consideration for the promise of X.

b) An abstinence or forbearance, i.e. astringing or refraining from doing something. In this

sense, consideration is in a negative form.

Example: X promises Y not to file a suit against him if he pays him Rs. 1000. The abstinence

of X is the consideration for the payment of Y.

c) A return promise.

1.6.1 Essentials of valid consideration

1) Consideration is essential: consideration in the sense of detriment is quite indispensable

to support a simple promise.

2) Consideration must move at the desire of the promisor: the act or forbearance must be

at the desire of the promisor. The act has done at the desire of the third party cannot be a

consideration. A promise which is gratuitous is void. A promise to give a donation is not

enforceable as there is no benefit to the promiser. But if the promise has incurred liability

relying upon the promise, it is enforceable.

3) Consideration may move from the promise or any other person: in Indian law, a

stranger to consideration may maintain a suit if he is a party to the contract. But under the

English law, consideration must move from the promise.

4) Consideration may be past, present or future: under the English past consideration is

no consideration. In other words, consideration must be either executed or executory, but

can never be past.

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In Indian law, consideration may be past, present or future.

Example: X promises to deliver certain goods to Y after a fortnight.

5) Consideration must be competent: although consideration need not be adequate, it must

be real, competent and not illusory. For example a promised to pay money a police

officer to investigate into a crim. It was held that the agreement was invalid because, the

officer was already under duty to do so by law.

6) Consideration must be lawful: if the consideration is unlawful, the contract is unforce

able and void.

1.7 Legality of an object

One of the most important elements of a valid contract is that its object and consideration

must be lawful. If the object or the consideration is unlawful, the contract is also unlawful

and unenforceable. Sec. 10 and sec. 23 emphasize this requirement in the following words:

Sec. 10 “all agreement is contract if they are made for lawful consideration and with lawful

object”.

Sec. 23” every agreement of which the object or consideration is lawful, is void”.

1.7.2 Meaning of object and consideration

Thus, a contract, the object and consideration of which is unlawful, the contract will be

unenforceable. The words’ object’ means the ‘purchase’ for which the contract has been

entered into. Where a loan of Rs. 50,000 is taken for the purpose of marriage, the

consideration for the contract is a loan and the object of the contract is marriage. There are

cases where consideration for an agreement may be legal but its purpose may be illegal or

unlawful. In such cases, agreement would be void.

1.7.3 Meaning of legality

The term ‘legality’ may be defined as ‘conformity to law’. In other words, any act or a

contract must not be outside the provisions of law in force from time to time. Sec. 23, states

the acts which are unlawful or done for unlawful object or consideration.

Cases of unlawful object or consideration

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An agreement, the object and consideration of which is unlawful, and unenforceable and

void. Under section 23 the object or consideration of an agreement is applicable in the

following cases:

1. If it forbidden by law.

2. If it defeats the provisions of any law. if it is fraudulent

3. If it involves injury to person or property of another.

4. If it is immoral

5. If the court regards it as opposed to public policy.

1. If the object is forbidden by law: where the object or consideration of an agreement is

forbidden by law it is void and unlawful, an act is forbidden and specially punishable

under the provisions of law of the country or if it is forbidden by special legislation or by

the regulations made by the competent authority under powers derived from the

legislation. The term ‘law’ includes any law for the time being in force in India including

personal law

Example: ram agrees to sell certain goods to Mohan. Ram knows that the goods are to be

smuggled out of India. The contract is unlawful because selling of goods for smuggling is

forbidden by law.

2. If object is of such a nature that, if permitted, it would defeat the provisions of law:

sometimes the object and consideration of an agreement is not directly forbidden by law,

but it is of such a nature that, if permitted, it would defeat the provisions of the law. In

such cases, the object of consideration is unlawful and void.

Example: Ramesh’s estate is sold for the recovery of land revenue. Under the provisions of an

act of legislature, by which the defaulter is not allowed to purchase directly or indirectly his own

estate, Naresh by an arrangement with Ramesh, agreed to purchase the land in auction. Naresh

purchased the land and he conveyed it to Ramesh receiving from him the price paid. The

agreement is unlawful, if it is allowed; it will defeat the purpose of the law.

3. If it is fraudulent: if the object of agreement is to cheat the other party it is unlawful and

void.

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Example: X, Y and Z enter into an agreement to divide among themselves the gain

acquired or to be acquired by them by fraud. The agreement is void as its object is

fraudulent

4. If it involves or implies injury to the person or property of another: where the

purpose of an agreement is to make injury to the person or property of another person it is

unlawful and void. Injury means damages, harm or wrong. Property may be movable or

immovable.

Example: an agreement which compels a debtor to do manual labor for the creditor as

long as the debt is not repaid is injurious to the person hence unlawful and void.

5. If the court regards it immoral: if the court regards the purpose of consideration of an

agreement immoral, it is void. The term ‘immoral’ depends upon the standards of

morality prevailing at a particular time and place and as approved by the court. In general

sexual immorality is regarded as an immoral act.

Example: X agrees to let his daughter to Y for concubinage. The agreement is void being

immoral, though the letting is not punishable under Indian panel code.

6. Where the court regards it as opposed to public policy: public policy is that principle

of law which provides that no person can lawfully do that which has a tendency to be

injurious to the public or pubic goods, the term public policy is not capable of exact

definition. This is a wider term and it is difficult to determine its limits with any degree of

exactness. Agreement as opposed to public policy is unlawful and void, if the object or

consideration of an agreement is against public goods or when it harms the public

welfare.

Activity- 2

Explain essentials of valid consideration----------------------------------------------------------------

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Check your progress A

(1) Consent means parties agree upon the………………

(a) Same thing (b) Different thing (c) Same thing in the same sense

(d) None of these

(2) An acceptance must be absolute and……………………

(a) Unconditional (b) Unnecessary (c) Valid (d) None of these

1.8 Capacity of parties

For a valid contract, the parties to a contract must have capacity i.e. competence to enter into a

contract.

Section 11 of the contract act deals with the competency of parties and provides that “every

person is competent to contract who is of age majority according to the law which he is subject,

and who is of sound mind and is not disqualified from contracting by any law to which he is

subject.”

According to this the following persons are incompetent to the contract

a) Minor

b) Person of unsound mind

c) Persons disqualified by any law to which they are subject

If the above persons entered into a contract then it is a voidable contract.

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a) Minor

An infant or a minor is a person who is not a major: according to the Indian majority act,

1875, a minor is one, who has not completed his or her age of 18 years,

Effects of minor’s agreement

The following are the various rule related to minor’s agreement:

1. An agreement with minor is a void contract: section 10 of the contract act requires that

the parties to a contract must be competent and section 11 says that a minor is not

competent. But neither section 10 nor 11 makes it clear that the contract made by minor

is void and voidable contract. But the Privy Council made it perfectly clear that a contract

entered by a minor is void contract and minor is not competent to a contract.

2. No ratification: an agreement with minor is completely void. A minor cannot ratify the

agreement even on attaining majority, because a void agreement cannot be ratified.

3. No estoppel against a minor: where a minor by misrepresenting his age and has induced

the other party to enter into a contract with him, he cannot be made liable on the contract.

There is no estoppel against him. The court may direct the minor to restore property

whether minor has got protection but he has no right to deceive others.

4. Minor can be a beneficiary: if a minor gets some benefit from a contract in which he

enter. Then there is no restriction on him to become a beneficiary

5. Insolvency: a minor cannot be declared insolvent as he is not able to pay debt and dues

from his personal property. He is not personally liable.

6. Minor can be an agent: a minor can be an agent but he will not be liable to his principal

for his act.

7. Partnership: a minor cannot enter in a contract or become a partner in partnership firm

but he can attain the benefits of partnership.

8. Joint contract by minor and adults: in such cases adult can be liable but not the minor.

When there is a joint purchase by two purchasers one is adult and other is minor then the

vendor can enforce the contract against the major partner not the minor.

9. Surety for a minor: in a contract of guarantee when an adult stands surety for a minor

then he is liable to third party as there is a direct contract between surety and third party.

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10. Minor as a shareholder: a minor being incompetent to contract cannot be a shareholder

of the company.

Persons of unsound mind

As per section 11 of contract act, for a valid contract each party to the contract must have

sound mind. Those contracts are void which are made by persons of unsound.

Section 12 deals with this question as to what is a sound mind for the aim of entering into

contract. According to this section “a person is said to be sound for the purpose of making a

contract if, at the time when he makes it he is capable of understanding it and of forming a

rational judgement as to its effect upon his interests”

Unsoundness of mind arises from idiocy, insanity, drunkenness, hypnotism and mental decay

etc.

d) Persons disqualified by any law to which they are subject:

1. Alien enemies: an alien is competent to a contract with Indian citizens. If he can enter

into a contract during peace time but if war is started an alien cannot enter into contract

and contract entered into before war are either stayed or terminated but contract during

war are unenforceable.

2. Foreign sovereigns and any minor: there persons have a right to enter into a contract

but cannot claim the privilege of not being sued,

3. Insolvents: an insolvent cannot enter into a contract as his property vests in official

receivers. This disqualification of an insolvent is removed after his discharge.

4. Convicts: when a convict is undergo imprisonment he is not capable of entering into

contract. But it comes into end when his sentence is over.

5. Corporations: a corporation is an artificial person recognized by law. It exists only in

the eyes of law. It can enter into a contract only by its agents.

1.9 Free consent

Free consent of all the parties is one moat important element of contract as per requirement

of section 10.

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1.9.1 Meaning of consent

Two or more persons are said to consent when they agree upon the same thing in the same

sense (section 13).it means that there is no contract if the parties have not agreed upon same

thing in the same sense. If the parties enter into an agreement concerning particular persons

or things but each other has different persons and thing in his mind then there is no presence

of contract according to law.

According to section 10- consent is said to be when it is not caused by

1. Coercion

2. Undue influence

3. Fraud

4. Misrepresentation

5. Mistake

When the consent to an agreement is caused by coercion, undue influence, Fraud or

Misrepresentation the contract is voidable at the option of the party whose consent was so

caused. But when consent is caused by Mistake the agreement is void.

Coercion

In simple words, coercion is a threat or force used by one party against another for

compelling him to enter into an agreement. Section 15 of Indian contract act defines coercion

as the committing or threatening to commit any act forbidden by Indian penal code or an

unlawful detaining or threatening to detain, any property to the prejudice of any person with

the intention of inducing any person to enter into an agreement.

Example: By threat of suicide, a Hindu induced his wife and son to execute a release in

favor of his brother in respect of certain properties which they claimed as their own. It was

held that threat of suicide amounted to coercion within section 15 and the release deed was

voidable

Example: A threatens to shoot B friend of C, if C does not let out his house to him C agrees

to do so. The agreement has been brought about by coercion.

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Undue influence

Sometimes the parties to an agreement are so related to each other that one party is in the

position to dominate the will of other party. On party compels the other to enter into contract

against his will as result of undue influence exerted by the other who is dominating position.

Coercion is the dominance of strong party on weak mind.

According to section 16 of Indian contract act “a contract is said to be induced by undue

influence where the relations subsisting between the parties are such that one of the parties is

in a position to dominate the will of the other and uses the position to obtain an unfair

advantage over the other”.

Example: A, police officer purchased a property worth Rs 2 lakhs for Rs. 20,000 from B, an

accused under his custody. But later on B wants to cancel the sale on the ground of undue

influence. It was held that A, the police officer is in the position to dominate the will of B

and existence of undue influence can be presumed.

Fraud

The term fraud includes all the acts committed by a person with an intention to deceive

another person.

Fraud is the willful representation made by a party to a contract with the intent to deceive the

other party or to induce such party to enter into a contract. It means a false statement made

by knowingly or without belief in its truth or recklessly without caring whether it is true or

false.

Example: A person aged over 60 years and thus beyond insurable age, deliberately makes a

false statement that he is 48 years old in order to take out an insurance policy. This amounts

to fraud, and the insurer is entitled to avoid the policy.

Misrepresentation

The word representation means a statement of fact made by one party to the other before or

at the time of contract is made with regard to some existing fact or some past event which

materially induces the information of the agreement. A wrong representation when made

innocently is misrepresentation.

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Example: A intends to sell his horse to B and says “My horse is perfectly sound” a genuinely

believe the horse to be sound, although he does not know that the horse has fallen ill

yesterday. B there upon buys the horse. There is misrepresentation on the part of A.

Mistake

Mistake may be defined as an erroneous belief concerning something. It means that parties

intending to do one thing have by intentional error done something else. Mistake may be of

two types:

1. Mistake of law

2. Mistake of fact

Check Your Progress B

State which of the following alternative is correct.

(1) Agreement= ………………. + acceptance

(a) Contract (b) offer (c) coercion (d) law

(2) Contract= agreement+ ……………..

(a) Mistake (b) void (c) voidable (d) Enforceability by law

1.10 SUMMARY

The concept of a contract consists of two elements, i.e. obligation and agreement. Obligation is

understood ‘as a legal tie, which impose upon a person or persons. When two or more parties

reach in identity of minds regarding a particular subject matter and express to each other that

identity of minds in some understandable manner, we call it an agreement.an agreement or

contract has essentials element which include free consent of parties, lawful consideration,

lawful object and capacity to parties etc.

1.11GLOSSARY

Contract: Contract is an agreement creating and defining obligations between parties.

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Fraud: Fraud is the willful representation made by a party to a contract with the intent to

deceive the other party or to induce such party to enter into a contract

Free consent: Two or more persons are said to consent when they agree upon the same thing in

the same sense (section 13).

Coercion: coercion is a threat or force used by one party against another for compelling him to

enter into an agreement.

Minor: An infant or a minor is a person who is not a major

1.12 ANSWERS TO CHECK YOUR PROGRESS

Check Your Progress A

(1) b

(2) d

Check Your Progress B

(1) c

(2) a

1.13 SUGGESTED READINGS

Garg, Sareen, Sharma, Chawla. Mercantile Law. Kalyani Publishers, 2010.

Kapoor, N.d. Elements of Mercantile Law. Sultan Chand & Sons, 2013.

1.14 TERMINAL AND MODEL QUESTIONS

1. “Parties to contract must be competent to contract” explain.

2. Define offer. What are the essentials of a valid offer?

3. “Two or more persons are said to consent when they agree upon the same thing in the same

sense”. Explain

4. In what cases the consideration and object of an agreement are said to be unlawful? Illustrate

with examples.

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Lesson-2

Law of Contract-2

Structure

2.0 Objectives

2.1 Performance of contract

2.1.1 Effect of refusal to accept offer of performance

2.1.2 By whom contracts must be performed

2.1.3. Demand of performance

2.2 Discharge of Contract

2.2.1 Discharge by agreement

2.2.2. Discharge by operation of law

2.2.3Discharge by breach

2.2.4 Discharge by performance

2.2.5 Discharge by impossibility

2.2.6 Discharge by lapse of time

2.3 Remedies for Breach of Contract

2.4 Summary

2.5 Glossary

2.6 Answer to check your progress

2.7 Model questions

2.8 Suggested readings

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2.0 Objectives


To understand the performance of contact.

To understand the performance of offer.

2.1 Performance of contract

Every contract creates a legal obligation which continues till the contract has been performed or

otherwise discharged. Performance of the contract is, in fact the most natural and usual mode of

extinction of an obligation. Performance of a contract consists in doing or causing to be done

what the promiser has promised to do. Section 37 of the act provides that the parties to a contract

must either

(a) Perform their respective promises or

(b) Offer to perform the same, unless

(c) Such performance is dispensed with or

(d) Excused under the provisions of this act, or of any other law.

A contract is said to be performed, when parties make:

1. Actual performance: when a party has done what he undertook to do there is nothing

left for to do. Then he said to have performed his obligation. The performance of contract

in order to be complete must, however, is made in accordance with the terms of the

contract.

2. Attempted performance or offer to perform: sometimes it so happens that the promiser

or offers to perform his obligation under the contract but the promise does not accept.

This is known as attempted performance or tender.

Where the promiser has made an offer of performance and the offer has been refused, the

promiser is not responsible for non-performance. Offer of performance is also known as

tender. The motive of the party ‘tendering to perform’ is to perform it. Thus a valid tender of

performance is considered to be the performance of a promise and it discharge a party from

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his obligation under a contract. If the offeror produces goods of the correct quality and

quantity, the rejection of his offer discharges him from further liability. If a debtor tenders

money due under a debt, the effect of such a tender is to stop the running of interest on the

amount payable but the debt is not discharged.

Essentials of a valid tender

In order that a tender should be valid and adequate, it must fulfil the following conditions

which are laid down in section 38.

i. It must be conditional. Where a tender or offer of performance is conditional, the other

party is under no obligation to accept it. A person is not bound to accept a tender of

railway receipt that is made subject to demurrage. But a tender with a request for a

receipt is valid.

Example: N sent a single cheque for two items, only one of which was due at the time,

while the other was payable after sometime. The cheque being one and indivisible could

be accepted as whole or not at all. It was held that the promise was within his right in

rejecting cheque.

ii. It must be made at a proper time and place. When the contract provides that tender should

be made at a particular place and time, it should be so done. If the place is not mentioned,

the rule is that the debtor must find the creditor. Where no time is fixed then it is valid to

make the tender at any reasonable time. A tender before due date is not valid.

Example: N owes M Rs 500 payable on 1st August with interest. But M offers to pay the

amount and interest on 1 December so this is not a valid tender as it is not made at

appointed time.

iii. A person to whom the tender is made must be given a reasonable opportunity of

inspection of goods or articles. The inspection is to satisfy oneself as to whether the thing

offered is what was promised. There is no valid tender where goods are locked in a box

and the other party is not allowed to open it.

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Example: we can take an example of online purchasing. someone purchases online

product. The company offers to check the material at the time of delivery before made the

payment.

iv. The tender must be whole and not of the part. Tender in part is no tender. A creditor need

not accept a smaller sum than that what he is entitled to. A tender by instalments is

invalid unless the contract so provides. A tender of a lessor amount does not stop the

running of interest on the entire amount.

v. The tender must be in proper form. Tender of money should be in the current coins. A

person is not bound to accept a cheque. A tender by cheque is valid when the person to

whom it is tendered is willing to accept such payment.

vi. The tender must be made to a proper person. Tender made to a stranger would be invalid.

It should be made to the promise or his duly authorised agent.

vii. Tender for the delivery of goods must be the quantity and quality as stipulated in the

contract.

viii. A tender made to one of the several joint promises has the same legal consequences as a

tender to all of them.

2.1.1 Effect of refusal to accept offer of performance

According to section 38 where a promisor has an offer of performance to the promise and the

offer have not been accepted:

a) The promisor is not responsible for the non-performance nor

b) Does he thereby lose his rights under the contract

2.1.2 By whom contracts must be performed

1. By the promisor: as a general rule, a contract may be performed by the promisor, either

personally or through any other competent person. But where personal considerations are

the foundation of contract, it has to be performed by the promisor himself and in case of

his death or disablement, a contract will be discharged and the other party would be freed

from liability.

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Example: A promises to make a dress for B. The promise must be performed by A

himself.

2. By the agent: where personal skill is not necessary and the work could be done by any

one, the promisor or his representatives may employ a competent person to perform it.

3. By the representative: in the event of the death of the promiser before performance,

their representative is bound by the promises, unless personal considerations are the

foundation of the contract. The legal representatives of the deceased promisor cannot be

required to perform contract involving personal skill and action.

4. By third person: if the promisee accepts performance of the promise from a third party,

there is a discharge of the contract. Once the third party performs the contract, and that is

accepted by the promisee there is an end of the matter and the promiser is thereby

discharge (section 41).

2.1.3. Demand of performance

It is only the promisee or his agent who can demand performance of the promise under a

contract. It is immaterial whether the promise is for the benefit of the promisee or for the

benefit of some other person. In the case of death of the promisee, his legal

representatives can demand performance. In certain cases a third person who is not a

party to the contact to the contact can also demand performance.

Time and place of performance

It is for the parties to a contract to decide the time and place for the performance of the

contract. Sections 46 to 50 0f the Indian contract act lay down certain rules in this

regarded which are as follows:

1. Where a contract does not specify any time for performance and the promisee is not

supposed to ask for performance, the promisor must perform it within a reasonable

time.(section 46)

2. When a contract is to be performed on a particular day, without any application of the

promisee being required, the promisor may perform contract on that particular day during

the usual hours of business on such day and at the place at which promise ought to be

performed (section 47)

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3. In above two cases, the promisor undertakes to perform the promise without application

by the promisee. But where the promise has to be performed on a certain day but the

promisor had not undertaken to perform it without application by the promisee, the

promisee is bound to apply for performance at proper time place and within the usual

hours of business (section 48)

4. When a promise is to be performed without application by the promisee, and no place is

fixed for the performance of it, it is the duty of the promisor to apply to the promisee to

appoint a reasonable place for the performance of the promise, and to perform it at such

place (section 49).

5. A contract should be performed in the manner and at the time prescribed in the contract

(section 50).

2.2 Discharge of Contract

A contract is said to be discharged or terminated when the rights and obligations created by it are

extinguished. A contract may be discharged in many ways. The following are the various modes

in which a contract may be discharged:

1. Discharge by agreement

2. Discharge by operation of law

3. Discharge by breach

4. Discharge by performance

5. Discharge by impossibility

6. Discharge by lapse of time

2.2.1 Discharge by agreement

A contract is created by the parties to it. Similarly, it can also come to an end by their mutual

agreement. The rights and obligations created by an agreement can be discharged without their

performance by means of another agreement between the parties which provides for the

extinguished of the earlier rights and obligations. The parties may agree to terminate the

existence of the contract by any of the following ways.

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a. Novation: it means that there being a contract in existence some new contract is

substituted for it, either between the same parties or between different parties, the

consideration mutually being the discharge of old contract, it is transaction by which,

with the consent of all the parties concerned, the old contract is revoked and substituted

by a new contract.

Novation may occur in two ways

1. New parties substituted for old one

2. Parties may substitute new contract for the old one

Example: A owes money to B under a contract. It is agreed between A, B and C that B shall

thenceforth accept C as his debtor instead of A. The old debt of A to B is at an end a new debt

from C to B has been contracted.

b. Alteration: it means a change in one or more of a contract. Alteration is valid if it is done

with the consent of all the parties to the contract. In alteration, unlike novation, there is

change in the terms of the contract but no change of the parties. Alteration made with the

consent of all the parties results in the discharge of the original contract.

Example: A enters into a contract with B for the supply of a 1,000 bales of cotton at his

warehouse on 1st June 1980. Later both A and B agree to postpone the date of delivery to 1st

September 1980. This change amounts to alteration of the contract.

c. Rescission: if the parties to a contract agree to rescind it, the original contract need not be

performed. This is discharged by rescission which requires mutual consent and

consideration. Rescission means cancellation of the contract. Rescission results in the

dissolution of the contract while novation results in dissolution and replacement of the

contract.

d. Remission: it means acceptance of lessor amount or lesser degree of performance than

what was actually due under the contract. It is a unilateral act of the promisee discharging

at his will and pleasure of the obligation of another.

e. Waiver: it means the abandonment of right which a person is entitled to. A party to a

contract may waive his rights under contract, whereupon the other party is released from

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his obligations. To constitute a waiver neither an agreement nor consideration is

necessary.

Example: A promises to write an article for B. B later on forbids him to do so. A is no longer

bound to perform the promise.

f. Accord and satisfaction: accepting any other satisfaction than the performance

originally agreed is known in English law as accord and satisfaction. Accord means the

promise to accept less than what is due under the old contract. Satisfaction means the

payment or the fulfilment of the smaller obligation. An accord is unenforceable but an

accord followed by satisfaction discharges the pre-existing obligation.

Once the promisee accepts such satisfaction as discharge of the original obligation, the

obligation is discharged. Under section 63 a promisee may accept instead of the

performance of the promise made to him any satisfaction which he thinks fit.

Activity-1

Explain different ways to discharge the contract by agreement with suitable examples--------------

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2.2.2 Discharge by operation of law

a. Insolvency: upon insolvency, the rights and liabilities of the insolvent are, with certain

expectations transferred to an officer of the court, known as official assignee in

presidency towns and as official receiver in other areas.

b. Merger: it occurs when there is acceptance of a higher security in the place of the lower.

It is an operation of law which extinguishes a right by virtue of its coinciding with

another and greater right in the same person.

c. Alteration: an alteration of a written contract made without the consent of the other party

has the effect of discharging the contract provided the alteration is of a material part.

Example: A bill of exchange for Rs 25000 has been altered to one for Rs 2500, the bill becomes

bad in law and the creditor cannot even ask for a decree of Rs. 2500.

d. Death: where performance of a contract is required to be made in person and the

personal qualifications of the promisor are the considerations for the contract, the death

of the promisor discharges the contract. In other contracts, the rights and liabilities of a

deceased person pass to his legal representatives.

2.2.3 Discharge by breach

Parties to contract are expected to perform their respective obligations. If any party fails to

perform his obligation, there takes place a breach of contract. Breach of the contract operates as

discharge of the contract. The breach of contract may be actual or anticipatory

Actual breach- it may take place in the following ways:

I. When performance is actually due or

II. When actually performing the contract

Breach of contract when performance is actually due: when a person does not perform his

part of the contract at the time when it is due, he will be liable for its breach. Thus, where A

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agrees to deliver to B 30nchairs on 1st June and fails to do soon that day there is a breach of

contract by A.

Breach of contract when actually performing the contract: when a party to a contract

performs his part of the contract, but the other party alleges that it is not a proper performance,

according to the terms of the contract, in that case if the breach is of a condition essential to the

main purpose of the contract, the contract is discharged,. But if the breach is only of a collateral

term, this will not entitle the other party to rescind the contract, but he can only claim damages.

C agreed to supply to a company with 5000 chairs. After 2000 chairs had been delivered the

company told to C that no more will be required. There is a breach of contract by company.

2.2.4 Discharge by performance

Performance of contract is one of the most usual ways of discharge of contract. The

performance of a contract lies in doing or causing to be done what the promisor has promised to

do.

2.2.5 Discharge by impossibility of performance

Impossibility of performance results in the discharge of the contract. Agreements which are

impossible in it are void because law does not compel the impossible. Thus a promise by A that

he will grow a tree in one hour in B’s garden by invoking some mantras is void. The

impossibility referred here must be in existence at the time when the contract is made and may or

may not be known to both the parties at that time.

A contract may become impossible of performance after the date of contract by:

1. Destruction of the subject matter: where the subject matter of a contract is destroyed,

without the fault of parties the contract, the contract is discharged.

2. Death or personal incapacity: a promise may become physically incapable of

performance by the reason of the death or inability of some person whose continued life

and heath are necessary for the performance of the contract. Such impossibility

discharges the promisor from liability.

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3. Change of law: contracts which are lawful when made but become unlawful later by

reason of change in law, become impossible of performance.

4. Non-existence or non-occurring of particular state of things: where a state of things

which was the basis of the contract ceases to exist, the contract is discharged.

5. Declaration of war: a contract entered into before the commencement of war remains

suspended during the war. However, such a contract may be revived and enforced at the

end of war, if the performance of the contract goes to help the enemy, it becomes void.

Exceptions

Some of the circumstances in which a contract is not discharged on the ground of supervening

impossibility are as follows

1. Difficulty of performance

2. Commercial impossibility

3. Impossibility due to the failure of a third person on whose work the promisor relied

4. Self-induced impossibility

5. Failure of one of the objects

2.2.6 Discharge by lapse of time

A contract is discharged by lapse of time. The Limitation act 1940 lies down that a contract

should be performed within a specified period. If the contract is not performed and no legal

action is taken by the promisee within the period of limitation, he is deprived of his remedy at

law. The contract is terminated in such a case. For instances, the period limitation to file a money

suit is three years. If within tree years the creditor fails to file a suit to recover his amount the

debtor is discharged.

Check your progress (A)

1. Which of the following is not an essential of valid tender?

a) It must be unconditional

b) It must be at proper time

c) It must be at proper place

d) A tender may be in part

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2. Which ONE of the following is not a method by which a contract can be discharged?

a) Discharge by misrepresentation

b) Discharge by performance

c) Discharge by breach

d) Discharge by agreement

3. Regarding the time of performance, which ONE of the following statements is untrue?

a) Where time is of the essence of a contract, a slight delay will not allow the non-breaching

party to terminate the contract.

b) Where a contract does not provide that performance must be completed by a certain date,

the parties to the contract must perform their obligations within a reasonable time

c) Here the time of performance is not 'of the essence of the contract,' then a party to the

contract can give notice that it has become of the essence of the contract.

d) Time will be of the essence where the subject matter of the contract indicates that time

shall be of the essence.

2.3 Remedies for Breach of Contract

Parties to lawful contract are bound to perform their respective obligations. But when one of the

parties repudiates the contract, by refusing to perform his obligations he is said to have

committed a breach of the contract. In case of breach of contract, the law provides the following

remedies to an injured party.

1. Cancellation or rescission: rescission is the revocation of a contract. It is a way by

which a contract may be discharged. Where one of the parties to a contract commits

breach, the other [arty may treat the contract as rescinded. He is freed from all the

obligations under the contract. Under section 64 the party rescinding a voidable contract

shall if he has received any benefit thereunder from all another party o such contract

restore such benefit to the person from whom it was received. Further under section 75 a

person who rightfully rescinds a contract is entitled to compensation for any damage

which he has sustained through the non- fulfilment of the contract.

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Example: A singer contracts with B, the manager of theatre to sing at his theatre for two

nights in every week during the next two months and B engages to pay her Rs. 200 for

each night performance. On the sixth night A wilfully absents herself from the theatre

and B in consequences rescinds the contract. B is entitled to claim compensation for the

damages which he has sustained through the non- fulfilment of the contract.

When rescission is be refused

Under section 27(1) of the specific relief act, the court may grant rescission in the following

cases

I. Where the contract is voidable at the option of the plaintiff the court grants rescission to

the plaintiff.

II. Where the contract is unlawful for causes not apparent on its face and defendant is more

to blame than the plaintiff, the court may grant rescission.

When rescission may be refused

The court may, however, refuse to rescind the contract

I. Where the plaintiff has expressly or implied ratified the contract or

II. Where owing to the change of circumstances, the parties cannot be resorted to their

original positions or

III. Where third parties have, during the subsistence of the contract acquired rights in good

faith and for value or

IV. Where only a part of the contract is sought to be rescinded and such part is not severable

from the rest of the contract.

2. Restitution: it means return of the benefit received by one party to the contract from the

other party under void contract. When a contract becomes void it need not be performed

by either party. Section 65 provides that when an agreement is discovered to be void or

when a contract becomes void any person who has received any advantage under such

agreement or contract is bound to restore it or to make compensation for it to the person

from whom he received it.

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This section applies to contracts ‘discovered to be void’ and contracts become void. It

does not apply to contracts which are known to be void. Thus, if A pays Rs. 300 to B to

beat C, the money is not recoverable.

Example: A pays B Rs. 2000 in consideration of B’s promising to marry C, A’s

daughter. C is dead at the time of promise. The agreement is void but B must repay A Rs.

2000.

3. Specific performance: under certain circumstances a person aggrieved by the breach of

the contract can file a suit for specific performance, i.e. for an order by the court upon the

party guilty of breach of contract directing him to perform what he promised to do.

Specific performance is discretionary remedy which is allowed only in limited number of

cases. Rules regarding the granting of this relief are contained in the section Relief Act,

1877

Some of the cases in which specific performance of contract may be enforced are as

follows:

a) Where monetary consideration is not adequate remedy for the breach of contract.

b) When there exist no standard for ascertaining the actual damage caused by the non-

performance of the contract.

In the following cases however specific performance will not be granted:

a. Where the contact is of personal nature.

b. Where damages are an adequate remedy.

4. Injunction: an aggrieved party can sue for an injunction i.e.an order of the court

restraining the wrong doer from doing continuing the wrongful act complained of.

Injunctions are usually granted to enforce negative stipulations in case where damages

are not adequate relief. Injunction is a preventive relief. It is particularly appropriate in

cases of anticipatory breach of contract.

Example: M, a firm actress agreed to act exclusively for brother’s son for one year.

During the year she contracted to act for Z. it was held that she could be restrained by

injunction from acting for Z.

5. Quantum meruit: the phrase ‘Quantum meruit’ means ‘payment in proportion to the

amount of work done.’ A right to sue on a quantum meruit arises where a contract, partly

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performed by one party, has become discharged by the breach of the contract by the other

party. The right is founded not on the original contract, which is discharged or is void,

but on an implied agreement to pay for what has been done.

6. Damages: a person who commits a breach of contract must make compensation therefore

to the injured party. The primary purpose of awarding damages is to put the injured

person in as good a position as he would have been if performance had been rendered as

promised. The term damages are used to mean compensation in money as a substitute for

the promised performance. Damages for the breach of a contract are intended to

compensate the injured party so as far as money can do so. Law of contract does not seek

to punish the guilty but, if by reason of his wrongful act, the other party has suffered any

pecuniary loss, and the court will compel the party in breach to make good the loss by

paying damage to the other party. Its purpose is compensation and compensation alone.

Damages are of four kinds:

1) General or ordinary damages

2) Special damages

3) Vindictive or exemplary damages

4) Nominal damages

Check your progress (B)

1. Which of the following is not the remedy for breach of contract?

a) Cancellation

b) Injunction

c) Damages

d) Mitigation of loss

2. Which one of the following is kind of damage?

a) Special damages

b) Injunction

c) Restitution

d) None of above

3. Explain the term restitution?

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Activity-2

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2.4 Summary

Every contract creates a legal obligation which continues till the contract has been performed or

otherwise discharged. Performance of the contract is, in fact the most natural and usual mode of

extinction of an obligation. Performance of a contract consists in doing or causing to be done

what the promiser has promised to do. It is only the promisee or his agent who can demand

performance of the promise under a contract. It is immaterial whether the promise is for the

benefit of the promisee or for the benefit of some other person. In the case of death of the

promisee, his legal representatives can demand performance. In certain cases a third person who

is not a party to the contact to the contact can also demand performance. Parties to lawful

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contract are bound to perform their respective obligations. But when one of the parties repudiates

the contract, by refusing to perform his obligations he is said to have committed a breach of the

contract. In case of breach of contract, the law provides remedies to an injured party.

2.5 Glossary:

Novation: it means that there being a contract in existence some new contract is substituted for

it, either between the same parties or between different parties

Damages: a person who commits a breach of contract must make compensation therefore to the

injured party.

2.6 Answers to check your progress

Answers to check your progress (A)

1. (d)

2. (a)

3. (a)

Answer to check your progress (B)

1. (d)

2. (a)

3. Return of benefit received by one party.

2.7 Model questions

1. Explain the term tender. What are the essential of a valid tender?

2. What do you mean by performance of contract?

3. State the various ways in which a contract may be said to be discharged.

4. When does merger takes place?

5. What are the various remedies available to a party in case of breach of contract?




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Lesson 3

Law of agency I

Structure

3.0 Learning objectives

3.1 Introduction

3.2 Meaning of an Agent

3.3 Procedure of appointing an agent

3.3.1 by express or direct appointment in oral or in writing

3.3.2 By inferring an agency

3.4 Creation of an Agency relationship between an agent and principal

3.5 Essentials of agency relationship

3.6 Types of Agent

3.7 Agent and Servant

3.8 Agent and independent contractor

3.9 Duties of an agent

3.10 Rights of an agent

3.11 Duties of principal

3.12 Rights of principal

3.13 Summary

3.14 Keywords


3.16 Terminal questions


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This lesson will enable you to understand the following

Concept and Importance of agency law.

Definition of an agent and its different types.

Differentiation between an agent and servant.

Rights and duties of an agent.

Rights and duties of principal

3.1 Introduction

The complexities in modern business are such that it is not possible for any man to transact

all business by himself. For this he has to depend on the services of other person in order to

run all day to day business. Such persons are called as agents. In law terminology, the term

agency is relationship which remains with the person who has an authority to make lawful

relationship between a person conquering to the position of principal and third parties. The

agency relationship arises whenever one person is an agent who has authority to act on behalf

of another person called the principal and accords to act. The agency contract may be in

written under seal like power of attorney or it may be an oral agreement. So person called an

agent can do any act for another or can be representative for another in making deals with

third party or person. The person for whom such act is done is termed as a “Principal

So we can conclude an agent as a person who acts in the name of and on behalf of other

person, given considerable authority and assuming it to act so. Currently most of the

organized human activity or along with all commercial activity virtually is done by an

agency. Without an agency concept establishment is not even possible even in the theory

concept. For example “General Motors is building cars in China,” but we can’t interact while

purchasing car and cannot even shake hands with General Motors. So it is clear that “The

General,” a company exists and works through an agency or agents. Same as in other

business organizations and in partnership firm depend on agents to carry on their business

broadly. If we say that agency is the keystone for most of the organization for their business

surely, it is not an overstatement. In a partnership firm each partner act as general agent,

while under corporation law the officers and all the employees are agents of the corporation.

The existence of agents does not have any requirement for a whole new law of contracts. A

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contract is neither harmful when committed by an agent; a contract nor binded when

negotiated by an agent. Overall mainly the manner of the agents act counts on the behalf of

his principal and towards a third party.

3.2 Meaning of an Agent

The law of agency is administered by Part X of the Contracts Act 1950”An Agent is a person

employed to do any act for another in making deals with third person”.

The person for whom such act is done is a Principal.

According to the law “Any person who is of age of majority to which he is subject and is of

sound mind can employ an agent. An agent is a person who acts in the name of and on behalf

of other, having been given and assumed some degree of authority to do so”. Mostly

organized human activity along with virtually all commercial activity is carried on by agency.

Thus an agent is one

Who is employed by another person called “Principal”.

To do any act for another person “Principal”.

To represent “Principal” in dealings with third party.

Definition: An agent is a person who is “employed” by another person called principal to

bring that other person into contractual relationship with third party e.g. real estate agent,

travel agent etc. P (principal) enters a contract with A (an agent) to negotiate contracts with T

(third party); which builds a legal contract between P and T.

The most important feature in an agency relationship is the authority given by principal to an

agent. The extent of the authority will be mentioned as a term in the contract between agent

and principal. What the agent can and cannot do on behalf of the principal is also mentioned.

Note that, Agent has contract with principal. Principal has contract with third party.

For example if Asif appoints Sahaj to sign the agreement on his behalf then in this case Asif

is the principal and Sahaj is his agent.

3.3 Procedure of appointing an agent

According to section 136 CA – “Any person who is eighteen years old and above and who is

of sound mind may be a principal. As between the principal and third persons, any person

may become an agent, but persons of unsound mind and who are below 18 years of age are

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not liable towards their principal for acts done by them as agents”. For example if Ajay

employs Bob (a minor person) to buy some goods from Chirag on his behalf and Chirag

supplies the goods to bob , now Ajay cannot allege that he is not liable to pay for the goods

just because Bob is not at the age of majority. Ajay is still liable to pay Chirag for those

goods.

There is some rule to be followed for an appointment of a person as an agent. Appointment

of agent may be made by any of the following ways:

3.3.1 by express or direct appointment in oral or in writing

Express appointment can be done in written or in oral form. Power of Attorney is an

example of an express appointment in writing. Even while appointing an agent, a

letter written or words spoken can be effective. Very specific and particular words are

used to mention that an agent has been appointed e.g. Ajay appoints Vijay as his agent

in writing. Such appointment is called direct or express appointment.

3.3.2 by inferring an agency

In some circumstances an agent may be appointed for many reasons like when the

appointer has not enough intellectual capability and skills to do the assigned work,

when appointer is lacking confidence while doing work by him and when an

appointer really wants to delegate the work with considerable authority. In the above

cases appointment is called “Implied appointment”.

3.4 Creation of an Agency relationship between an agent and principal

Almost all agency relationships are known as depository relationships. This refers to involve

certain level of trust and confidence in the agency relationship. The agent has obligation to

act at his best in accomplishing the interest of the principal because the actions taken by an

agent will generate obligations on the legal ground for the principal. This agency relationship

permits the agent to act on behalf of his principal whether the principal was present or acting

alone.

For example, suppose wilka contracts with Rosy to buy 600 rawhide bones. Rosy delivers the

bones, but bobby and Bubbly fails to pay the bill. As wilka as the principle is legally

responsible even though she never personally made this deal for Rosy's bill. If rosy decides to

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sue for collection of the bill, they'll likely to sue Bobby and Bubbly and Wilka, rather than

Wilka. As long as Wilka was properly acting as my agent when she made this deal, she's not

legally responsible.

An agency can be created by any of the following ways:

By Agreement

When both the parties contract in normal contractual way it is known to be creating agency

relationship by agreement. The considerable authority that principal provides to agent is most

important characteristics in an agency relationship. There should be properly mentioned the

extent of the authority provided by the principal in the contract, it will be a definite term in

the contract between principal and agent. The scope of the act of an agent is decided by this

term i.e. the agent can act and cannot act on behalf of the principal.

The authority given can be of two types namely apparent authority and actual authority

(whether implied or express authority).

Apparent authority: Apparent authority said to be exist where the conduct of

principal would lead a sound person in the third party's place or position to have

faith on the agent who had authority to act, even if the purported agent and principal

had never involved in a discussion over such a relationship. An example would be an

agent that displayed signs, pre -printed company forms and stationary with the

company logo would lead one to believe that the agent had the authority to act for the

principal (the insurer).

For example: Ajay and Pranay are brothers. Ajay lives in Delhi while Pranay lives in

Mumbai. Ajay with the knowledge of Pranay’s leases lands in Delhi. He realises the

rent and remits it to Pranay. Ajay is the agent of Pranay, though not expressly

appointed as such.

Express Authority: Express actual authority exists when an agent has expressly told

to act on the behalf of principal. An insurer specifically authorizes an agent to bind

certain risks.

For example: The usual form of written contract is power of attorney.

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Implied actual authority: Implied actual authority is the authority possess by an

agent who has by virtue of being reasonably necessary to carry out his or her express

authority. As such, it can be inferred by virtue of a position held by an agent. An

insurance agent implied authority would suggest an agent can accept premium

payments on behalf of the principal (i.e. the insurer).

For example: A women allowed her son to drive a car for her, she paying all the

expenses of maintenance and operation. The son caused an accident injuring his wife.

Held, the wife could sue the mother as the son was an implied agent of the mother.

By Ractification –A person may act on the behalf of another without his knowledge. For

example, A may act as P’s agent though he has no prior authority from P. In such a case P

may subsequently either accept the act of A or reject it. If he accepts the act of A, done

without his consent, he is said to have ratified that the act and it places the parties in

exactly the same position in which they would have been if A had P’s authority at the

time he made the contract. Likewise, when an agent exceeds the authority given to him by

principal, the principal may ratify the unauthorised act.

Taking another example to develop our understanding; Say A insures P’s good without

his authority. If P ratifies A’s act, the policy will be valid as if A had been authorised to

insure the goods.

By Estoppel – “When Principal allows any third party to believe on agent that he has

power/authority to act on his behalf. Agent has apparent (also called “ostensible”)

authority. The principal is estopped (prevented) from denying that agent had not

authority”. A court will defend a contract where there is apparent authority.

For example: Ajay tells Tarun within the hearing of Pankaj that he (Ajay) is an agent

of Pankaj. Pankaj does not have any objection to this statement. Later Tarun supplies

certain goods to Ajay, who pretends to act as an agent of Pankaj. Pankaj is liable to

pay the price to Tarun. By being calm, Pankaj had led Tarun to believe that Ajay is

really his agent.

By Necessity – When any kind of emergency arises then agency relationship is

automatically created without consent of the parties. This type of agency relationship is

said to be created by necessity

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For example: Pankaj consigns provisions to Ajay at Gwalior with direction to send them

immediately to Varun at Indore, Ajay may sell the provisions at Gwalior, if they will not

bear the journey to Indore without spoiling the consignment.

Agency by operation of law:

Sometimes operation of law gives rise to an agency relationship. According to Sec 18 and

19 of the Indian Partnership Act.1932 “When a company is formed, by operation of law,

its promoters are its agents. A partner is the agent of the firm for the purpose of the

business of the firm, and act in a partnership, which is done to carry on business activity,

in an usual way, kind of the business carried on by the firm binds the partner in the firm,

in all these cases, agency is implied by operation of law”.

3.5 Essentials of agency relationship

There are two essentials in the relationship of the agency:

Agreement between the principal and an agent:

“Agency depends on the agreements but not necessarily on contract. As between the

third persons and the principal, any person may become an agent” [Sec.184].

As such even a minor or a person of unsound mind may be an agent; The Principal is

liable for the acts of such an agent.

Intention of the agent to act on behalf of the principal:

Whether a person has intention to act on the behalf of another person is a question of

the fact. Where a person does intend to act on behalf of another, agency may arise

although the contract between the parties provides that there is no such relationship.

3.6 Types of Agent

There are basically two types of agent Mercantile and Non-Mercantile. But in this lesson we

are concerned about different types of mercantile agents.

“Mercantile Agent has an important role in transferring goods from the manufacturer to the

consumer”.

The following are the different kinds of Mercantile Agent:

Broker: A Broker is a mercantile agent , he is employed to buy or sell goods on the behalf of

another person. He has been appointed to make negotiation and establish a contract for

selling or purchasing of goods but the possession and control of the goods remains with his

principal He cannot act or sue in his own name, he has no possession and has no right of lien.

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Usual mode of dealing by a broker is to put the terms of contract in writing in a book, sign it

and then send the particulars of the contract to both the parties. The document sent to the

buyer is called the “bought note” and then sent to the seller the “sold note”, If these

documents agree, the term of contract are defined. If they do not agree, there is no binding

contract. A reference is then made to signed entry in the broker’s book.

Factor: A factor is also a mercantile agent who has the authority to sell or dispose goods

which are in his possession. He has authority to do such things as are usual way in the

conduct of business. He sells goods in his own name as an owner. He can sell goods on credit

as well. He can also receive price for goods and give a good discharge to the purchaser.

Example: P owned a motor car and delivered it to A, a mercantile agent for sale at not less

than 500000 INR.A sold the car for 400000 INR to T, who bought it in good faith and

without notice of any fraud. A misappropriated the 400000 INR and F sued to recover the car

from T .Held, as A was in possession of the car with P’s consent for the purpose of sale, T

got a good title.

Auctioneer: An Auctioneer is a mercantile agent, and is appointed by a seller to sell his

goods by public auction for a reward generally in the form of a commission, who sells goods

by way of public offer to the highest bidder for the Principal. An auctioneer is. He is primly

the agent of seller but after the sale has taken place he then become the agent of purchaser

also. He has authority to receive the price for selling goods. He can also sue for the price in

his own name.

Example:

P instructed to sell pony to A by auction, subject to a reserve price of 25000 INR.A at the

time of sale stated that there was no reserve price and sold pony to D at 16000 INR. Held, the

sale was binding on p.

Del Credere: A Del Credere is also a mercantile agent is who make establishment in the

form of the contract between his principal and a third party and also gives surety to the

principal about the performance of the contract by the third party but remember he is not

liable for an act to the third party.

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Commission Agent: When one person is appointed by principal to buy goods from the

market on his behalf on a commission basis then this person is said to be commission agent.

He is also a mercantile agent who charges commission for his act. He belongs to indefinite

class of agents. He is employed to buy and sell goods, or transacts business generally for

other person and receives money for his labour and trouble a money payment, called

commission.

Commission agents are of two kinds:

i).Kuchha Arhatya: He is very similar to a broker. He brings together the buyer and the

seller in order to make negotiation and then collects a brokerage fee from the contract made

between them.

ii).Pakka Arhatya: He is an agent who purchases and sells goods in his name without

revealing the name of the principal.

Activity

Aarti enters into a contract with Bhawna for buying Bhawna’s Car as agent for Chirag without

Bhawna’s authority. Bhawna repudiates the contract before Chirag comes to know of it. Chirag

subsequently ratifies the contract and sues to enforce it. Advise Bhawna.

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3.7 Agent and Servant: There are so many similarities between an agent and a servant as

both are employed to act for and on behalf of another person. However, there are a lot of

dissimilarities between an agent and a servant too.

The points of differences are summarized as follows:

An agent has an authority to create contractual relationship between the principal and

a third party. But servant has no such authority.

An agent does not come under the direct control or supervision of the principal. A

principal has the right to direct the act of an agent. An agent has also the right to say

how it is to be done in what ways. On the contrary a servant acts under the direct

control and supervision of his master, and is bound to carry out all orders given to him

in the course of his work.

An agent receives commission on the basis of his work done. A servant is paid by

way of salary or wages.

A principal is liable for only those acts which are within the scope of the authority

given to the agent, so scope is limited .A master is liable for the wrongs of his

servants committed in the course of employment.

An agent may work for a number of principals at the same time. A servant usually

serves only one master.

3.8 Agent and independent contractor

An agent acts under the supervision or in the control of his principal but contractor

uses his own material, labour machines and equipment etc.

An agent is bound by the instructions of his principal but an independent contractor is

bound by the terms of the contract.

An agent can bind his principal by his act but an independent contractor cannot bind

his employer.

3.9 Duties of an agent

An agent owes a number of duties to his principal which may vary in degree according to the

nature of agency. These duties are as follows:

To carry out the work undertaken as per the direction of the principal.

To carry out the work with reasonable care, skill and diligence.

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To render proper accounts to his principal.

To communicate with the principal in case of difficulty.

Not to deal on his own account.

To pay sums received for the principal.

To protect and preserve the interest of the principal in case of his death or insolvency.

Not to use information obtained to the course of the agency against the principal.

Not to make secret profit from agency.

Not to set up an adverse title.

Not to put himself in a position where interest and duty conflict.

Not to delegate authority.

3.10 Rights of an agent

An agent has the following rights:

1. Rights of retainer:

As per the section 217 “The agent may retain, out of any sums received on account of the

principal in the business of the agency, all money due to himself in respect of his

remuneration and advances made properly incurred by him in conducting such business”.

2. Right to receive remuneration:

As per the section 219 “The agent is entitled to his agreed remuneration, or if there is no

agreement, to a reasonable remuneration”.

3. Right of lien:

As per the section 221 “In the absence of any contract to the company ,an agent is entitled to

retain goods, papers and other property whether movable or immovable of the principal

received by him until the amount due to himself for commission ,disbursement and services

in respect of the same has been paid or accounted for to him”.

4. Right of indemnification:

As per section 222 “The agent has a right to be indemnified against the consequences of all

lawful acts done by him in exercise of the authority conferred upon him”

5. Right of compensation:

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As per section 225” The agent has the right to be compensated for injuries sustained by him

by neglect or want of skill on the part of the principal”.

6. Right of stoppage in transit:

This right can be availed by agent in two cases:

1. Where goods bought by agent for his principal by incurring a personal liability then he has

a right of stoppage in transit against the principal in respect of the money which he has paid

or is liable to pay. This is same as right of an unpaid seller.

2. Where he is personally liable to the principal for the price of the goods sold.

3.11 Duties of principal

The principal owes following duties to an agent.

To indemnify the agent against the consequences of all lawful acts.

To indemnify the agent against the consequences of acts done in good faith.

To indemnify agent for injury caused by principal’s neglect.

To pay the agent the compensation or other remuneration agreed.

3.12 Rights of principal

When an agent has fails in his duty towards the principal then principal has following

remedies against agent:

To recover damages.

To obtain an account of secret profits and recover them and resist a claim for

remuneration.

To resist agent’s claim for indemnity against liability incurred.

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Check your progress

1.________ agency is the most common form of agency

2. Agency by ________ occurs when (1) a person misrepresents himself or herself as another's

agent when in fact he or she is not and (2) the purported principal accepts the unauthorized act.

3. Apparent agency is also referred to as ________.

4. A principal accepts an agent's unauthorized contract through ________ of the contract.

5. A principal-agent relationship is formed when an employer hires an employee and gives that

employee authority to act and enter into contracts on his or her behalf.(True/False)

6. An employer-independent contractor relationship exists when an employer hires an employee to

perform some form of physical service. (True/False)

7. Implied agency is the most common form of agency. (True/False)

8. A power of attorney is one of the most formal types of implied agency agreements. (True/False)

9. Agency by ramification occurs when (1) a person misrepresents himself or herself as another's

agent when in fact he or she is not and (2) the purported principal ratifies (accepts) the unauthorized

act. (True/False)

10. Apparent agency, or agency by estoppel, arises when a principal creates the appearance of an

agency that in actuality does not exist. (True/False)

3.13 Summary

In conclusion to the concept of an agent we can say that an Agent is a person employed to do

any act for another in making deals with third person. The person for whom such act is done

is the Principal. An agent can be mercantile and non-mercantile, and mercantile agents are

broker, factor, an auctioneer, Del Credere and Commission Agent.

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3.14 Keywords

Agent is a person engaged to do any act for another or to represent another in dealings

with third persons.

Mercantile Agent has an important role in transferring goods from the manufacturer

to the consumer.

Express appointment when an agent is directly appointed.

Implied appointment by inferring agency in the circumstances of the case.

Commission Agent: When one person is appointed by principal to buy goods from

the market on his behalf on a commission basis then this person is said to be

commission agent.


Ans.1 Express.

Ans.2 Ratification

Ans.3Agency by estoppel

Ans.4 Ratification

Ans.5 True

Ans.6 False

Ans.7 False

Ans.8 False

Ans.9 False

Ans.10 True


1) Name any two types mercantile agents.

2) Write about appointment of an agent.

3) Why appointment of an agent is needed?

4) Elaborate the concept of an agent in detail.

5) Differentiate between an agent and an independent contractor?

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6) Differentiate between an agent and servant?

7) Write notes on Agency by estoppel?

8) What is the extent of liability of the principal when his agent exceeds authority?

9) What are the essentials of the relationship of an agency?

10) What is meant by agency by ratification?


1. N.D. Kapoor, Company Law, Sultan Chand & Sons, New Delhi.

2. P.P.S. Gogna, Mercantile Law, S.Chand & Company, New Delhi.

3. S.K. Aggarwal, Business Law, Galgotia Publishing Company, New Delhi.

4. S.C. Aggarwal, Company Law, Dhanpat Rai Publications, New Delhi.

5. G.K. Varshney, Elements of Business Law, S Chand & Co., New Delhi.

6. S.S. Gulshan & G.K. Kapoor, Business Law, New Age International Publishers, New

Delhi.

7. K.R. Balchandari, Business Law for Management, Himalaya Publication House, New

Delhi.

8. Avtar Singh, the Principles of Mercantile Law, Eastern Book Co., Lucknow.

9. S.C. Kuchhal, Mercantile Law, Vikas Publishing House, New Delhi.

10. M.C. Shukla, Manual of Mercantile Law, S. Chand & Co., New Delhi.

11. R.S.N. Pillai and Bagavathi, Business Law, S. Chand & Co., New Delhi.

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Lesson 4

Law of agency II

Structure


4.1 Introduction

4.2 Definition of bailment

4.3 Essential elements of bailment

4.4 Duties and liabilities of a Bailor

4.5 Important rights of bailor

4.6 Duties of bailee

4.7 Important rights of the bailee

4.8 Detailed comparison between Sale and Bailment:

4.9 Pledge

4.10 Basic requisite of pledge

4.11 Rights of a Pawnee

4.12 Key Differences between Bailment and Pledge

4.13 Pledge by non-owner

4.14Summary

4.15Keywords


4.17Terminal questions

4.18Suggested readings

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After reading this lesson, you should be able to

Define bailment its essentials.

Define pledge and explain its components.

Make a comparison between sale and bailment.

State the rights in bailment and pledge.

4.1 Introduction

Bailment is that type of activity in which one’s property goes into another’s possession

temporarily. The ownership of the property remains with the giver, only the possession goes

to another for example parking a scooter in a parking lot , giving car or motorcycle for repair,

or, giving a cloth to a tailor for stitching etc. Pledge is a special kind of bailment in which a

person transfers the possession of his property to another for securing the loan taken from the

other side. It only differs from bailment in the matter of purpose. When the purpose of the

bailment is to secure a loan or a promise, it is called a pledge.

4.2 Definition of bailment

Section 148 - “A bailment is the delivery of goods by one person to another for some

purpose, upon a contract that they shall, when the purpose is accomplished, be returned or

otherwise disposed of according to the directions of the person delivering them”. The person

delivering the goods is called the bailor and the person to whom they are delivered is called

thebailee.

Explanation –

If A sells his old books to B and B is supposed to be returned those books after examination.

Then there is a contract of bailment.

4.3 Essential elements of bailment

Delivery of goods

Goods in possession must transfer from one person to another person. What so ever

be the purpose of bailment goods must be handed over to the bailee.

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Types of Delivery - As per section 149, “The delivery to the bailee may be made by

doing anything which has the effect of putting the goods in the possession of the

intended bailee”.

There can be two types of delivery i.e. Actual and Constructive In the actual delivery,

the good’s physical possession is handed over by bailor to the bailee and in constructive

delivery the good’s physical possession remains with the bailor upon authorization of the

bailee.

Delivery upon contract

There must be contract for the delivery of goods and when the purpose is solved and over

then it will be returned. Remember that if there is no contract made for delivery of goods

then there is no bailment.

Delivery is conditional

There is the condition mentioned in the contract regarding the goods that it will be

disposed and returned after accomplishment of objectives or wishes of the bailer so

keeping goods is not permanent, it is temporary. On this particular condition goods’

possession is given by bailor to the bailee. For further explanation we can take one

example that when we give unstitched suit material to the tailor for stitching then after

stitching is done, he has to return to us the stitching is complete, the tailor is supposed to

return the garment to the bailor.

4.4 Duties and liabilities of a Bailor

Following are the important duties and liabilities of bailor:

Explain the defect:-

According to the Sec.150, “It is the first and foremost duty of the bailor that if he

knows any fault in the goods then he should disclose all the defects of the goods

before delivering of goods to the bailee”.

According to the Sec.150, “In case the goods are bailed for hire, the duty of the bailor is

still greater and he is responsible even for those faults which are not known to him”.

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Example: - Mr Yash hires a bike from Mr Zanish. Bike is defective. Mr Yash does not

disclose facts that bike has some kind of defective. Mr Zanish uses a bike and he gets injured.

In this case he is responsible.

2. Warning to the Bailee:-

If a bailor senses and observes that bailee is careless regarding usage of goods and goods can

be damaged and are in danger then he can warn the bailee.

3. Payment of necessary expense:-

It is the duty of the bailor and can say bailor is bound to bear regarding the payments of

necessary expenses of the bailment sustained by the bailee in connection with the bailment.

4. To Indemnify The Bailee:-

As per the Sec.164,” Where the title of the bailor to the goods is defective and bailee suffers

as a consequences, the bailor is responsible to the bailee for any loss which the bailee may

sustain by reason that the bailor was not entitled to make bailment, or to receive back the

goods ,or to give directions respecting them”.

4.5 Important rights of bailor

Following are the important rights of bailor :

1.Enforcement of rights :-

When purpose of bailment completes bailor has a right to take back the goods bailed. The

bailor can enforce all the duties and liabilities by suit of bailee. If bailee fails to return then

bailor has a right to claim compensation.

2. Return Before time:-

By mutual conversation or agreed condition with bailee, the bailor may return his goods

before the specified period.

3. Right of termination:-

In the case where goods are mishandled or treated not as per the contract condition then the

bailor can terminate bailment contract.

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4. Right of profit:-

The bailor has right to gain profit from the goods bailed but according to the contract’s

conditions.

5. Return of goods lent gratuitously :-

As per Sec.180” when the goods are lent gratuitously , the bailor can demand their return

whenever he pleases even though he lent them for a specified time or purpose. But if the

bailee suffers any loss exceeding the benefit actually derived by him from the use of such

goods because of premature return of goods, the bailor shall have to indemnify the bailee”.

4.6 Duties of bailee

1. Duty to take reasonable car

The bailee is bound to take proper care of the goods bailed to him.

Example: Reeta was admitted to the hospital and she handed over her jewellery to the

hospital official for safe custody. The jewellery was stolen.Held , the hospital officials were

bailees for reward and were liable for the loss as they had failed to take care of jewellery.

2. Duty not to make unauthorized use (Section 154)

Section 154 states “ if the bailee makes any use of the goods bailed which is not according to

the conditions of the bailment, he is liable to make compensation to the bailor for any damage

arising to the goods from or during such use of them”.

Example: A hires ship from B for his use and give it to C one of the family member of A.

While going in that ship suddenly it stopped may be for any reason, in this case for that loss

A is liable to B.

3. Duty not to mix (Section 155-157)

“The bailee should maintain the separate identity of the bailor's goods. He should not mix his

goods with bailor's good without bailor's consent. If he does so, and if the goods are

separable, he is responsible for separating them and if they are not separable, he will be liable

to compensate the bailor for his loss”.

Example: Anita bails 100 bales of cotton having with particular mark to Vijay. Vijay without

the consent of Anita mixed the 100 bales of different mark to that .Anita is entitled to have

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her 100 bales returned and Vijay is bound to bear all the expenses incurred in the separation

of the bales , and any other incidental charges.

4. Duty to return (Section 160)

Section 160 – “It is the duty of the bailee to return or deliver according to the bailor's

directions, the goods bailed, without demand, as soon as the time for which they were bailed

has expired or the purpose for which they were bailed has been accomplished”.

5. Duty to return increase (Section 163)

As per Section 163 “In absence of any contract to the contrary, the bailee is bound to deliver

to the bailor, or according to his directions, any increase of profit which may have accrued

from the goods bailed”.

Example - A leaves a cow in the custody of B to be taken care of. The cow has a calf. B is

bound to deliver the calf as well as the cow to B.

6. Duty not to set up jus tertii (Section 166)

As per Section 166 “if the bailor has no title and the bailee, in good faith returns the goods

back to the bailor or as per the directions of the bailor, he is not responsible to the owner in

respect of such delivery. Thus, once the bailee takes the goods from the bailor, he agrees that

the goods belong to the bailor and he must return them only to the bailor. He cannot deny

redelivery to the bailor on the ground that the bailor is not the owner “.

4.7 Important rights of bailee

The duties of the bailor are the rights of the bailee. Following are the important right of

bailee:

1. Compensation Right :-

It is the right of the bailee that he should received compensation from the bailor for any loss

which he has suffered due to defects in the title of the bailor.

2. Recovery of Losses:-

If the bailee suffers a loss or damage due to the defects of the bailed goods he has a right to

recover it from the bailor.

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3. Right of Indemnity:-

Any loss which bailee has sustained may recover from the bailor on the following grounds,

"The bailor was not entitled to make the bailment, or receive back the goods, or to give

directions in this respect."

4. Right of Retain:-

Sometimes bailee performs some services for the purpose of bailment. In such cases bailee

has a right to detain such bailed goods until he receives the reward of his services.

5. Recovery of Expenses:-

All the expenses incurred for the bailment may be recovered by the bailee from the bailor.

Activity A

A’s coat , while he was having lunch in a restaurant ,was taken by a waiter and hung on a hook behind

A. The coat was stolen.

a) Can A recover the loss?

b) If So, from whom?

________________________________________________________________________________

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________________________________________________________________________________

____________________________________________________________________________

_____________________________________________________________________________

________________________________________________________________________________

4.8 Detailed comparison between Sale and Bailment:

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Sale Bailment

Possession Possession of goods is

transferred to the buyer.

Possession of goods is

transferred to the bailee.

Ownership Ownership is transferred to

the buyer.

Ownership resides with the

bailor.

Usage The buyer may use the goods

in any way he likes.

A bailee can use the goods

only according to the

directions of the bailor.

Return There is no return of goods

from the buyer to the seller,

unless there is breach.

The goods are returned after

the specified time or

accomplishment of the

purpose.

Consideration The consideration is the price

i.e. money.

The consideration is not the

money in this case ,an

undertaking to return the

goods after the

accomplishment of the

purpose.

Charges The question of any charges to

be paid by the seller to buyer

or vise versa does not arise.

The bailor has to repay the

charges which the bailee has

incurred in keeping the goods

safe.

Duration Final. Once the sale is

transacted, the seller keeps the

goods until he decides to sell

them to another.

Temporary. The bailee has to

return the goods to the bailor

once the specified time is

passed.

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1. The person who deliver goods during the contract of bailment is called -------------.

2. The person whom goods are delivered according bailment is called -------------.

3. In bailment, bailor is duty bound to disclose fault in goods bailed as provided in section-----

------------.

4. The bailment of goods as security for payment of debt or performance of a promise is

called----------------.

4.9 Pledge

It can be defined as "Bailment of goods as a security for the payment of a debt or

performance of a promise is called pledge.".

As per Sec.172 “The bailment of goods as security for payment of debt or performance of a

promise is called ‘pledge’ .The bailor in this case , is called pledger or "Pawnor" and Bailee

is called "Pawnee" or pledgee.

Example:- Mr. Rathi borrows Rs. Twenty thousand from Mr. jai and keeps his motor cycle

as security for payment of the debt. The bailment of motor cycle is called pledge.

Note: In this example Mr. Rathi is a Pawnor and Mr. Jai is a pawnee.

4.10 BASIC REQUISITES OF PLEDGE

Following are the important essentials of pledge :

1. Moveable Property :-

All types of goods and valuable documents are involved in pledge should be regarding

movable ability of goods so the pledge is concerned with the moveable property..

2. Transfer of Possession:-

Only possession of goods is transferred by the pawnor to the pawnee.

Example :- Mrs. Neelu ledges car with Mr. Ramesh and gets Rs. 200,000. He gives the

possession of car to Mr. Ramesh.

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3. Ownership Right:-

The ownership of the goods remains with the pawnor not with the pawnee.

Example:- Mr. Walia pledges the plot with Mr. Raizada and gets 20 lac. The ownership of

the plot remains with Mr. Walia.

4. Case of Mere Custody:-

People who have only mere custody of goods they are having ,cannot pledge them.

Example:- A custodian cannot pledge his master’s kothi. It will be invalid pledge.

5. Limited Interest:-

Pledge is not valid for unlimited interest. If someone pledges goods for some specific purpose

i.e. only limited interest is there, the pledge is valid to the extent of that interest only.

Example:- Mrs. Neelu gives car to Mr. Andy for repair, but does not pay Rs. 10,000 repair

charges. Mr Andy pledges the car with Mrs. Sunita and borrows Rs. 50000. This pledge is

valid only up to ten thousands.

4.11Rights of a Pawnee

1. Right of retainer (Section 173- 174) - As per section 173,” the pawnee may retain

the goods pledged, not only for a payment of a debt or the performance of the promise,

but also for the interest of the debt, and all necessary expenses incurred by him in respect

of the possession or for the preservation of the goods pledged”.

Further, as per section 174,” in absence of any contract to the contrary, the pawner shall

not retain the goods pledged for debt or promise other than the debt or promise for which

they have been pledged”.

However, such contract shall be presumed in absence of any contract to the contrary

with respect to any subsequent advances made by the pawnee.

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This means that if A pledges his gold watch with B for 2000 Rs and later on he promises

to teach B's son for a month and takes for 700Rs for this promise , and if he does not

teach B's son, B cannot retain A's gold watch after A pays 2000 Rs. Thus, the right of

retainer is a sort of particular lien.

2. Right to extra ordinary expenses (Section 175) - As per section 175, “the pawnee is

entitled to receive from the pawner, extra ordinary expenses incurred by him for the

preservation of the goods pledged. For such expenses, however, he does not have right to

detain the goods”.

3. Right of sale (Section 176) - As per section 176 ,”If the pawnor makes default in

payment of the debt or performance at the stipulated time, of the promise, in respect of

which the goods were pledged, the Pawnee may bring a suit against the pawn or upon the

debt or the promise and retain the goods pledged as a collateral security; or he may sell

the thing pledged, on giving the pawnor reasonable notice of the sale”.

4.Pawnor's Right to Redeem (Section 177)

As per section 177, “It provides a very important right to the pawnor. It allows the

pawnor to redeem his property even if he has defaulted. It says that if a time is stipulated

for the payment of a debt or performance of the promise for which the pledge is made,

and the pawnor make default in payment of the debt or performance of the promise at the

stipulated time, he may redeem the goods pledged at any subsequent time before the

actual sale of them; but he must, in that case, pay, in addition, any expense which have

arisen from his default”.

Activity B

A, a doctor, persuades his patient B by exercise of undue influences to sell his valuable diamond

at a very low price to him then A obtains possession of the diamond and pledges it with C.Is this a

valid pledge?

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4.12 Key Differences between Bailment and Pledge

The following are the major differences between Bailment and Pledge

1. A Bailment is a contract in which goods are transferred from one party to another

party for a short period of time for a specific objective. The Pledge is a kind of

Bailment in which goods are pledged as security against payment of debt.

2. A Bailment is defined under section 148 while Pledge is defined under section 172 of

the Indian Contract Act, 1872.

3. In bailment, the consideration may or may not be present, but in case of pledge, the

consideration is always present.

4. The objective of bailment is safe custody or repairing of goods delivered. On the other

hand, the sole purpose of delivering the goods is to act as security against debt.

5. The receiver has no right to sell the goods in case of bailment whereas if the goods are

not redeemed by pawnor within the reasonable time the pawnee can sell the goods

after giving a notice to him.

6. In bailment, the goods are used by the bailee only for the said purpose. Conversely, in

pledge, pawnee has no right to use the goods.

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4.13 Pledge by non- owners

As we all know that there must be an owner who can create a valid pledge. But following are

the cases where even non-owner can make a valid pledge:

1. Pledge by mercantile agent:

As per Sec 178,” Where a mercantile agent is, with the consent of the owner, in the

possession of goods or the documents of titles to goods ,any pledge made by him

,when acting in the ordinary course of business of a mercantile agent is as vaild as if

he were expressly authorised by the owner of the goods to make the same. But the

pledge is valid only if the pawnee acts in good faith and has not at the time of the

pledge notice that the pawnor has the authority to pledge”.

2. Pledge by buyer or seller after sale:

Sec.30 states that ,” A seller left in the possession of goods after sale and a buyer who

obtains possession of goods with the consent of the seller before sale, can create a

valid pledge provided the pawnee acts in good faith and has no notice of the previous

sale of goods to the buyer or the lien of the seller over the goods”.

3. Pledge where pawnor has a limited interest:

As per the section 179,” where a person pledges goods in which he has only a limited

interest, the pledge is valid to the extent of that interest”.

4. Pledge by co-owner in possession:

One of the co-owner who is in possession of goods with the assent of other co-owner

may create a valid pledge of the goods.

5. Pledge by person to possession under a voidable contract:

As per sec.178 ,” Where a person obtains possession of goods under a voidable

contract ,the pledge created by him is valid provided (1) the contract has not been

rescinded before the contract of pledge, and (2) the pawnee acts in good faith and

without notice of the pawnor’s defect of title”.

Check your progress B

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1. In pledge bailor is called -------------.

2. The term "Pledge" means thing which is given as-------------.

3. A person employed to do any act for another or to represent another in dealings with third

person is called-----------------.

4. Section 178, of the Contract Act 1872 deals with----------------.

4.14 Summary

When we make bailment and pledge type of contract in our life especially the contract of

bailment because all of us has left our car or motor cycles in the service centre for repairs, it

is bailment. Pledge has a limited scope as compared to bailment , many businessmen take a

loan from financial institution by pledging their stock as security. In short, we can say that

every pledge is a bailment, but every bailment is not pledge. So, both of them are very

important at their places and we must know their differences.

4.15 Keywords

Bailment is delivering goods for a specified purpose on trust. The goods are to be

returned after the purpose is over.

Gratituous Bailment : Where neither the bailor nor the bailee get any kind of

remuneration, then it is gratuitous.

Non-Gratituous Bailment : When either the bailor or bailee get any remuneration, then it is

known as non-gratuitous bailment.

Pledge: Bailment of goods as a security for payment of debts or performance of promise is

called pledge. The bailor is called pledger or pawnor and the bailee is called Pawnee.

Contract of Sale: Sec 4 states “A contract of sale of the goods is a contract whereby the

seller agrees to transfer and transfer property in goods to the buyer for a price”.

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Goods: As per Section 2 (7) of the ‘Act’ goods are , “Every kind of movable property other

than actionable claims and money; and includes stock and shares, growing crops, grass, and

things attached to or forming part of the land which are agreed to be severed before sale or

under the contract of sale.”

Sale: When the goods is transferred from the seller to the buyer under a contract of sale , the

contract is called a sale.

Agreement to Sell: Where the transfer of the property in the goods is to take a place at a

future time or subject to some condition thereafter to be fulfilled the contract is called an

agreement to sell.

Future Goods: These are that goods which are not in the existence at the time of contract of

sale.

Price: The money paid for the purchase of goods is called the price. It is expressed in terms

of money.

Hire Purchase Agreement: When the owner delivers his goods on hire basis to a person ,a

hire purchase agreement is said to be exist.

Bailment: When the goods are delivered by one person to another for some purpose and on

the condition that the goods shall be returned back on the achievement of the purpose, it is a

case of bailment of goods.

4.16Answer to check your progress

Answer to check your progress A

Ans.1 Bailor

Ans.2 Bailee

Ans.3 149, of the Contract Act

Ans.4 Pledge

Answer to check your progress B

Ans.1 Pawnor

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Ans.2 Security

Ans.3 Agent

Ans.4 Pledge by mercantile agent


1. Define a bailment and briefly state the rights and duties of bailor and bailee.

2. Define bailment and give its characteristics. How does bailment differ from ‘sale’? What

is a bailee’s lien?

3. Explain the nature of the bailee’s particular lien. How does it differ from the general lien

of bankers and factors?

4. What are the rights and obligations of a finder of goods?

5. Define pledge, and state the respective rights and duties of pawnor and pawnee.

6. When does bailment come to an end?

7.”The position of a finder of goods is exactly that of a bailee in case of a deposit.”

Comment.

8. To what extent is a bailee responsible for loss arising from defective title of the bailor.

9. When is a pledge created by non-owners valid?

10.Distinguish between ‘bailment ’ and ‘ pledge’.


1. N.D. Kapoor, Company Law, Sultan Chand & Sons, New Delhi. S.C. Aggarwal,

Company Law, Dhanpat Rai Publications, New Delhi.



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4.R.H. Pandia, Priciples of Mercantile Law, N.M. Tripathi Pvt. Ltd., Mumbai.

5. S.R. Davar, Mercantile Law, Progressive Corporation Pvt. Ltd., Mumbai.

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Lesson 5

Indemnity and Guarantee

STRUCTURE


5.1 Introduction

5.2 Definition of Contract of Indemnity

5.3 Parties involved in Contract of Indemnity

5.4 Rights of indemnity holder

5.5 Definition of Guarantee of Contract

5.6 Parties involved on contract of guarantee

5.7 Essential elements of contract of guarantee

5.8 Rights of a surety in contract of guarantee

5.9 Difference between Contract of guarantee & Contract of indemnity

5.10 Summary


5.12 Keywords



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5.0 Learning Objective


a) Define Indemnity and Guarantee its essentials.

b) Make a distinction the two concepts.

c) State the rights under Indemnity and Guarantee.

5.1 Introduction

The term Indemnity means “Security against loss”. In a contract of indemnity one party (the

indemnifier) promise to compensate the other party (the indemnified) against the loss

suffered by the other. As per sec.124, “A contract by which one party promises to save the

other from loss occurred by promisor is called a Contract of indemnity”. Guarantee means

security. As per sec. 126,”A contract of guarantee is a contract to perform the promise, or

discharge the liability, of a third person in case of his default. The person who gives the

guarantee is called the "surety"; the person in respect of whose default the guarantee is given

is called the "principal debtor ", and the person to whom the guarantee is given is called the”

creditor ". A guarantee may be either oral or written”. Guarantee and Indemnity both contract

are a kind of modes of compensation .They are like “two sides of the same coin” i.e. differ on

a lot of issues while being similar on various issue. In this lesson we will discuss it one by

one. First we will go about explaining what indemnity and guarantee means. Then we will go

into the differences and the similarities between guarantee and indemnity.

5.2 Definition of Contract of Indemnity

It is defined in the following words as in sec 124, "A contract by which one party promises to

save the other from the loss caused to him by the contract of the promisor himself or by the

conduct of other person”.

In its widest sense, it means recompense for any loss or liability which one person has

incurred, whether the duty to indemnify comes from an agreement or not.

Example: A contracts to indemnify B against the consequences of any proceedings which C

may take against B in respect of a certain sum of Rs.2000. This is a contract of indemnity.

The English law definition of a contract of indemnity is – “it is a promise to save a person

harmless from the consequences of an act”. Thus it includes within its ambit losses caused

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not merely by human agency but also those caused by accident or fire or other natural

calamities.

The definition provided by the Indian Contract Act confines itself to the losses occasioned

due to the act of the promisor or due to the act of any other person.

Example1. A and B claim certain goods from a railway company as rival owners. This is a

contract of indemnity between A and Railway Company. If A takes delivery of the goods by

agreeing to compensate the railway company against loss in case B turns out to be the true

owner.

Example2: Mr. Jha makes a contract of indemnity with Mr. Raman against the consequences

of any proceeding. Which Mr.Chandesh may take against Mr. Raman in respect of certain

sum of Rs.200000 The contract between Mr. Jha and Mr. Raman is called the contract of

indemnity.

5.3 Parties involved in Indemnity contract

In this type of contract, two parties involved. A person who contributes the indemnity of

protection to other person is called indemnifies. On the other hand a person whom protection

is provided is called indemnity holder.

The above particular definition of contract of indemnity consists of the following Essential

elements -

1. There should be or you can say must be some type of loss.

2. That loss must be produced either by the promisor or by any other person.

3. Indemnifier has the liability for the loss only.

Thus, it is well clear that this contract of indemnity has contingent nature and can be enforced

only when the loss occurs not all the time.

A contract of indemnity is a species of the general contract so it contains all essentials of a

valid contract.

Activity 1

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X and Y go in to shop. X told shopkeeper, “let Y purchase the goods and he does not pay, I (x)

will,” What kind of the contract is this?

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5.4 RIGHTS OF INDEMNITY HOLDER

Following are the important rights of indemnity holder:

Suit expenditure recovery:

As per sec 125,”Holder has right to recover all the expenditure spent by him on suits

defending his case. It is necessary that holder had acted according to indemnifies direction.

Rights of loss recovery:

As per sec 125,”It is a right of the indemnity holder to recover all the losses which he is

compelled to pay in the related suit for indemnifies”.

Compromise cost recovery:

As per sec 125,”Under the terms of any compromise in such suit sometimes money is also

paid. Holder is entitled to recover all the sum of money paid by him for this purpose”.

Rights of Indemnifies

As per sec 125,”He is entitled to the benefit of all the securities which the creditor has against

the principal debtor, whether he was aware of them or not”.

5.4 Rights of indemnifier: The Indian Contract Act has no content for rights of indemnifier

in the indemnity contract but it is included in the dictionary of the English Law, that rights of

indemnifier is similar to the rights of a surety under Sec. 141 that are discussed later in this

chapter.


5.5 Definition of Guarantee of Contract

Indian Contract Act 1872 (Section 126) defines a contract of guarantee as follows:

"A contract of guarantee is a contract to perform the promise, or to discharge the liabilities of

a third person in case of his default. The person who gives the guarantee is called Surety, the

1. Indemnity" means--------------

2. Section 124, of the Contract Act, define------------.

3. A contract by which one party promises to save the other from loss caused to him by the

conduct of the promisor himself or by the conduct of any other person is called----------

4. The contract of insurance is a contract of--------------

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person in respect of whose default the guarantee is given is called Principal Debtor, and the

person to whom the guarantee is given is called Creditor. A Guarantee may be either oral or

written."

Examples:

a) P requests to Q to lend Rs.1000 to C and guarantees that if C fails to pay the amount, he

will pay. This is a contract of guarantee. In this case, P is the surety, Q the creditor and C,

the principal debtor.

b) S requests C to lend Rs.5000 to P and guarantees that if p will fail to pay the in that case S

will pay. This is a contract of guarantee. In this case, S is the surety, C the creditor and C,

the principal debtor is P.

Note that A “contract of guarantee” is a tripartite agreement that means three parties are

involved, for example: when Ajay promises to a shopkeeper Chirag that ajay will pay for

the items bought by Bikram if Bikram fails to pay, , Chirag can sue ajay to recover the

balance, this is a contract of guarantee. There is a triangular relationship between three

collateral contracts which has been distinguished as follows:

1. As between P and C, there is a contract out of which the guaranteed debt arises.

2. As between C and S, there is a contract exists through that S guarantees to pay C, P‘s

debt in case of P’s default.

3. As between P and S, there is a contract that P shall indemnify S in the case S pays in

the event of a default by P. It is implied always if in the contract it is not expressed.

5.6 Parties involved on contract of guarantee:-

There are three parties involved in this contract. A person who gives the guarantee is called

the Surety, The person on whose default the guarantee is given is called the Principal

Debtor and the person to whom the guarantee is given is called the Creditor.

5.7 Essential elements of contract of guarantee

1. Existence of Creditor, Surety, and Principal Debtor –

The economic function of a guarantee is to help a credit-less person to get a loan or

employment or something else. Thus, there must be the existence of a principal debtor for a

recoverable debt for which the surety is liable in case of the default of the principal debtor.

Example: C made contracts with P .Without any communication S undertakes with P for

moving from C to indemnify C against any kind of damage that results from breach of P’s

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obligation. This not at all make S as P’s surety because without the consent of principal

debtor person cannot become a surety.

2. Distinct promise of surety –

There must be a distinct promise by the surety to be answerable for the liability of the

Principal Debtor.

3. Liability must be legally enforceable –

Only if the liability of the principal debtor is legally enforceable, the surety can be made

liable. For example, a surety cannot be made liable for a debt barred by statute of limitation.

4. Consideration –

As with any valid contract, the contract of guarantee also must have a consideration. The

consideration in such contract is nothing but anything done or the promise to do something

for the benefit of the principal debtor.

Example: P requests C to deliver goods to P on credit. C agrees to do so, provided S will give

guarantee for the payment of C’s good .S promises to guarantee the payment in the

consideration of C’s promise to deliver goods. There is sufficient consideration in this case.

Section 127 clarifies this as follows:

"Anything done or any promise made for the benefit of the principal debtor may be sufficient

consideration to the surety for giving the guarantee."

Illustrations:

1. Ajay is agree to sell certain goods to Bikram only if Chirag guarantees the payment for

the goods sold . Chirag makes promise to ajay to guarantee the payment in consideration of

Ajay's promise to deliver goods to Bikram. This is a sufficient consideration for Chirag's

promise.

2. Ajay sells and delivers goods to Bikram. Chirag, afterwards, requests Ajay to forbear to

sue Bikram for an year and promises that if Ajay does so, he will guarantee the payment if

Bikram does not pay. Ajay forbears to sue Bikram for one year. This is sufficient

consideration for Chirag’s guarantee.

3. Ajay sold and delivered goods to Bikram. Later on, Chirag, without any kind of

consideration makes promise to pay Ajay if Bikram fails to pay. The agreement is void due to

lack of consideration.

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5.8 Rights of a surety in contract of guarantee

A surety has the following rights against

1. The creditor,

2. The principal debtor

3. Co-sureties.

1. As against the Creditor:

According to the Indian Contract Act, 1872,

Sec. 133 –“The creditor ought not fluctuate terms of the agreement between the

creditor and the principal debtor without the surety’s assent. Any such fluctuation

releases the surety as to transactions ensuing to the difference. However in the event

that the change is for the profit of the surety or does not prefer him or is of an

irrelevant character, it might not have the impact of releasing the surety”.

Sec. 134 – “The creditor ought not discharge the principal debtor from his liability

under the agreement. The impact of the release of the principal debtor is to release the

surety too. Any enactment or exclusion from the creditor which in law has the impact

of releasing the principal debtor puts a close to the liability of the surety”.

Sec. 135 -,”In the event that an agreement is made between the Creditor and Principal

debtor for intensifying the last’s liability or making a guarantee to him growth of time

for doing the commitments or swearing up and down to not to beyond any doubt,

releases the surety unless he consents to such an agreement".

Sec. 139 – ,”The surety is released if the creditor debilitates the surety’s possible

remedy against the principal debtor”.

2. Against the Principal Debtor

Right of subrogation – The surety on making good of the debt obtains a right of

subrogation.

Sec. 140,”the surety can’t assert the right of subrogation to the creditor’s securities in

the event that he has agreed as a security for a part of the contract and security has

been procured by the creditor for the complete debt”.

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Example: P is indebted to C and S is surety for the debt. C demands payment from S

and he refuses and then C sues S for that amount, S defends the suit on reasonable

ground but after that S is forced to make payment for the amount of the debt with

costs.

4. Against the co-sureties

Rights of contribution: When two or more person guaranteed the debt they are called

co-sureties. The co-sureties are liable to make contribution, as per the agreement and

towards the payment of the guaranteed debt. When any of the co-sureties makes

payment he can claim contribution from the other co-sureties. In this heads following

are the rules:

Co-sureties liable to contribute equally

Sec.146 states that” Where two or more persons are co-sureties for the same debt or

duty, either jointly or severally, and whether under the same or different contracts,

and whether with or without the knowledge of each other, the co-sureties, in the

absence of any contract to the contrary, are liable, as between themselves, to pay each

an equal share of the whole debt, or of that part of it which remains unpaid by the

principal debtor”.

Example: P1, P2 and P3 are the sureties to P4 for the sum of 3000 INR lent to S. S

makes default in the payment, P1, P2 and P3 are liable to pay 1000INR each between

themselves.

Liability of co-sureties bound in different sums

Sec.147 states “Where the co-sureties have agreed to guarantee different sums, they

have to contribute equally subject to the maximum amount guaranteed by each one.

The fact that the sureties are jointly or severally liable under the contract, or without

the knowledge of each other, is immaterial”.

Example: Ajay, Vijay and Charu, are the sureties for Dinesh and enter into three

several bonds each in different penalty as Ajay has the penalty of 10,000 rupees,

Vijay has penalty of 20,000 rupees, Charu has penalty of 40,000 rupees, conditioned

for Dinesh's duly accounting to Eimely. Dinesh makes default to the extent of 40,000

rupees. Ajay is liable to pay 10,000 rupees, and Vijay and Charu 15,000 rupees each.

Release of Co- Surety:

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As per sec 138,”Where there are co-sureties, a release by the creditor of one of them

does not discharge others, neither does it free the surety so released from his

responsibility to the other sureties”.

Activity 2

Calls on shares by Q in R ltd. were guaranteed by S. On non- payment of the last call, the company

forfeited the shares. Is S discharged of his liability?

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5.15 Difference between Contract of guarantee & Contract of indemnity

1. Difference in Meaning

Contract of guarantee: In the contract of guarantee one person gives guarantee for the

performance of the contract.

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Contract of indemnity: In the contract of indemnity one person promises to save the

other from any loss.

2. Difference in the Number of Parties involved in the contract:-

Contract of guarantee : Contract of guarantee is a tripartite in nature. Under the contract

of guarantee there are three parties.

Contract of indemnity: Under the contract of indemnity there are two parties.

3. Difference in the Liability:-

Contract of guarantee: In case of guarantee contract surety has the secondary liability.

Contract of indemnity: Under indemnity contract the basic liability falls on indemnifies.

4. Difference in the number of contracts:

Contract of guarantee: Under the contract of guarantee there must be at least three

contracts i.e. collateral contracts.

Contract of indemnity: Under the indemnity contract there is one contract only.

5. Difference in the nature of interest:

Contract of guarantee: Under the contract of guarantee guarantor he has only interest in

guarantee.

Contract of indemnity: In case of indemnity contract, indemnifies has the interest in

earning commission and premium.

6. Difference in the right of claim:

Contract of guarantee: If Guarantor has paid the debt , he is entitled to proceed against

the principal debtor in his own name.

Contract of indemnity: Indemnifies cannot sue the third party.

7. Difference in the Performance of Contract:-

Contract of guarantee: In case of guarantee there is an existing debt or duty

performance about which guarantee is given.

Contract of indemnity: Contract of indemnity depends upon the possibility of risk or

loss.

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1. Section 124 to 147, of the Contract Act, deals with--------------

2. A guarantee which extend to a series of transactions is called ------------.

3 A in consideration that B will employ C in collecting the rent of B's zamindari, promises B

to be responsible, to the amount of 5000 rupees for the due collection and payment by C of

those rents. This is -----------------

4. Section 142 of the Contract Act 1872 deals with --------------

5.10 Summary

Guarantees and Indemnities have an important role in commercial lease cases, particularly in

difficult financial crises. An indemnity, by contrast, accommodates simultaneous obligation

with the principal although and there is no compelling reason to “look first” at the principal.

Generally it is an agreement that the surety will hold the lender innocuous against all

misfortunes emerging from the agreement between the principal and the lender. Generally, a

guarantee accommodates an obligation far-reaching with that of the principal. At the end of

the day, the guarantor can’t be at risk for much more than the client. The document will be

understood as a guarantee if, on its actual development, the commitments of the surety are to

“remained behind” the principal and just go to the fore once a commitment has been broken

as between the principal and the lender. The commitment is an auxiliary one, reflexive in

character. An indemnity emerges on event of an occasion, whereas a guarantee emerges on

default by a third party. Hence we have explained what indemnity and guarantee means and

on what grounds they differ on like the number of parties involved and the nature of risks

involved and we have also worked upon the small but significant differences both in working

and in principal between guarantee and indemnity. Therefore, though guarantee and

indemnity have a few similarities, they are inherently different in nature.



Ans.1 Security from damage or loss and Security for more profit

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Ans.2 Contracts of indemnity

Ans.3 Contracts of indemnity

Ans.4 indemnity


Ans.1 Contracts of indemnity & Contracts of Guarantee.

Ans.2Continuing guarantee

Ans.3 continuing guarantee

Ans.4 Guarantee obtained by misrepresentation

5.12 Keywords

Indemnity: Security against loss.

Indemnity Contract: It is defined in the following words, "A contract by which one party

promises to save the other from the loss caused to him by the contract of the promisor himself

or by the conduct of other person”.

Indemnifier: Person who gives the indemnity of protection to other person.

Guarantee of Contract: A contract of guarantee is a contract to perform the promise, or to

discharge the liabilities of a third person in case of his default.

Surety: The person who gives the guarantee is called Surety.

Principal Debtor: The person in respect of whose default the guarantee is given is called

Principal Debtor


1. Define contract of indemnity? Illustrate your answer.

2. What do you mean by the term “guarantee”.

3. What are the rights of an indemnity holder when sued?

4. Differentiate between contract of indemnity and contract of guarantee?

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5. When is a contract of guarantee held to be invalid?

6. The liability of surety is secondary. Discuss.

7. The liability of a surety is co-extensive with that of the principal debtor.

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

9. What is the nature if a surety is act as authority?

10. What are the rights of indemnifier?


1. S.R. Davar, Mercantile Law, Progressive Corporation Pvt. Ltd., Mumbai.

2. R.H. Pandia, Principles of Mercantile Law, N.M. Tripathi Pvt. Ltd., Mumbai

3. N.D. Kapoor, Company Law, Sultan Chand & Sons, New Delhi. S.C. Aggarwal, Company

Law, Dhanpat Rai Publications, New Delhi.



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Lesson-6

Sale of Goods Act

Structure

6.0 Objective

6.1 Introduction

6.2 Contract of sale

6.2.1 Essential of contract of sale

6.2.2 Difference between sale and sell to agreement

6.3 Formation of contract of sale

6.4 Subject matter of contract of sale

6.5 Effect of destruction of subject matter

6.6 Price

6.6.1 The mode of fixing the price

6.6.2 The mode of payment of price

6.7 Earnest money

6.8 Summery

6.9 Glossary

6.10 answer to check your progress

6.11 suggested reading

6.12 model Questions

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6.0 Objectives


To understand meaning of goods.

To understand the contract of sale of goods act.

6.1 Introduction

The sale of goods acts 1930 deals with the law relating to sale of goods in India. The term goods

mean every kind of movable property, other than money and actionable claims. The sale of

goods act, 1930 is mainly based on the English sale of goods act, 1893, before the sale of goods

act, 1930, the law relating to sale of goods was covered under the chapter VII of Indian contract

act, 1872, the provision of which were found to be inadequate.

Therefore a strong need was felt to have an independent sale of goods act and consequently a

new act called sale of goods act, 1930 was passed. The presently act containing 66 sections came

into force from 1st July, 1930 which extends to whole of India expect the state of Jammu and

Kashmir

6.2 Contract of sale

Section 4 of the sale of goods act define “A contract whereby the seller transfer or agrees to

transfer the property in goods to a buyer for a price”

A contract of sale consists of the following:

i. Sale (or absolute sale),

ii. Agreement to sell (or conditional sale).

I. Sale (or absolute sale)

Where the property (ownership) in the goods is immediately transferred from the seller to

buyer, and nothing is left on the part of the seller, there is a sale or absolute sale. Counter sale in

a shop is a sale or an absolute sale.

II. Agreement to sell or conditional sale

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Where the transfer of property (ownership) in the goods shall take place in future or on the

fulfillment of certain conditions, it shall be an agreement to sell or a conditional sale. The

property (ownership) in goods shall not be transferred from the seller to the buyer until and

unless some condition is fulfilled for the completion the contract.

How agreement to sell becomes a sale

In the first stage every contract of sale is an agreement to sell. When seller and buyer agree to

sell and buy some goods at a price, there is an agreement between the two for the sale of the

goods. Now what remains, is the transfer of ownership of goods from the seller to the buyer? If

the ownership is transferred by the seller immediately it becomes a sale and if he does not

transfer the ownership until some condition is fulfilled it shall remain an agreement to sell till the

condition is fulfilled and the ownership is transferred.

6.2.1 Essentials of a contract of sale

To constitute a valid contract of sale, the following essentials must be present,

(1) valid contract

A contract of sale is just like any other contract made under Indian contract act, 1872.

Therefore to constitute a valid contract of sale, it should satisfy all the essentials of a valid

contract namely, a valid offer, a valid acceptance, free consent of parties, a valid and lawful

consideration, parties must be competent to contract and lawful object etc.

(2) Two parties

To constitute a contract of sale, there must be a transfer or agreement to transfer the property

in goods by the buyer. It means that there must be two persons, one the seller and the other

the buyer. The seller and buyer must be two different people, because one person cannot buy

its own products. The parties must be competent to contract.

Example: A club supplies food and drinks at fixed prices. This was held to be not a sale as a

member of the club pays to the members jointly i.e. to the club. “Members of club are

undivided joint owners and not part owners.”

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There are certain exceptions to the rule that the same person cannot be both a purchaser and a

seller. These are:

a) Where a person’s goods are sold in execution of a decree, he may himself buy them.

b) A part owner can sell his share to the other part owner so as to make the other part-

owner the sole owner of goods.

c) Where a Pawnee sells the goods pledged with him on non-payment of bill money.

The pawnor may himself buy such goods.

d) A partner may also buy the goods from the firm in which he is a partner and vice

versa.

e) In case there is a sale by auction, the seller may reserve right of making a bid at the

auction and may thus purchase his goods.

(3) Agreement for the transfer of ownership

To constitute a valid contract of sale, there should be immediate transfer or an agreement

to transfer the general property in goods sold or agreed to be sold. It is essential to

transfer the general property in the goods from the seller to the buyer with or without

physical possession of the goods.

(4) Goods:

The subject matter of the contract of sale must be ‘goods’ the property in which is to be

transferred from the seller to the buyer. According to section 2(7), “goods means every

kind of immoveable property other than actionable claims and money and includes stock

and shares, growing crops, grass, trees and things attached to or forming part of the land

which are agreed to be served it before sale or under contract of sale.”

Example: where the trees were sold so that they were to be cut out and separated from

land and taken away by the buyer. The contract was for sale of trees as movable goods.

(5) Price:

To constitute a valid contract of sale, consideration for transfer must be money paid or

promised. Where there is no money consideration the transaction is not a contract of sale,

as for instance goods given in exchange for goods or as remuneration for work or labour.

However, an existing debt due from the seller to buyer is sufficient. Further, there is

nothing to prevent the consideration from being partly in money and partly in goods or

some other articles of value.

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Example: A refrigerator company supplies a new refrigerator of Rs. 7000 in exchange of

old refrigerator and Rs. 5000 in cash. It is a sale under the sale of goods act.

It may be noted that no particular form is necessary to constitute a contract of sale. A

contract of sale may be made in writing or by words of mouth or may be implied from the

conduct of the parties.


1. Which of the following is the Essentials of a contract of sale

a) valid contract

b) Price

c) Agreement for the transfer of ownership

d) Contract

2. A contract of sale consists of the following

a) Sale

b) Agreement to sell

c) Both A and B

d) None of these

6.2.2 Difference between sale and agreement to sell

The distinction between sale and an agreement to sell is very necessary to determine the

rights and the liabilities of parties to the contract. The main points of distinction are:

(1) Nature of contract

An agreement to sell is an executory contract is a contract pure and simple and no

property passes, whereas a sale is an executed contract plus a conveyance.

(2) Transfer of property(ownership)

In sale the property in goods passes from seller to buyer immediately and buyer becomes

the owner of the goods immediately.

But In an agreement to sell the property in goods passes from seller to buyer at some

future date or subject to the fulfilment of certain conditions i.e. the seller continues to be

the owner of the goods supplied until the agreement to sell becomes a sale.

(3) Risk of loss:

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In a sale, if the goods are destroyed, the risk of loss falls on the buyer even if the goods

were in the possession of the seller because the risk of loss passes with the ownership.

But in an agreement to sell if goods are destroyed the risk of loss falls on the seller even

if the goods were in the possession of the buyer because ownership has not passed from

the seller to the buyer and the risk passes with the ownership.

(4) Consequences of the breach:

On the branch of an agreement to sell by the seller, the buyer has only a personal remedy

against the seller, but if after a sale the seller breaks the contract(e.g. resells the goods)

the buyer may sue for delivery of the goods or for damages.

In an agreement to sell, if the buyer fails to accept the goods the seller may sue for

damages only and not for the price. On a sale, if the buyer does not pay the price, the

seller may sue him for the price.

(5) Insolvency of the buyer:

In a sale, if the buyer is adjudged an insolvent, the seller in the absence of a lien over the

goods is bound to deliver the goods to the official receiver or assignee. The seller will,

however, be entitled to a ratable dividend for the price of the goods.

In an agreement to sell, when the buyer becomes insolvent before he pays for the goods,

the seller may not part with the goods.

(6) Insolvency of the seller:

In a sale, if the seller becomes insolvent, the buyer is entitled to recover the goods from

the official receiver or assignee as the property of goods is with the buyer.

In the agreement to sell, if the buyer has already paid the price and the seller becomes

insolvent, the buyer can claim only a ratable dividend and not the goods.

(7) General and particular property:

In case of an agreement to sell the buyer and seller get remedy against each other in case

of breach of an agreement. The agreement of sale creates a right with which only the

contracting parties are concerned and not the whole world.

Whereas in case of sale, the buyer gets an absolute right of ownership and this right of the

buyer is recognized by the whole world.

(8) Right of re-sale

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In a sale, the seller cannot resell the goods even if he is in possession of the goods after

sale. If he does so the new buyer does not get the good title and the first buyer can

recover the goods.

In an agreement to sell, the seller may sell the goods since ownership is with the seller. If

he does so, he may become liable for breach of agreement. But in this case the new buyer

gets good title.

6.3 Formation of contract of sale

Section 5 lays down the formalities of the contract of sale as under:

1) A contract of sale is made by an offer to buy or sell goods for a price. The contract may

provide for the immediate delivery of goods or immediate payment of the price or both,

or the delivery or payment by instalments, or that the delivery or payment or both shall be

postponed.

2) A contract of sale may be made in writing or by word of mouth or party in writing and

partly by word of mouth, or may be implied from the conduct of parties.

Explanation: a contract of sale is made like any other contract under the general law of contract,

without any particular form of a contract of sale as such. A contract of sale is made by a buyer

offering to buy or a seller offering to sell goods for a price, and the other party accepting the

offer of the buyer or the seller as the case may be. Therefore every contract of sale shall have two

parties, i.e. a buyer and a seller, one of them must offer and the other must accept to buy or sell

goods for a price.

The parties to a contract of sale may agree in the following terms:

1) That delivery of goods shall be made immediately

2) That delivery of goods shall be made at some future date.

3) That payment of price shall be made immediately

4) That payment of price shall be made at some future date.

5) There may be immediate payment of price and delivery of the goods.

6) That the goods may be delivered in due course and payment be made in instalments.

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A contract of sale may be expressed or implied. It can be oral or in writing and partly oral and

partly in writing. An oral offer can be accepted in writing and written offer can be accepted

orally.

6.4 Subject matter of contract of sale

Section 6 provides that “Goods” form the subject matter of a contract of sale. “Goods” mean

every kind of movable property other than actionable claims and money and includes stock and

shares, growing crops, grass, and things attached to or forming part of the land which are agreed

to be served before sale or under the contact of sale. The definition of ‘goods’ as given the act is

exhaustive. Actionable claims and current money have been expressly excluded from the scope

of the definition. The definition of ‘goods’ under the act includes all growing crops and grass and

things attached to or forming part of the land which are agreed to be served before sale. The

interest of a partner in partnership also comes within the definition of goods.

Goods which form the subject matter of a contract of sale may be divided into three types

namely:

1) Existing goods

2) Future goods

3) Contingent goods

(1) Existing goods

Goods owned and possessed by the seller at the time of the making of the contract of sale

are called existing goods. Sometimes the seller may be in possession but may not be the

owner of the goods. In case of sale by a mercantile agent or a pledge the goods are

possessed but not owned by the seller. Where the existing goods are the subject matter of

a contract, it is essential that they must be in actual existence, for a present sale can be

made only of a subject matter having actual or possible existence. Thus for example if A

sells his horse to B, believing it to be in existence but in fact the horse is dead, no

contract will arise.

The existing goods can be further classified as under:

(i) Specific goods

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(ii) Ascertained goods

(iii) Unascertained goods

i) Specific goods:

Specific goods are those goods which are identified and agreed upon at the time of

contract of sale are made. It is essential that the goods are identified and separated

from the other goods at the time of contract of sale is made and the goods merely in

an identified position does not make the goods specific.

Example: Pin case of sale of one horse out of 30 horses, goods shall be specific if the

horse is selected before the contract of sale is made. Here it is important to note that

all the horses are horses but they cannot be exactly similar to each other. Therefore it

is essential to select the horse out of the lot as specific goods.

ii) Ascertained goods:

Sometimes the term “specific goods” and “Ascertained goods” are used

interchangeably. But actually they are not same and different in the sense that specific

goods are identified at the time of contract of sale whereas the ascertained goods are

identified after the contract of sale as per the terms decide. It is important to note that

the goods are almost of exactly the same type and quality and the buyer is to select

keeping in mind the defective pieces only.

Example: If there is going to be a sale of 30 chairs for an office out of a lot of 100

such chairs of the same design and quality, the goods are unascertained till 30

particular chairs are selected so that they are not defective in any way and are

considered to be the best of the lot for the satisfaction of the buyer, though they are all

best and equal in quality from the point of view of seller. When the required 30 chairs

are selected out of the lot, the goods are said to be ascertained goods for the contract

of sale.

iii) Unascertained goods:

When the goods are not separately identified or ascertained at the time of making a

contract of sale, are known as unascertained goods. When the buyer does not select

the goods for him from a lot of goods, but are defined or indicated only by

description, we call them unascertained goods. As soon as particular goods are

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separated from the lot they become ascertained goods. Ion the example quoted in

ascertained goods, the lot of 100 chairs is ascertained goods. When 30 chairs are

selected or identified for purchase they become ascertained goods.

(2) Future goods

It means goods to be manufactured or produced or acquired by the seller after the making

of contract of sale, as rule, any person may sell or offer for sale at any price goods of

which he is not the owner, but which he hopes or expects to acquire. A contract to sell oil

not yet pressed from seeds in his possession is a contract for the sale of future goods.

It may, however be noted that where by a contract the seller purports to effect the present

sale of future goods, the contract operates as an agreement to sell. The reason is same is

that the ownership of the goods cannot be transferred before the goods come into

existence. Thus a contract for the sale of future goods cannot be transferred before the

goods come into existence. Thus a contract for the sale of future goods is always an

agreement to sell.

Example: A agrees to sell to Q all the mangoes which will be produced in his garden next

year. This is an agreement for the sale of future goods.

(3) Contingent goods

These are a type of goods of future goods, the acquisition of which by the seller depends

upon a contingency which may or may not happen. A seller may contact to sell goods

conditionally on their acquisition, that is, goods which might be expected to come into

existence, as

a. Goods to arrive

b. Future crops

c. The eggs

Such contracts are completed when goods arrive or crops mature or the eggs grow. But such

contracts give no right of action if the contingency does not happen.

Example: A agrees to sell B a certain ring provided he is able to purchase it from its present

owner. This is an agreement for the sale of contingent goods.

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Activity-1

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6.5 Effect of destruction of subject-matter

Section 7 and 8 lay down the rules applicable to cases where the subject-matter of a contract of

sale is destroyed before and after the contract.

1. Goods perishing before making of contract

Where there is a contract for the sale of specific goods, the contract is void, if the goods, without

the knowledge of the seller have at the time when the contract was made, perished or become so

damaged as no longer to answer to exist, the agreement of sale is void and there is no sale.

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Example: A agrees to sell to B, a specific cargo supposed to be on its way from England to

Bombay. It turns out that, before the day of the bargain the ship carrying the cargo has been cast

away and the goods lost. Neither party was aware of the facts. The agreement is void.

To make a contract void under this section, the following conditions must be fulfilled

a. The goods must be specific goods. The section does not apply to unascertained goods.

b. The goods must have perished or damaged before entering into contract without the

knowledge of the seller.

The words ‘perished goods’ are not defined in act. It means not only goods physically destroyed,

but also if they have ceased to exist in a commercial sense, that is , if their merchantable

character as such had been lost and, therefore , unsaleable as dates which had become

contaminated or sugar which had been converted into sharbat, or cement which had lost through

moisture its properties as such.

This section pre-supposes that the seller does not know that the goods have perished. When the

seller knows the goods to have perished, agreed to sell them. He will be liable in damages if the

buyer did not know of this fact. If buyer has the knowledge of the perishable goods, but not the

seller, will be estopped from setting up a contract.

In the case of a contract for supply of specific goods, if part of the goods are lost or destroyed,

the question arises as to whether performance would be excused with regard to the whole. The

answer would depend upon whether the contract is divisible or indivisible. Where the subject

matter of the sale is an indivisible whole, and part of the goods has been destroyed, the seller

would be wholly discharged. If the subject matter of contract of sale is divisible, the contract will

not be void.

Example: There was a sale of 700 bags of nuts. Unknown to the seller before sale 109 bags had

been stolen, the sale is void and the buyer cannot be compelled to take the remainder.

2. Goods perishing before sale but after agreement to sell

Section 8 deals with the effect of perishing of specific goods before sale but after agreement

to sell. Unlike section 7, it deals with a case where the goods are in existence at the time of

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making the contract but perish without the fault of either party before the risk has passed to

the buyer. While under section 7 the contract is void. Under present section it is not so, but

performance on either side is excused as from the time of the perishing of the goods.

An agreement to sell specific goods becomes void if subsequently the goods without the fault

of the seller or buyer have perished or become so damaged as no longer to answer their

description in the agreement, provided this happens before the risk has passed to the buyer.

According to section 8 a contact can be avoided on the ground of impossibility of

performance of the contract, if it satisfied the following conditions:

a. The contract must be an agreement to sell and not an actual sale.

b. The loss must be specific, i.e. it should relate to specific goods.

c. The goods must have perished or damaged before the property or the risk passes to

the buyer.

d. The perishing of or the damage to goods must be without any fault on the part of

seller or the buyer.

6.6 The price

Price is an essential element of sale; price means the money consideration for a sale of goods. No

valid sale can take place without a price. If no consideration is given, then it will be a gift. It may

be noted that old and rare coins not included in the definition of the term money. The price

constitutes the essence of a contract of sale as no sale can take place without a price. The price

may be money actually paid or promised to be paid depending on whether the agreement is for

cash or credit sale. However, where goods are for a fixed sum and the price is paid partly in

terms of cash and partly in terms of valued goods it is sale.

6.6.1 Modes of fixing the price

Section 9 provides the following modes of the determination of price.

1. Expressly stated in the contract: the parties may fix such price for the goods as they

may please. Mere inadequacy of price does not affect a sale. But the sum should be

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definite. Thus, a man may sell his goods at any price he likes and may even sell them at a

loss.

2. Price to fix in agreed manner: the contract may provide for the manner in which the

price is to be fixed. The agreement may be to pay as much for the goods as others pay, or

a fair market value. But, where

(i) Where the price is left to be fixed by only one of the contracting parties the

agreement would be uncertain as to price and hence void

(ii) The price tis agreed to whatever sum as such shall be offered by any third party.

3. Determined by the course of dealing between the parties: a practice to deduct

discount in determining the price may be implied from a course of dealing. Similarly a

usage to pay the price at the rate prevailing in the market on the date of delivery may be

implied from the course of dealing

4. Reasonable price: where the price is not determined in accordance with the above three

modes, the buyer shall pay the seller a reasonable price. What is a reasonable price is a

question of fact dependent upon the circumstances of each particular case.

5. Price to be fixed by the valuation of third party: when such third party makes the

valuation. There is a determination of price and the agreement becomes a contract of sale.

In case the party which had to fix the price does not fix the same, the agreement thereby

is avoided. Where goods or part thereof have been delivered and appropriated by the

buyer he shall [pay a reasonable price therefore. If one of the parties wrongfully prevents

the valuation from taking place, the part not in fault may claim damages from the other

party.


1. Which of the following is the modes of fixing the price

a) Reasonable price

b) Price to fixed in agreed manner

c) Expressly stated in the contract

d) All of these

2. Goods which form the subject matter of a contract of sale are

a) Existing goods

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b) Future goods

c) Contingent goods

d) All of these

Activity-2

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6.6.2 Mode of payment of price.

In the absence of an agreement to the contrary, the seller is not bound to accept any kind of

payment other than the currency of the country. He is not bound to accept payment of cheque

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unless he has accepted cheque on previous occasions. By common consent or in accordance

with an established course of dealing, the seller may accept payment.

a. By a cheque or draft

b. By a bank guarantee

c. By a letter of credit

d. By any other mode

6.7 Earnest money

Where buyer has paid some amount by way of earnest money as security for the performance of

his part of the contract, it will stand adjusted against the price on performance. If the buyer fails

to perform his promise, the seller can forfeit the money.

6.8 Summary

The sale of goods acts 1930 deals with the law relating to sale of goods in India. The term goods

mean every kind of movable property, other than money and actionable claims. The sale of

goods act, 1930 is mainly based on the English sale of goods act, 1893, before the sale of goods

act, 1930, the law relating to sale of goods was covered under the chapter VII of Indian contract

act, 1872, the provision of which were found to be inadequate. The act explains the formation of

the sale of goods act and describes different types of goods.

6.9 Glossary

Reasonable price: where the price is not determined in accordance with the above three modes,

the buyer shall pay the seller a reasonable price.

Contingent goods: These are a type of goods of future goods, the acquisition of which by the

seller depends upon a contingency which may or may not happen.



1. (d)

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2. (c)


1. (a)

2. (d)




6.12 Model questions

1. Explain clearly the essential elements which must co-exist for constituting a valid sale

of goods. In what respect does a sale differ from an agreement to sell?

2. Defied the term ‘goods’. Distinguish between specific and unascertained goods.

3. Explain the rules regarding the ascertainment of price in a contract of sale.

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Lesson 7

Conditions and Warranties

STRUCTURE

7.0 Learning Objectives

7.2 Meaning of Condition

7.3 Meaning of Warranty

7.4 Difference between Condition and Warranty

7.5 Difference between Transfer of Property (ownership) and Possession

7.6 Rights of an unpaid seller

7.7 Summary

7.8 Keywords


7.10 Terminal Questions

7.11Suggested readings

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After reading this lesson you should be able to

a) Define the condition and warranty and differentiate between them.

b) Differentiate between transfer of property and possession.

c) Discuss the rights of an unpaid seller.

7.1 Introduction

Before a contract of sale is entered into, a seller makes certain statements or representation

with a view to induce buyer to buy goods to clinch the bargain. Such statements or

representation are generally about the nature, quality of the goods and about their fitness for

the buyer’s purpose which are different in character and importance. Some statements are just

opinion but not a part of contract. A statements which forms part of the contract of sale and

affects the contracts called a’ stipulation’ which may be either a condition or a warranty. An

unpaid seller is one who has not been paid or tendered the whole of the price or one who

receivers a bill of exchange or other negotiable instrument as conditional payment and the

condition on which it was received has not been fulfilled by reason of the dishonour of the

instrument or otherwise

7.2 Meaning of Condition

Sec.12 (1A) states, “Stipulation in a contract of sale with reference to goods which are the

subject thereof maybe a condition or warranty”.

Section 12(2) , “states that a condition is a stipulation which is essential to the main purpose

of the contract”. The breach of a condition gives rise to a right to treat the contract as

repudiated or broken.

A condition is a term (oral or written) which goes directly 'to the root of the contract', and it is

essential that if it is broken the innocent party can treat the contract as discharged. That party

will not therefore be bound to do anything further under that contract.

Example 1: By a charter party (a contract by which a ship is hired for the carriage of

goods),it was agreed that ship P of 450 tons ” now in the port of Amsterdam” should proceed

direct to Newport to load a cargo. In fact at the time of the time of the contract the ship was

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not in the port of Amsterdum and when the ship reached Newport, the charterer refused to

load. Held, the words “now in the port of Amsterdum” amounted to a condition, the breach of

which entitled the charterer to repudiate the contract.

Example 2 – Aruna bought hair oil from Varun that was advertised as pure coconut oil. Later

she found out that the oil was not pure but are mixed with herbs. In this case Aruna can return

the oil and also she can claim for the refund of price paid by her for that oil.

In a contract of sale there are two types of conditions, which are as follows:

Expressed Condition: when there are the conditions which are clearly defined and

agreed upon by the parties while entering into the contract. In this parties can agree

expressly that some event must occur before a party’s duty to perform arises. Usually,

all the requirements of the express condition must be met before a duty to render the

dependent performance arises.

For example: If a contract for the sale of car requires that a down payment be made

by a specific date as a condition of delivery’s late payment discharges the duty to

deliver.

Implied Condition: As per the law some conditions are supposed to be present while

making contracts but when conditions which are not expressly provided, however,

these conditions can be waived off through express agreement. Some examples of

implied conditions are:

Condition relating to title of goods:

According to Sec. 14(a),” In a contract of sale, unless the circumstances of contract are as to

show different intention, there is an implied condition on the part of the seller that

a) In case of a sale , he has the right to sell the goods

b) In case of an agreement to sell, he will have a right to sell the goods at the time when the

property is to pass”.

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The term 'right to sell' expect not only that the seller has the title to what he purports to sell,

but also that the seller has the right to pass the property. If the seller's title turns out to be

defective, the buyer may reject the goods.

Example: Ram brought a car from Dinesh and used it for five months. Dinesh has no title to

the car and consequently ram had to hand it over to the true owner. In this case Ram could

recover the price paid.

Condition with respect to the quality and fitness of the goods:

As per Sec. 16(1),” Where the buyer, expressly or by implication, makes known the seller the

precise purpose for which goods are needed so as to show that the buyer relies on the seller's

ability or judgment and the goods are of a description which it is in the course of the seller's

business to supply (whether or not as the manufacturer of producer), there is an implied

condition that the goods shall be reasonably fit for such purpose”.

In other words, this condition of fitness shall apply, if:

a. The buyer makes aware to the seller about the purpose for which the goods are

required by buyer,

b. The buyer has reliance on the seller's ability or judgment,

c. The goods are of a description which sellers ordinarily supplies in the course of his

business, and

d. The goods supplied are reasonably fit for the buyer's purpose.

Example 1 Suppose an order was being placed for some trucks to be used “for heavy traffic

in a hilly area. The trucks supplied were unfit and broke down. In this case there is breach of

condition as to fitness.

Example 2 Gopal purchased a coat which caused skin irritation to him. But in this case, the

seller was not liable, the cloth being fit for anyone with a normal skin.

Example 3.Bikram told Manu, a car dealer, that he wanted a car which is comfortable for

touring purpose. Manu recommended a ‘Bugatti car’ and Bikram hence bought that one .The

car was uncomfortable and unsuitable for touring purpose. In this case Bikram can reject the

car and can claim for recovery of the price, and there mere fact that Bikram bought the car

under its trade name did not necessarily exclude the condition of fitness.

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Condition as to wholesomeness:

In case of selling eatable foodstuff and provisions, there is one another implied condition as

in case of merchantability that the goods shall be wholesome. So, the provisions or foodstuff

must not only correspond to their description, but must also be merchantable and wholesome.

By 'wholesomeness' it means that “goods must be for human consumption”.

For example: Falguni bought milk from Anita. The milk contained germs of typhoid fever.

Falguni’s father took the milk and got infection due to which she died. Held, Falguni could

recover damages.

Sale by sample

Sec.17,” A contract of sale is a contract for sale by sample where there is a term in the

contract, express or implied to that effect”. Usually, a sale by sample is implied when a

sample is shown to the parties and the parties intend that the goods should be of the kind and

quality as the sample is. There is an implied condition in sale by sample that the bulk shall

correspond with the quality of the sample, the buyer can compare the bulk to the sample

quality and the goods shall be free from any defect, rendering the un-merchantable. As sec

17(2) states “the defect should not however be apparent on a reasonable examination of the

sample”.

Example: In a sale contract of brandy by sample, brandy coloured with a dye was supplied. In

this case buyer was not bound to the contract even though the goods supplied were not equal

to the sample as the defects were not apparent on a reasonable examination of sample.

Sale by description:

As per Sec. 15,”In a contract for sale by description, there is an implied condition the goods

supplied must correspond with the description”. A vast majority of cases where samples

are shown, and sales by description

For example: A ship was contracted to be sold as a ‘copper-fastened vessel’ to be taken with

all faults, without any allowance for any defects whatsoever. The ship turned out to be

‘partially copper-fastened’. Held the buyer was entitled to reject.

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Activity A

A purchased hot water-bottle from a retail chemist shop .The water -bottle could stand hot

water but not boiling water. When it was filled by A with boiling water, it burst and

injured his wife. A sues for damages. Decide.

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7.3 Meaning of Warranty

Section 12(3) states, “a warranty is a stipulation which is collateral to the main purpose of

the contract. The breach of a warranty gives rise to a claim for damages but not a right to

reject the goods and treat the contract as repudiated”.

Example – A while selling his old car to B, stated the car gives a mileage of 12 km per litre

in petrol. But later the car gives only 10 km per litre. B cannot reject the car. It is breach of

warranty. He can only claim for the damages due to extra consumption of petrol.

A warranty can be for lifetime or for a limited time -period. It may be either expressed, i.e.,

which is specifically defined or implied, which is not explicitly defined same as in case of

conditions , but arises according to the nature of sale like:

Implied Warranty of Quiet Possession – Under Sec. 14 (b),”In every contract of sale,

unless there is a contrary intention, there is implied warranties that the buyer shall have and

enjoy quiet possession of the goods. If the buyer's right to possession and enjoyment of the

goods is in any way disturbed as consequences of the seller's defective title, the buyer may

sue the seller for damages for breach of this warranty”.

Implied Warranty of Freedom from Encumbrances - Under Sec. 14(c),” The buyer is

entitled to a further warranty that the goods shall be free from any charge or encumbrance

in favour of any third party not declared or known to buyer before or at the time when the

contract is made. If the buyer is required to discharge the amount of the encumbrance it shall

be a breach of this warranty and the buyer shall be entitled to damages for the same”.

Warranty as to quality or fitness by usage of trade: Under Sec. 16(4),” An implied

warranty as to quality or fitness for a particular purpose may be annexed by the usage of

trade”.

Warranty to disclose dangerous nature of goods: Where a person intends to sells goods.

After knowing that the goods are inherently dangerous or they are harmful to the buyer and

the buyer remain ignorant of the danger, then he must warn the buyer of the probable danger,

otherwise he will be liable for damages.

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A condition becomes a warranty when – Under Sec.13

a) As per Sec. 13(1),”The buyer waives the conditions or opts to treat the breach of

the condition as a breach of warranty “; or

b) As per Sec. 13(2),”The buyer accepts the goods or a part thereof, or is not in a

position to reject the goods”.

Activity B

A purchases some chocolates from a shop. One of the chocolate contains poisonous matter and

as a result A’s daughter who has eaten it falls seriously ill. What remedy is available to A

against the shopkeeper.

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7.4 Difference between Condition and Warranty

The following are the major differences between warranty and condition

1. A warranty is a surety given by the seller regarding the state of the product. A

condition is an obligation which requires fulfilment before another proposition takes

place.

2. The term ‘condition’, is defined in section 12 (2) of the Indian Sale of Goods, Act

1930 whereas ‘warranty’ is defined in section 12 (3).

3. Warranty is additional term whereas Condition is vital to the theme of the contract.

4. The breach of warranty may not result in the cancellation of the contract, but breach

of any condition may result in the termination of the contract.

5. Violating a condition means violating a warranty too, but this is not the case with

warranty.

6. In breach of warranty, the aggrieved party can only sue the other party for damages.

On the other hand in case of breach of condition, the innocent party has the right to

rescind the contract as well as a claim for damages.

7.5 Difference between Transfer of Property (ownership) and Possession

Property means ‘ownership’. Transfer of property in the goods is another essential of

contract of sale of goods

Ownership:

The idea of ownership trails the idea of possession.

The ownership is the recognition of the right over the property.

Ownership is the subjective as well as objective. It signifies the externally and

internally.

The right of alienation is an essential feature of ownership.

The concept of ownership is used in widest meaning.

The owner has the right to consume, destroy and alienate with his or her will.

The residuary power is vested in the owner.

Ownership is the guarantee of the law.

Ownership without possession is right, unaccompanied by that environment of fact in

which it normally realizes itself.

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Ownership strives to realize itself in possession.

The ownership is left to seek “proprietary remedies”.

The law of prescription determines the process by which, through the influence of

time, ownership without possession withers away and dies.

Transfer: the ownership generally can be transferred by the way of convincing and

registration in case of immovable properties and by way of delivery in case of

movable properties.

“Ownership is a matter of multiple rights”.

Ownership is a legal concept.

Possession

First the idea of possession came into existence in the human civilization.

Possession is the exercise of a claim over the property.

Possession is the objective realization of ownership. It is the external significance of

ownership.

This right is not seen in possession.

The concept of possession is narrower in this sense. The possession has limited rights

to consume, destroy and alienate.

The residuary power is not given to possessor.

Possession is the guarantee of the facts.

Possession without ownership is the body of fact, uniformed by the spirit of right

which usually accompanies it.

Possession to Endeavour’s to justify itself as ownership.

The possessor is left with “possessory remedies”.

The law of prescription determines the process by which, through the influence of

time, possession without title ripens into ownership.

Transfer: the possession, comparatively, can easily be transferred. It does not require

convincing.

A right can only be owned, and it cannot be possessed.

“Whereas possession in singular, but stronger”.

“Possession is both a legal and a non-legal or pre-legal concept”.

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Check your progress 1

State whether the following statements are true or false.

1. If a buyer once waives a condition, he cannot afterwards insist on its fulfilment.

2. Packing of goods is not an important consideration in judging their ‘merchantability’.

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

sample.

4. An article is sold under its patent name. There is no implied condition regarding fitness of

goods.

7.6 Rights of an unpaid seller

UNPAID SELLER:-

Seller: - A person who sells the goods or agrees to sell the goods is called seller.

Unpaid: - It means payment is not made or without payment.

In simple words, "Unpaid seller" means a person who has sold the goods for a price but price

has not been paid to him.

Sales act defines the "unpaid seller" as a person ,”To whom the whole price has not been paid

or tendered and where a bill of exchange or other negotiable instruments has been accepted

by him as a condition on which it was received has not been fulfilled by reason of dishonour

of the instrument or otherwise”. It is also declares that any person who is in the position of a

seller like agent is also considered seller.

Rights of Unpaid Seller or Lien of Unpaid Seller:-

As per Sec. 46(1),” Where the property in the goods has passed to the buyer ,an unpaid seller

has the rights against the goods”.

An unpaid seller has two-fold rights as following

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I. Rights of unpaid seller against the goods, and

II. Rights of unpaid seller against the buyer personally. We shall now examine these rights in

detail.

Rights of unpaid Seller against the Goods:

An unpaid seller has the following rights against the goods notwithstanding the fact that the

property in the goods has passed to the buyer:

1. Right of lien;

2. Right of stoppage of goods in transit;

3. Right of resale [Sec. 46 (1)]

1. Right of Lien:

Sec.46 (1) (a) states, “A lien is a right to retain possession of goods until payment of the

price”. For the recovery of price an unpaid seller has a right to keep the goods in his own

possession.

Example: - Mr. Hunny sells the goods to Mr. Abhijit for Rs. 10 lac. Mr. Abhijit pays 5 lac

and promises to pay the remaining 5 lac after two month. Mr. Hunny has a right of lien on the

goods.

2. Rights of stopping:

As per Sec. 50,”If buyer becomes insolvent, an unpaid seller has a right of stopping the goods

in transit.

Example: - "X" sells 100 bales of cotton to "Y" but delivery will be two stages. "X" delivers

50 bales first. Later on he comes know that "Y" has become insolvent. "X" can stop delivery

of bales in transit.

3. Right of resale:

An unpaid seller is considered the owner of the goods until he is not paid by the buyer. So he

has a right to sell his goods subject to few conditions.

The right of resale is a very valuable right in the hand of an unpaid seller. In the absence of this

right, the unpaid seller’s other rights against the goods, namely, ‘lien’ and ‘stoppage in

transit,’ would not have been of much use because these rights only entitle the unpaid seller to

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retain the goods until paid by the buyer. As per Section 46(1) (c ) and Sec. 54,” the unpaid seller

a limited right to resell the goods in the following cases:

Where the goods are of a perishable nature; or where such a right is expressly reserved in the

contract in case the buyer should make a default”.

Example: - "X" sells one horse to "Y" on credit. "Y" does not pay. "X" can resell to other

person.

II. Rights of Unpaid Seller against the Buyer Personally

The unpaid seller has the following three rights of action against the buyer personally:

1. Suit for price (Sec. 55) ,”Where property in goods has handed to the buyer; or where the

sale price is payable ‘on a day certain’, although the property in goods has not passed; and the

buyer wrongfully neglects or refuses to pay the price according to the terms of the contract,

the seller is entitled to sue the buyer for price, irrespective of the delivery of goods. Where

the goods have not been delivered, the seller would file a suit for price normally when the

goods have been manufactured to some special order and thus are un -saleable otherwise”.

2. Suit for damages for non-acceptance (Sec. 56), “Where the buyer wrongfully neglects or

refuses to accept and pay for the goods, the seller may sue him for damages for non-

acceptance. The seller’s remedy in this case is a suit for damages rather than an action for the

full price of the goods”.

The damages are calculated in accordance with the rules contained in Section 73 of the Indian

Contract Act, that is,” the measure of damages is the estimated loss arising directly and

naturally from the buyer’s breach of contract. Where the goods have a ready market the

principle applicable is that the seller may recover from the buyer damages equal to the

difference between the contract price and the market price on the data of the breach of the

contract”. Thus, if the difference between the contract price and market price is nil, the seller

can get only nominal damages. But where the goods do not have any ready market, the

measure of damages will depend upon the facts of each case.

For example, in ABC Ltd. Vs Tony’s the damages were assessed on the basis of profits lost.

In that case, ABC Ltd., who were truck dealers, contracted to supply a truck to tony refused

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to accept delivery. It was found as a fact that the supply of trucks exceeded the demand at

the time of breach and hence in a sense there was no market price on the date of breach. Held,

ABC Ltd., were entitled to damages for the loss of their bargain viz., the profit they would

have made, as they had sold one truck less than they otherwise would have sold. To take

another illustration, if the goods have been manufactured to some special order and they are

unsaleable have no value at all for other buyers, then the seller may even be allowed the full

price of the goods as damages.

1. Suit for special damages and interest (Sec.61),”This Section entitles the seller to sue the

buyer for ‘special damages’ also for such loss “which the parties knew when they made the

contract, to be likely to result from the breach of it.” In fact the Section is only declaratory of

the principle regarding ‘special damages’ laid down in Section 73 of the Indian Contract Act.

The Section also recognizes,” unpaid seller’s right to get interest at a reasonable rate on the

total unpaid price of the goods sold, from the time it was due until it is actually paid”.

(a) Suit for Damages for Non-delivery: As per Section 57,”Where the seller wrongfully

neglects or refuses to deliver the goods to the buyer, the buyer may sue the seller for damages

for non-delivery.

(b) Suit for Specific Performance: As per Section 58,” In any suit for breach of contract to

deliver specific or ascertained goods, the court may direct that the contract shall be performed

specifically”.

(c) Suit for Breach of Warranty : As per Section 59,” Where there is a breach of warranty by

the seller, or where the buyer elects or is compelled to treat any breach of a condition on the

part of the seller as a breach of warranty, the buyer is not by reason only of such breach of

warranty entitled to reject the goods, but he may –

(i) Set up against the seller the breach of warranty in diminution or extinction of the price; or

(ii) Sue the seller for damages for breach of warranty”.

Example: X sold a second hand Radio to Y who spent Rs 500 on the repair of this Radio.

This Radio was seized by the police as it was a stolen one. Y filed a suit against X for

recovery of damages for breach of warranty of quite possession including the cost of repairs.

It was held that Y was entitled to recover the same.

(d) Right to Treat the Contract as Rescinded or Operative in Case of Repudiation of Contract

by Seller before due Date: As per Section 60,”Where seller repudiates the contract before the

date of delivery, the buyer may either treat the contract as subsisting and wait till the date of

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delivery, or he may treat the contract as rescinded and sue for damages for the breach”.

(e) Suit for Interest: As per Section 61(2),” In case of breach of the contract on the part of the

seller, the buyer may sue the seller for interest from the date on which the payment was

made”.

4. Right of delivery:

The unpaid seller has a right of withholding the delivery of goods where the property in the

goods has not passed to the buyer.

An unpaid seller loses the lien in the following cases:

Termination by waiver:

If an unpaid seller himself waives his right of lien then it will be terminated.

Goods in buyer’s possession:

When a buyer or his agent obtains the possession for goods lawfully, unpaid seller lien

terminates.

Does Not Reserve The Right of Disposal:-

When unpaid seller fails to reserve the right of disposal of the goods at the times of

delivery to the bailee for transferring it to the buyer. Then this right of lien terminates.

Check your progress 2


1. A seller who has obtained a money decree for the price of the goods is not an unpaid seller

even if the decree has not been satisfied.

2. The right of stoppage in transit is an extension of the right of lien.

3. Transit comes to an end where the carrier wrongfully refuses to deliver the goods to buyer or

his agent.

4. The right of lien is available to an unpaid seller of the goods who is in possession of them and

the term of credit has expired.

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7.7Summary

To the conclusion it can be said that a condition is defined as a “representation made by the

seller which is so important that its non-fulfilment conquests the very purpose of the buyer.

Warranty is a representation made by the seller which is not of that importance as a

condition”. Sometimes, a condition is changed to the status of a warranty and in such cases;

the buyer loses the right to reject the goods on the ground of breach of condition. Unpaid

seller is a person who is not yet paid and in this regards he has the rights against goods sold

and against the buyer. He can also exercise fis right of stoppage of goods in transit under

some circumstances.

7.8 Keywords

Condition: It is defined as,” representation made by the seller which is so important that its

non-fulfilment defeats the very purpose of the buyer”.

Warranty: Warranty may be defined as a” representation made by the seller which is not of

that importance as a condition”.

Implied Condition: It is a condition, which the law implies into the contract of sale.

Express Warranty: It is a warranty which has been expressly agreed upon by both the

parties at the time of contract of sale.

Unpaid Seller: A person who remains unpaid by buyer after he has sold goods to that buyer,

or has been un-paid partially.

Right of Lien: When the ownership of goods has been transferred to the buyer but the goods

are in the possession of the seller and when seller of goods has not been paid, then seller has

the right of retain the goods till he receives the price of goods from the buyer.

Stoppage in Transit: It is clear by its term that means stopping of the goods while they are in

the course of its transit.

Breach of Contract of Sale: In the case where buyer fails to pay the price for goods or

accept the goods, or the seller fails to deliver the goods, the breach is said to have occurred.


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Answer to check your progress 1

Ans.1 True

Ans.2 False

Ans.3 False

Ans.4 True

Answer to check your progress 2

Ans.1 False

Ans.2 True

Ans.3 True

Ans.4 True

7.10 Terminal Questions

1. When is a seller called an unpaid seller? Give details about the rights of an unpaid seller

against the goods and the buyer personally?

2. Compare the unpaid seller’s right of stoppage in transit and in lien .

3. In the Sales of Goods Act, 1930 describe the law relating to the right of resale available to

an unpaid seller

4. Comment on “Sub sale by the buyer does not extinguish unpaid seller’s right to the lien. “

5. What do you understand by the right of stoppage in transit in respect of sale of goods?

6. Define the term 'condition' and 'Warranty'. Explain the difference between the two.

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7. Discuss the provision of the sales of Goods Act relating to the implied conditions in a

contract of sale by description.

8. Comment on "Let the buyer beware".

9. State the conditions in a contract for the sale of goods (i) by description (ii) required for a

particular purpose.

10. Describe the characteristics of an unpaid seller.



2. M.C. Shukla, a Manual of Mercantile Law, S. Chand & Co., New Delhi.






Delhi.





Delhi.

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Lesson 8

Negotiable Instrument

STRUCTURE

8.0 Learning Objectives:

8.1 Introduction

8.2 Meaning of Negotiable Instruments

8.3 Characteristics of Negotiable instrument

8.4 Types of Negotiable Instruments

8.4.1. Promissory Note

8.4.2 Bill of Exchange

8.4.3 Cheques

8.5 Difference between bill of exchange and Promissory Note

8.6 Difference between bill of Exchange and a Cheque

8.7 Rules Regarding the Crossing of Cheques

8.8 Dishonour of cheques

8.8.1 Kinds of dishonour of cheque

8.9 Liability of drawer in dishonouring of cheque

8.10 Liability of banker in dishonouring of cheque

8.11 Summary

8.12 Keywords

8.13 Answer to check your progress.



Page 116 of 257


After reading this lesson you should be able to

a) Define the Negotiable Instrument and its different types.

b) Make comparison among bills of exchange, promissory notes, and cheques.

c) Explain rules regarding the Crossing of Cheques, liability of banker and drawer and

Dishonour of cheques.

8.1 Introduction

Every business is based on the exchange of goods and services. Goods are being purchased

and sold for cash as well as on credit also. These all transactions have a requirement of cash

flow, either immediately or sometimes later. Now a day in modern business, a huge number

of transactions involved huge amount of money take place on a daily basis. It is quite

troublesome as well as quiet risky for any of the party to make and receive cash payments. To

this problem there are certain documents which are freely used in transaction commercially

as well as monetary dealings Therefore, it is a general practices for businessmen to use of

certain documents for making payment. If they satisfy certain conditions then these

documents are called negotiable instruments,. In this lesson we will study about these

documents in detail.

8.2 Meaning of Negotiable Instruments

To understand the concept of negotiable instruments let us take a few examples:

Suppose Manish is a book publisher and has sold books to Vivek for Rs 20,000/- on three

months credit. To make sure that Vivek will pay the amount after three months, Manish can

give written order addressed to Vivek For value of goods received by him, Rs.20,000/- that

he is supposed to pay after three months to Manish before Vivek for payment. To show his

acceptance Vivek must signed this written document. Now, Manish can keep the document

with him for three months and on the due date or after can collect the money from Vivek. He

can also make use of it for meeting different business transactions need. For example, after a

month, if he required, he can borrow money from Nakul for a period of two months by

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passing on this document to Nakul. He can write on the backside of the document an

instruction to Vivek to pay money to Nakul, and signed it. After that Nakul becomes the

owner of that document and he can claim money based on that document from Vivek on the

due date. If it is required that Nakul, can again pass on the document to Amit after instructing

and signing on the backside of the document as we mentioned previously. Till final payment

is made this passing on process may continue. In the above example, Vivek who has bought

books worth Rs. 20,000/- can also give an undertaking mentioned that after three month he

will make payment to Manish. Now Manish can retain that document with himself till the

end of three months period or pass it again on to others for meeting business obligation (like

with Nakul, as discussed above) before the expiry of that three month.

Take an example of cheque. It is a document issued to a bank that entitles the person whose

name it bears to claim the amount mentioned in the cheque. If he wants, he can transfer it in

favour of another person. For example, if Sarika issues a cheque worth Rs. 5,000/ - in favour

of Bivan, then Bivan can claim Rs. 5,000/- from the bank, or he can transfer it to Chandel to

meet any business obligation, like paying back a loan that he might have taken from Chandel.

Once he does it, Chandel gets a right to Rs. 5,000/- and he can transfer it to Nitu, if required.

Such transfers may continue till the payment is finally made to somebody.

In the above examples, we find that there are certain documents which are freely used in

commercial deal; such documents are called Negotiable Instruments.

Thus, we can say negotiable instrument is a transferable document, where negotiable means

transferable and instrument means document.

A negotiable instrument is a document guaranteeing the payment of a specific amount of

money, either on demand, or at a set time, with the payer named on the document.

In simple words, all the law regarding negotiable instruments act is contained in the

Negotiable Instruments Act.1881 states, “a negotiable instrument is a document, which

entitles a person to a sum of money and which is transferrable from one to another person”.

According to Section 13 (a) of the Act, “Negotiable instrument means a promissory note, bill

of exchange or cheque payable either to order or to bearer, whether the word order or bearer

appear on the instrument or not.”

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8.3 Characteristics of negotiable instrument

The characteristics of negotiable instrument are as follows

Free Transferability- There is no need to make a transfer deed, any registration, pay for

stamp duty, etc. in case of a negotiable instrument. A negotiable instrument is freely

transferable. The ownership is changed by simple delivery (when payable to the bearer).

Additionally, in the course of transferring it is also not required to give a notice to the

previous holder.

Title of holder free from all defects - A person taking an instrument bonafide and for

value known as holder in due course, gets the instrument free from all defects in the title

of the transferor. It means that a person who receives a negotiable instrument has a clear

and undisputable title to the instrument. However, the title of the receiver will be

absolute, only if he has got the instrument in good faith and for a consideration. Also the

receiver should have no knowledge of the previous holder having any defect in his title.

Such a person is known as holder in due course.

Example: Shayam sells goods to bobby. Bobby gives a promissory note to Shayam for

the price. He refuses to pay the promissory note, claiming that the goods are not

according to order specification. Shayam sues bobby on the note B’s defence in good.

But if he negotiates the note to harry, a holder in due course, bobby’s defence will be of

no avail.

The holder in due course is not affected by certain defence, for example, fraud which

might be available against previous holder, provided he himself is not a party to it.

Must be in writing- A negotiable instrument must be in written form including computer

printout, handwriting, engraving and typing etc.

Unconditional Order- Every negotiable instrument must have an unconditional order or

promise for payment.

Payment- The instrument must involve payment of a certain sum of money; one cannot

make a promissory note on assets, securities, or goods.

The time of payment must be certain- It means that the instrument must be payable at a

time which is certain to arrive. If the time is mentioned as ‘when convenient’ it is not a

negotiable instrument. However, if the time of payment is linked to the death of a person,

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it is nevertheless a negotiable instrument as death is certain, though the time thereof is

not.

The payee must be a certain person- The person in whose favour the instrument is

made must be named or described with reasonable certainty. The term ‘person’ includes

individual, body corporate, trade unions, even secretary, director or chairman of an

institution. The payee can also be more than one person.

Signature- A negotiable instrument must bear the signature of its maker. Without the

signature of the drawer or the maker, the instrument shall not be a valid.

Delivery- Delivery of the instrument is essential. Any negotiable instrument like a

cheque or a promissory note is not complete till it is delivered to its payee. For example,

you may issue a cheque in your brother’s name but it is not a negotiable instrument till it

is given to your brother.

Stamping- Stamping of Bills of Exchange and Promissory Notes is mandatory. This is

required as per the Indian Stamp Act, 1899. The value of stamp depends upon the value

of the bill and the time of their payment.

Right of file suit- The transferee of a negotiable instrument is entitled to file a suit in his

own name for enforcing any right or claim on the basis of the instrument.

Notice of transfer- It is not necessary to give notice of transfer of a negotiable

instrument to the party liable to pay.

Presumptions- Certain presumptions apply to all negotiable instruments, for example

consideration is presumed to have passed between the transferor and the transferee.

Number of transfer- These instruments can be transferred indefinitely till they are at

maturity.

Rule of evidence- These instruments are in writing and signed by the parties, they are

used as evidence of the fact of indebtness because they have special rules of evidence.

Exchange- These instruments relate to payment of certain money in legal tender, they are

considered as substitutes for money and are accepted in exchange off goods because cash

can be obtained at any moment by paying a small commission.

8.4 Types of Negotiable Instruments

According to the Negotiable Instruments Act, 1881 there are just three types of negotiable

instruments i.e., promissory note, bill of exchange and cheque.

8.4.1. Promissory Note

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Section 4 of the Negotiable Instruments Act, 1881 defines a promissory note as “an

instrument in writing (not being a bank note or a currency note) containing an unconditional

undertaking, signed by the maker, to pay a certain sum of money only to or to the order of a

certain person or to the bearer of the instrument”.

Specimen of a Promissory Note

Rs. 50,000/- New Delhi

September 20, 2010

On demand, I promise to pay Rakesh, s/o Suresh of Gwalior or order a sum of Rs 50,000/-

(Fifty Thousand only), for value received.

To , Ramesh Sd/ Sanjeev

Address…….. Stamp

Parties to a Promissory Note

There are primarily two parties involved in a promissory note.

They are:

i) The Maker or Drawer – the person who makes the note and promises to pay the

amount stated therein. In the above specimen, Sanjeev is the maker or drawer.

ii) The Payee – the person to whom the amount is payable. In the above specimen it

is Rakesh.

In course of transfer of a promissory note by payee and others, the parties involved may

be –

a. The Endorser – the person who endorses the note in favour of another person. In the

above specimen if Rakesh endorses it in favour of Ramesh and Ramesh also endorses it in

favour of ram , then Ram and Ramesh both are endorsers.

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b. The Endorsee – the person in whose favour the note is negotiated by endorsement. In

the above, it is Ramesh then Ram

Features of a promissory note

i. It must contain an undertaking or promise to pay. Only acknowledgement of

indebtedness is not enough. For example, if someone writes ‘I owe Rs. 5000/- to Om

Prakash’, it is not a promissory note.

ii. A promissory note may be payable on demand or after a certain date. For example, if

it is written ‘three months after date I promise to pay Jatinder or order a sum of

rupees Five Thousand only’ it is a promissory note.

iii. A promissory note must be in writing, duly signed by its maker and properly stamped

as per Indian Stamp Act.

iv. It must contain a promise to pay money only. For example, if someone writes ‘I

promise to give Bhawna a Maruti car’ it is not a promissory note.

v. The promise to pay must be conditional. For example, if it is written ‘I promise to

pay Suresh Rs 5,000/- after my sister’s marriage’, is not a promissory note.

vi. The sum payable mentioned must be certain or capable of being made certain. It

means that the sum payable may be in figures or may be such that it can be

calculated.

vii. The parties to a promissory note, i.e. the maker and the payee must be certain.

8.4.2 Bill of Exchange

Take an example of Rajesh; he has given a loan of Ten Thousand Rupees to Sumit, which

Sumit has to return. Now, Rajesh also has to give some money to Varun. In this case, Rajesh

can make a document directing Sumit to make payment up to that ten Thousand to Varun on

demand or after expiry of a specified period. This document is called a bill of Exchange,

which can be transferred to some other person’s name by Varun.

Section 5 of the Negotiable Instruments Act, 1881 defines a bill of exchange as “an

instrument in writing containing an unconditional order signed by the maker directing a

certain person to pay a certain sum of money only to or to the order of a certain person or to

the bearer of the instrument”.

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Specimen of bills of exchange

Rs. 10,000/- New Delhi

May 2, 2001

Five months after date pay Varun or (to his) order the sum of Rupees Ten Thousand only

for value received.

To Accepted Stamp

Sumit Varun S/d

Address Rajesh

Parties to a bill of exchange

There are three parties involved in a bill of exchange.

They are

i. The Payee – The person to whom the payment is to be made. In the above case it

is Varun. The drawer can also draw a bill in his own name and thereby he himself

becomes the payee. Here the words in the bill would be Pay to us or order. In a

bill where a time period is mentioned is called a Time Bill. But a bill may be made

payable on demand also. This is called a Demand Bill.

ii. The Drawee – The person to whom the order to pay is made. He is generally a

debtor of the drawer. It is Sumit in this case.

iii. The Drawer – The person who makes the order for making payment. In the above

specimen, Rajesh is the drawer.

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Features of a promissory Bills of exchange:

i. “A bill must be in writing, duly signed by its drawer, accepted by its drawee and

properly stamped” as per Indian Stamp Act.

ii. The parties to a bill must be certain.

iii. It must contain an order to pay. Words like ‘please pay Rs 5,000/- on demand and

oblige’ are not used.

iv. The order must be to pay money and money alone.

v. The order must be unconditional.

vi. The sum payable mentioned must be certain or capable of being made certain.

Activity A

A bill is drawn, payable at 66 Lucknow Road. Kanpur but does not contain the name of the

drawee. Vijay who resides there accepts the bill, Is it a valid bill?

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8.4.3 Cheques

Cheque is a very common form of negotiable instrument. You can issue a cheque in your

own name or in favour of others, if you have a savings bank account or current account in

a bank, thereby directing the bank to pay the specified amount to the person named in the

cheque. Therefore, a cheque may be regarded as a bill of exchange; the only difference is

that the bank is always the drawee in case of a cheque. A cheque is a bill of exchange

drawn upon a specified banker and payable on demand and it includes the electronic

image of a truncated cheque and a cheque in the electronic form.

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The Negotiable Instruments Act, 1881 defines a cheque,” as a bill of exchange drawn on

a specified banker and not expressed to be payable otherwise than on demand”. Actually,

a cheque is an order by the account holder of the bank directing his banker to pay on

demand, the specified amount, to or to the order of the person named therein or to the

bearer.

Features of a cheque

i. The cheque must bear a date otherwise it is invalid and shall not be honoured by

the bank.

ii. The amount specified is always certain and must be clearly mentioned both in

figures and words.

iii. A cheque must be in writing and duly signed by the drawer.

iv. It is issued on a specified banker only.

v. It contains an unconditional order.

vi. The payee is always certain. vi. It is always payable on demand.

8.5 Comparison between bill of Exchange and Promissory Note

Bill of Exchange Promissory Note

1. It contains an unconditional order.

2. There are three parties – the x drawer,

the drawee and the payee.

3. It is made by the creditor.

4. Acceptance by the drawee is a must.

5. The liability of the maker/drawer is

secondary and conditional upon non-

payment by the drawee.

1. It contains an unconditional promise.

2. There are two parties – the maker and the

payee.

3. It is made by the debtor.

4. Acceptance is not required.

5. The liability of the maker/drawer is primary and

absolute.

8.6 Comparison between a Cheque and a Bill of Exchange

Cheque Bill of Exchange

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1. It is drawn only on a banker.

2. The amount is always payable.

3. It can be crossed to end its

negotiability.

4. Acceptance is not required.

1. It can be drawn on anybody including a

banker.

2. The amount is payable on demand on

demand after a specified period.

3. It cannot be crossed.

4. Acceptance is a must

8.7 Rules Regarding the Crossing of Cheques

There are two types of cheques, open cheques and crossed cheques. A cheque which is

payable in cash across the counter of a bank is called open cheque. A crossed cheque is one

on which two parallel transverse lines with or without the words ‘& Co.’ are drawn. A

common instruction is to specify that it must be deposited directly into an account with a

bank and not immediately cashed by a bank over the counter. The format and wording varies

between countries, but generally two parallel lines and/or the words 'Account Payee' or

similar may be placed either vertically across the cheque or in the top left hand corner. This

cheque that has been marked to specify an instruction about the way it is to be redeemed. By

using crossed cheques, cheque writers can effectively protect the cheques they write from

being stolen and cashed.

Types of crossing:

There are two types of crossing

1. General crossing: As per Sec.123 ,”Any cheque is said to be crossed generally where it

bears across its face an addition of the words ‘& CO’ or any other abbreviation thereof

between two parallel lines either with or without the words non-negotiable or two parallel

transverse lines simply either with or without the words not negotiable”.

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2. Special crossing: As per Sec.124 ,”A cheque is specially crossed where a cheque bears

across its face an addition of the name of a banker, either with or without the words ‘not

negotiable’ the cheque is deemed to be crossed specially”. The transverse line is not

necessary in this case. The payment of specially crossed cheque can be obtained through the

particular banker whose name appears across the face of the cheque or between the transverse

lines, if any.

As per sec.126, “A cheque may be crossed by drawer, holder and the banker”.

8.8 Dishonour of cheques

Section 92 of the Act defines, “a cheque is said to be dishonoured by non-payment when the

maker of the note, acceptor of the bill or drawee of the cheque makes default in payment

upon being duly required to pay the same”.

Following are the some important reasons for dishonouring a cheque

If the name of the payee is not written or not written clearly.

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If the ordered or crossed cheques are transferred without proper endorsement and

delivery.

If the date is not written or written incorrectly or the date given is of three months

before or if the advance date is given.

If the alteration made on the cheque is not proved by the drawer giving signature.

If the account number is not mentioned or if it is not clear or if it is

not mentioned clearly.

If the amount is not written in words and figures or written incorrectly or if the

amount written in words and figures does not match with each other.

If the cheque is overwritten.

If the signature is not given or if the signature given in the cheque does not match

with the signature given on the signature specification card kept by the bank.

If the amount mentioned on the cheque is more than the amount that the drawer has in

his bank account or if as per bank's rule the minimum balance in the account of the

drawer cannot remain.

If the bank balance remains shortage on account of not collecting

the cheque deposited.

If the bank has got the information regarding the death or insolvency or lunacy of the

drawer of depositor.

If the cheque is not found in proper condition or it is found wet, torn or spotted.

If the drawer has given order to the bank to stop payment of the cheque.

If the court of law orders the bank to stop payment of the cheque.

If the drawer has closed his/her account before presenting the cheque

8.8.1 Kinds of dishonour of cheque

1).Dishonour by non-acceptance:

Sec 91[14] of the act states, “dishonour of cheque by non-acceptance i.e. presentment for

acceptance is needed and normally acceptance and payment go hand in hand and is payable

after sight thus cheques are payable at sight”.

2).Dishonour by non –payment:

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When the drawee of a cheque makes default in payment and when the drawer of the cheques

issues instructions to the bank not to make any payment of a particular cheque issued by him.

A cheque is dishonoured by non-payment

8.9 Liability of drawer in dishonouring of cheque:

According to section 30 of the Negotiable Instrument Act 1881 “the drawer of the cheque is

bound in case of dishonour by drawee to compensate the holder provided due notice of

dishonour has been given to, or received by the drawer”.

Section 138 of Negotiable Instrument Act states, “the payee to issue notice in written to

drawer to make payment of check amount within 30 days of information from bank regarding

the return of cheque as unpaid”.

8.10 Liability of banker in dishonouring of cheque:

“When a cheque is dishonoured, the payee can take legal action against the drawer” under the

Negotiable Instruments Act. The complainant needs to produce the dishonoured cheque and

the bank advice as evidence. In case of dishonoured cheque is lost by the bank then drawee

filed a consumer complaint in the District Forum.

Activity B

A company issue a cheque on its bankers. A receipt was appended to the cheque and it ordered

the banker to make the payment” provided the receipt form at foot hereof is duly signed, stamped

and dated.” Is the cheque valid?

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Check your progress

State whether the following statements are true or false:

1. Bill payable on demand must be presented for acceptance.

2. Any person can be an acceptor for honour.

3. A bill can be accepted for honour in the absence of noting or protest.

4. A bill can be accepted for honour without the consent of holder.

5. A promissory note can be accepted for honour.

6. All negotiable instruments are governed by Negotiable Instrument Act.

7. A cheque is always payable on demand.

8. A promissory note can be made originally payable to bearer.

9. A bills of exchange can be made originally payable to bearer.

10.A lost instruments is not presumed by law to have been duly stamped

8.11 Summary:

In conclusion we can say that Negotiable instruments are particular type of documents use in

business transactions, the ownership of which can be freely transferred from one person to

another. Types of Negotiable Instruments are Promissory note, Bill of exchange ,Cheque.

Promissory note – “An instrument in writing containing an unconditional undertaking, signed

by the maker, to pay a certain sum of money only to or to the order of a certain person or to

the bearer of the instrument”. Bill of exchange – “An instrument in writing containing an

unconditional order, signed by the maker, directing a certain person to pay a certain sum of

money only to or to the order of a certain person or to the bearer of the instrument”. Cheque –

“It is an order by the account holder of the bank directing his banker to pay on demand the

specified amount, to or to the order of the person named therein or to the bearer”.

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8.12 Keywords:

Holder in due course: The Uniform Commercial Code (UCC) defines ,” holder in due

course as one who takes an instrument for value in good trust absent any notice that it is

overdue, has been dishonoured, or is subject to any defence against it or claim to it by any

other person”.

Drawee:

A person or bank that is ordered by its depositor, a drawer, to withdraw money from an ac

count to pay a designated sum to a person according to the terms of a check or a draft.

Negotiable instrument: A negotiable instrument is a document guaranteeing the payment

of a specific amount of money, either on demand, or at a set time, with the payer named

on the document.

Cheque: A cheque is a bill of exchange drawn upon a specified banker and payble on

demand and it includes the electronic image of a truncated cheque and a cheque in the

electronic form.

Promissory note :promissory note as ‘an instrument in writing (not being a bank note or

a currency note) containing an unconditional undertaking, signed by the maker, to pay a

certain sum of money only to or to the order of a certain person or to the bearer of the

instrument’.

Bill of exchange: bill of exchange as ‘an instrument in writing containing an

unconditional order, signed by the maker, directing a certain person to pay a certain sum

of money only to or to the order of a certain person, or to the bearer of the instrument’.

8.13 Answer to check your progress.

Ans.1 False

Ans.2 False

Ans.3 False

Ans.4 False

Ans.5 False

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Ans.6 False

Ans.7 True

Ans.8 False

Ans.9 True

Ans.10 False

8.14 Terminal questions:

1) Mention two types of negotiable instruments which are commonly used.

2) Write difference between a promissory note and a cheque.

3) “A cheque need not bear a date.” Do you agree? Give reason.

4) State any four essential features of a bill of exchange.

5) “A bill of exchange must contain an unconditional promise to pay.” Comment.

6) Write the number of parties involved in a bill of exchange.

7) Define Promissory note with its any four important features.

8) Describe the important features of a bill of exchange.

9) Define ‘cheque’. How does it differ from a promissory note?

10) What are the liability of bank in case of dishonouring of cheque?



Delhi.








Delhi.



11. Avtar Singh, The Principles of Mercantile Law, Eastern Book Co., Lucknow.

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Lesson-9

Law of insurance

Structure

9.0 Objectives

9.1 Introduction

9.2 Meaning

9.3 Nature of Insurance

9.4 Kinds of insurance

9.5 Principle of Insurance

9.6 Types of insurance

9.6.1 Life insurance

9.6.2 Fire insurance

9.6.3 Contract of marine insurance

9.7 Summary

9.8 Glossary


9.10 Model Questions


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9.0 Objectives


To understand the meaning of insurance To understand the law of insurance

9.1 Introduction

Future is unknown and uncertain. The lack of knowledge about future exposes life and propertyto varied risks. Business itself is a risky road. Businessman has to be very careful in, driving on itif he is to reach the destination of prosperity. A person may die untimely leaving his dependentsderived of all means of livelihood. Similarly his property is open to all types of risks e.g.destruction by fire, floods and other natural calamities.

Insurance is a co-operative way of spreading the loss by the following the principle of pooling ofrisks.

The institution of insurance is an attempt to provide safeguard against financial loss/hardshiparising on account of life and property being in danger of accidents, mishaps or contingencies.Insurance does not, rather it can’t prevent or eliminate the risks arising from such uncertainevents, and it only spreads the loss over a large number of people. It can be merely financialcompensation for the effects of misfortune.

9.2 Meaning

According to Thomas, insurance is a provision which a prudent man makes against inevitablecontingencies, loss or misfortune and is a form of spreading risks.

In the “dictionary of business and finance”, insurance has been defined as

“A form of contract or agreement under which one party agrees in return for a consideration topay an agreed amount of money to another party to make good a loss, damage or injury tosomething of value in which the insured has a pecuniary interest as results of some uncertainevent.”

In simple words insurance is a contract wherein an insurer undertakes to compensate an insuredin consideration of premium.

Contract of insurance

A contract of insurance may be defined as a contract between two parties whereby a personundertakes in consideration of a fixed sum to pay to the other a fixed amount of money on thehappening of certain events (death or attaining a certain age in case of human life) or to pay theamount of actual loss when it takes place through a risk insured (In case of property). The

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instrument containing the contract of insurance is called a policy. The person whose risk isinsured is called insured or assured, and the person or the company which insures is known asinsurer or assurer or underwriter. The consideration in return for which the insurer agrees tomake good the loss is known as premium. The thing or property which forms the basis ofinsurance is called the subject matter of insurance. The interest of the assured in the subjectmatter is called the insurable interest.

9.3 Nature of contract of insurance

The contract of insurance is a special type of contract. Lord Mansfield described insurance as a‘contract on speculation’ amounting to wagering contact. Over a period of time, the attitude thatinsurance was a contract on speculation has changed and the law regards it now as a system ofsharing risks. It is a type of contingent contract. So, the rules relating to valid contact apply to acontract of insurance. Like other contracts, it comes into existence; when there is offer orproposal on one side and acceptance of the same by the other. Both the parties to a contract ofinsurance must be competent to contract. The object must not be immoral or illegal. Forexample, insurance taken by thief against being caught while attempting a burglary would beillegal and therefore not enforceable at law. It must be supported by a lawful consideration.There should be free consent of both the parties. The contract must be in written form i.e. apolicy which must be duly executed.

9.4 Kinds of insurance

Insurance business can be classified into two main categories:

1. Life insurance business2. Non-life insurance business i.e. general insurance business.

General insurance business refers to fire, marine or miscellaneous insurance business that is cropinsurance, burglary insurance, motor vehicles insurance, bad debts insurance etc.

Statutes governing insurance business

The insurance business in India is governed by the following acts:

1. The insurance act, 1938.2. The life insurance corporation act, 1956.3. The marine insurance act, 1963.4. The general insurance business (nationalization) act, 1972.5. The insurance regulatory and development authority (IRDA) act, 1999.

9.5 Principle of insurance

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The contract of insurance is a special type of contract. So, it must satisfy all the essentialelements of a valid contract embodied in Indian Contract Act 1872. In addition to these, all typesof insurance contracts are based on following fundamental principles:

1. Aleatory contract: most contracts are commutative, i.e. each party gives up goods orservices presumed to be equal value. The insurance contract, however, is aleatory i.e.the contracting party know that the amount to be paid by each party is not equal. Inthe insurance policy, the insured pays the amount of the premium. If he suffers losshe may receive a much larger amount from the company than he paid in premiums,and if he suffers no loss, he will collect nothing.All gambling contracts are aleatory, but not all aleatory contracts are gamblingcontracts. Insurance is not gambling as the requirement of insurable interest removesinsurance from the category of gambling.

2. Utmost good faith: Most ordinary contracts are bonafide or good faith contacts.Insurance contracts however are contracts uberrimae fidei, or contracts of utmostgood faith. It is a condition of every insurance contract that both the parties shoulddisplay the utmost good faith towards each other in regard to the contract. This dutycontinues up to the negotiations for the contract are completed and it is not acontinuing obligation. Thus any material fact coming to the knowledge after theconclusion of the contract need not be disclosed. But the duty to disclose revives withevery renewal of the old policy.The insured is bound to disclose all material facts to him but unknown to the insurer,every fact which is likely to influence the mind of the insurer in deciding whether toaccept the proposal or in fixing the rate of premium is material for the purpose.Where the insured fails to make complete disclosure of every material fact, theinsurer can avoid the contract.Similarly the insurer is bound to exercise the same good faith in disclosing the scopeof insurance which he is prepared to grant. The duty of disclosure is absolute. Non-disclosure or misrepresentation of any material fact gives the insurer an option toavoid the contract.However, he is bound to disclose the facts:1. Already known by the insurer.2. Tending to lessen the risk3. Which the insurance company is supposed to know4. Waived by the insurer5. It can be inferred from information already given.

3. Insurable interest: the insured must have an insurable interest in the subject matterinsured. Without such interest the contract will be regarded as a wagering contractand thus void. Insurable interest means some pecuniary interest. A person said tohave an insurable interest in the subject matter insured where he will derive pecuniarybenefit from its existence or will suffer pecuniary loss from its destruction.

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A person has insurable interest in property even though he may not be the owner of it,for example, a person who has advanced money on the security of a house has aninsurable interest in the house. Again every person has an insurable interest in hisown life. A creditor has an insurable interest in the life if debtor. A business firm hasan insurable interest n the life of partner or key executive because their death willinflict a financial loss upon the firm. A bank has insurable interest in the propertymortgaged to it.At what time insurable interest should exist: it differs widely in respect of differentkinds of insurance as stated below:a) Life insurance: insurable interest must exist at the time when the policy is taken.

It may or may not exist at the time of claim.b) Fore insurance: it must exist both at the time when the policy is taken and at the

time when claim is made.c) Marine insurance: in case of marine and all other types of insurance, it must be

established at the time when loss is incurred and claim made.4. Indemnity: all contact of insurance are contract of indemnity, except those of life

assurance and personal accident insurance. Indemnity means compensation of loss. Itmeans that the assured in the case of loss against which the policy has been madeshall be fully indemnified but never more than fully indemnified. It would be againstpublic policy to allow persons who insure their goods to make any profits out of thegoods insured, otherwise there will be a constant temptation to destroy propertyintentionally. Thus if the value of goods insured increase after the date of the policythe insurers are not liable to make good the loss in respect of the increase value. Acontract of insurance cease to be contact of indemnity where the insurer promise toPay a fixed sum whether the insured has suffered any loss or not.For example: A, doctor after insuring his house against fire, entered into anagreement with B to sell house for Rs. 3000. Before the completion of transaction,house was destroyed by fire. A received the claim. Subsequently he received the pricefrom B as per contract. Insurance company was held entitled to recover from A theamount they had paid.It is worthwhile to mention that the principle of indemnity is linked with insurableinterest, if a one third co-owner gets the full property insured, he shall be indemnifiedto the extent of his interest or share only in the case of total destruction of theproperty.

5. Causa proxima: this is a Latin phrase which means nearest or proxy ate orimmediate cause. When a loss has been caused by a number of cases, the nearestcause will be taken into consideration for fixing the liability of insurance company.By the term proximate cause is not meant the least i.e. proximate in time, but thedirect, dominant and efficient cause.

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Marine insurance is affected against damages caused by various marine losses. Somemarine losses are to be borne by the insurance company while for other shippingcompany is liable. The principle of cause proxima is applied to the liability of theinsurance company. For this, immediate cause of loss has to be ascertained. It iscovered by the terms of policy; the insurance company will be liable.For example: The rice bags in a shop were destroyed due to sea water gushing intoship through a hole made by rats in a pipe. Held, the underwriter was liable. Theproximate cause was sea water. Had the loss been caused by rats directly thecompany would not have been liable?

6. Subrogation: the term subrogation literally means substitution i.e. substitution of theinsurer in the place of insured in respect of the latter’s right and remedies. Accordingto the principle of subrogation, the insurer who has agreed to indemnify the assuredwill, on making good the loss, be entitled to step into the shoes of assured, i.e. theright of the assured pass on to the insurer. The doctrine of subrogation is a corollaryof the principle of indemnity and as such this principle does not apply to personalassurance. The right of the insurer to be subrogated arises only after the payment ofthe policy money. The principle of subrogation does not authorize the insurer to suethe third parties in their own names; they can only enforce their rights in the name ofthe assured.Rules governing subrogation:a) It does not apply to life insurance.b) The insurer assumes the right of insured only after the settlement of the case.c) The insurer will enjoy the same right against third party which previously insured

had.d) Such rights can be exercised in the name of insured.e) Insurer’s entitlement to benefit is limited to the amount actually paid. Surplus has

to be paid to insured.f) Insured in trustee for the insurer in respect of any compensation received from

third party.7. Risk must attach: premium is the consideration for risk run by the insurance

companies and if there is no risk, there should be no premium. It is general principleof law of insurance that where the insurer has never been on the risk. They cannot besaid to have earned the premium. Thus where a policy is declared to be void or wherethe policy is avoided before the risk began to run, the assured is entitled to arepayment of the premium that may have been paid. Once the risk has begun to runthe premium cannot be recovered.

8. Mitigation of loss: literally speaking, it means minimization of loss. When the eventinsured against occurs it is the duty of the insured to take all such steps to mitigate orminimize the loss as if he was uninsured. The insured should not become negligent orinactive in the event of the occurrence merely because the property which is getting

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damaged is insured. He must instead act like any uninsured prudent man would actunder similar circumstances. But this does not mean that while doing his best for theinsurer he should risk his own life.

9. Contribution: this principle is another corollary of the principle of indemnity. Thereis nothing in law to prevent a person from effecting to or more insurance in respect ofthe same subject matter. But in case there is a loss, insured will have no right torecover more than the full amount of his actual loss. If he recovers the full amount ofthe actual loss from one insurer, he will have no right to obtain further payment fromthe other insurers. In such a case the principle of contribution will apply according towhich the insurer who has paid the insured the full amount of compensation willrecover the proportionate contribution from the other insurer. In order to apply theright of contribution between two or more companies, the following factors mustexist:a) The subject matter of the insurance must be same. It is not necessary the amount

of insurance in each policy should be same.b) The event insured against must be same.c) The insured must be the same.

For example: A property is insured against fire for Rs. 50,000 with insurer A and forRs. 30,000 with insurer B. there occurred a fire and damages is estimated at Rs40,000. A and B should share the loss in proportion to the amount assured by each ofthem, i.e. in the proportion of 3:1. A should pay Rs.30, 000 and B pay Rs. 10.000.

10. Period of insurance: an insurance policy specified the term or period of time itcovers. Often the nature of risk against which insurance is sought determines theperiod or life of the policy. A life insurance policy may cover a specified number ofyears. Or the balanced of insured’s life. A contract of fire insurance is normally for aperiod one year. A contract of marine insurance may be either for a particular periodor for particular voyage. In case it is for a particular period and the voyage has notcome to an end, the liability of the insurer comes to an end on the expiry of theperiod. If the contract for a particular voyage, the liability of the insurer comes to anend only after the completion of the voyage.

Activity-2

What are the different Principles of insurance--------------------------------------------------------------

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1. Which of the following is the type of insurance?

a) Life insurance

b) Fire insurance

c) Marine insurance

d) All of above

2. Which one of the following is not the kind of fire insurance policy?

e) Specified policy

f) Valued policy

g) Average policy

h) Voyage policy

9.6 Types of insuranceThere are three types of insurance:

9.6.1 Life insurance

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Life insurance is a contract where by the insurer is consideration of a premium paid eitherin lump sum or in periodical instalments undertakes to pay an annuity or a certain sum ofmoney, either on the death of the insured or on the expiry of a certain number of years,whichever is earlier. The person who agrees to identify is call insurer. The person whoselife is insured is called the assured. The consideration paid to the insurer is called thepremium. The written agreement of insurance is called the policy.

a) Any contract whereby the payment of is assured on death(except death by accident only);or

b) On the happening of any contingency dependent on human life; andc) Any contract which is subject to payment of premiums for a term dependent on human

life.

Contracts of assurance will also include-

a. The grating of disability and double or triple indemnity accident benefits if soprovided in the contract of insurance;

b. The granting of annuities upon human life; andc. The grating of superannuation allowance and annuities payable out of any fund

applicable solely to the relief and maintenance of person engaged in any particularprofession, trade or employment or of the dependents of such persons.

Types of life insurance policies

The life insurance policies are many types. The principal types of policies are following-

1) Whole life policy: under this policy premiums are paid throughout life and the suminsured becomes payable only at the death of the insured. This is the cheapest policy aspremium charged is the lowest under this policy. This is also known as ordinary lifepolicy.

2) Endowment policy: under this policy the sum assured becomes payable if the assuredreaches a particular age or after the expiry of fixed period called the endowment period orat the death of the assured whichever is earlier. The premium under this policy is to bepaid up to the maturity of the policy, i.e. the time when the policy becomes payable.Premium is naturally a little higher in the case of this policy than the whole life policy.This is a very popular policy these days as it serves the dual purpose of family and oldage pension.

3) Limited payment life policy: in the case of whole life policy there is one disadvantage inthat the assured must continue to pay the premium even during his old age when he is nomore employed. Under the limited payment life policy premiums are payable for aselected number of years or until death, if earlier. The assured knows how much he willbe required to pay, no matter how long he lives. The sum insured becomes payables onlyat the death of the insured. It is a suitable policy to meet the family needs.

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4) Joint life policy: this policy covers the risk on two lives and is generally available topartners in business. Policies are however, issued on the lives of husband and wife underspecified circumstances. Sum assured becomes payable at the end of the selected term oron the death of either of two lives assured, whichever is earlier.

5) With or without profit polices: under the with profit or participating polices the policyholder is allowed a share in the profits of the corporation in the form of bonus and it isadded to the total sum assured and paid at the time of maturity of the policy. In the caseof without profit or non-participating policies, no such profit is allowed. Premium in thefirst case is higher and is lower in the latter case.

6) Convertible whole life policy: this policy initially provides maximum insuranceprotection at minimum cost and offers a flexible contract which can be altered at the endof five years from the commencement of the policy to endowment insurance. This issuitable for young persons or persons who are at the initial stage of career in businesswith prospects of increase in earnings in future. Premium being low, policy is affordable.

7) Convertible term assurance policy: this policy meets the needs of those who areinitially unable to pay the larger premium required for a whole life or endowmentassurance policy but hope to be able to do so within a few years. It would also enablesuch persons to take final decision at a later date about the plan suitable for their futureneeds.

8) Children policy: LIC issues several policies for the benefits of children. Two importantpolicies are:

I. The fixed term (marriage) endowment policy andII. The education annuity policy

9) Annuities: it is policy under which the insured amount is payable to the assured bymonthly or annual instalments after he attains a certain age. The assured may pay a lumpsum of money at the outset. These policies are useful to persons who wish to provide aregular income for themselves and their dependents.

10) Sinking fund policy: such a policy is taken with a view to providing for the payment ofliability or replacement of an asset.

11) Money back policy: this type of policy provides money back at regular intervals beforethe policy expires. For example, on a 12- year’s policy, one gets 20 per cent of the sumassured after four years, another 20 per cent on the expiry of another next years andbalance at the end of 12 years. In case death of assured occurs during 2 years, the fullsum assured is paid irrespective of instalments already paid. Thus, the policy givesmoney in hand plus insurance cover.

12) Multipurpose policy: this policy meets several insurance needs of a person- likeprovision for himself in old age, income for his family and provision for the education,marriage or the start in life of his children. It gives maximum protection to thebeneficiaries in the event of the early death of the assured.Besides these, LIC has been introducing various other policies

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1) Janta policy2) Children’s deferred endowment assurance policy3) Children’s anticipated policy4) Jeevan sathi double joint life policy5) Jeevan mitra double cover endowment with profits6) Jeevan suraksha7) Jeevan dhara8) Jeevan griha plan9) Money back plan

Activity-2

Explain different Types of life insurance policies---------------------------------------------------------------------------------------------------------------------

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9.6.2 Fire insurance

The law relating to fire insurance in India is contained in the Insurance Act, 1938, and theGeneral Insurance Business (Nationalization) Act, 1972. The fire insurance business was

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nationalized in 1972 through the above mentioned Act. From January 1, 1974, fire insurancebusiness is being transacted only by the general Insurance Corporation of India and its foursubsidiaries.

Definition of contract of fire insurance

A fire insurance contract may be defined as an agreement between the insurer and the insuredwhereby the insurer undertakes to indemnify the insured for destruction of or damage to propertycaused by fire or other specified perils during a stated period, in return for payment in lump sumor by installments. Section 2 (6A)of insurance Act, 1938 defines fire insurance business as ‘ thebusiness of effecting otherwise that incidentally to some other class of insurance business,contracts of insurance against loss by or incidental to fire or other occurrence customarilyinclude among the risk insured again in fire insurance policies.’ The document which containsthe terms and conditions of the fire insurance contract is called the fire policy. A policy of fireinsurance is intended to protect the insured against loss caused by fire and allied perils. In otherwords fire insurance affords cover for material damage. The need for fire insurance arisesbecause of the following reasons

a) The existence of property susceptible to damage or destruction by fire or other peril,b) The fact that property has intrinsic value measurable in terms of moneyc) The fact that the occurrence of a fire will result not only in loss of or damage to material

property but also other consequential losses such as loss of production.

Example: A chemist gets his stock of medicine insured against loss by fire. A fire takes place inhis shop because of which stock of medicine is not burnt but is damaged due to excessive heat.He is entitled to recover the loss.

Subject matter of insurance

Subject matter of fire insurance may be any kind of movable and immovable property havingpecuniary value i.e. building, fixtures and fittings, plant and machinery, household contents,stocks and goods and premises in the open or in transit. The property intended to be insured mustbe properly described. If a house is insured against fire, it would not include household goods.

Kind of fire insurance policy

1. Specify policy: it is a policy in which the value insured against is specified. Under thispolicy a definite amount is insured on a specified property and in the event of loss, it willbe paid if the loss falls within the specified amount. For example if a person has taken apolicy of Rs. 10,000 against a property worth Rs. 15,000 and he suffers a loss of 9,000,he can realize the whole loss from the insurer. But if the loss amounts to Rs. 13,000 onlyRs. 10,000 can be recovered.

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2. Valued policies are not generally issued in fire insurance. They are usually issued onpictures, works of art, sculptures and such other things whose value cannot be easilydetermined.

3. Average policy: a fire policy containing an “average clause” is called an average policy.Under this policy, if the actual policy, if the actual is greater than the insured amount, theinsurance company will pay proportionally and the insured is deemed to be his owninsurer, for the balance. The claim is arrived at by dividing the amount of insurance bythe actual value of the subject matter and multiplying it by the amount of loss.

4. Floating policies: this policy is taken out to cover goods belonging to the same personbut lying in different lots at different places under one sum for one premium. Forexample, a manufacturer or a trader may take one floating policy for all his goods lyingin part in warehouses, railway stations, port etc. the premium charged under such a policyis generally the average of the premium that would have been paid if each lot of thegoods had been insured under specific policy for specific amounts.

5. Reinstatement or replacement policies: under this policy the insurer undertakes to paythe full price of the property required to be replaced. Here it is possible to recover not thedepreciated value of buildings or machinery, but the cost of replacement of the damagedproperty by new property but of the same kind.

6. Declaration policy: goods which are subject to frequent fluctuations in value or involume, present a special problem for insurance.

7. Comprehensive policy: a fire policy usually does not cover loss occurring as result ofriots, civil strife, rebellion, etc.

8. Consequential loss policy: it is a policy in which the underwriter agrees to indemnify theinsured for the loss of profits which he suffers due to the dislocation of his business,caused by fire. It is also called ‘loss of profits policy’.

9.6.3 Contract of marine insurance

A contract of marine insurance is defined as an agreement whereby the insurer undertakes toindemnify the assured in the manner incidental to marine adventure (Section 3). It is, thus, acontract to indemnify against loss from marine perils.

Marine policies

1. Voyage policy: it is a policy which covers a particular voyage. Where the contract is toinsure the subject matter “ at and from” or from “one port to another”, the policy is calledvoyage policy

2. Time policy: it is policy which covers a specified period of time.3. Valued policy: it is a policy which mentions the value of the subject matter of insurance.4. Unvalued policy: it is a policy which does not specify the value of the subject matter

insured.

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5. Wagering policy: it is a policy which is issued has no insurable interest in the subjectassured and has no expectation of acquiring such interest at the time of contact.


1. Which of the following is not the element of insurance?

a) Utmost good faith

b) Insurable interest

c) Mitigation of loss

d) damage

2. Which one of the following is not the kind of marine insurance policy?

a) Time policy

b) Voyage policy

c) Restitution

d) None of above

9.7 Summary

The contract of insurance is a special type of contract. Lord Mansfield described insurance as a

‘contract on speculation’ amounting to wagering contact. Over a period of time, the attitude that

insurance was a contract on speculation has changed and the law regards it now as a system of

sharing risks. It is a type of contingent contract. So, the rules relating to valid contact apply to a

contract of insurance. Like other contracts, it comes into existence; when there is offer or

proposal on one side and acceptance of the same by the other. Both the parties to a contract of

insurance must be competent to contract.

9.8 Glossary

Insurance: insurance is a provision which a prudent man makes against inevitable

contingencies, loss or misfortune and is a form of spreading risks.

Contract of insurance: A contract of insurance may be defined as a contract between two

parties whereby a person undertakes in consideration of a fixed sum to pay to the other a fixed

amount of money on the happening of certain events

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1. (d)

2. (d)


1. (c)

2. (d)


1. What is insurance and explain different elements of insurance?

2. Explain different types of insurance policies?

3. Describe different types of life insurance policy?




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Lesson-10

Basic Features of Law Relating to Carriers

Structure

10.0 objectives

10.1 Introduction

10.2 classification Carriers

10.2.1 Common carrier

10.2.2 Private carrier

10.3 Railway as carrier

10.4 Carriage by sea

10.4.1 Duties of carriage by sea

10.4.2 Liability as Carriage by Sea

10.5 Carriage by air

10.5.1Liabilityof Carriage by air

10.6 Summary

10.7 Glossary




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10.0 objectives


To understand meaning of carrier. To understand the contract of carriage.

10.1 Introduction

Transportation is the means of marketing of our huge national production. It is an important linkin the development of many industries in the country. The vast system of collection of rawmaterial and distribution of finished products would not be possible without the presentdevelopment of the various forms of transportation – train, truck, plane and ship.

A carrier is one who undertakes the transportation of persons and goods either for hire orgratuitously. The consignor or shipper is the person who delivers goods to the carrier forshipment. The consignor is the person to whom the goods

The law relating to carriage of goods in India is contained in the following statutes:

1. Carriage by land- The common carriers Act, 1865, which deals with common carriers of goods over

land and inland water ways. The railway Act, 1890, which deals with carriage by railways.

2. Carriage by sea- The Indian Bills of Lading Act, 1856. The carriage of Goods By Sea Act, 1925. The Merchant Shipping Act, 1958. The Marine Insurance Act, 1963.

3. Carriage by air- Carriage by Air Act, 1963.

10.2 Classification of carriers

Carriers may be classified into carriers of passengers and carriers of goods. However the samecarrier may carry both goods and passengers. Another way to classify carriers is on the basis ofreward, which are gratuitous carriers and private carries.

The common law recognizes two classes of carriers namely common carriers and privatecarriers.

10.2.1 Common carrier

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A common carrier is one who undertakes for hire to transport from one place to another thegoods of all such persons as think fit to employ him. According to section 2 of the Carriers Act,1865, common carrier denotes “a person other than the government engaged in the business oftransportation for hire property from place to place by land or inland navigation, for all personsindiscriminately” person includes any association or body of persons whether incorporated ornot. The carrier is not at liberty to refuse business. A person who reserves the light of acceptingor rejecting the offer of goods for carriage is not a common carrier.

Characteristics: to render a person liable as a common carrier, the following characteristics mustbe present

The person must be engaged in the business of transporting. Where a man carriergoods occasionally or by special agreement, he is not a common carrier. Thebusiness of transporting should not be merely a casual occupation

The term common carrier is applied in only case of carriage by land or inlandnavigation. Thus carrier by sea is excluded.

Generally, common carrier is carrier of goods or money. A carrier of passengersis not a common carrier. It may be noted that a post office is not a common carrierthough it is a carrier of goods. Railway (owned and run by government) is notcarrier although they carry the goods.

The common carrier should get some consideration for carriage. He is not acommon carrier when there is no consideration.

The most important characteristics of a common carrier are that he must carry forall persons indiscriminately. If he retains the right to choose as among persons orgoods, he is not a common carrier. If a man holds himself out to do it foreveryone who asks him he is a common carrier.

A common carrier is lawfully justified in refusing to carry the goods-

If the conveyance is already full If the goods subject him to some extraordinary risk or danger If the goods are such that the carrier is not in the habit of carrying or does not profess to

carry If the goods are to be carried over a route over which he does not operate If the consignor is not willing to pay reasonable charges for the carriage If the goods are not properly packaged If the consignor refuse to disclose the nature of goods offered for carriage

If the common carrier refuses to carry the goods of any person without any of the reasonsmentioned above he can sued and made liable for damages.

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Duties of a common carrier

The duties of common carrier in India are governed by the Carrier Act, 1865, and by the rules ofEnglish law

These duties are as follows:

1. A common carrier must receive and carry the goods of all persons who offer them. Theconsignor can recover damages from the carrier if he wrongfully refuses to accept andcarry his goods.

2. A common carrier must follow his customary route and must not deviate from it withoutcause. He need not carry by the shortest route.

3. He is bound to carry the goods safety4. He must deliver the goods to the consignee within the time expressed in the contract or

within a reasonable time.5. He must deliver the goods to the consignee at a place designated by the consignor unless

the consignee requires the goods to be delivered at another place.6. When the goods are in transit the carrier is bound to obey the instruction of consignor

regarding change in the delivery of goods.

Right of a common carrier

1. He can ask the consignor to deliver the goods to him.2. Ha can claim payment in advance i.e. before he carries but not before he receives the

goods.3. He is entitled to reasonable compensation for the services rendered.4. He has a lien to retain the goods until charges for the carriage are paid. It is a particular

and not general lien. The lien cannot be enforced if the carrier has agreed to give credit.5. The carrier is entitled to make a charge for the unreasonable detention of his vehicles by

the consignor or the consignee. This is the right to charge demurrage.6. Where a consignor delivers goods of a dangerous character to a common carrier the

consignor will be liable in damages if the carrier suffers any loss or injury therefore.7. A common carrier has a right to refuse to carry the goods under certain circumstances.8. A common carrier can limit his liability by entering into a special contract under certain

circumstances.

Labilities of a common carrier

Under the carrier act, 1865

The liability of a common carrier in India is governed by the principle of English CommonLaw as modified by the carriers Ac, 1865. Goods for the purpose of liability are divided intotwo categories namely scheduled goods and non-scheduled goods.

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Liability in respect of scheduled goods: scheduled goods are those which are enumerated in aschedule to the act. They are usually valuable articles for example, gold and silver coins,precious stones and pearls, jewelry, bills and maps, work of art, title deeds, glass, articles ofivory, ebony or sandal wood, furs, government, opium etc.

A common carrier shall not be liable for loss or damage to property delivered to him forcarriage exceeding in value Rs. 100 and of the description mentioned in the schedule to theAct, unless their value and description are expressly declared to such carrier. But even insuch cases the common Carrier would be liable where loss or damage to the goods shall havearisen from the criminal act of the carrier or any of his agents or servants except when theloss is caused under the exceptional circumstances as mentioned under the English CommonLaw. Further, the carrier cannot limit his liability by any special contract with the consignorin case of scheduled goods. However, if the value is declared, the carrier is entitled to chargean extra freight or reward, but will be liable for loss or damage.

Liability in respect of non-scheduled goods: non-scheduled goods are those when are notspecified in the schedule. The liability of a common carrier for loss or damage to non-scheduled goods can be limited by a special contract signed by the owner of the goods. Butthe common carrier shall be liable for any loss or damage caused to the goods by the criminalact or negligence of the carrier or any of his agents or servants or agents in these goods.

Section 10 of the carriers Act, 1865 provides that in case of loss or damage, the claimantmust notify his claim in writing within six months of the date when the claimant first knew ofsuch loss or injury. However, when non-delivery, short delivery or missed delivery occursdue to any claimant act of the carrier or his servant or agent, no notice is necessary.

10.2.2 Private carrier

Private carrier carries the goods on occasions and for particular persons of his own choosingunder a special contract either for hire or gratuitously. Thus he is one who instead of serving allalike picks and choose his customers. A private carrier is not governed by the carrier’s Act,1865. His position is that of a Bailee.

Activity-1

Explain duties and rights of common carriage---------------------------------------------------------

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10.3 Railways as carriers

Rail transport occupies an important place as one of the chief means of land transport inIndia. As railways are owned and operated by the government in India. It is not governed bythe carrier Act, 1865. The carriage of goods by railways act is discussed briefly, so far asthey are applicable to carriage of goods.

Duties of railways administration

The railway administration has certain duties under the Railways Act. Railways are commoncarrier so far goods and animals are concerned.

Duties of railways are as under:

1. The Railways Administration is bound to carry of every person who is prepared topay the necessary freight and the regulations concerning packing etc. are observed.

2. Section 28 of the Indian Railway Act, 1890 provides, “A Railway Administrationshall not make or give any undue or unreasonable preference or advantage to, or infavor of any particular person or Railway Administration, or any particulardescription of traffic, in any respect whatsoever, or subject any particular person orRailway Administration, or any particular description of traffic to any undue orunreasonable prejudice or disadvantage in any respect whatsoever.

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3. The Railway administration is under a duty to comply with any directions given bycentral government in regard to transport of goods. (Section 27 A).

Liabilities of railways

The liability of the railway administration before 1961 with respect to loss, non-delivery of thegoods entrusted for carriage was that of a Bailee only. Since the amendment of the IndianRailways act in 1961, the liability of the railways is that of a common carrier. The liability of therailway administration as a carrier is laid down in chapter VII of the Railway act. The mainprovisions are summarized as under.

General responsibility

Save as otherwise provided in this act, a railway admi9nistration shall be responsible for the loss,destruction, damage, deterioration or non-delivery, in transit of animals or goods delivered to theadministration to be carried by railway, arising from any cause except the following, namely

(a) Act of God(b) Act of war(c) Act of public enemies(d) Arrest, restraint or seizure under legal process(e) Order of restriction imposed by the Central government or state government or by the

officer or authority subordinate to them, authorized in this behalf(f) Act or omission or negligence of the consignee or their agent or servant.(g) Natural deterioration or wastage in bulk or weight due to inherent defect, or vice of the

goods.(h) Latent goods.(i) Fire, explosion, or unforeseen risk.

Railway risk or owner’s risk rate (Section 74)

Animals or goods may be carried by the railway administration either at ordinary rate (railwayrisk rate) or at a special reduced rate (owner’s rate). The animals or goods shall be deemed to becarried at owner’s risk rate. In the latter case, the railway administration shall issue a certificateto consignor to that effect. The owner’s risk rate is lower as compared to the railway risk rate.Where the goods are carried at owners risk rate the railway administration cannot be made liablefor any loss or damage in transit of goods, except upon the proof that such loss or damage wasdue to negligence or misconduct of the railway or its servants. The rule stated in this section is anexception to section 73.

1. Responsibility for delay or detention

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A railway administration is responsible for loss, destruction, damage or deterioration of animalsor goods caused by delay or detention in their transit unless it proves that the delay or detentionarose without negligence or misconduct on the part of the railways (section 76)

2. Responsibility for deviation of route

Where due to a cause beyond the control of a railway administration, or due to congestion in theyard, or other operational reasons, animals or goods delivered to the railway are carried by aroute nit agreed upon, the railway administration shall not be deemed to have committed abreach of the contract of carriage by reason only of the deviation of route. (Section 76-A)

3. Responsibility for wrong delivery

When railway administration delivers the goods or animals in good faith to a person whoproduces the original railway receipt, it shall not be responsible on the ground that such person isnot legally entitled thereto or that endorsement on the railway receipt is forged or otherwisedefective. (Section 76-B)

4. Responsibility for goods to be delivered at siding

Where the railway administration places wagons at the siding it shall not be responsible for loss,destruction, etc. from whatever the cause arising. His responsibility of the railway administrationshall cease only when the owner of the siding has been informed in writing that the wagon hasbeen so placed. (Section 76-C)

5. Responsibility after termination of transit

The railway administration shall be responsible as a Bailee under sections 151, 152, and 161 ofthe contract act, 1872 for the loss, destruction etc. of goods carried by railway within a period ofseven days after the termination of transit. But where the goods are carried at owner’s risk rate, itshall not be responsible for such loss, destruction etc. except on the proof of negligence ormisconduct on its part.

The railway administration shall not be responsible in any case, foe loss, and destruction etc. ofthe goods carried by railway arising after the expiry of seven days after termination of the transit.(Section 77)

6. Responsibility as a carrier of animals

The liability of the railway in case of loss or damage of animals shall not exceed the amountspecified in the 1st schedule to the Act. However the railway may accept a higher liability if theconsignor declares a higher value in the forwarding note and pays higher charges. The railway isnot responsible where the loss occurs due to the restiveness of the animal. (Section 77-A)

7. Responsibility as a carrier of articles of special value

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When any parcel or package containing articles of the kind mentioned in the second schedule isdelivered to the railway for carriage, the consignor is required (if the value of the goods exceedsRs. 500) to disclose the value and contents of the parcel or package. The railway can demandextra freight for the increased risk. When such extra freight is paid and the required declaration ismade, the railway is liable to make good any loss or damage to the article. (Section 77-B)

8. Responsibility for damage to goods in defective condition or defectively packed

When the goods delivered to the railway are defective condition or are defectively packed andthe fact is noted in the forwarding note, the railway administration shall not be responsible fordamages except upon proof of negligence or misconduct on its part. It shall in no case beresponsible for any damage, leakage, etc. of such goods after the expiry of seven days after thetermination of transit (Section 77-C)

9. Responsibility as carrier of passenger luggage

The railway administration shall not be responsible for a passenger’s personal luggage unless arailway servant has booked it and has given a receipt.

Where the luggage is in the charge of the passenger, the railway is not liable unless the loss ordamage was due to the negligence or misconduct on the part of the railway administration(Section 75)

10. Exoneration from responsibility

A railway administration shall not be responsible for loss or damage in the following cases

1. Where the goods have been dispatched with a false description2. Where a fraud has been practiced by the consignor or the consignee or their agent3. Where damage, non -delivery etc. is caused by (a) improper loading or unloading by the

consignor or consignee or their agents; (b) riot, civil commotion, strike, lockout, stoppageor restraint of labor from whatever cause partial or general.

4. For any indirect or consequential damage or loss of particular market. (Section 78)

Notice of claim

A person shall not be entitle to any compensation for the loss, destruction, damage, or non-delivery of animals or goods delivered to be so carried or to a refund of an overcharge in respectof animals or goods carried by railway, unless his claim to the compensation or refund has beenforwarded in writing by him to the railway administration. The claim must be made within sixmonths from the date of the delivery of the animals or goods for carriage by railway. (Section78-B)

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1.Which of the following is the right of a common carrier(a) He can ask the consignor to deliver the goods to him.(b)He can claim payment in advance i.e. before he carries but not before he receives thegoods.(c)He is entitled to reasonable compensation for the services rendered(d)all of these

2.which of the following is the liabilities of railways(a) Responsibility as carrier of passenger luggage(b) Exoneration from responsibility(c) Responsibility as a carrier of articles of special value(d) All of these

10.4 Carriage by sea

Contract of affreightment

A contract for the carriage of goods by sea is known as ‘Contract of Affreightment’. It is acontract by which a ship owner undertakes to carry the goods of another in consideration of aprice called ‘freight’. Such a contract need not be in writing, but in practice it is usuallyexpressed in writing. A contract of affreightment may take the form of

(a) A charter party(b) A bill of lading.

The rights and liabilities of parties to a contract of affreightment are regulated, subject to anystipulations in the contract, by the Bill of Lading Act, 1856 and the carriage of goods by sea Act,1925.

Charter party

It often happens that a merchant wishes either

1. To hire a ship for a fixed time2. To hire a ship or a portion of a ship for a certain voyage3. To become for the time being owner of a ship, by causing her to be leased to him.

The contact entered in any of these three cases is charter party. It is an agreement by which aship owner agrees to place an entire ship or of it, at the disposal of a merchant for theconveyance of goods to the agreed port of destination for a sum of money which the merchantundertakes to pay for carriage. The person whose goods are so carried is called the ‘charterer’.The form of the charter party depends on the agreement between the parties to it, the custom of

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the particular ports involved and the nature of the adventure. The charter party may notnecessarily be under seal, but it must be stamped.

Activity-2

Explain the term bill of lading--------------------------------------------------------------------------------

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Kinds of charter party

A charter part may be:

1. Time charter: if the hiring of ship is for a specified period, irrespective of the number ofvoyages performed, it is called time charter. In time charter the ownership and alsopossession of the ship remains in the original owner whose remuneration or hiregenerally calculated at a monthly rate on the tonnage of the ship.

2. Voyage charter party: where the vessel is chartered for a definite voyage or voyages, itis known as a voyage charter party. A voyage charter is thus a contract to carry specifiedgoods on a defined voyage on a remuneration or freight usually calculated according to

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the quantity of cargo carried. As in the case of time charter, here also the possession andcontrol of the ship are not transferred to the charterer.

3. Charter by demise: in such a case, the charterer becomes for the time being the owner ofthe ship and the master and the crew of the ship become the servant of the charterer. Theowner of the ship divests himself of all control either over the ship or over the master andcrew. His sole right is to receive the stipulated hire and to take back the ship when thecharter party comes to end.

Implied undertakings in a charter party

In case of a voyage charter party, the ship owner impliedly undertakes

1. To provide a seaworthy ship2. That the ship shall proceed with a reasonable dispatch.3. That she shall proceed without unjustifiable deviation4. That the charterer undertakes not to ship dangerous goods.

In case of a time charter, the ship owner impliedly undertakes that the vessel is seaworthy atthe commencement of hire, while the charter impliedly undertakes also not to ship dangerousgoods. These conditions may however be varied or exclude by clear terms in the contract

A brief discussion of the various conditions is as follows:

1. Seaworthiness: the implied condition is that the ship is fit in design, structure, conditionand equipment to encounter the ordinary perils of voyage. Seaworthiness means that theship is fit to undertake the particular voyage to carry the specific cargo. Thus, where thecontract is far the carriage of frozen meat in a ship fitted with refrigerating machinery,there is an implied warranty that the ship and refrigerating machinery are fit to receiveand carry frozen meat safely on the agreed voyage.

2. Reasonable dispatch: the ship owner impliedly undertakes that the ship shall be readyto commence the voyage and shall carry out the same with all reasonable dispatch ordiligence. A breach this condition entitles the charterer to repudiate the contract if thedelay is such as to frustrate the venture as a commercial enterprise. If it is not, the onlyremedy is damage.

3. No deviation: it is an implied condition that the ship shall precede on the voyage withoutdeparture from her proper course. Deviation means the going off from the usual orcustomary course of voyage between two given terminals. If such a course is deviatedfrom the whole contract of affreightment becomes void. Deviation is justified where it isnecessary to save life (but not to save property) or to secure the safety of the ship.

4. Not to ship dangerous goods: the charterer or shipper impliedly undertakes that he willnot ship dangerous goods. Even if the master accepts them on board, the charterer will beliable for any loss or damage they may cause unless the master knew their nature.

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Bill of lading

Meaning: when the carrier accepts goods for shipment, it ordinary issues to the shipper a bill oflading. It is a document acknowledging the shipment of goods, signed by or on behalf of thecarrier and containing the terms and conditions upon which it has been agreed that they are to becarried. A bill of lading is generally used for the carriage of goods on a general ship i.e. a shipwhich is used for the carriage of goods of several merchants and which is not employed for thecarriage of charterer’s goods only. A bill of lading is also used even when a ship is charterer as awhole.

A bill of lading performs in the eyes of law the following functions:

(a) As evidence of the contract(b) As a receipt

10.4.1 Duties of a carrier by sea

The Carrier of Goods by Sea Act, 1925 lays down the following duties on the carrier of goods bysea from an Indian port.

1. The carrier shall be bound, before and at the beginning of the voyage, to exercise duediligence to:

(a) Make the ship seaworthy(b) Properly man, equip and supply the ship(c) Make the holds refrigerating and cool chambers, and all other part of the ship in which

the goods are carried fit and safe, for their reception, carriage and preservation.2. Subject to the provisions of this Act, the carrier shall properly load, handle, stow, carry,

keep, care for and discharge the goods carried.3. After receiving the goods into charge, the charge, the carrier or the master or agent of the

carrier shall, on demand of the shipper, issue to the shipper, a bill of lading showing theprescribed particulars.

10.4.2 Liabilities of carrier by sea

The rule regarding the liabilities of a carriage of goods by sea from an Indian port are laiddown by the carriage of goods by sea Act, 1925, and are as follows:

1. Any clause in a contract of carriage relieving the carrier or the ship from liability for loosor damage arising from negligence, fault, or failure in the duties and obligationsprovided in this act shall be null and void and of no effect.

2. The carrier or the ship shall not be liable for loss or damage arising or resulting fromunseaworthiness unless caused by want of due diligence on the part of carriers, to makethe ship seaworthy, the burden of proving the exercise of due diligence shall be on thecarrier.

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3. The carrier or the ship shall not be responsible for loss or damage arising or resultingfrom the following causes, neglect or default of the master or servants of carrier in thenavigation or in the management of the ship, fire unless caused by the fault or privet ofthe carrier, perils, dangers and accidents of sea, act God, act of war, act of publicenemies, quarantine restrictions, act or omission of the shipper or his agent, strike orlock-outs or stoppage or restraint of labor, riots and civil commotions, wastage in bulk orweight or any other loss arising from inherent defect of the goods.

4. The carrier or the ship shall not be liable for any loss or damage to goods exceeding Rs100 per package or unit, unless the nature and value of such goods have been declaredby the shipper before shipment and interested in the bill of lading.

5. A cargo owner will lose any remedy he has against the carrier unless the suit is institutedwithin one year.

10.5 Carriage by air

The carriage by Air Act, 1934 now stands repealed by carriage by Air Act, 1972. The carriage byAir Act, 1972 was passed with a view to give effect to the convention for the unification ofcertain rules relating to international carriage by air signed at Warsaw in 1929 and to the saidconvention as amended by the Hague protocol in 1955 and to make provision for applying therules to non-international carriage by air and for matters connected there with, the new actsimplifies the document of carriage and increase the liability of the air carrier from 12500 francsper passenger to 2,50,000 francs per passenger.

Definition:

High contracting party: under section 4(2) of the act, the central government may by notificationin the official gazette certify who are high contracting parties to the amended convention and inrespect of what territories they are parties.

10.5.1 Liability of the carrier

The carrier is liable for damage where the passenger dies or is wounded on board the aircraft, orin the course of nay of the operations of embarking or disembarking. Under rule 22(1) of theamended convention the liability of the carrier for each passenger is limited to a sum of 2, 50,000francs. The statutory liability to pay the quantum of damages fixed under this may be increasedby an agreement between the carrier and the passenger.


1. A bill of lading performs in the eyes of law the following functions:a. As evidence of the contractb. As a receipt

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c. None of thesed. A and B

2. A railway administration shall not be responsible for loss or damage in the followingcasesa. Where the goods have been dispatched with a false descriptionb. Where a fraud has been practiced by the consignor or the consignee or their agentc. Where damage, non -delivery etc. is caused by improper loading or unloading by the

consignor or consignee or their agentsd. All of these.

10.6 Summary

Transportation is the means of marketing of our huge national production. It is an important linkin the development of many industries in the country. The vast system of collection of rawmaterial and distribution of finished products would not be possible without the presentdevelopment of the various forms of transportation – train, truck, plane and ship.

A carrier is one who undertakes the transportation of persons and goods either for hire orgratuitously. The consignor or shipper is the person who delivers goods to the carrier forshipment. The consignor is the person to whom the goods

10.7 Glossary

Common carrier: A common carrier is one who undertakes for hire to transport from one placeto another the goods of all such persons as think fit to employ him.

Bill of lading: when the carrier accepts goods for shipment, it ordinary issues to the shipper abill of lading.



1. (d)

2. (d)


1. (d)

2. (d)

10.9 Model Question

1. Define the term common carrier. How do you distinguish between common carrier andprivate carrier?

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2. Define a contact of affreightment. What are the conditions implied in a contract for thecarriage of goods by sea?

3. Define the term high contacting party?




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Lesson -11

Company Law

Structure


11.1 Introduction

11.2 Definition of Company

11.3 Characteristics of a company

11.4 Types of company

11.5 Incorporation of company

11.6 Memorandum of Association

11.7 The Articles of Association

11.8 Contents of articles

11.9 Alteration of Articles

11.10 Membership of a company

11.11 Summary

11.12 Keywords




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After reading this lesson, you should be able to:

(a) Define a company and explain its features.

(b) Describe the process of formation of a company.

(c) Explain the different clauses of memorandum of association and the alterations thereof.

(d) Discuss the contents of articles of association.

11.1 Introduction

In this era of industrial revolution many big business organization exists and many more

emerges. All these required big investment and involvement of risk. The Multinational

companies like Coca-Cola, General Motors and Reliance have their investors and customers

all over the world. We know that a company is a separate legal entity which is formed and

registered under the Companies Act. It may be noted that before a company is actually

formed (i.e., formed and registered under the Companies Act), certain persons, who wish to

form a company, come together with a view to carry on some business for the purpose of

earning profits. Such persons have to decide various questions like (a) which business they

should start or begin with, (b) whether they should form a new company or take over some

existing company, (c) if new company is to be started, whether they should start a private

company or pubic company, (d) what should be the capital of the company etc. After

deciding about the formation of the company, the desirous persons take necessary steps, and

the company is actually formed. Thereafter, they start their business. Thus, there are various

stage in the formation of a company from thinking of starting a business to the actual starting

of the business. We will go one by one on these topic stating with meanings of company and

its different type then all relevant documents AOA, MOA etc.

11.2 Definition of Company

Company is a voluntary association which is formed and organized to carry out business

activity.

A company is a "corporation" - an artificial person created by law.

A human being is a "natural" person.

A company is a "legal" person.

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A company thus has legal rights and obligations in the same way that a natural person

does.

Section 3 (1) (i) of the Companies Act, 1956 defines a company as “a company formed and

registered under this Act or an existing company”. Section 3(1) (ii) Of the act states that “an

existing company means a company formed and registered under any of the previous

companies laws”.

According to Chief Justice Marshall of USA, “A company is a person, artificial, invisible,

intangible, and existing only in the contemplation of the law. Being a mere creature of law, it

possesses only those properties which the character of its creation of its creation confers upon

it either expressly or as incidental to its very existence”.

Another comprehensive and clear definition of a company is given by Lord Justice Lindley,

“A company is meant an association of many persons who contribute money or money’s

worth to a common stock and employs it in some trade or business, and who share the profit

and loss (as the case may be) arising there from.

Example: Suppose, two persons want to do business at large scale but they have limited

money. They are also not interested to make partnership due to its unlimited liability. They

go to the office of registrar of companies and fill the form of creation of company and

attaching required documents. They also pay the required fees. After

this, registrar will register their company. This registered company will be independent

Identity.

11.3 Characteristics of a company

Following are the characteristics of the company:

1. Incorporated association: A company is created after registration under the

Companies Act. It comes into existence from the date mentioned in the certificate of

incorporation. Section 11 provides that an association of more than ten persons

carrying on business in banking or an association or more than twenty persons

carrying on any other type of business must be registered under the Companies Act

and is deemed to be an illegal association, if it is not registered in such way. For

forming a public company at least seven persons and for a private company at least

two persons are persons are required. These persons will subscribe their names to the

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Memorandum of association and also conform with other legal requirements of the

Act in respect of registration to form and incorporate a company, with or without

limited liability [Sec 12 (1)].

2. Artificial legal person. A company is not natural person as we discussed already in

the beginning of this chapter it is an artificial person. It exists in the eyes of the law

but cannot act on its own. It has to act through a board of directors chosen by

shareholders. It was rightly pointed out in Bates V Standard Land Co. “The board of

directors are the brains and the only brains of the company, which is the body and the

company can and does act only through them”.

3. A company has a legal distinct entity and is independent of its members: The

creditors of the company can recover their money only from the company and the

property of the company. They cannot sue individual members. Similarly, the

company is not in any way liable for the individual debts of its members.

4. Perpetual succession

The life of company is very stable that human being’s life. There is no effect of

changing, death, insolvency of respected member on company. Its existence is not

affected by members’ existence at any time. Shares can easily transfer from one

member to another member, so liquidation of company is only possible by law. Thus,

a company has a perpetual existence, irrespective of changes in its membership.

5. Common seal

Company cannot sign on any contract being an artificial person so it works with

common seal. Every document of contract with company is only valid, if there is

common seal of company on it.

6. Limited Liability

Limited liability is also another important feature of company. It is the reason that

large number of investors invest in limited liability companies. It is the liability of

company to repay not the liability of its members. Members’ liability is only limited

up to the purchased value of shares. They have to pay balance amount of their shares.

7. Separate Property

It is also feature of company that property of company is different from its member’s

property. It can purchase or sell property without the permission of shareholders. In

other words, assets of company are not the assets of members.

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8. Right to Sue

Company can sue other parties like natural person for protecting its assets and

properties. Other persons can also charge on the company.

11.4 Types of company

There are different types of company based on formation, liability and investment. These

are as follows:

Types of company based on formation:

a) Chartered companies

Chartered Companies are incorporated under a special charter by the king or

sovereign such as East Indian Company. This company are rarely formed now-a-days.

b) Statutory Companies: These companies are formed by special acts of Legislatures

for example the Reserve Bank of India, the Industrial Finance Corporation, and

Damodar Valley Corporation etc.

c) Registered Companies: Such Companies are incorporate under the Companies Act,

1956 or were registered under the previous Companies Act.

Types of company based on liabilities:

a) Limited Companies: In limited companies, the liability of each member is limited to

the extent of a price value of shares held by him. Suppose ajay takes a share of Rs 50.

, he remains liable to the extent of that amount only. As soon as that amount in paid,

he is no more liable.

b) Guarantee Companies: The liability of the member of such kind of companies is

limited to the amount member has undertaken to contribute to the assets of the

company in the event of its wound up. This guaranteed amount is limited to fixed sum

which is specified in the memorandum. Chambers of commerce, trade associations

and sports clubs are usually guarantee concerns. The object of such companies is not

to make profit and distribute dividend.

c) Unlimited Companies: They are nothing but large partnership firm registered under

the Companies Act and the members just like partners have unlimited liability and

share contribution as well as their property are at stake when the company is to be

wound up. Such companies are rare these days.

Types of company based in investment:

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a)Private Companies :A private company means a company which by its articles (i)

restricts the right to transfer its shares, if any (ii) limits the number of its members to

fifty excluding past or present employees of the company who are also members of

the company. (iii) Prohibits any invitation to the public to subscribe for any shares in

our debentures of the company.

b) Public Companies: Public companies are those companies which are not private

companies. All the three restrictions are not imposed on such companies.

11.5 Incorporation of company

In a common meaning a company is an association of a group of person to achieve any

objective whether it is towards social objective or economic objective.

It has no legal existence until is get registered under the companies act. Thus, a Company

comes into legal existence only after registration under the Act, which can be termed as

formation or incorporation of a company.

Procedure of formation or incorporation of a company:

In case of private company any two persons or in case of public company any seven member

can join to form incorporated company. The following procedures are to be followed in

registering of a company.

1. Application regarding the name of proposed company which is to be incorporated is

made to Registrar of companies in a prescribed format in the state where registered

office of a company is to be situated.

2. After the name is made available, Memorandum and Article of association is to be

filed with all necessary stamp duty and filing fees according to authorised capital

with Registrar.

3. It is always advisable to file with the registrar along with MOA and AOA,

particulars of the situation of the registered office and particulars of first directors of

the company. If at this stage this particulars are not filed then, same has be filed

within 30 days of obtaining certificate of incorporation.

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4. A declaration by an advocate of supreme court or a high court is entitled to appear

before a high court or a secretary or a chartered accountant practising in India who

is engaged in the formation of a company or by a person named in AOA as director

,manager or secretary of the company, that all requirement of the act have been

compiled with respect of registration ,shall be filed with registrar.

5. If a company intends to participate in an industry included in the schedule of

Industries act 1951, a licence to that effect must be obtained.

In case of public company further following requirement are to be compiled with

(i) List of persons who have consented to act as directors.

(ii) A written consent of the directors to act in that capacity.

(iii) An undertaking by the directors to take up and pay for their qualification

shares.

If Registrar is satisfied with all requirement under the act for the purpose of registration of a

company have been compiled, he shall register the company and issue a certificate of

incorporation under his hand and seal.

Advantages of incorporation

1. Transferability of shares: Shares of a company can easily be transferred without the

consent of directors.

2. Separate legal entity: Only after getting certificate of incorporation company is legally

formed.

3. Perpetual succession: As the company has separate legal existence ,it is not affected by

death and insolvency of any member.

4. Common seal: No members of a company have their own seal to make business but

they all have common company’s seal.

5. Separate property: Though capital and assets are contributed by its member but

ownership is enjoyed by company only.

6. Capacity to sue or be sued: A company being a corporate body can sue or be sued in its

own name.

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State whether the following statements are true or false:

1. A company being a corporate body can sue or be sued in its own name.

2. Members of a company have their own seal to make business.

3. Company has no legal existence until is get registered under the companies act.

4. In limited companies, the liability of each member is limited to the extent of a price value

of shares held by him.

5. RBI is an example of statutory company.

11.6 Memorandum of Association (MOA): The Company has to be registered under the

companies Act, required two stamped and registered documents i.e. MOA and AOA. First we

will discuss MOA.

MOA is the most important documents for the company to be registered. It contains rules

regarding activities and constitution or objects of a company. MOA sets limit on the working

of company outside which a company is not supposed to work. In this sense, it is considered

as the fundamental documents of the company. It also includes regulation norms for the

affairs of the company with out-siders.

The following clauses are contained in Memorandum of Association of company:

1. Name clause. This clause tells about the name of the company. It should not be

identical to the name of any existing company registered with the Registrar of

companies.

2. Situation clause. By definition, a company is an artificial and an invisible person.

To enable notices and letters to be sent to that invisible person, there must be a

registered office. The State in which a company has its registered office is to be stated

in this clause. Exact address within the State need not be, and in fact is not, given in

the Memorandum. This clause determines the jurisdiction of the Registrar of

Companies.

(iii) Object clause. This clause may, in fact, be regarded as the most important clause

in the Memorandum. It should specify in unambiguous language the ob rejects for this

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which the company is formed. The objects defined lay down the maximum permitted

range of activities in which the company may engage and beyond which it cannot go.

(iv)Liability clause. It contains a statement that the liability of the members is limited

to the face value of the shares taken up by them and if some amount has already been

paid on the shares, a member can be called upon to pay only the unpaid amount of the

shares. If the liability of members of the company is limited by guarantee under this

clause, it must be stated clearly as to what is the amount of guarantee which is agreed

to be contributed by each member towards the liability arising in the event of the

company going into liquidation.

(v) Capital clause. This clause is required to specify only the amount of share capital

with which a company is proposed to be registered and the division of that capital into

shares of a fixed amount. The classes of shares and their rights need not be disclosed

here.

(vi)Association and subscription clause. This contains a declaration by the

subscribers to the Memorandum that they are desirous of forming themselves into a

company and agree to take the number of shares in the capital of the company written

against their respective names. Thereafter, each subscriber signs the Memorandum in

the presence of a witness. There must be at least seven subscribers in case of a public

company and two subscribers in case of a private company and each of them has to

take up at least one share.

In addition to the above clauses which are required by the statute to be included in a

Memorandum, and other information, such as the rights of members, contracts with

managing agents, etc, may also be given there at the discretion of the promoters.

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Activity A

“Six/seven of the signatures to the memorandum of association of a company were forged. The

Memorandum was duly presented, registered and a certificate of incorporation was issued. Can

the existence of the company be subsequently attacked on the ground that the registration was

void”. Decide.

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11.7 The Articles of Association

These are rules and regulations for the internal working of a company.

Each and Every company is required to file Articles of Association along with the

Memorandum of Association with the Registrar at the time of its incorporation/registration.

Companies Act defines “Articles as Articles of Association of a company as originally

framed or as altered from time to time in pursuance of any previous companies Acts. They

also include, so far as they apply to the company, those in the Table A in Schedule I annexed

to the Act or corresponding provisions in earlier Acts.”

Articles of Association work to the rules, regulations and laws to guide the governing of the

company’s internal affairs. They place down the manner and mode in which the business of

any company is to be conducted.

While framing AOA utmost care should be taken so that farmed regulations do not go beyond

company’s power.

In framing Articles of Association care must be taken to see that regulations framed do not go

beyond the powers of the company itself as envisaged by the Memorandum of Association

nor should they be such as would violate any of the requirements of the companies Act, itself.

All clauses in the Articles ultra vires the Memorandum or the Act shall be null and void.

Articles’ means the articles of association of a company as originally framed or as altered

from time to time in pursuance of any previous companies’ law of this act. The articles of

association are the rules and regulations of a company framed for the purpose of internal

management of its affairs. It deals with the rights of the member of the company inter-se. The

articles are framed for carrying out the aims and object of the Memorandum of association.

The articles of association of a company are sub -ordinate to and are controlled by the

memorandum of association. Lord Cairns observed in this regard, “The memorandum is as it

were the area beyond which the action of the company cannot go; inside that area the

shareholder may make such regulation for their own government as they think fit.”

“It is not obligatory to register articles in the case of a public company limited by shares. In

such a case model articles contained in ‘Table A’ of schedule I will apply. However, a private

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company, a company limited by guaranteed and an unlimited company must register their

articles along with the memorandum”[section26].

“In the case of an unlimited company, the articles shall state the number of the members, with

which the company is to be registered, and if it has a share capital, the amount of share

capital with which it is to be registered”[section 27(1)].

In the case of a company limited by guarantee, the articles shall state the number of members

with which the company is to be registered.

In the case of a private company, articles must contain provisions which

(a) Restrict the right to transfer its shares;

(b) Limit the number of its member to fifty excluding past and the present employees of the

company;

(c) Prohibit any invitation to the public to subscribe for any share in or debenture of the

company.

The articles must be printed and divided into paragraph, numbered consecutively. The articles

must be signed by each subscriber of the memorandum in the presence of at least one witness

who will attest the signature and likewise add his address, description and occupation, if any.

11.8 Contents of articles:

The articles generally contain provision related to the following matters:

1. Exclusion wholly or in part of Table A.

2. Adoption of preliminary contracts.

3. Number and value of shares.

4. Allotment of shares.

5. Calls on shares.

6. Lien on shares.

7. Transfer and Transmission of shares.

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8. Forfeiture of share.

9. Alteration of capital.

10. Share certificates.

11. Conversion of share into stock.

12. Voting rights and proxies.

13. Meeting.

14. Directors their appointment etc.

15. Borrowing powers.

16. Dividends and reserves.

17. Accounts and audit.

18. Winding up.

Articles’ Model form:

In schedule I to the act various different model form of AOA and MOA for various types of

companies are specified.

The whole schedule is divided into tables which are as follows.

Table A which deals with rules and regulations for management of a company which is

limited by shares.

Table B contains MOA’s model form of a company limited by shares.

Table C states model forms of MOA and AOA of a company which is limited by guarantee

and which does not have share capital.

Table D states model forms of MOA and AOA of a company which is limited by guarantee

and which have share capital.

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Table E gives model forms of memorandum and Articles of Association of an unlimited

company. A Public Company have its own Article of Association but in case it does not have

its own Articles, it can adopt Table A given in Schedule I to the Act.

11.9 Alteration of Articles:

Companies do have powers to make some alteration in their articles. There are no restrictions

on exercising powers. Company can make alteration in their articles through special

resolution. It has same capacity of binding as that of original article. The company must have

to file with the registrar a copy of the special resolution for altering the articles within one

month from the date of its passing.

Limitations

The right to alter an existing article have some limitations which are as follows:

1. The alteration must be consistent with provisions of the memorandum or should not go

beyond the provisions of the memorandum.

2. The alteration must provide all for anything which is similar to provisions of the act; say

for example, articles cannot give any authority to a company to purchase its own shares.

3. The alteration of articles must be made for a company as a whole and in good faith for the

benefit of the company.

4. The alteration of articles must not establish any fraud on minority.

5. No member of a company will be bound by any alteration made in the memorandum or the

articles after he become a member which requires him to take or subscribe for more shares or

in any way increases his liability to contribute to the share capital of or otherwise to pay

money to the company, unless he agrees in writing before or after the alteration is made.

6. There are no alterations possible in articles which can convert the public company into a

private company unless approved by the central government.

7. An alteration in the articles which reasons a breach of contract with an outsider will be

inoperative.

8. The alteration must be legal.

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Check your Progress A

State the following statement as true and false:

1. Registration with of alteration of AOA and MOA of the companies with ROC is mandatory.

2. Section 8 of the Companies act cannot alter their AOA & MOA.

3. Default in noting the alteration of AOA & MOA attracts imprisonment.

4. Within 30 days altered AOA is to be filed with ROC.

5. Shifting of company’s registered office to jurisdiction of different ROC required approval of

RD along with passing special resolution.

11.10 Membership of a company

A shareholder is a person who owns the shares and member is a person whose name is

mentioned on the register of member. But in practicality member and shareholder are

interchangeably used reason for this is that in normal course member can also be shareholder

and vice-versa. But closely there are few cases where shareholder cannot be a member and

member cannot be shareholder. Examples are in an unlimited company there is no share

capital but it has members on the contrary to it a holder of a share warrant is a shareholder

but not member.

Methods for attaining membership:

Any person may become a member of a company by any of the following methods:

1. By allotment:

In general a person becomes a member of the company by securing allotment and by

applying for shares in writing.

2. By subscribing to the memorandum:

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Section 41 of the Act provides that—”The subscribers of the memorandum of a company

shall be deemed to have agreed to become members of the company, and on its registration

shall be entered as members in its register of members.”

3. By agreeing to purchase qualification shares:

Section 266(2) states that “all such persons who have signed an undertaking to take and pay

for their qualification shares, for acting as a director of the company and delivered it to the

Registrar, are also in the same position as subscribers to the memorandum. As such they are

also deemed to have become members automatically on the registration of the company”. But

this method of becoming a member is only possible in public companies having a share

capital

4.By transfer:

By purchasing shares in the open market and then registered them in his name makes a

person member of that company.

5.By succession or transmission:

Transmission of shares on lunacy of a member or death makes a person shareholder .It is a

kind of transfer which is involuntary and takes place by operation of law, to a person who is

entitled under the law to succeed to the estate of the lunatic automatically and does not

require an instrument of transfer.

6. By principle of estoppel:

“If a person’s name is improperly placed on the register of members and he knows and

assents to it, that is, agrees in writing to become member or attends company meetings or/and

accepts dividend, he shall be deemed to be a member”. Under the principle of estoppel if a

person holds himself out being in a position of membership which is not true, he will then be

estopped from denying that he is a member”.

It is important to note that such a person whose name has been wrongly entered in the

Register of Members, does not become liable as a member unless either he agrees in writing

to become a member of the company or he has in fact accepted the position and acted as a

member. A person cannot be deemed to have become a member by means of ‘estoppel’

simply because his name is entered wrongly in the ‘Register’.

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11.11 Summary

Company can be defined as group of persons associated together to achieve some common

business objective. A company formed and registered under the Companies Act has certain

special features, which disclose the nature of a company. Companies can be classified into

five categories according to the mode of incorporation, on the basis of liability of the

member, on the basis of investment. The entire process of formation of a company can be

divided into four distinct stages namely promotion incorporation, capital subscription and

commencement of business. However, a private company can start business as soon as it

obtains the certificate of incorporation. The memorandum of Association of a company tells

about the objectives behind the company's formation and the maximum possible scope of its

operations beyond which its actions cannot go. Memorandum of association cannot be altered

by the will of the members of the company. It can be altered only by following the procedure

prescribed in the Companies Act. Articles of association contain the rules and regulations

which are granted for the internal management of the company. The company may alter its

articles of association any time by following the procedure as prescribed in the Companies

Act. Every person dealing with the company is presumed to have read the memorandum and

articles of association and understood them in their time perspective. This is known as

doctrine of constructive notice.

11.12 Keywords

Company: A company means a body of individuals associated together for a common

objective, which may be business for profit or for some charitable purposes.

Registered Company: A registered company is one which is formed and registered under the

Indian Companies Act, 1956 or under any earlier Companies Act in force in India.

Public Company: A public company means a company which is not a private company. Any

seven or more persons can join hands to form a public company.

Holding Company: A company shall be deemed to be the holding company to another if that

other is its subsidiary.

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Unlimited Company: A company not having any limit on the liability of its member is

called an unlimited company.

Promotion: Promotion means the discovery of business opportunities and the subsequent

organization of funds, property and managerial ability into a business concern for the purpose

of making profits therefrom.

Promoter: A promoter is a person who undertakes to form a company with reference to a

given object and brings it into actual existence.

Preliminary Contract: Preliminary contract refers to those agreements or contracts entered

into between different parties on behalf and for the benefit of the company prior to its

incorporation.

Certificate of Commencement of Business: A public company, having a share capital and

issuing a prospectus inviting the public to subscribe for shares, will have to file a few

documents with the registrar who shall scrutinize them and if satisfied will issue a certificate

to commence business.

Memorandum of Association: It is the document which defines the objects and lays down

the fundamental conditions upon which along the company is allowed to be incorporated.

Articles of Association: Articles of association are the rules, regulation and byelaws for

governing the internal affairs of the company.



Ans.1 True.

Ans.2 False.

Ans.3 True.

Ans.4 True.

Ans.5 True.


Ans.1 True.

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Ans. 2 False

Ans.3. False

Ans.4. True

Ans.5 True.


1. Explain the process of formation of a company under the Companies Act, 1956.

2. “A certificate of incorporation is conclusive evidence that all the requirements of the

Companies Act have been complied with”. comment.

3. What is a Memorandum of Association? Discuss its clauses

4. How the alteration in the different clauses of Memorandum of Association can be made?

5. What is Articles of Association? What are its contents?

6. Distinguish between Memorandum of Association and Articles of Association.

7. Define ‘Company’. What are its essential characteristics?

8. Explain the special privileges of a private company as compared to a public company.

9. Bring out the difference between partnership and company form of organization.

10. Write notes on: a) Chartered Companies b) Government Companies

11. Classify company form of organization on the basis of liability of members.



Delhi.





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Delhi.






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LESSON: 12

Prospectus, Issue of capital, Loans, investments, deposits and charges

STRUCTURE


12.1 Introduction

12.2 Definition of prospectus

12.3 Objectives of Prospectus

12.4 Contents of Prospectus

12.5 Statement in Lieu of Prospectus

12.6 Misstatement in the Prospectus

12.7 Issue of capital

12.8 Shares

12.9 Procedure for issues of capital

12.10Loans

12.11 Register of loans

12.12 Penalty

12.13 Investments

12.14 Deposits

12.15 Charges

12.16 Fixed and Floating Charges

12.17 Characteristics of a floating charges

12.18 Consequences of floating charges

12.19 Crystallisation of a floating charges

12.20 Registration of charges

12.21 Summary

12.22 Keywords


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12.24 Self -assessment questions


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After reading this lesson, you should be able to:

(a) Define a prospectus and explain the requirement regarding issue of prospectus.

(b) Describe the contents of the prospectus.

(c) Explain the civil and criminal liabilities for misstatement in prospectus.

(d) Discuss the conditions to be fulfilled by a public company to get certificate of

commencement of business.

(e) How to issue capital, loans, advancements and deposit

12.1 Introduction

The promoters of a company will have to take paces to raise the necessary capital for the

company, after getting the Certificate of Incorporation. A public company may call the public

to subscribe to its shares or debentures. Prospectuses are to be issued for this purpose. To

issue a prospectus is very essential for a public company. If the promoters of the company are

confident of raising the required capital privately from their friend or relatives, they need not

issue a prospectus. In such a case, a statement in lieu of prospectus must be filed with the

Registrar. A private company is not allowed to issue a prospectus since it cannot invite the

general public to subscribe to its shares and debentures.

12.2 Definition of prospectus

Section 2(36)-“ any document described or issued as a prospectus and includes any notice,

circular, advertisement, or other document inviting deposits from the public or inviting offers

from the public for the subscription or purchase of any share in, or debentures of, a corporate

body”.

In simple words, any document inviting deposits from the public or inviting offers from the

public for the subscription of shares or debentures of a company is a prospectus.

Any document to be called a prospectus must have the following elements:

I. The invitation must be or on behalf of the company or in relation to an intended company;

II. There must be an invitation offering to the public;

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III. The invitation must be to subscribe.

IV. The invitation must relate to shares or debentures.

Before issuing to the public, a prospectus must be field with the Registrar of companies. The

issue of prospectus is essential when the company wishes the public to purchase its shares or

debentures.

12.3 Objectives of Prospectus

It informs about the formation of a new company.

It serves as a written evidence about the terms and conditions of issue of shares or debentures

of a company.

It encourages the investors to invest in the shares and debentures of the company.

It describes the nature, extent and future prospectus of the company.

It maintains all authentic records on the issue and make the directors liable for the

misstatement in the prospectus.

12.4 Contents of Prospectus

The following elements are included in the prospectus:

The prospectus contains the main objectives of the company, the name and addresses of the

signatories of the memorandum of association and the number of shares held by them.

The name, addresses and occupation of directors and managing directors.

The number and classes of shares and debentures issued.

The qualification share of directors and the interest of directors for the promotion of

company.

The number, description and the document of shares or debentures which within the two

preceding years have been agreed to be issued other than cash.

The name and addresses of the vendors of any property acquired by the company and the

amount paid or to be paid.

Particulars about the directors, secretaries and the treasures and their remuneration.

The amount for the minimum subscription.

If the company carrying on business, the length of time of such businesses.

The estimated amount of preliminary expenses.

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Name and address of the auditors, bankers and solicitors of the company.

Time and place where copies of balance sheets, profits and loss account and the auditors

report may be inspected.

The auditor’s report so submitted must deal with the profit and loss of the company for each

year of five financial years immediately preceding the issue of prospectus.

If any profit or reserve has been capitalized, the particulars of such capitalization will be

stated in the prospectus.

12.5 Statement in Lieu of Prospectus

A public company raises its capital from the public and it issues prospectus for this purpose.

Sometimes, the promoters of a company decide not to approach the public for raising

necessary capital. They are hopeful of raising funds from the friends and relations or through

underwriters. In that case a prospectus need not be issued but a Statement in Lieu of

Prospectus must be field with the registrar at least three days before the first allotment of

shares. Such a statement must be signed by every person who is named therein as a director

or proposed director of the company. This statement will be drafted strictly in accordance

with the particulars set out in a part I of Schedule III of the Act.

12.6 Misstatement in the Prospectus

As per Section 65 of the Act, “a statement included in a prospectus shall be deemed to be

untrue, if the statement is misrepresentative in the form and context in which it is included,

the omission from a prospectus of any matter is calculated to mislead”.

If there is any misstatement of a material fact in a prospectus as if the prospectus is wanting

in any material fact, this may arise

1. Civil Liability

Section62 incorporates, “the provision relating to the civil liability for misstatement in

prospectus. It provides very clearly that where a prospectus invites persons to subscribe for

shares in or debentures of a company liability accrues to pay compensation to every person

who subscribes for any shares or debentures on the faith of the prospectus for any loss or

damage he may have sustained by reason of any untrue statement included therein. The

measure of damages for the loss suffered by reason of the untrue statement, omission etc. is

the difference between the value which the shares would have had but for such statement or

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omission and the true value of the shares at the time of allotment”. The period prescribed for

a suit for damage by shareholder is 3 years as per Article 113 of the Limitation Act, 1963.

2. Criminal Liability

Section 63 of the Act incorporates the provision relating to the criminal liability for

misstatement in prospectus. It provides,” where a prospectus includes any untrue

statement, every person who authorized the issue of prospectus shall be punishable with

imprisonment for a term which may extend to 2 years or with fine which may extend to

Rs 50,000 or with both”.

Activity A

A company issued a prospectus containing misstatements on which action could be taken

against the company. A person purchased shares in the market relying on the prospectus

and filed a suit against the company for damages for the misstatements. Will he succeed?

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12.7 Issue of capital

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Here capital means share capital and it is the amount which is raised by issue of shares by a

company.

Share capital can be classified as:

1. Authorised capital or nominal capital: Company is registered with this capital. This

contains total face value of shares of a company and it is mentioned in MOA.

2. Issued capital: According to the requirement company issue its capital by shares.

This is called issued capital and it cannot be exceeded by authorized capital.

3. Subscribed capital: It is that part of issued capital which is taken up by public.

4. Paid-up capital: Amount paid actually by the subscribers towards capital accepted by

them is called paid-up capital.

5. Un-called capital: Sometimes the company is not in need to have full amount of

subscribed capital and it can call up only a part of it and remaining part which is not

called up is called ‘un-called capital’.

12.8 Shares

Section 2(46) of the companies act defines a ‘Share’ as under: “A share means ‘share’ in the

share capital of a company. It includes stock except where a distinction between stock and

share is implied or expressed”.

Classification of shares:

Under the companies act 1956, the shares are classified as:

1. Preference share [sec-85] preference share capital is “the sum total of preference

shares. These share have some preferential rights over equity shares:

(i) Regarding dividend, to be paid a fixed amount or an amount calculated at a

fixed rate;

(ii) On winding up of the company, to return of capital paid up”.

2. Equity share: As per sec. 85(2) & 86,”Shares which are not preference shares are

equity shares and sum total of equity share is called equity capital. These shares have

no special preferences like preference shares. All the rights and privileges of the

equity share are mentioned in articles of the company”.

12.9 Procedure for issues of capital

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A limited company with share capital if authorized by articles increases its share capital by

issue of new shares.

Where at any time after the expiry of two years from the incorporation of a company, or at

any time after one year from allotment of shares in that company made for the first time after

its formation whichever is earlier, it is proposed to increase the subscribed capital of the

company by allotment of further shares, then------

(i) Further shares shall be offered to the persons ,who ,at the date of the offer are the

holders of the equity shares of the company, in proportion to the capital paid-up

on those shares at that date;

(ii) Such offer shall be made by notice specifying the number of shares offered and

limiting a time not being less than 15 days from the date of offer within which the

offer, if not accepted, will be deemed to have been declined.

After expiry of the time specified in the said notice, or on receipt of earlier intimation

from the person declining to accept the shares offered, the board of directors may dispose

them in a beneficial manner for the company.

Activity B

A company has sufficient cash which it cannot profitability employ. Hence it proposes to repay 25

% of the capital and reduce the paid-up amount on each share from Rs.100 to Rs. 75. State the

procedure it must adopt for this purpose.

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12.10Loans

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Loan means a lending, advancing of money with absolute promise to repay. Loan

includes any deposit of money made by one company with another company, not being a

banking company.

A company shall not make any loan or give guarantee or provide any security unless the

making of such loan, giving such guarantee or providing security has been previously

authorized by a special resolution of the lending company.

12.11 Register of loans

Every lending company have to keep register showing following things:

(i) Names of all corporate bodies under same management as lending company and

the name of every firm in which a partner is a body corporate under the same

management as the lending company;

(ii) The following particulars in respect of every loan made , guarantee given or

security provided by lending company in relation to any such corporate body-

(a) The name of the corporate body to which loan is made.

(b) The amount of loan made

(c) The date of loan made

(d) The date on which the guarantee has been given or security has been provided.

The register shall be kept at the registered office of the lending company and open to

inspection at such office.

12.12 Penalty

Every person who is a party to any contravention of the above provisions including in

particular any person whom loan is made shall be punishable with fine which may extend to

Rs.50000.

12.13 Investments

According to sec.49(1)(4) &(11), “All investment made by a company on its behalf, except in

cases of a company whose principal business consists of buying or selling of shares or

securities, shall be made and held by in its own name .Securities include debentures and

stock”.

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According to sec.49 (7),”A certificate or a letter of allotment relating to the shares or

securities in which investments have been made by a company shall be in the custody of such

company or the bankers of the company”.

Where any shares in which investment has been made by a company are not held by it in its

own name, the company shall enter that in the register of investments—

(i) The nature, value ,and such other particulars as may be necessary to identify the

shares and;

(ii) As per sec.49 (7),”The bank or person in whose name or custody the shares or

securities are held “.

Such register shall be open to the inspection of any member or company without charge

during business hours. A company is to hold shares, stocks or debentures in another body

corporate only its name and not that of its nominee. An investing company is free to invest

exceeding 30% of its subscribed capital in bodies corporate not in the same group.

An investment company is one where principal business is the acquisition of shares,

debentures or other securities. Unanimous resolution at the meeting of the board of directors

before making an investment is not required.

12.14 Deposits [Sec.58A, 58B & companies (Acceptance of deposit) Rules, 1975]

“Deposit means any deposit of money with, and includes any amount borrowed by a

company but shall not include such categories or amount as may be prescribed in consultation

with the RBI”.

Deposit does not include following:

(i) Any amount received from Central Government or a State Government or any

amount received from any other source and whose repayment is guaranteed by the

Central Government or a State Government.

(ii) Any amount received as a loan from any banking company or from the state bank

of India or any of its subsidiary banks or from a banking institution or from a

cooperative bank;

(iii) Any amount received by a company from any other company;

(iv) Any amount received from an employee of a company by way of security deposit;

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(v) Any amount received by the way of security or as an advance from any

purchasing agent, selling agent or other agents in the course of or for the purposes

of the company or any advance received against orders for the supply of goods or

properties or for the rendering of any services.

(vi) Any amount received by the way of subscription to any shares, stock, bonds or

debentures pending the allotment of the said shares , stocks ,bonds, or debentures;

(vii) Any amount received in trust or any amount in transit;

(viii) Any amount received from a director or a shareholder by a private company;

(ix) Any amount raised by the issue of bonds or debentures secured by the mortgage of

any immovable property of the company;

(x) Any amount brought in by the promoters by the way of unsecured loans subject to

the stipulation imposed by the financial institutions.

12.15 Charges

The debt owned by debtor to creditor may be either unsecured or secured. In case of

unsecured debt, if the debtor defaults, the creditor can sue that amount owned but if debtor

becomes insolvent or disappears; the creditor has no security so for this reason creditor

usually demand for security. Company has power to borrow money on credit against security.

12.16 Fixed and Floating Charges

The borrowing power of a company also includes power to create a charge upon its assets.

This charge can be a fixed charge or a floating charge.

1. Fixed Charge: A fixed charge can be created on specific assets of the company e.g. a

charge on building.

2. Floating Charge: A floating charge is an equitable charge which is created on some

class of property which is constantly changing e.g. a charge on stock –in- trade, trade

debtors etc. Debentures usually create a floating charge on the assets of a company.

12.17 Characteristics of floating charges

According to Romer L.J. characteristics of floating charges are as follows:

1. It is a charge on a class of assets of the company both present and future.

2. Charges are changing from time to time.

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3. It is contemplated by the charges that until some steps are taken by or on behalf of those

interested in the charge, the company may carry on the business in the ordinary way.

12.18 Consequences of floating charges

The company can deal in the property on which a floating charge is created, till the charges

crystallises; create specific mortgages of its property having priority over the floating

charges; and can sell the whole.

12.19 Crystallisation of floating charges

Crystallisation is the process of converting floating charges into fixed charges on the assets

charged at the moment of crystallisation. But it can be possible only in the following

conditions:

1. The company goes into liquidation;

2. The company ceases to carry on business;

3. a receiver is appointed ,or

4. a default is made in paying the principal and interest and the holder of the charge brings an

action to enforce his security.

12.20 Registration of charges:

The following charges are to be registered as per [Secs.125 and 127]

1. (a) A charge for the purpose of securing any issue of debentures.

(b) A charge on uncalled share capital of the company.

(c) A charge on any immovable property, wherever situate or any interest therein.

(d) A charge on any book debt of the company.

(e ) A charge not being a pledge ,on any movable property of the company.

(f ) A floating charge on the undertaking or any property of the company including

stock in trade.

(g) A charge on calls made but not paid.

(h) A charge on ship or any share in a ship.

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(i) A charge on goodwill, on a patent or licence under a patent, on a trade mark or on

a copyright or a licence under a copyright.

2. “A charge created out of India comprising solely property situate outside India with

particulars and the instrument creating or evidencing the charge or a copy thereof” [Sec.125].

3. “A charge created in India comprising property outside India with the instrument creating

or purporting to create the charge or a verified copy thereof” [Sec.125].

4.”A charge on a property acquired subject to charge” [Sec.127].

Time of registration:

The prescribed particulars of the charges are to be registered within 30 days after the date of

creation of charges. The registrar may extend the period of 30 days for another 30 days on

payment of such additional fee not exceeding 10 times the amount of fee specified in

Schedule X as the registrar may determine.

Effects of non-registration of a charge:

Following are the consequences of non -registering of charges

1. The charge is void.

2. The money secured becomes immediately payable.

3. No right of lien on the documents of title.

4. Penalties.

Date of notice of charge [sec.130]

“Where any charge on any property of a company required to be registered under sec.125 has

been so registered, any person acquiring such property shall be deemed to have notice of the

charges as from the date of registration. Such a charge is binding on the company even in its

winding up”.

Particulars of charges kept by the registrar [sec .130],”The Registrar of each company

should keep register particulars to be contained of all charges requiring registration”.

Particulars of charges to be forwarded by the company:

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Every company shall be forwarded to its registrar for being entered in the register kept under

sec. 130 the particulars of all the charges requiring registration in such form and manner, and

after payment of, such fees as may be prescribed. The sum prescribed is rupees 10 with effect

from April 17, 1989.

Company’s register of charges [Sec.143]

“Every company shall keep a register of charges at its registered office. It shall enter therein

all charges specifically affecting property of the company and all floating charges on the

undertaking or any property of the company. It shall give therein in each case of following

particulars:

1. a short description of the property charged;

2. the amount of the charge; and

3. Except in the case of securities to bearer, the name of the person entitled to the

charge”.

Penalty: If any officer of the company knowingly or wilfully permits the omission of any

entry required to be made in the company’s register of charges, he shall be punishable with

fine which may extend to Rs. 5,000.

Check your progress


1. A prospectus is issued be public company seeking investment in public.

2. Statement in lieu of prospectus can be filed by a public company going for a public issue.

3. The prescribed particulars of the charges are to be registered within 45 days after the date of

creation of charges.

4. A provisional contract is signed by promoters before the incorporation of the company.

5. It is necessary to get every company incorporated, whether private or public.

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12.21 Summary

A prospectus means any invitation issued to the public inviting it to deposit money with the

company or to take share or debentures of the company such invitation may be in the form of

a document or a notice, circular, advertisement etc. Section 55 state,” every prospectus must

be dated, and that date is deemed to be the date of publications of the prospectus, prospectus

should neither contain any misstatement i.e. untrue or misleading nor omit to disclose any

material fact. It there is any misstatement or omission of material facts, then the directions

promoters, the persons responsible for the issue of prospectus, and the company incur a

liability for the same”. The company can also allot shares or debentures without issuing the

prospectus. However, in such a case, a statement known as 'Statement in lieu of Prospectus' is

required to be prepared and field with the Registrar of Companies.

12.22 Keywords

Prospectus: A document inviting offers from the public for the subscription of shares in on

debentures of a company is known as a prospectus.

Minimum Subscription: Minimum subscription is the amount which, in the opinion of the

board of directors, must be raised by the issue of share capital.

Statement in lieu of Prospectus: If a public company makes a private arrangement for

raising capital then it must file a statement in lieu of prospectus with the Registrar three days

before any allotment of shares or debentures can be made.

Civil Liability: It means the liability to pay damages or compensation.

Criminal Liability: Criminal liability means the liabilities that improve punishment of

imprisonment or fine or both.


Ans. 1 True

Ans. 2 True

Ans. 3 False

Ans. 4 False

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Ans. 5 True

12.24 Self -assessment questions

1. What is a prospectus? Explain the requirements regarding issue of prospectus.

2. Is it compulsory for a company to issue prospectus?

3. Explain the civil and criminal liabilities for misstatement in the prospectus of a company.

4. Write short notes on the following:

A) Minimum subscription

B) Statement in lieu of prospectus

5. Explain the conditions that a public company is required to fulfil in order to obtain a

certificate of commencement of business.

6. Write a note on the borrowing power of a company.

7. By whom are the charges created on the property of a company to be registered?

8. Distinguish between floating and fixed charges?

9. Explain the consequences of non –registering for charges?

10. What particulars must be entered in a company’s register of charges?


1. Nirmal Singh, Business Law, Deep and Deep Publication Pvt. Ltd., New Delhi.

2. M.C. Kuchhal, Mercantile Law, Vikas Publishing House Pvt. Ltd., New Delhi.

3. 5. S.R. Davar, Mercantile Law, Progressive Corporation Pvt. Ltd., Mumbai.



Delhi.


Delhi.

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Lesson 13

Meetings

STRUCTURE

13.0 Objectives

13.1 Introduction

13.2 Meaning of Meetings

13.3 Kinds of meetings

13.3.1. Shareholder meetings\ statutory (legal) meetings

13.3.2 Annual General Meeting (AGM)

13.3.3 Extra ordinary General Meetings

13.4 Requisites of meetings

13.5 Role of chairmen of a meeting

13.6 Secretarial work relating to statutory meeting

13.6.1 Functions before the meeting

13.6.2 Functions at the meeting

13.6.3 Functions after the meeting

13.7 Accounts and auditors

13.7.1 Introduction

13.7.2 Annual accounts

13.7.3Accounting reference dates

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13.7.4 Requirement for accounts to be audited

13.7.5 Auditor

13.8 Appointment of Auditors

13.8.1 For private companies

13.8.2 For public companies

13.9 Purpose of audit

13.10Auditor’s duties

13.11 Auditor’s right to information

13.12 Auditor’s report

13.13 Compromise or Arrangements

13.14 Statutory provision

13.15 Reconstruction and amalgamation

13.16 Acquisition of shares of dissenting shareholders in case of Take-over Bid

13.17 Amalgamation in national interest

13.18 Summary

13.19 Keywords




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13.0 OBJECTIVE


(a) Define a meeting and explain different types of meeting.

(b) Describe the provisions regarding voting and poll, proxies and resolutions

(c )Discuss the statutory provision regarding the various types of meeting of shareholders.

(d ) Explain the prerequisites of a valid meeting.

13.1 INTRODUCTION

The company is a legal creation, a separate entity distinct from its members and is an

artificial person. Being an artificial person, it cannot take any decisions on its own. It has to

conduct meetings to make any decisions relating to its wellbeing by passing resolutions at

properly constituted meetings of its shareholders or directors. Routine management of a

company is in the hands of the directors, not in the hand of shareholders but the shareholders

are important and retain some important powers. Many decisions require a resolution of the

shareholders and cannot be decided by the directors alone. When two or more than two

persons come together to have discussion on the matters of common interest, it is said to be a

meeting.

13.2 Meaning of Meetings

When two or more than two persons come together to make decision after having discussion

on the matters of common interest of its member, it is said to be a meeting. In simple

language get together of persons with some objective and plan is known as meetings.

Who is a ‘Member’

(i) Anyone who subscribes the memorandum.

(ii)Any other person who agrees to become a member and whose name is entered on the

register of members.

(b) Register of Members

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CA 1985, s.352 requires” that every company must keep a register of its members. The

register must show name and address of each member, date person became a member and,

where applicable, the date he ceased to be a member ,the number of shares held by each

member and the amount paid on them”.

13.3 Kinds of meetings

13.3.1. Shareholder meetings\ statutory (legal) meetings

Sec-165 states, ”Such a meetings may be called within a period of less than 1 month and not

more than 6 months from the date of issue of Certificate of Commencement of Business”.

Companies exempt from conducting a Statutory meeting:

•Private Company

•A public Company not having Share Capital

•A Public company limited by Guarantee and not having share capital

•An Unlimited Company

•A Government Company

Objectives of the Statutory Meeting:

1. To discuss the success of the formation of the company.

2. To approve/modify the contracts specified in the prospectus

3. Providing information to the members regarding Shares.

Note: Sec-433(b) provides, “the statutory report be delivered to the ROC otherwise company

will be wound up”.

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Requirements to conduct a Statutory Meeting:

Time, date and place of statutory meeting.

Notice: A clear 21 day notice must be given to all.

Agenda: Since all items are of Special Business category therefore each must

be accompanied with an explanatory note for each item.

Statutory Report: Directors must send a report to every member 21 days before the date of the

meeting.

Contents of the Statutory Report

Shares

Cash Received

Abstract of Receipts and Payments

Directors, Auditors and other Managerial personnel

Contracts

Underwriting Contracts

Arrears of Calls

Commission and Brokerage

Certification of the Statutory Report: At least 2 directors and the auditors must certify the

Correctness. The Statutory report must be filed with the ROC in e-form 22.

13.3.2 Annual General Meeting (AGM)

This meetings must be held by every kind of company whether it is public or private once in

a year. This meeting is to be call and held by the directors of company. The interval between

two meetings cannot exceed than 15 months. The first AGM must be held within 18 months

from date of its corporation.

A notice of the meetings to the directors should send at least 21 day before the meetings. The

AGM must hold on a working day during business hours at the place of registered office of

the company.

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Objectives of the Meetings:

1) To check annual accounts.

2) Declaration of dividend.

3) Election of directors.

4) Appointment of auditors.

13.3.3 Extra ordinary General Meetings:

This meeting is different than statutory and AGM as it is held in the emergency situations like

at the time of venture etc.

Objective of the business:

1) Special business e.g. a case of 20 billion rupees of export is at the door.

2) In some innovative cases: e.g. an idea of launching a new product.

13.4 Requisites of meetings

The necessities of a valid meeting are as following:

1. Right convening authority: A meeting is valid when it is convened by the proper

authority otherwise it is invalid. For example Company’s secretary is the proper authority

to call a formal meeting.

2. Proper notice: Duly signed notice must be submitted to members before meeting. The

place of meeting, time and date must be stated on that notice.

3. Proper publicity of agenda: Every member of the meeting should be properly informed

of the agenda and must be aware of it.

4. Legal purposes: Every meeting must have a legal purpose.

5. Requisite quorum: For valid meeting requisite quorum is necessary. The meeting should

not be stared until the requisite members of member s are resent.

6. Presence of right persons: Only members which are legally exists can present in the

meeting. If there is an unauthorized person in the meeting, the meeting will be invalid.

7. Proper presiding officer: The chairman of a valid meeting must be a proper person.

8. Conducting meeting according to the agenda: A valid meeting must be conducted

according to the agenda.

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13.5 Role or function or duties of chairmen of a meeting: In all types of meetings, you

have the following responsibilities as a presiding officer.

Arranging the time and place

Preparing and serving an agenda.

Calling the meeting to order on time

Making clear the purpose of the meeting

Keeping the discussion on course

Controlling over enthusiastic members

Electing contributions from each member

Creating a good atmosphere

Summarizing the discussion form time to time

Working to end the meeting on schedule

Thanking to the members

13.6 Secretarial work relating to statutory meeting

13.6.1 Functions before the meeting:

Serving the notice to the concerned members.

Maintaining time for statutory meeting,

Drafting a notice for the meeting,

Preparing statutory statement or report,

Collecting the auditor’s certificate,

Preparing agenda of the meeting,

Selection the place of the meeting,

Calling on board of directors meeting,

Listing the name of members who will attend the meeting,

Calling on board of directors meeting,

Preparing final notice of the meeting.

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13.6.2 Functions at the meeting:

Determining the quorum of the meeting,

Stating the agenda,

Supply necessary explanations,

Giving the explanations,

Writing the rough minutes.

13.6.3 Functions after the meeting:

Preparing final minutes and resolutions,

Submitting the statutory report

13.7 Accounts and auditors

13.7.1 Introduction

To make directors to prepare accounts for showing the company’s financial position to take

decision at any particular point of time every company need to keep adequate accounting

records in accordance with the Companies Act 2006,” The records must show all sums of

money received and spent by the company and a record of assets and liabilities and if the

company fails to do so it will attract imprisonment or fine or both. Public company needs to

keep records for 6 years from the date they were made while for private company this period

is 3 years”.

13.7.2 Annual accounts

The directors of a company must prepare accounts of the company for each of its financial

years. These are ‘individual accounts’ .It should include fair detail of company’s assets,

liabilities, financial position and profit and loss ,balance sheet. It should have compliance

with international accounting standards under Companies Act 2006 .

13.7.3Accounting reference dates

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The accounting reference date is the anniversary of the last day in the month in which the

company was incorporated for all Companies which are incorporated after 1 April 1996. The

subsequent accounting reference dates will be automatically on the same date each year

further. Companies incorporated before 1 April 1996 will already have mentioned an

accounting reference date according to previous company legislation. A company can an

accounting reference date by giving notice to the registrar of companies.

13.7.4 Requirement for accounts to be audited

A company’s annual accounts must be audited but an exemption is there for a small

company, a dormant company or a non-profit making company subject to a public sector

audit.

13.7.5 Auditor

“An auditor is an independent person of the with a current practicing certificate issued by one

of the recognised supervisory bodies”. As per the Institute of Chartered Accountants in

England and Wales, The Institute of Chartered Accountants of Scotland, The Institute of

Chartered Accountants in Ireland, and the Association of Chartered Certified Accountants .

13.8 Appointment of Auditors

13.8.1 for public companies

In public companies also first auditor is chosen by the directors of the company and

then members can re-appoint the auditor, or appoint a different auditor to hold office

until the end of the next meeting at which the accounts are laid. If a public company

fails to make appointment of an auditor then Secretary of State may appoint one or

more persons to fill the vacancy

13.8.2 for private companies

In private companies the first auditor is appointed by the directors. The members must

then appoint, or re-appoint an auditor for each year within 28 days of the directors

sending the accounts to members or at the end of the time allowed for the sending out

of the accounts.

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13.9 Purpose of audit

The auditor examines the company’s financial accounts in accordance with the International

Standards on Auditing (UK and Ireland) and check whether company’s financial accounts

(evidence) is supporting the amounts and disclosures in the company’s financial statements

or not and whether they reflect the true position of the company’s affairs or no

13.10Auditor’s duties

An auditor must be satisfied adequate accounting records that have been kept by the

company’s accounts are in agreement with the accounting records and, in the case of a quoted

company that the relevant part of the directors’ remuneration report is in agreement with the

accounting records. Further, if in the opinion of the auditor, the accounts were incorrectly

prepared in accordance with the small companies provisions this should be stated in the

report.

13.11 Auditor’s right to information

An auditor has a right to access the company’s books, accounts and vouchers at any time.

Further, an auditor can require a number of people associated with the company or its

subsidiary to provide information or explanations as he/she requires for the performance of

his/her duties.

13.12 Auditor’s report

At the conclusion of an audit the auditor must report to the company’s members before

general meeting. The report includes, an introduction identifying the accounts that were the

subject of the audit, a description of the audit identifying the auditing standards used, a

statement that the accounts have been prepared in accordance with the relevant financial

reporting framework (currently the Companies Act 2006) and where appropriate Article 4 of

the European Union Regulation on International Accounting Standards (Regulation (EC)

1606/2002). The auditor must state as to whether the accounts give a true and fair view of the

company’s financial affairs or not if it is not then it referred as unqualified or otherwise

qualified. The auditor must confirm whether the directors’ report is consistent with the

accounts .The auditor’s report must state the name of the auditor and be signed and dated. If

the auditor is an individual the report must be signed by him/her. If the auditor is a firm the

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report must be signed by the senior statutory auditor in his/her own name, for and on behalf

of the auditor.

Activity

At a meeting of a company, only 15 shareholders were present.9 voted for special resolution

and 2 against and 4 did not vote at all. No poll was demanded and the chairman declared the

resolution to be carried. Is this a valid resolution?

13.13 Compromise or Arrangements

“The scheme compromise or arrangements are mainly applicable to foreign companies

formed outside India and doing business in India and government company i.e. those

companies are liable to wound up” under the act sec 390(a). By the Compromise or

Arrangement provision is kind of substitute for winding up and saving a company to go for

liquidation.

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13.14 Statutory provision (section 391,392,393)

Section 391 states that,” where a compromise or rearrangements is proposed between a

company and its creditors, between a company and its members. The compromise or

rearrangements will be on binding on all the creditors, all the members, the company,

liquidators and contributor in case of company which is being wound up. If the certified copy

of order is not filed with registrar then it is not effective. Every copy of the memorandum

should be annexed with the copy of every order. If it is not done in respect it will attract fine.

Any order under this section is open to appeal to high court”.

Section 392 deals with power of courts and lays down ,”when a court has made order to

company regarding compromise and arrangements it can exercise following powers to

supervise carrying out the scheme compromise and arrangements, to give direction and make

modifications for proper functioning of compromise and arrangements.

Section 393 deals with rules regarding meetings of creditors.

13.15 Reconstruction and amalgamation (section 394 & 395)

“When a company is suffering loss for several past years and suffering

from financial difficulties, it may go for reconstruction .i.e. Formation of a new company to

take-over the Assets of an existing company with the idea that the persons interested and the

nature of business substantially remains the same. The term Amalgamation is taken to mean

as the union of two or more companies, so as to form a third entity or one company is

absorbed into another company”. Both reconstruction and amalgamation have similar legal

procedures and schemes can be carried out.

(a) Section 494 and 507 provide for Reconstruction or Amalgamation of companies by

winding up the company voluntary.

(b) Section 394 and 395 provide for a scheme of Reconstruction and Amalgamation without

winding up.

Section 394 lays down,” Transfer of the undertaking , property or liabilities of one company

to another , the allotment or appropriation by the transferee company of any shares ,

debentures , policies , or other like interests in that company, the continuation by or against

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the transferee company of any legal proceedings pending by or against the transferor

company ,the dissolution , without winding up , of the transferor company ,the provision to

be made for any person who dissents from the scheme ,such incidental , consequential and

supplemental matters as may be necessary to secure that the reconstruction or Amalgamation

shall be fully and effectively carried out” .

13.16 Acquisition of shares of dissenting shareholders in case of Take-over Bid

The method of Amalgamation by take-over bid is quite common.

A “takeover Bid” means an offer to acquire shares of company with a view to obtaining legal

control of the company.

Section 395 provides for the compulsory Acquisition of the shares of the dissenting

minorities.

The provisions of sec.395 are as follows:

1. The offer of the transferee company to acquire the shares or any class of shares, must be

placed before the shareholder of the transfer or company

2. The shareholders have the option to approve the offer within four month. Approval must

be Accorded by the holders of at least 90 % in value of the shares .whose transfer is involved

(other than shares already held by transferee company at the date of the offer or by its

nominees or by its subsidiary)

3. If the scheme is so approved, the transferee company may, at any time, within two month,

after the expiration of the Above four months , give notice to the dissenting shareholders .

4. The dissenting shareholders can, with in one month of the receipt of such notice, apply to

the court for annulling the scheme.

5. If the court refuse to issue the order annulling the scheme of Amalgamation or if no

application is made to the court, the transferee company shall be entitled and bound to

Acquire the share of dissenting shareholders .

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6.The transfer of shares pursuant to the notice given by the transferee company after the

disposal of the appeal field by the dissenting shareholders .

7. Any sums which so received by the transferee company must be paid in to a bank account

and this amount or any other consideration received must be held for dissenting share holders

13.17 Amalgamation in national interest

Under section 396 of the Act, “the central Govt. is given power to order Amalgamation of

two or more companies in public interest”. The section provide as follows:

1. If the central govt. is satisfied that it is essential in the public interest that two or more

companies should be amalgamated.

2. The order aforesaid may provide for the continuation by or against the transferee company

of any legal proceedings pending by transferee company.

3. Every member, debenture holder or any other creditors of the Amalgamation companies ,

continue to have the same interest in the new company.

4. No order under this section shall be made by the central govt. unless:

(a) A draft copy of the proposed order has been sent to each of the companies to file their

objectives and suggestions.

(b) The time for preferring an appeal to company law board has expired.

(c) It has considered and made such modifications if any, in the draft order as may seem to it

desirable in the light of any suggestions and objectives.

5. Copies of the order made by the govt. in this connection must, as soon as possible, be laid

before both the house of parliament.

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Check your progress

1. The minimum number of members that must be present at the meeting is termed as ------------

------.

2. A person who is conducting Audit or person appointed by the company to execute the audit is

called --------

3. -----------------is the resolution which is passed, at a valid meeting by simple majority of the

members.

4. ------------------is the first meeting of the members of the company after its incorporations.

5. A notice of the meetings to the directors should send at-least---------- day before the meetings.

13.18 Summary

A meeting is a gathering or assembly of a number of persons for transacting any lawful

business. But every gathering of persons does not constitute a meeting. A meeting would be

valid if it is held by following the prescribed rules and regulations. The meetings of a

company are of three kinds namely meetings of shareholders directors and creditors.

Statutory meeting is the first meeting of the members of the company after its incorporations

and must be held within six months from the date at which the company is entitled to start

business. Annual general meeting is the regular meeting of the members of the company and

the purpose of this meeting is to provide an opportunity to the members of the company

express their views on the management of company's affairs. Any meeting other than the

statutory and the annual general meeting of the company is known as extra-ordinary general

meeting, class meeting is the meeting of a particular class of shareholders. The business of

the meeting is conducted in the form of resolutions passed at the meeting and the resolutions

proposed in the meeting are decided on the votes of the members of the company. The

remuneration payable to directors is determined by the articles of association of the company,

or by a resolution of the company passed in its general meeting. The overall maximum limit

of management remuneration in fixed by Section 198 of the Companies Act. The goal of an

audit is to form and express an opinion on financial statements. The audit is performed to get

reasonable assurance on whether the financial statements are free of material misstatement.

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An audit also includes assessing the accounting principles used and the significant estimates

made by the management. Audit conclusions and reporting are one of the principles

governing an audit. Reporting is the last procedure of the process of an audit. The scheme

compromise or arrangements are mainly applicable to foreign companies formed outside

India and doing business in India and government company i.e. those companies are liable to

wound up under the act sec 390(a). When a company is suffering loss for several past years

and suffering from financial difficulties, it may go for reconstruction .i.e. Formation of a new

company to take-over the Assets of an existing company with the idea that the persons

interested and the nature of business substantially remains the same. The term Amalgamation

is taken to mean as the union of two or more companies, so as to form a third entity or one

company is absorbed into another company.

13.19 Keywords

Meeting: A meeting may be defined as gathering or assembly of a number of persons for

transacting any lawful business.

Statutory Meeting: Every public company limited by shares and every company limited

by guarantee and having a share capital shall, within a period of not less than one month

but more than six months from the date on which the company is entitled to commence

business hold a general meeting of the members of the company. This meeting is called

the statutory meeting.

Annual General Meeting: Every company must in each year hold in addition to any

other meeting, a general meeting as its annual general meeting.

Extra Ordinary General Meeting: Any meeting other than a statutory and an annual

general meeting is called an Extra Ordinary General Meeting.

Class Meeting: Class meetings are separate meetings of holders of different classes of

shares. They are held in cases where their rights are sought to be affected.

Quorum: It means the minimum number of members that must be present at the meeting.

Vote: A vote is the formal expression of the will of the members of the house either for or

against a proposal.

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Ordinary Resolution: It is the resolution which is passed, at a valid meeting by simple

majority of the members, i.e., where the votes cast in favour of resolution exceeds the

votes cast against it.

Managerial Remuneration: The total managerial remuneration payable by a public

company or a private company which is a subsidiary of a public company to its directors,

managing agent, secretaries and treasurer or manager in respect of any financial year shall

not exceed 11% of the net profit of that company for that financial year.

Auditor: A person who is conducting audit or person appointed by the company to

execute the audit is called Auditor.

Reconstruction: Formation of a new company to take-over the Assets of an existing

company with the idea that the persons interested and the nature of business substantially

remains the same.

Amalgamation: The combination of one or more companies into a new entity. An

amalgamation is distinct from a merger because neither of the combining companies

survives as a legal entity. Rather, a completely new entity is formed to house the

combined assets and liabilities of both companies.


Ans.1 Quorum

Ans.2 Auditor

Ans.3 Ordinary Resolution

Ans.4 Statutory meeting

Ans.5 21

13.21 SELF ASSESSMENT QUESTIONS

1. What do you mean by statutory meeting? What business is transacted at such meeting?

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2. What are the statutory provisions regarding the holding of an annual general meeting?

3. What are the essentials of a valid meeting? Discuss in detail

4. What is a quorum? What happens if there is no quorum at a meeting at all?

5. Discuss the statutory provisions relating to payment of managerial remuneration of a

public limited company.

6. What are different types of resolutions which must be passed in the meeting of

shareholders?

7. State the reason for a company for Amalgamation, reconstructions, arrangements and

compromises.

8. Discuss the purpose of an audit.

9. What are different types of meetings?

10. What do you understand by quorum?


1. S.R. Davar, Mercantile Law, Progressive Corporation Pvt. Ltd., Mumbai .



4. R.H. Pandia, Principles of Mercantile Law, N.M. Tripathi Pvt. Ltd., Mumbai.

5. N.D. Kapoor, Company Law, Sultan Chand & Sons, New Delhi. S.C. Aggarwal, Company

Law, Dhanpat Rai Publications, New Delhi.

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Lesson – 14

Provision With Respect To Appointment and Removal of Director

Structure

14.1 Objective

14.2 Meaning of director

14.3 Appointment and Qualifications of Directors

14.4 Disqualifications for appointment of director

14.5 Duties of directors

14.6 Removal of director

14.7 Modes of winding up

14.8 Summary

14.9 Glossary




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14.1 Objective

To understand the meaning of director To understand the appointment and qualification of director

14.2 Meaning of director

A company director does not have to be a stockholder (shareholder) or an employee of the firm,and may only hold the office of director. Directors act on the basis of resolutions made atdirectors' meetings, and derive their powers from the corporate legislation and from thecompany’s articles of association.As the company's agents, they can bind the company with valid contracts entered into with third-parties such as buyers, lenders, and suppliers14.3 Qualifications of Directors

According to section 149 Company to have Board of Directors

1. Every company shall have a Board of Directors consisting of individuals as directorsand shall have—a) A minimum number of three directors in the case of a public company, two directors in

the case of a private company, and one director in the case of a One Person Company;and

b) A maximum of fifteen directors:

Provided that a company may appoint more than fifteen directors after passing a specialresolution:

Provided further that such class or classes of companies may be prescribed shall have at least onewoman director.

2. Every company existing on or before the date of commencement of this Act shall withinone year from such commencement comply with the requirements of the provisions ofsub-section (1).

3. Every company shall have at least one director who has stayed in India for a total periodof not less than one hundred and eighty-two days in the previous calendar year.

4. Every listed public company shall have at least one-third of the total number of directorsas independent directors and the Central Government may prescribe the minimumnumber of independent directors in case of any class or classes of public companies.

5. Every company existing on or before the date of commencement of this Act shall, withinone year from such commencement or from the date of notification of the rules in this

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regard as may be applicable, comply with the requirements of the provisions of sub-section (4).

6. An independent director in relation to a company, means a director other than a managingdirector or a whole-time director or a nominee director-

a) Who, in the opinion of the Board, is a person of integrity and possesses relevantexpertise and experience

b) Who has or had no pecuniary relationship with the company, its holding,subsidiary or associate company, or their promoters, or directors, during the twoimmediately preceding financial years or during the current financial year.

c) None of whose relatives has or had pecuniary relationship or transaction with thecompany, its holding, subsidiary or associate company, or their promoters, ordirectors, amounting to two per cent. or more of its gross turnover or total incomeor fifty lakh rupees or such higher amount as may be prescribed, whichever islower, during the two immediately preceding financial years or during the currentfinancial year.

d) Who, neither himself nor any of his relatives-

i) Holds or has held the position of a key managerial personnel or is or has beenemployee of the company or its holding, subsidiary or associate company in anyof the three financial years immediately preceding the financial year in which heis proposed to be appointed.

ii) Is or has been an employee or proprietor or a partner, in any of the three financialyears immediately preceding the financial year in which he is proposed to beappointed, of-

a) A firm of auditors or company secretaries in practice or cost auditors of thecompany or its holding, subsidiary or associate company; or

b) Any legal or a consulting firm that has or had any transaction with the company,its holding, subsidiary or associate company amounting to ten per cent. or more ofthe gross turnover of such firm;

iii) Holds together with his relatives two per cent or more of the total voting power ofthe company; or

iv) Is a Chief Executive or director, by whatever name called, of any nonprofitorganization that receives twenty-five per cent. Or more of its receipts from thecompany, any of its promoters, directors or its holding, subsidiary or associatecompany or that hold two per cent or more of the total voting power of thecompany; or

e) Who possesses such other qualifications as may be prescribed.

7. Every independent director shall at the first meeting of the Board in which he participatesas a director and thereafter at the first meeting of the Board in every financial year or

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whenever there is any change in the circumstances which may affect his status as anindependent director, give a declaration that he meets the criteria of independence asprovided in sub-section (6).

8. The company and independent directors shall abide by the provisions specified inSchedule IV.

9. Notwithstanding anything contained in any other provision of this Act, but subject to theprovisions of sections 197 and 198, an independent director shall not be entitled to anystock option and may receive remuneration by way of fee provided under sub-section (5)of section 197, reimbursement of expenses for participation in the Board and othermeetings and profit related commission as may be approved by the members.

10. Subject to the provisions of section 152, an independent director shall hold office for aterm up to five consecutive years on the Board of a company, but shall be eligible forreappointment on passing of a special resolution by the company and disclosure of suchappointment in the Board's report.

11. Notwithstanding anything contained in sub-section (10), no independent director shallhold office for more than two consecutive terms, but such independent director shall beeligible for appointment after the expiration of three years of ceasing to become anindependent director.

12. Notwithstanding anything contained in this Act-

i. An independent director;ii. A non-executive director not being promoter or key managerial personnel, shall

be held liable, only in respect of such acts of omission or commission by acompany which had occurred with his knowledge, attributable through Boardprocesses, and with his consent or connivance or where he had not acteddiligently.

13. The provisions of sub-sections (6) and (7) of section 152 in respect of retirement ofdirectors by rotation shall not be applicable to appointment of independent directors.

14.4 Appointment of Directors

According to section 152 of company act 2013-

1. Where no provision is made in the articles of a company for the appointment of the firstdirector, the subscribers to the memorandum who are individuals shall be deemed to bethe first directors of the company until the directors are duly appointed and in case of aOne Person Company an individual being member shall be deemed to be its first directoruntil the director or directors are duly appointed by the member in accordance with theprovisions of this section.

2. Save as otherwise expressly provided in this Act, every director shall be appointed by thecompany in general meeting.

3. No person shall be appointed as a director of a company unless he has been allotted theDirector Identification Number under section 154.

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4. Every person proposed to be appointed as a director by the company in general meetingor otherwise, shall furnish his Director Identification Number and a declaration that he isnot disqualified to become a director under this Act.

5. A person appointed as a director shall not act as a director unless he gives his consent tohold the office as director and such consent has been filed with the Registrar within thirtydays of his appointment in such manner as may be prescribed:

Provided that in the case of appointment of an independent director in the general meeting, anexplanatory statement for such appointment, annexed to the notice for the general meeting, shallinclude a statement that in the opinion of the Board, he fulfils the conditions specified in this Actfor such an appointment.

6. a) Unless the articles provide for the retirement of all directors at every annual generalmeeting, not less than two-thirds of the total number of directors of a public companyshall-

i. Be persons whose period of office is liable to determination by retirement of directorsby rotation; and

ii. Save as otherwise expressly provided in this Act; be appointed by the company ingeneral meeting.

b) The remaining directors in the case of any such company shall, in default of, andsubject to any regulations in the articles of the company, also be appointed by thecompany in general meeting.

c) At the first annual general meeting of a public company held next after the date of thegeneral meeting at which the first directors are appointed in accordance with clauses(a) and (b) and at every subsequent annual general meeting, one-third of such of thedirectors for the time being as are liable to retire by rotation, or if their number isneither three nor a multiple of three, then, the number nearest to one-third, shall retirefrom office.

d) The directors to retire by rotation at every annual general meeting shall be those whohave been longest in office since their last appointment, but as between persons whobecame directors on the same day, those who are to retire shall, in default of andsubject to any agreement among themselves, be determined by lot.

e) At the annual general meeting at which a director retires as aforesaid, the companymay fill up the vacancy by appointing the retiring director or some other personthereto.

7. a) If the vacancy of the retiring director is not so filled-up and the meeting has notexpressly resolved not to fill the vacancy, the meeting shall stand adjourned till thesame day in the next week, at the same time and place, or if that day is a nationalholiday, till the next succeeding day which is not a holiday, at the same time andplace.

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b) If at the adjourned meeting also, the vacancy of the retiring director is not filled upand that meeting also has not expressly resolved not to fill the vacancy, the retiringdirector shall be deemed to have been re-appointed at the adjourned meeting, unless-

i) At that meeting or at the previous meeting a resolution for the re-appointment of suchdirector has been put to the meeting and lost;

ii) The retiring director has, by a notice in writing addressed to the company or its Boardof directors, expressed his unwillingness to be so re-appointed;

iii) He is not qualified or is disqualified for appointment;

iv) A resolution, whether special or ordinary, is required for his appointment or re-appointment by virtue of any provisions of this Act; or

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14.5 Disqualifications of appointment of director

According to section 164 Disqualifications for appointment of director

1. A person shall not be eligible for appointment as a director of a company, if -a) He is of unsound mind and stands so declared by a competent court;

b) He is an undischarged insolvent;

c) He has applied to be adjudicated as an insolvent and his application is pending;

d) He has been convicted by a court of any offence, whether involving moral turpitudeor otherwise and sentenced in respect thereof to imprisonment for not less than sixmonths and a period of five years has not elapsed from the date of expiry of thesentence:

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e) An order disqualifying him for appointment as a director has been passed by a courtor Tribunal and the order is in force;

f) He has not paid any calls in respect of any shares of the company held by him,whether alone or jointly with others, and six months have elapsed from the last dayfixed for the payment of the call;

g) He has been convicted of the offence dealing with related party transactions undersection 188 at any time during the last preceding five years; or

h) He has not complied with sub-section (3) of section 152.

2. No person who is or has been a director of a company which-a) Has not filed financial statements or annual returns for any continuous period of three

financial years; or

b) Has failed to repay the deposits accepted by it or pay interest thereon or to redeemany debentures on the due date or pay interest due thereon or pay any dividenddeclared and such failure to pay or redeem continues for one year or more, shall beeligible to be re-appointed as a director of that company or appointed in othercompany for a period of five years from the date on which the said company fails todo so.

3. A private company may by its articles provide for any disqualifications for appointmentas a director in addition to those specified in sub-sections (1) and (2):

Provided that the disqualifications referred to in clauses (d), (e) and (g) of sub-section (1) shallnot take effect—

i) For thirty days from the date of conviction or order of disqualification;ii) Where an appeal or petition is preferred within thirty days as aforesaid against

the conviction resulting in sentence or order, until expiry of seven days from thedate on which such appeal or petition is disposed of or

iii. where any further appeal or petition is preferred against order or sentence withinseven days, until such further appeal or petition is disposed of.

14.6 Duties of directors

According to section 166 Duties of directors

1. Subject to the provisions of this Act, a director of a company shall act in accordance withthe articles of the company.

2. A director of a company shall act in good faith in order to promote the objects of thecompany for the benefit of its members as a whole, and in the best interests of thecompany, its employees, the shareholders, and the community and for the protection ofenvironment.

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3. A director of a company shall exercise his duties with due and reasonable care, skill anddiligence and shall exercise independent judgment.

4. A director of a company shall not involve in a situation in which he may have a direct orindirect interest that conflicts, or possibly may conflict, with the interest of the company.

5. A director of a company shall not achieve or attempt to achieve any undue gain oradvantage either to himself or to his relatives, partners, or associates and if such directoris found guilty of making any undue gain, he shall be liable to pay an amount equal tothat gain to the company.

6. A director of a company shall not assign his office and any assignment so made shall bevoid.

7. If a director of the company contravenes the provisions of this section such director shallbe punishable with fine which shall not be less than one lakh rupees but which mayextend to five lakh rupees.

14.7 Removal of directors

According to the section 169

1. A company may, by ordinary resolution, remove a director, not being a directorappointed by the Tribunal under section 242, before the expiry of the period of his officeafter giving him a reasonable opportunity of being heard

2. A special notice shall be required of any resolution, to remove a director under thissection, or to appoint somebody in place of a director so removed, at the meeting atwhich he is removed.

3. On receipt of notice of a resolution to remove a director under this section, the companyshall forthwith send a copy thereof to the director concerned, and the director, whether ornot he is a member of the company, shall be entitled to be heard on the resolution at themeeting.

4. Where notice has been given of a resolution to remove a director under this section andthe director concerned makes with respect thereto representation in writing to thecompany and requests its notification to members of the company, the company shall, ifthe time permits it to do so-a) In any notice of the resolution given to members of the company, state the fact of the

representation having been made; and

b) Send a copy of the representation to every member of the company to whom notice ofthe meeting is sent (whether before or after receipt of the representation by thecompany), and if a copy of the representation is not sent as aforesaid due toinsufficient time or for the company’s default, the director may without prejudice tohis right to be heard orally require that the representation shall be read out at themeeting.

5. A vacancy created by the removal of a director under this section may, if he had beenappointed by the company in general meeting or by the Board, be filled by the

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appointment of another director in his place at the meeting at which he is removed,provided special notice of the intended appointment has been given under sub-section (2).

6. A director so appointed shall hold office till the date up to which his predecessor wouldhave held office if he had not been removed.

7. If the vacancy is not filled under sub-section (5), it may be filled as a casual vacancy inaccordance with the provisions of this Act:

Provided that director, who was removed from office, shall not be re-appointed as a director bythe Board of Directors.

8. Nothing in this section shall be taken-a) As depriving a person removed under this section of any compensation or damages

payable to him in respect of the termination of his appointment as director as per theterms of contract or terms of his appointment as director, or of any other appointmentterminating with that as director; or

b) As derogating from any power to remove a director under other provisions of thisAct.

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14.8 Modes of winding up

According to section 270 winding up can be done by using two methods-

1. The winding up of a company may be either-a) By the Tribunal; or

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b) Voluntary.

2. Notwithstanding anything contained in any other Act, the provisions of this Act withrespect to winding up shall apply to the winding up of a company in any of the modesspecified under sub-section (1).

a) Winding up by the Tribunal

According to section 271 Circumstances in which company may be wound up by Tribunal

1. A company may, on a petition under section 272, be wound up by the Tribunal-a) If the company is unable to pay its debts;

b) If the company has, by special resolution, resolved that the company be wound up bythe Tribunal;

c) If the company has acted against the interests of the sovereignty and integrity ofIndia, the security of the State, friendly relations with foreign States, public order,decency or morality;

d) If the Tribunal has ordered the winding up of the company under Chapter XIX;

e) If on an application made by the Registrar or any other person authorized by theCentral Government by notification under this Act, the Tribunal is of the opinion thatthe affairs of the company have been conducted in a fraudulent manner or thecompany was formed for fraudulent and unlawful purpose or the persons concernedin the formation or management of its affairs have been guilty of fraud, misfeasanceor misconduct in connection therewith and that it is proper that the company bewound up;

f) If the company has made a default in filing with the Registrar its financial statementsor annual returns for immediately preceding five consecutive financial years; or

g) If the Tribunal is of the opinion that it is just and equitable that the company shouldbe wound up.

2. A company shall be deemed to be unable to pay its debts-a. If a creditor, by assignment or otherwise, to whom the company is indebted for an

amount exceeding one lakh rupees then due, has served on the company, by causing itto be delivered at its registered office, by registered post or otherwise, a demandrequiring the company to pay the amount so due and the company has failed to paythe sum within twenty-one days after the receipt of such demand or to provideadequate security or re-structure or compound the debt to the reasonable satisfactionof the creditor;

b. If any execution or other process issued on a decree or order of any court or tribunalin favor of a creditor of the company is returned unsatisfied in whole or in part; or

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c. If it is proved to the satisfaction of the Tribunal that the company is unable to pay itsdebts, and, in determining whether a company is unable to pay its debts, the Tribunalshall take into account the contingent and prospective liabilities of the company.

Check your progress-A1) Which of the following is the mode of winding up:-

a) By the Tribunal

b) Voluntary

c) None of these

d) Both A and B

Which of the following is the section under which the mode of winding up is explained:

a) 270

b) 217

c) 271

d) 280

Procedure of winding up by tribunal

1) According to section 272 Petition for winding up

1. Subject to the provisions of this section, a petition to the Tribunal for the winding up ofa company shall be presented by—a) The company;

b) Any creditor or creditors, including any contingent or prospective creditor orcreditors;

c) Any contributory or contributories;

d) All or any of the persons specified in clauses (a), (b) and (c) together;

e) The Registrar;

f) Any person authorized by the Central Government in that behalf; or

g) In a case falling under clause (c) of sub-section (1) of section 271, by the CentralGovernment or a State Government.

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2. A secured creditor, the holder of any debentures, whether or not any trustee or trusteeshave been appointed in respect of such and other like debentures, and the trustee for theholders of debentures shall be deemed to be creditors within the meaning of clause (b) ofsub-section (1).

3. A contributory shall be entitled to present a petition for the winding up of a company,notwithstanding that he may be the holder of fully paid-up shares, or that the companymay have no assets at all or may have no surplus assets left for distribution among theshareholders after the satisfaction of its liabilities, and shares in respect of which he is acontributory or some of them were either originally allotted to him or have been held byhim, and registered in his name, for at least six months during the eighteen monthsimmediately before the commencement of the winding up or have devolved on himthrough the death of a former holder.

4. The Registrar shall be entitled to present a petition for winding up under subsection (1) onany of the grounds specified in sub-section (1) of section 271, except on the groundsspecified in clause (b), clause (d) or clause (g) of that sub-section:

Provided that the Registrar shall not present a petition on the ground that the company is unableto pay its debts unless it appears to him either from the financial condition of the company asdisclosed in its balance sheet or from the report of an inspector appointed under section 210 thatthe company is unable to pay its debts.

5. A petition presented by the company for winding up before the Tribunal shall be admittedonly if accompanied by a statement of affairs in such form and in such manner as may beprescribed.

6. Before a petition for winding up of a company presented by a contingent or prospectivecreditor is admitted, the leave of the Tribunal shall be obtained for the admission of thepetition and such leave shall not be granted, unless in the opinion of the Tribunal there isaprima facie case for the winding up of the company and until such security for costs hasbeen given as the Tribunal thinks reasonable.

7. A copy of the petition made under this section shall also be filed with the Registrar andthe Registrar shall, without prejudice to any other provisions, submit his views to theTribunal within sixty days of receipt of such petition.

2) Powers of Tribunal

According to section 273 Powers of Tribunal

1. The Tribunal may, on receipt of a petition for winding up under section 272 pass any ofthe following orders, namely:—a) Dismiss it, with or without costs;

b) Make any interim order as it thinks fit;

c) Appoint a provisional liquidator of the company till the making of a winding uporder;

d) Make an order for the winding up of the company with or without costs; or

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e) Any other order as it thinks fit:

Provided that an order under this sub-section shall be made within ninety days from the date ofpresentation of the petition:

Provided further that before appointing a provisional liquidator under clause (c), the Tribunalshall give notice to the company and afford a reasonable opportunity to it to make itsrepresentations, if any, unless for special reasons to be recorded in writing, the Tribunal thinks fitto dispense with such notice:

Provided also that the Tribunal shall not refuse to make a winding up order on the ground onlythat the assets of the company have been mortgaged for an amount equal to or in excess of thoseassets, or that the company has no assets.

2. Where a petition is presented on the ground that it is just and equitable that the companyshould be wound up, the Tribunal may refuse to make an order of winding up, if it is ofthe opinion that some other remedy is available to the petitioners and that they are actingunreasonably in seeking to have the company wound up instead of pursuing the otherremedy.

3) Directions for filing statement of affairs

According to section 274 Directions for filing statement of affairs

1. Where a petition for winding up is filed before the Tribunal by any person other than thecompany, the Tribunal shall, if satisfied that a prima facie case for winding up of thecompany is made out, by an order direct the company to file its objections along with astatement of its affairs within thirty days of the order in such form and in such manner asmay be prescribed.

2. A company, which fails to file the statement of affairs as referred to in sub-section (1),shall forfeit the right to oppose the petition and such directors and officers of thecompany as found responsible for such non-compliance, shall be liable for punishmentunder sub-section (4).

3. The directors and other officers of the company, in respect of which an order for windingup is passed by the Tribunal under clause (d) of sub-section (1) of section 273, shall,within a period of thirty days of such order, submit, at the cost of the company, the booksof account of the company completed and audited up to the date of the order, to suchliquidator and in the manner specified by the Tribunal.

4. If any director or officer of the company contravenes the provisions of this section, thedirector or the officer of the company who is in default shall be punishable withimprisonment for a term which may extend to six months or with fine which shall not beless than twenty-five thousand rupees but which may extend to five lakh rupees, or withboth

5. The complaint may be filed in this behalf before the Special Court by Registrar,provisional liquidator, Company Liquidator or any person authorised by the Tribunal.

4) Company Liquidators and their appointments

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According to section 275 Company Liquidators and their appointments

1. For the purposes of winding up of a company by the Tribunal, the Tribunal at the time ofthe passing of the order of winding up, shall appoint an Official Liquidator or a liquidatorfrom the panel maintained under sub-section (2) as the Company Liquidator.

2. The provisional liquidator or the Company Liquidator, as the case may be, shall beappointed from a panel maintained by the Central Government consisting of the names ofchartered accountants, advocates, company secretaries, cost accountants or firms orbodies corporate having such chartered accountants, advocates, company secretaries, costaccountants and such other professionals as may be notified by the Central Governmentor from a firm or a body corporate of persons having a combination of such professionalsas may be prescribed and having at least ten years’ experience in company matters.

3. Where a provisional liquidator is appointed by the Tribunal, the Tribunal may limit andrestrict his powers by the order appointing him or it or by a subsequent order, butotherwise he shall have the same powers as a liquidator.

4. The Central Government may remove the name of any person or firm or body corporatefrom the panel maintained under sub-section (2) on the grounds of misconduct, fraud,breach of duties or professional incompetence.

5. The terms and conditions of appointment of a provisional liquidator or CompanyLiquidator and the fee payable to him or it shall be specified by the Tribunal on the basisof task required to be performed, experience, qualification of such liquidator and size ofthe company.

6. On appointment as provisional liquidator or Company Liquidator, as the case may be,such liquidator shall file a declaration within seven days from the date of appointment inthe prescribed form disclosing conflict of interest or lack of independence in respect ofhis appointment, if any, with the Tribunal and such obligation shall continue throughoutthe term of his appointment.

7. While passing a winding up order, the Tribunal may appoint a provisional liquidator, ifany, appointed under clause (c) of sub-section (1) of section 273, as the CompanyLiquidator for the conduct of the proceedings for the winding up of the company.

5) Removal and replacement of liquidator

According to section 276 removal and replacement of liquidator

1. The Tribunal may, on a reasonable cause being shown and for reasons to be recorded inwriting, remove the provisional liquidator or the Company Liquidator, as the case maybe, as liquidator of the company on any of the following grounds, namely:—a) Misconduct;

b) Fraud or misfeasance;

c) Professional incompetence or failure to exercise due care and diligence inperformance of the powers and functions;

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d) Inability to act as provisional liquidator or as the case may be, Company Liquidator;

e) Conflict of interest or lack of independence during the term of his appointment thatwould justify removal.

2. In the event of death, resignation or removal of the provisional liquidator or as the casemay be, Company Liquidator, the Tribunal may transfer the work assigned to him or it toanother Company Liquidator for reasons to be recorded in writing.

3. Where the Tribunal is of the opinion that any liquidator is responsible for causing anyloss or damage to the company due to fraud or misfeasance or failure to exercise due careand diligence in the performance of his or its powers and functions, the Tribunal mayrecover or cause to be recovered such loss or damage from the liquidator and pass suchother orders as it may think fit.

4. The Tribunal shall, before passing any order under this section, provide a reasonableopportunity of being heard to the provisional liquidator or, as the case may be, CompanyLiquidator.

6) Intimation to Company Liquidator, provisional liquidator and Registrar

According to section 277 Intimation to Company Liquidator, provisional liquidator and Registrar

1. Where the Tribunal makes an order for appointment of provisional liquidator or for thewinding up of a company, it shall, within a period not exceeding seven days from the dateof passing of the order, cause intimation thereof to be sent to the Company Liquidator orprovisional liquidator, as the case may be, and the Registrar.

2. On receipt of the copy of order of appointment of provisional liquidator or winding uporder, the Registrar shall make an endorsement to that effect in his records relating to thecompany and notify in the Official Gazette that such an order has been made and in thecase of a listed company, the Registrar shall intimate about such appointment or order, asthe case may be, to the stock exchange or exchanges where the securities of the companyare listed.

3. The winding up order shall be deemed to be a notice of discharge to the officers,employees and workmen of the company, except when the business of the company iscontinued.

4. Within three weeks from the date of passing of winding up order, the Company Liquidatorshall make an application to the Tribunal for constitution of a winding up committee toassist and monitor the progress of liquidation proceedings by the Company Liquidator incarrying out the function as provided in sub-section (5) and such winding up committeeshall comprise of the following persons, namely:—i. Official Liquidator attached to the Tribunal;

ii. Nominee of secured creditors; and

iii. A professional nominated by the Tribunal.

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5. The Company Liquidator shall be the convener of the meetings of the winding upcommittee which shall assist and monitor the liquidation proceedings in following areasof liquidation functions, namely:—i. Taking over assets;

ii. Examination of the statement of affairs;

iii. Recovery of property, cash or any other assets of the company including benefitsderived there from;

iv. Review of audit reports and accounts of the company;

v. Sale of assets;

vi. Finalization of list of creditors and contributories;

vii. Compromise, abandonment and settlement of claims;

viii. Payment of dividends, if any; and

ix. Any other function, as the Tribunal may direct from time to time.

6. The Company Liquidator shall place before the Tribunal a report along with minutes ofthe meetings of the committee on monthly basis duly signed by the members present inthe meeting for consideration till the final report for dissolution of the company issubmitted before the Tribunal.

7. The Company Liquidator shall prepare the draft final report for consideration andapproval of the winding up committee.

8. The final report so approved by the winding up committee shall be submitted by theCompany Liquidator before the Tribunal for passing of a dissolution order in respect ofthe company.

7) Effect of winding up order

According to section 278 Effect of winding up order

The order for the winding up of a company shall operate in favor of all the creditors and allcontributories of the company as if it had been made out on the joint petition of creditors andcontributories.

8) Jurisdiction of Tribunal

According to section 280 Jurisdiction of Tribunal

The Tribunal shall, notwithstanding anything contained in any other law for the time being inforce, have jurisdiction to entertain, or dispose of,—

a. any suit or proceeding by or against the company;

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b. any claim made by or against the company, including claims by or against any of itsbranches in India;

c. any application made under section 233;d. any scheme submitted under section 262;e. any question of priorities or any other question whatsoever, whether of law or facts,

including those relating to assets, business, actions, rights, entitlements, privileges,benefits, duties, responsibilities, obligations or in any matter arising out of, or in relationto winding up of the company, whether such suit or proceeding has been instituted, or isinstituted, or such claim or question has arisen or arises or such application has beenmade or is made or such scheme has been submitted, or is submitted, before or after theorder for the winding up of the company is made.

9) Submission of report by Company Liquidator

According to section 281 Submission of report by Company Liquidator

1. Where the Tribunal has made a winding up order or appointed a Company Liquidator,such liquidator shall, within sixty days from the order, submit to the Tribunal, a reportcontaining the following particulars, namely:—a. the nature and details of the assets of the company including their location and

value, stating separately the cash balance in hand and in the bank, if any, and thenegotiable securities, if any, held by the company:

Provided that the valuation of the assets shall be obtained from registered valuers for thispurpose;

b. Amount of capital issued, subscribed and paid-up;

c. The existing and contingent liabilities of the company including names, addresses andoccupations of its creditors, stating separately the amount of secured and unsecureddebts, and in the case of secured debts, particulars of the securities given, whether bythe company or an officer thereof, their value and the dates on which they were given;

d. The debts due to the company and the names, addresses and occupations of thepersons from whom they are due and the amount likely to be realised on accountthereof;

e. Guarantees, if any, extended by the company;

f. List of contributories and dues, if any, payable by them and details of any unpaidcall;

g. Details of trademarks and intellectual properties, if any, owned by the company;

h. Details of subsisting contracts, joint ventures and collaborations, if any;

i. Details of holding and subsidiary companies, if any;

j. Details of legal cases filed by or against the company; and

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k. Any other information which the Tribunal may direct or the Company Liquidator mayconsider necessary to include.

2. The Company Liquidator shall include in his report the manner in which the companywas promoted or formed and whether in his opinion any fraud has been committed byany person in its promotion or formation or by any officer of the company in relation tothe company since the formation thereof and any other matters which, in his opinion, it isdesirable to bring to the notice of the Tribunal.

3. The Company Liquidator shall also make a report on the viability of the business of thecompany or the steps which, in his opinion, are necessary for maximizing the value of theassets of the company.

4. The Company Liquidator may also, if he thinks fit, make any further report or reports.5. Any person describing himself in writing to be a creditor or a contributory of the

company shall be entitled by himself or by his agent at all reasonable times to inspect thereport submitted in accordance with this section and take copies thereof or extracts therefrom on payment of the prescribed fees.

10) Directions of Tribunal on report of Company Liquidator

According to section 282 Directions of Tribunal on report of Company Liquidator

1. The Tribunal shall, on consideration of the report of the Company Liquidator, fix a timelimit within which the entire proceedings shall be completed and the company isdissolved:

Provided that the Tribunal may, if it is of the opinion, at any stage of the proceedings, or onexamination of the reports submitted to it by the Company Liquidator and after hearing theCompany Liquidator, creditors or contributories or any other interested person, that it will not beadvantageous or economical to continue the proceedings, revise the time limit within which theentire proceedings shall be completed and the company be dissolved.

2. The Tribunal may, on examination of the reports submitted to it by the CompanyLiquidator and after hearing the Company Liquidator, creditors or contributories or anyother interested person, order sale of the company as a going concern or its assets or partthereof:

Provided that the Tribunal may, where it considers fit, appoint a sale committee comprising suchcreditors, promoters and officers of the company as the Tribunal may decide to assist theCompany Liquidator in sale under this sub-section.

3. Where a report is received from the Company Liquidator or the Central Government orany person that a fraud has been committed in respect of the company, the Tribunal shall,without prejudice to the process of winding up, order for investigation under section 210,and on consideration of the report of such investigation it may pass order and givedirections under sections 339 to 342 or direct the Company Liquidator to file a criminalcomplaint against persons who were involved in the commission of fraud.

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4. The Tribunal may order for taking such steps and measures, as may be necessary, toprotect, preserve or enhance the value of the assets of the company.

5. The Tribunal may pass such other order or give such other directions as it considers fit.

11) Custody of company's properties

According to section 283 Custody of company's properties

1. Where a winding up order has been made or where a provisional liquidator has beenappointed, the Company Liquidator or the provisional liquidator, as the case may be,shall, on the order of the Tribunal, forthwith take into his or its custody or control all theproperty, effects and actionable claims to which the company is or appears to be entitledto and take such steps and measures, as may be necessary, to protect and preserve theproperties of the company.

2. Notwithstanding anything contained in sub-section (1), all the property and effects of thecompany shall be deemed to be in the custody of the Tribunal from the date of the orderfor the winding up of the company.

3. On an application by the Company Liquidator or otherwise, the Tribunal may, at any timeafter the making of a winding up order, require any contributory for the time being on thelist of contributories, and any trustee, receiver, banker, agent, officer or other employeeof the company, to pay, deliver, surrender or transfer forthwith, or within such time as theTribunal directs, to the Company Liquidator, any money, property or books and papers inhis custody or under his control to which the company is or appears to be entitled.

12) Promoters, directors, etc., to cooperate with Company Liquidator

According to section 284 Promoters, directors, etc., to cooperate with Company Liquidator

1. The promoters, directors, officers and employees, who are or have been in employmentof the company or acting or associated with the company shall extend full cooperation tothe Company Liquidator in discharge of his functions and duties.

2. Where any person, without reasonable cause, fails to discharge his obligations under sub-section (1), he shall be punishable with imprisonment which may extend to six months orwith fine which may extend to fifty thousand rupees, or with both.

13) Settlement of list of contributories and application of assets

According to section 285 Settlement of list of contributories and application of assets

1. As soon as may be after the passing of a winding up order by the Tribunal, the Tribunalshall settle a list of contributories, cause rectification of register of members in all caseswhere rectification is required in pursuance of this Act and shall cause the assets of thecompany to be applied for the discharge of its liability:

Provided that where it appears to the Tribunal that it would not be necessary to make calls on oradjust the rights of contributories, the Tribunal may dispense with the settlement of a list ofcontributories.

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2. In settling the list of contributories, the Tribunal shall distinguish between those who arecontributories in their own right and those who are contributories as being representativesof, or liable for the debts of, others.

3. While settling the list of contributories, the Tribunal shall include every person, who is orhas been a member, who shall be liable to contribute to the assets of the company anamount sufficient for payment of the debts and liabilities and the costs, charges andexpenses of winding up, and for the adjustment of the rights of the contributories amongthemselves, subject to the following conditions, namely:—a) A person who has been a member shall not be liable to contribute if he has ceased to

be a member for the preceding one year or more before the commencement of thewinding up;

b) A person who has been a member shall not be liable to contribute in respect of anydebt or liability of the company contracted after he ceased to be a member;

c) No person who has been a member shall be liable to contribute unless it appears tothe Tribunal that the present members are unable to satisfy the contributions requiredto be made by them in pursuance of this Act;

d) In the case of a company limited by shares, no contribution shall be required fromany person, who is or has been a member exceeding the amount, if any, unpaid on theshares in respect of which he is liable as such member;

e) In the case of a company limited by guarantee, no contribution shall be required fromany person, who is or has been a member exceeding the amount undertaken to becontributed by him to the assets of the company in the event of its being wound upbut if the company has a share capital, such member shall be liable to contribute tothe extent of any sum unpaid on any shares held by him as if the company were acompany limited by shares.

14) Obligations of directors and managers

According to section 86 Obligations of directors and managers

In the case of a limited company, any person who is or has been a director or manager, whoseliability is unlimited under the provisions of this Act, shall, in addition to his liability, if any, tocontribute as an ordinary member, be liable to make a further contribution as if he were at thecommencement of winding up, a member of an unlimited company:

Provided that —

a. A person who has been a director or manager shall not be liable to make such furthercontribution, if he has ceased to hold office for a year or upwards before thecommencement of the winding up;

b. A person who has been a director or manager shall not be liable to make such furthercontribution in respect of any debt or liability of the company contracted after he ceasedto hold office;

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c. Subject to the articles of the company, a director or manager shall not be liable to makesuch further contribution unless the Tribunal deems it necessary to require thecontribution in order to satisfy the debts and liabilities of the company, and the costs,charges and expenses of the winding up.

15) Advisory committee.

According to section 287 Advisory committee

1. The Tribunal may, while passing an order of winding up of a company, direct that thereshall be, an advisory committee to advise the Company Liquidator and to report to theTribunal on such matters as the Tribunal may direct.

2. The advisory committee appointed by the Tribunal shall consist of not more than twelvemembers, being creditors and contributories of the company or such other persons in suchproportion as the Tribunal may, keeping in view the circumstances of the company underliquidation, direct.

3. The Company Liquidator shall convene a meeting of creditors and contributories, asascertained from the books and documents, of the company within thirty days from thedate of order of winding up for enabling the Tribunal to determine the persons who maybe members of the advisory committee.

4. The advisory committee shall have the right to inspect the books of account and otherdocuments, assets and properties of the company under liquidation at a reasonable time.

5. The provisions relating to the convening of the meetings, the procedure to be followedthereat and other matters relating to conduct of business by the advisory committee shallbe such as may be prescribed.

6. The meeting of advisory committee shall be chaired by the Company Liquidator.

16) Submission of periodical reports to Tribunal

According to section 288 Submission of periodical reports to Tribunal

1. The Company Liquidator shall make periodical reports to the Tribunal and in any casemake a report at the end of each quarter with respect to the progress of the winding up ofthe company in such form and manner as may be prescribed.

2. The Tribunal may, on an application by the Company Liquidator, review the orders madeby it and make such modifications as it thinks fit.

17) Power of Tribunal on application for stay of winding up

According to section 289 Power of Tribunal on application for stay of winding up

1. The Tribunal may, at any time after making a winding up order, on an application ofpromoter, shareholders or creditors or any other interested person, if satisfied, make anorder that it is just and fair that an opportunity to revive and rehabilitate the company beprovided staying the proceedings for such time but not exceeding one hundred and eightydays and on such terms and conditions as it thinks fit.

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2. The Tribunal may, while passing the order under sub-section (1), require the applicant tofurnish such security as to costs as it considers fit.

3. Where an order under sub-section (1) is passed by the Tribunal, the provisions of ChapterXIX shall be followed in respect of the consideration and sanction of the scheme ofrevival of the company.

4. Without prejudice to the provisions of sub-section (1), the Tribunal may at any time aftermaking a winding up order, on an application of the Company Liquidator, make an orderstaying the winding up proceedings or any part thereof, for such time and on such termsand conditions as it thinks fit.

5. The Tribunal may, before making an order, under this section, require the CompanyLiquidator to furnish to it a report with respect to any facts or matters which are in hisopinion relevant to the application.

6. A copy of every order made under this section shall forthwith be forwarded by theCompany Liquidator to the Registrar who shall make an endorsement of the order in hisbooks and records relating to the company.

18) Power of Tribunal to make calls

According to section 296 Power of Tribunal to make calls

The Tribunal may, at any time after the passing of a winding up order, and either before or afterit has ascertained the sufficiency of the assets of the company,—

a. Make calls on all or any of the contributories for the time being on the list of thecontributories, to the extent of their liability, for payment of any money which theTribunal considers necessary to satisfy the debts and liabilities of the company, and thecosts, charges and expenses of winding up, and for the adjustment of the rights of thecontributories among themselves; and

b. Make an order for payment of any calls so made.

19) Dissolution of company by Tribunal

According to section 302 Dissolution of company by Tribunal

1. When the affairs of a company have been completely wound up, the Company Liquidatorshall make an application to the Tribunal for dissolution of such company.

2. The Tribunal shall on an application filed by the Company Liquidator under sub-section(1) or when the Tribunal is of the opinion that it is just and reasonable in thecircumstances of the case that an order for the dissolution of the company should bemade, make an order that the company be dissolved from the date of the order, and thecompany shall be dissolved accordingly.

3. A copy of the order shall, within thirty days from the date thereof, be forwarded by theCompany Liquidator to the Registrar who shall record in the register relating to thecompany a minute of the dissolution of the company.

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4. If the Company Liquidator makes a default in forwarding a copy of the order within theperiod specified in sub-section (3), the Company Liquidator shall be punishable with finewhich may extend to five thousand rupees for every day during which the defaultcontinues.

Check your progress-B1) Removal of liquidator of the company on any of the following grounds, namely:—

a) Misconductb) Fraud or misfeasancec) Professional incompetence or failure to exercise due care and diligence in

performance of the powers and functionsd) All of These

14.8 Summary

A company director does not have to be a stockholder (shareholder) or an employee of the firm,and may only hold the office of director. Directors act on the basis of resolutions made atdirectors' meetings, and derive their powers from the corporate legislation and from thecompany’s articles of association.As the company's agents, they can bind the company with valid contracts entered into with third-parties such as buyers, lenders, and suppliers

14.9 Glossary

Director- A person who is in charge of an activity, department, or organization


Check your progress-A

1) (a)

2) (d)

Check your progress-B

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1) (d)





1. Explain the procedure of appointment of director?

2. Explain the duties of director?

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Lesson-15

Taxation

Structure

15.0 Objectives

15.1 Introduction

15.2 Meaning of direct and indirect tax

15.3 Features of direct and indirect tax

15.4 Constitutional framework of Taxation

15.5 Basic features of excise duty

15.6 Basic features of custom duty

15.7 Central and state sales tax

15.8 VAT

15.9 Summary

15.10 Glossary




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15.0 Objectives


To understand the mean of direct and indirect tax To understand the laws related to taxation

15.1 Introduction

Government needs funds for various purposes like maintenance of law and order, defense,social/health services, etc. government obtains funds from various sources, out of which onemain source is taxation. Justice Holmes of US Supreme Court, has, long ago, rightly said that taxis the price which we pay for a civilized society.

15.2 Meaning of direct and indirect tax

1. Direct tax- Direct taxes are paid directly to government by the person liable to pay tax2. Indirect tax- Indirect taxes are paid to government by one person, but he recovers the

same from another person. Thus, the person who actually, bears the tax burden (theultimate ‘customer’) pays it indirectly to government through some other person.

15.3 Features of Direct and indirect tax

Taxes are conventionally broadly classified as direct taxes and indirect taxes.

Direct taxes Indirect taxesIncome tax, corporation tax and wealth tax aremajor direct taxes.

Central sales tax, central excise, service taxand customs law are major indirect taxes.Beside these, there are some other indirecttaxes, like octroi, entry tax, luxury tax etc.

Central government revenue is about 56% oftotal tax revenue.

Central government revenue is about 44% oftotal revenue.

Direct taxes are paid directly to government bythe person liable to pay tax.

Indirect taxes are paid to government by oneperson, but he recovers the same from anotherperson. Thus, the person who actually, bearsthe tax burden (the ultimate ‘customer’) pays itindirectly to government through some otherperson.

Direct taxes are those which the taxpayer paysdirectly from his income/wealth/estate etc.

Indirect taxes are those which the taxpayerpays indirectly i.e. while purchasing goods andcommodities, paying for services etc.

Broadly speaking, direct taxes are those whichare paid after the income reaches hands oftaxpayer.

Indirect taxes are paid before the goods/servicereach the taxpayer

Important direct taxes are income tax, gift taxand wealth tax, expenditure tax etc.

Important indirect taxes are central excise(Duty on manufacturing), custom (duty on

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imports and exports), sales tax, octori, entrytax, service tax etc.

Advantage of Indirect taxes Advantage of direct taxesPsychological resistance- it is psychologicallyvery difficult for a person to pay some amountafter it is received in his hands. Hence, there ispsychological resistance (this is the reason whyeven income tax act is widening the scope oftax deduction at source’ TDS and TCS. Thus ,a direct tax is converted to an indirect tax)

Psychological advantage- since the price ofcommodities or service already inclusive ofindirect taxes, the customer i.e. the ultimate taxpayer does not feel a direct pinch while payingindirect taxes and hence, resistances to indirecttaxes is much less compared to resistance todirect taxes.Manufacturer/dealers’ psychology favorsindirect taxes- the manufacturer/ trader whocollects the taxes in his invoice and pays it togovernment has a psychological feeling that heis only collecting the taxes and is not payingout of his own pocket(though this feeling maynot be always correct)

Direct taxes are mainly on income/wealth ofindividuals, firms or corporate bodies, wheremillions of transactions are carried out in lakhsof places and keeping an eye over all suchtransaction is virtually impossible.

Indirect taxes are easier to collect as indirecttaxes are mainly ongoods/commodities/service, for which recordkeeping, verification and control is relativelyeasy (at least in organized sector).Manufacturing activities are carried out mainlyin organized sector, where records and controlsare better.

Tax evasion is comparatively more in directtaxes where it is on unorganized sector, sincecontrol is difficult.

Tax evasion is comparatively less in indirecttaxes in organized sector due to convenience ofcontrol.

Collection cost of direct taxes as percentage oftax collected are higher in indirect taxescompared to direct taxes.

Collection cost of indirect taxes as percentageof tax collected is lower in indirect taxescompared to direct taxes.

Direct taxes can be control such wastefulexpenditure only indirectly by taxing higherincome group people.

Government can levy higher taxes on luxurygoods, which reduces the wasteful expenditure.

Government can judiciously use the directtaxes to support development in desirableareas, while discouraging it in others, i.e. taxincentives for industries in backward areas etc.infrastructure development etc.

Government can judiciously use the indirecttaxes to support development in desirableareas, while discouraging other, i.e. reducingtaxes on goods manufactured in tiny or smallscale units, lowering taxes in backward areasetc.

Disadvantage of indirect taxes Disadvantage of direct taxesIndirect taxes are progressive as they dependon paying capacity. Rich person is taxed moreas compared to poor person.

Indirect taxes do not depend on payingcapacity. Since the indirect tax is uniform, thetax payable on commodity is same, whether itis purchased by a poor person or a rich person.Hence the indirect taxes a are termed as

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regardless. (this argument is partially correct,as it is possible to levy lower taxes on goods ofbaily consumption while levying higher taxeson luxury goods and the regressive effect canbe reduced in many circumstances)

Direct taxes do not affect prices of goods andservices

Tax on goods and services increase its price,which reduces demand of goods and services.Lesser demand means lower growth ofindustrialization.

High income tax rate increases tax evasion andhavala transaction

High customs/ excise duty increase smuggling,havala trade and mafia gangs, which is harmfulin many ways. Similarly, high excise dutyleads to evasion.

Direct taxes do not have such effect Higher customs duty and excise duty increasescost of modern machinery and technology.

Direct taxes are not inflationary Indirect taxes increase the prices of productsand hence are often perceived as inflationary.

15.4 Constitutional framework of taxation

In India, constitution which came into effect on 26th January, 1950 is supreme and all laws andgovernment actions are subordinate to our constitution. Clear understanding of concepts is vitalfor any discussion on taxation matters as power to levy and collect tax is derived fromconstitution. If it is found that any act, rule, notification or government order is not according tothe constitution, it is illegal and void and it is called ultra vires the constitution.

India is Union of State: the structure of government is federal in nature. Article 1(1) ofConstitution of India reads, ‘India, that is Bharat, shall be a Union Of states’

Government of India (Central government) has certain powers in respect of whole country. Indiais divided into various states and union Territories and each state and union territory has certainpowers in respect of that particular state. Thus, there are states like Gujrat, Maharashtra,Tamilnadu, Kerala, Uttar Pradesh, Punjab etc. and Union Territories like Pondicherry,Chandigarh etc.

Bifurcation of powers between Union and States- Article 246(1) of constitution of India statesthat parliament has exclusive powers to make laws with respect to any of matters enumerated inList I in the Seventh Schedule to Constitution (called union list). As per Article 246(3), stategovernment has exclusive powers to make laws for state with respect to any matter enumeratedin list II of Seventh Schedule to Constitution.

Seventh schedule to constitution consists of following three lists:

List I (Union list) contains entries under exclusive jurisdiction of Union Government.

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List II (State list) contains entries under exclusive jurisdiction of State Government. List III (Concurrent list) contains entries where both Union and State Government can

exercise power.

Taxation under constitution

Union List (List I) State List (List II)Only union government can make laws Only state government can make lawsGiven in schedule seven of constitution Given in schedule seven of constitutionImportant taxes in Union list Important taxes in State listEntry No. 82- tax on income than agriculturalincome.

Entry No. 83- duties of customs includingexport duties

Entry No. 84- duties of excise on tobacco andother goods manufactured or produced in Indiaexcept alcoholic liquors for humanconsumption, opium, narcotic drugs, butincluding medicinal and toilet preparationscontaining alcoholic liquor, opium or narcotics

Entry No. 85- corporation tax

Entry No. 86- taxes on the capital value ofassets, exclusive of agricultural land, ofindividual and companies, taxes on capital ofcompanies.

Entry No. 92(A) -taxes on the sale or purchaseof goods other than newspapers, where suchsale or purchase takes place in the course ofinterstate trade or commerce.

Entry No. 92(B) - taxes on consignment ofgoods where such consignment takes placeduring interstate trade or commerce.

Entry No. 92(C) - tax on services (amendmentpassed by parliament on 15-1-2004, but not yetmade effective).

Entry No. 97- any other matter not included inlist II, List III and any tax not mentioned in list

Entry No. 46- taxes on agricultural income

Entry No. 51 excise duty on alcoholic liquors,opium and narcotics

Entry No. 52- tax on entry of goods into a localarea for consumption, use or sale therein(usually called entry tax or octroi)

Entry No. 54- tax on sale or purchase of goodsother than newspapers except tax on interstatesale or purchase.Entry No. 55- tax on advertisement other thanadvertisement in newspaper

Entry No. 56- tax on goods and passengerscarried by road or inland waterways

Entry No. 59- tax on profession, trades,callings and employment.

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II OR list III.(these are called Residual powers)

Activity-1

What is the difference between direct and indirect taxes--------------------------------------------------

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15. 5 Basic features of Central excise tax

1. Laws relating to central excise

Provisions regarding central excise are covered under various acts and rules, as under:

Central excise act, 1944(CEA)- this is the basic act providing for charging of duty, valuation,powers of officers, provisions of arrests, penalty, etc. it has been amended from time to time.

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Central excise rules- as per usual scheme of any act, section 37(1) of the central excise act grantspowers to government to frame rules to carry into effect the purpose of central excise act. Rulescan make provision of penalty and prosecution.

Central excise tariff act, 1985(CETA)- since it is essential to prescribe different duties fordifferent types of production, it is necessary to classify the items under various heads. Centralexcise tariff act, 1985 classifies all the goods under 96 chapters and specific code is assigned toeach item.

2. Nature of excise duty

Entry No. 84 of list I of Seventh Schedule to the constitution Reads as follows: “duties of exciseon tobacco and other goods manufactured or produced in India except alcoholic liquors forhuman consumption, opium, narcotic drugs, but including medicinal and toilet preparationscontaining alcoholic liquor, opium or narcotics”.

Basic conditions of excise liability- Section 3 clearly signify that there are four basic conditionsfor levy of central excise duty.

(1) The duty is on goods.(2) The goods must be excisable.(3) The goods must be manufactured or produced.(4) Such manufacture or production must be in India.3. Person liable to pay excise duty

Rule 4(1) of central excise rules states that excise duty is payable by the manufacturer orproducer of excisable goods.

4. Types of excise duty

Basic duty and special duty of excise are levied central excise act.

1. Education cess:Education cess of 2% of duty has been imposed, which is payable on central excise,customs, service tax and income tax. If excise duty rate is 16%, education cess will be0.32% of assessable value. If excise duty is 10%, cess will be 0.20% of assessable value.If excise duty is exempt, education cess is also exempt.

2. Secondary and higher education cess(SAH education cess):In addition to existing education cess, an education cess of 1% of the total duties ofexcise has been imposed.

3. National calamity contingent duty:National calamity contingent duty (NCCD) has been imposed vide section 136 of FinanceAct, 2001 on some products.

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At present NCCD is payable on branded chewing tobacco, cigarettes, pan masalacontaining tobacco, domestic crude oil and mobile phones.

4. Duties under other actsSome duties and cess are levied on manufactured products under acts. The administrativemachinery of central excise is used to collect those taxes. The duties are-

Additional excise duty on pan masala and tobacco products. Duty on medical and toilet preparations. Additional duty on mineral products.

5. Other cessesBesides education cess, cess is leviable under various products. Machinery of excise isused to collect these cesses. Some cesses are-

Cess on automobiles Cess on tractors Cess on jute manufacturers Cess on sugar Cess on tea Cess on tobacco Cess on coffee Cess on paper and paper board Cess on rubber Cess on mines Cess on limestones and dolomite Cess on manganese ore

Check your progress A1. Which of the following are basic conditions for levy of central excise duty?

a) The duty is on goods.b) The goods must be excisable.c) The goods must be manufactured or produced.d) All of these

2. Which of the following is not the types of excise dutye) Basic dutyf) special dutyg) central dutyh) none of these

15.6 Basic features of Customs duty

Customs duty is on import into India and export out of India. As per ancient custom, a merchantentering a kingdom with his goods had to make a suitable gift to the king. In the course of time

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this custom was formalized into customs duty. This is collected on imports (and occasionally onexports too). Taxes on goods were levied on various goods right the Veda period,

Customs duty as we understand today has its origin in British period. Customs Act, 1962 waspassed to consolidate Sea Customs Act, Land Customs Act and provisions for air customs.

Customs Tariff Act- Customs Tariff Act, 1975 was passed. On 28th February, 1986 Importschedule to the customs Tariff Act, 1975 was replaced with a new schedule, based on HSN(central excise tariff was also replaced by a new tariff based on HSN on 28th February, 1986).

1. Scope of customs law

Section 12(1) of customs act is the charging section, which provides that duties of customs shallbe levied at such rates as may be specified under. The customs tariff act, 1975 or any other lawfor the time being in force, on goods imposed into, or exported from, India. The rate of duty is asprescribed in customs tariff act, 1975, read with relevant exemption notifications. Import duty islevied on almost all items, while export duty is levied only on a few limited products, whereIndian goods are in commanding position.

Imports by government- section 12(2) of customs act makes it clear that customs duty is payableby government also. Thus there is no general exemption to goods imported by government.However, various exemption notifications have been issued and imports by Indian Navy, specificequipment required by police, ministry of defense, coastal guard etc. are fully exempt fromcustoms duty. However, if there is no such exemption notification, duty will be payable even ifgoods are imported by central/state government.

2. Overview of customs act

Raising revenue for central government is the main but not the only purpose of customs act.Customs act is used to

(a) Regulate imports and exports(b) Protect Indian industry from dumping(c) Collect revenue of customs duty.

Provisions of customs Act are used for other acts like Foreign Trade (Development andRegulation) act, foreign exchange management act (FEMA) etc.

Functions of customs department

Indian customs handle various tasks, import among them are as follows-

Collection of customs duties on imports and exports as per basic customs laws. Enforcement of various provisions of customs act governing imports and exports of

cargo, baggage, postal articles and arrival and departure of vessel, aircrafts etc.

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Discharge of various agency functions and enforcing various prohibitions and restrictionson imports and exports under customs act and other allied enactments

Prevention of smuggling including interdiction of narcotics drug trafficking. International passenger processing.3. Nature of customs duty

Entry 83 to list I- (Union list) of seventh schedule to constitution reads ‘duties of customsincluding export duties’. Thus imports and export duty is a Union subject and power to levy isderived from constitutions. Section 12 of customs act, often called charging sections providesthat duties of customs shall be levied at such rates as may be specified under the customs tariffact, 1975, or any other law for the time being in force, on goods imported into, or exported fromIndia.

4. Goods under customs act

Customs duty is on goods as per section 12 of customs act. The duty is payable on goodsbelonging to government as well as goods not belonging to government.

Section 2(22) give inclusive definition of ‘goods’ as follows. Goods includes

(a) Vessels, aircrafts and vehicles(b) Stores(c) Baggage(d) Currency(e) And negotiable instruments(f) Any other kind of movable property

Thus, ship or aircrafts brought for use in India or for carrying cargo for ports out of India wouldbe dutiable.

Dutiable goods- section 2(14) define dutiable goods as any goods which are chargeable to dutyand on which duty has not been paid. As per section 2(15) duty means a duty of customs leviableunder customs act.

Thus, goods continue to be dutiable till they are not cleared from the port. However, once goodsare assessed at ‘nil rate of duty, they no more remain dutiable goods’.

Export goods as well as imported goods can be dutiable goods. If imported goods or exportgoods are not chargeable to duty, they will not be dutiable goods.

Imported goods- section 2(25) defines imported goods as any goods brought I India from a placeoutside India. But do not include goods which have been cleared for home consumption. Thusonce goods are cleared by customs authorities from customs area, they are no longer imported

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goods. (Though in common discussions, goods cleared from customs are also called importedgoods).

If imported goods are not chargeable to duty, they will not be dutiable goods.

Smuggled goods are not imported goods; hence, exemption that is available to imported goods isnot available to smuggled goods.

Export goods- as per section 2(19) of customs act, export goods means any goods which are tobe taken out of India to a place outside India. Goods brought near customs area for exportpurpose will be export goods. Note that once goods leave Indian Territory, Indian laws have nocontrol over them and hence the term exported goods has been used or defined.

15.7 Central and state sales tax

Categories of sale:

Inter –state sale (levied by union government under CST act- powers under entry 92A oflist I i.e. union list)

Sale in course of import (no sales tax is payable, but import duty is payable) Sale in course of export( no sales tax is payable but export duty has been imposed on

some commodities) Intra state (i.e. within the state) sale(levied by state government under state vat act power

to levy under entry 54 of list II i.e. State list)1. No model law for all states

Each state has made changes as per their needs. Though basic concepts are same in VAT act ofall states, provisions in respect of credit allowable, credit of tax on capital goods, credit whengoods are sold inter-state are not uniform. Even definitions of terms like business, sale, saleprice, goods, dealer, turnover, input tax etc. are not uniform.

Schedules indicating tax rate on various articles are also not uniform, though broadly, theschedule are expected to be same.

2. Highlights of state sales tax

The highlights are as follows-

Tax credits- manufacturer will be entitled to credit of tax paid on inputs used by him inmanufacture. A trader (dealer) will be entitled to get credit of tax on goods which he haspurchased for re-sale.

Input tax credit- credit will be available of tax paid on inputs purchased within the state. Creditwill not be available of certain goods purchased like petroleum products, liquor, petrol, diesel,motor spirit.no credit is available in case of inter-state purchases

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3. Credit of tax on capital goods:

Credit will be available of tax paid on capital goods purchased within the state. Credit will beavailable only in respect of capital goods used in manufacture or processing. The credit will bespread over three financial years and not in first year itself. There will be a negative list of capitalgoods.

The credit of capital goods is available only to a manufacturer or processor. A trader can availinput tax credit on capital goods only when he is trading of those capital goods. (i.e. purchaseand sale of those capital goods).

Instant credit- credit will be available as soon as inputs are purchased. It is not necessary to waittill these are utilized or sold.

15.8 VAT

Basic concept of VAT

Basic concept of vat is same for central vat (Cenvat) applicable to central excise and service taxand state vat (applicable to state sales tax). Hence, the vat concept is discussed first.

Generally any tax is related to selling price of product. In modern production technology, rawmaterial passes through various stages and processes till it reaches the ultimate stage. Output ofthe first manufacturer becomes the input for the second manufacturer, who carries out furtherprocessing and supplies it to third manufacturer. This process continues till a final productemerges. This product then goes to distributor/wholesaler, who sells it to retailer and then itreaches the ultimate consumer.

For example: steel ingots are made in a steel mill by A. these are rolled into plates by a rerollingunit B. while third manufacturer say C makes furniture from these plates. He sells it to D who isretailer. Of tax on a product is 10% of selling price, the transaction would go as follows

details A B C DPurchase - 110 165 220Value added 100 40 35 30Sub-total 100 150 200 250Add tax 10% 10 15 20 25total 110 165 220 275The value added by B is only Rs. 40 while he is paying tax on Rs. 100 on which A has alreadypaid ta . he is also paying tax on Rs. 10 which is actually tax paid by A. similarly, C is paying taxon material on which A and B have already paid the tax. Thus, tax is paid again and again on thematerial which has already suffered tax. There is also tax on tax.

VAT is consumption based tax

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You will find that actually tax is collected by government only at final stage i.e. consumptionstage. Till then, the credit is passed on to next buyer. Hence, vat is termed as consumption basedtax.

For example: if the goods are manufactured in X state, sent to Y state and sold in Y state. The taxrevenue will be collected only by Y state and no revenue will be accrue to X state government.

This does not make difference in respect of central taxes like excise duty and service tax aswhatever tax is paid, revenue goes to central government. However, this makes huge differencein respect of state vat.

Check your progress B1. Which of the following is the Advantage of VAT(a) Exports can be freed from domestic taxes, which is permissible under WTO.(b) Vat provides an instrument of taxing consumption of goods and services.(c) Inference in market force is minimum.(d) All of these.2. Which of the following is the functions of customs department(a) Collection of customs duties on imports and exports as per basic customs laws.(b) Enforcement of various provisions of customs act governing imports and exports of

cargo, baggage, postal articles and arrival and departure of vessel, aircrafts etc.(c) Prevention of smuggling including interdiction of narcotics drug trafficking.(d) All of these

Advantage of VAT

Advantages of vat are as follows:

(a) End use based exemptions or concessions can be given as tax as shown in invoice is thetotal tax borne by that commodity. Concessions can be given to goods used for poorpeople. Government has flexibility in applying varying tax rates to differentcommodities.

(b) Exports can be freed from domestic taxes, which is permissible under WTO.(c) Vat provides an instrument of taxing consumption of goods and services.(d) Inference in market force is minimum.(e) Aids tax enforcement by providing audit trail through different stages of production and

trade.(f) Vat acts as a self- policing mechanism. For example, B will get credit only if A issues

invoice showing tax. Hence, B insists on tax invoice from A. thus, B acts as police formA, C acts as police for B and so on. This increases tax compliance. It also indirectlyincreases income tax revenue.

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(g) Tax evasion is reduced. Even if the tax is evaded at one stage, the transaction gets caughtin next stage of production or distribution and then government gets its revenue.

(h) Simplicity with minimum distortion in tax structure- as there are few variations in taxrates and exemptions from taxation are very low.

(i) Input tax credit of both inputs and capital goods is available. Hence there is no distinctionbetween labor intensive and capital intensive industries.

(j) Transparent- the invoice shows total tax borne by that commodity. There are no hiddentaxes.

(k) Certainty in taxation due to simple shows tax structure and minimum variations.Most of the countries have adopted tax credit method for implementation of vat.

Disadvantages of VAT

(a) Heavy compliance cost- detailed accounting and paper work required as is not as simpleas a single point sales tax.

(b) Hindrance in inter-state movement of goods – each state wants to keep record of goodscoming in and going out of state, for which check posts are required. This delaysmovement and increase corruption.

(c) States where goods are produced do not get any tax revenues as all revenue goes to statewhere goods are consumed as vat works on destination principle. For example, majorquantity of wheat produced in Punjab goes outside the state. Similar situation exists incase of minerals in Jharkhand, software in karnataka or manufactured products inindustrially advanced states. Of course the states get Indies benefits like growth ofemployment, improved economy etc. but no direct benefit of vat/sales tax.

(d) Tax evasion through bogus invoices. Input tax credits are on the basis of invoice, theinvoice is like currency note to the seller. Printing invoice is much easier than printingcurrency notes.

Activity-2

What are advantage and disadvantages of VAT-------------------------------------------------------

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15.9 Summary

Government needs funds for various purposes like maintenance of law and order, defense,social/health services, etc. government obtains funds from various sources, out of which onemain source is taxation. Justice Holmes of US Supreme Court, has, long ago, rightly said that taxis the price which we pay for a civilized society.

15.10 Glossary

Tax credits- manufacturer will be entitled to credit of tax paid on inputs used by him inmanufacture.

Direct tax- Direct taxes are paid directly to government by the person liable to pay tax

Indirect tax- Indirect taxes are paid to government by one person, but he recovers the same fromanother person. Thus, the person who actually, bears the tax burden (the ultimate ‘customer’)pays it indirectly to government through some other person.

15. 11 Answer to check your progress


1. (d)2. (c)


1. (d)2. (d)

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1. Vat is termed as consumption based tax. Explain2. What is the basic distinction between VAT & sales tax?3. Explain the difference between direct and indirect tax?



Kapoor, N.d. Elements of Mercantile Law. Sultan Chand & Sons, 2013

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