Basics of Contract Formation

An agreement between two parties constitutes a contract between them. The definition of a contract given under the Indian Contract Act, 1872 denotes that the agreement must also be enforceable by law to form a contract. A contract imposes certain responsibilities and obligations and is also legally binding upon both parties. A contract can be called as a valid contract only when it meets certain essential elements that are prescribed under the said act. The classification of contracts can be done on their performance, formation, and execution. The significant aspect of contracts is that how they are formed. Contract formation is a very crucial process as it determines the validity of the contract. The general principles of contract formation majorly rely on the essential elements of a contract and hence, a contract must fulfill all the essential elements that are given the said Act.

Introduction

A contract is an agreement or promise between two or more parties which is enforceable by law. The term ‘enforceable by law’ means that the affected party can seek legal remedies in case there is any breach of contract. Contracts between parties are made and regulated under the Indian Contract Act, 1872 (ICA) which came into existence on 1^st September 1872. The importance of ICA is mostly reflected in commercial law. Contract law was formed due to the principle of a transaction of goods and services on a day-to-day basis through agreements between people. The State stepped in and enforced these agreements so that no aggrieved person is left without a legal remedy, to maintain social and economic order of the society.

The formation of a contract is the beginning of a contractual journey. A contract must be formed in order to determine the responsibilities and obligations of the concerned parties. To form a contract between two or more parties, some essential conditions need to be fulfilled as will be discussed below. A contract when formed is regulated by the ICA. In a case where there is a breach of contract, it is the responsibility of ICA to ensure that the rights and obligations ascending from the contract are honored and the aggrieved person is given proper remedy.

What is a Contract under the Indian Contract Act, 1872?

The term ‘Contract’ has been defined under Section 2(h)[1] of ICA. It provides that “An Agreement enforceable by law is a contract”. It implies that any agreement that is enforceable by the law of land is a contract. Hence, a contract is an agreement between two or more parties which is enforceable by law. The two main elements in the definition of the contract are ‘agreement’ and ‘enforceable by law’. These two terms are the main ingredients of a contract.

The term ‘Agreement’ is defined under Section 2(e)[2] of ICA. It says, “Every promise and every set of promises, forming the consideration for each other, is an agreement”. This definition implies that a set of promises between the two or more parties with some consideration is called an agreement. In an agreement, a promise must essentially be made for some consideration. An offer and acceptance are what constitute a promise. When an offer is made to another person and he, in turn, accepts that offer, it is said to be a promise between the two parties. The definition of ‘promise’ is provided under Section 2(b)[3] of ICA thatsays,  “When the person to whom the proposal is made signifies his assent thereto, the proposal is said to be accepted. A proposal, when accepted, becomes a promise”.

The term ‘Enforceable by Law’ is not defined under the ICA. An agreement to become a contract needs to be enforceable by law which means that it must raise certain legal obligations. In other words, an agreement must be within the scope of law otherwise it will not form a contract under ICA. Therefore, we can conclude that a contract is a result of a promise made from one side and accepted from the other which is enforceable by law.

Essentials of a Valid Contract

A contract as defined under the ICA is an agreement that is enforceable by law but it is significant to note that not all agreements form a contract. An agreement must necessarily fulfill certain elements provided under Section 10[4] of the ICA to form a contract. These elements are considered as essentials of a Valid Contract. They are as follows:-

• There must be at least two parties to a contract.
• There must be an Agreement.
• The agreement must be made by the free consent of the parties.
• It must be entered into by competent parties.
• It must be for lawful consideration.
• It must be with a lawful object.
• It must not be expressly declared void.
• There must be an intention to create a legal relationship.
• Other formalities: The ICA does not impose any formality to enter into a contract. A contract can be express i.e. oral or written or implied i.e. by conduct, but if the law requires, a contract must fulfill all legal formalities such as in writing, attestation, and registration.

Types of Contracts

Contracts are made between two or more parties so that they have responsibilities and obligations upon them to fulfill their duty towards the terms of the contract. Contracts can be made between different people who carry their business is different prospects and hence the terms of each contract are different from the other. The classification of contracts can be done on three bases that are:

Based on Enforcement

1.      Valid Contracts

Under Section 10 of ICA, certain conditions are given that are essential in order to make a valid contract that is enforceable by law. These essential conditions must be present in every contract for it to be valid under the court of law. it must be legally binding. The said elements are discussed above.

2.      Voidable Contracts

Under Section 2(i)[5] of ICA, the term voidable contract is defined. It implies that a voidable contract is a valid contract because at least one of the parties to contract must be bound to the obligations of the contract. The other party can choose to rescind the terms of the contract or can accept the contract by giving their consent. Until the rescindment by the other party, the contract remains valid.

3.      Void Contracts

Under Section 2(j)[6] of ICA, the definition of void contracts is provided which simply says that a contract becomes void when it ceases to be enforceable by law. Such contracts are not within the scope of the law and the parties to the contract can give their consent and make a void contract valid. Section 20[7] of ICA also provides that if the consent to an agreement id obtained by a mistake of essential fact, then the agreement is void.

4.      Unenforceable Contracts

These types of contracts are rendered unenforceable by law because of some technical deficiency and the parties cannot be sued on this technical deficiency. Technical deficiency such as the absence of writing, registration, etc.

5.      Illegal Contracts

Illegal contracts are those which are opposed to public policy. The contracts that result in breaking laws or the rules and regulations of society by one or all parties are called illegal contracts and they are not enforceable by law. Illegal contracts are void ab initio which means void from the beginning. Due to the criminal nature of illegal contracts, all the parties agreeing to the terms of these contracts are punished by the court of law.

Based on Performance

1.      Executed Contracts

In simple terms, an executed contract means that both or all the parties to a contract have successfully performed their duties and obligations towards the contract and thus the contract has been executed.

2.      Executory Contracts

The executor contracts are those which are to be executed sometime in the future. The obligations of these contracts are yet to be performed by one or all the parties. In these contracts, the promise to perform the obligation is made with some consideration.

3.      Unilateral Contracts

The unilateral contracts are one-sided. In these contracts, the promise is made by only one person. It induces action from some other person and it could be anyone who wishes to fulfill the promise. However, the other person is not bound to fulfill the promise.

4.       Bilateral Contracts

Bilateral contracts are the traditional contracts that involve two parties. Both parties agree to certain terms of the agreement and enter into a contract. Mostly, in a bilateral contract, parties set a time limit to perform the obligations of the contract.

Based on the Formation

1.      Express Contract

Section 9[8] of ICA has defined express contracts which says that when the terms of a promise are expressed by words, written or oral, and is accepted by both parties, then it is called as an express contract. The main aspect of express contracts is that the terms of the contract are expressed very clearly to both parties either orally or by writing.

2.      Implied Contracts

Section 9 of ICA has also defined implied contracts in its second part which says that when the promise is not expressed in words spoken or written, then it is said to be an implied contract. The intention to enter into a contract is implied by the party’s conduct and thus it is called an implied contract.

3.      Quasi-Contracts

A quasi-contract is one that does not arise from an agreement between parties but due to some special circumstances. The court’s interference is what gives rise to quasi-contracts and not the agreement between the parties. Mostly, these contracts are ordered by the court of law so that no party can take advantage o the other. Quasi-contracts are not defined under ICA but it deals with these types of contracts under Chapter V.

Contract Formation

As discussed above, the definition of a contract is given under Section 2(h) of ICA which clearly states that an agreement between two or more parties, within the scope of the law, is known as a contract. A contract is formed when a promise is made with some consideration between two parties. Also, there must be an intention to create a legal relationship between the two parties. A promise is made when a person offers or proposes something to another and there is acceptance of that offer by the other person. Hence, a contract is formed by an acceptance of a proposal. Although, the person offering must have an intention to create a legal relationship with the other person.

The essentials of a valid contract that are discussed above can also be considered as the general principles of contract formation as they are required to form a contract between two or more parties. Essentials elements such as free consent of the parties, competent parties, lawful object, and lawful consideration, etc. are all needed to form a contract. Hence, they are the basic principles of contract formation.

Elements of Contract Formation

A contract is an agreement between parties and to form this contract, the presence of certain elements is necessary. A contract formation constitutes four main elements that are an offer/proposal, acceptance, consideration, and an intention to create a legal relationship. These four elements are vital in the formation of any contract otherwise a contract between two parties cannot be formed.

A.      Offer/Proposal

A person making an offer or a proposal is called a ‘promisor’, and the person accepting it is called a ‘promisee.’ When a person expresses his willingness to do or not to do an act, he is said to make an offer. Although, the desire to do or to abstain from doing an act will not solely constitute an offer. An offer or a proposal can be negative or positive. A negative offer would be to refrain from doing an act and a positive one would be to do an act, however, both proposals are valid.

Essentials of a Valid Offer

• A valid offer must contemplate at least two parties.
• An offer if leads to a contract must create a legal relationship between the parties.
• An offer must be duly communicated to the offeree in order to obtain acceptance.
• An offer should not be vague and difficult to understand. It must be clearly stated.
• An offer must be conditional but the acceptance to it cannot be conditional.
• An offer can be expressed, implied, specific, or general.

Kinds of Offers

·         Expressed and Implied Offers

An act or omission makes an offer for the parties. It can be made either in words (oral or written) or it can be made by the conduct of the parties or circumstances of a case. An offer that is made in words spoken or written is called an expressed offer and an offer made by the conduct of the parties is called an implied offer. An implied offer is made by an omission to do an act whereas, an offer made by words spoken or written is made an act of the parties.

·         Specific and General Offer

A specific offer is one that is made to a particular person or a group of persons and on the other hand, a general offer is made to the public at large. The acceptance of a specific offer can only be done by the person or group of persons to whom it is made but a general offer can be accepted by anyone who satisfies the terms of the offer.

·         Cross Offer

A cross-offer occurs when two parties make an identical offer to each other without having any knowledge of the other person’s offer. In such a case, no party can accept the offer made to them and hence it results in no contract between the parties.

·         Counter Offer

When the offeree accepts the proposal but with certain conditions and makes another offer with changes in the original offer, it is termed as a counter-offer. A Counter-offer is considered as the rejection of the original offer. Such acceptance is a qualified acceptance.

B.      Acceptance

When a person signifies his assent to the offer made to him, it is said that he has accepted the offer and thus it becomes a promise. The acceptance should be unconditional by the offeree. After an offer is accepted, it becomes a promise and a promise is irrevocable as it imposes legal obligations on the parties. Hence, once the communication of acceptance has been made, the offer cannot be revoked.

Essentials of Acceptance

• An acceptance must be communicated to the offeror.
• It should be absolute and unconditional.
• It must be made in a manner prescribed by the offeror.
• It must be communicated while the offer is still existing weird or within the time stipulated in the offer.

Communication of Acceptance

Acceptance of an offer is only effective when it is properly communicated. This rule is to protect the offeror so that he is not bound by a contract of which he has no knowledge that it is accepted or not by the offeree. However, there is one exception to acceptance of the offer which is ‘acceptance by post’ which is also called the postal rule. In the postal rule, the acceptance will be effective when it is posted and not when it is received by the offeror. But this exception cannot be applicable unless it is specified in the offer or it is reasonable to send acceptance by post. There are also other modes of communication of acceptance such as on the telephone, voice mail, e-mail, etc. Also, it is significant to note that communication of acceptance must be made to the offeror only or his agent and no third person.

C.      Consideration

Section 2(d)[9] of ICA defines the term consideration which implies that something done or abstained from doing at the desire of the promisor, is called consideration. A contract is entered into by two parties when a promise is made with some lawful consideration otherwise it will not be enforceable by law. Consideration is the value that is given in return for the performance done by the other party. Consideration is mostly in monetary terms. In Currie v. Misa[10],  consideration was defined as “providing a benefit to one party through the detriment of another”. Thus, we can conclude that consideration Quid Pro Quo i.e. something in return.

D.     Intention to create a Legal Relationship

An agreement must be legally binding on both parties and hence the formation of a contract must be with an intention to create legal obligations on the parties. An agreement must be enforceable by law otherwise it will be a void contract. Therefore, it is important to intend to create a legal relationship between the parties so that they are within the scope of the law.

Conclusion

A contract imposes obligations on the parties to do perform a certain act. A contract can come under many forms but each type of contract has something in common which is the essentials elements of a valid contract. The absence of these elements can make a contract void or voidable. The Indian Contract Act, 1872 defines a contract as an agreement between two parties which is enforceable by law. The said act also lays out the formation of a contract. A contract is formed when a person makes an offer and the other person accepts it, however, there are many layers to this simple process of contract formation. Contract formation is necessarily an important aspect of a contract because it determines what kind of contract a person is entering into and what obligations would be imposed on him. Hence, it is concluded that the process of contract formation is very vital.

Frequently Asked Questions (FAQs)

1. What is a contract?
2. What essential elements are needed for a valid contract?
3. How many types of contracts are there?
4. How a contract is formed?
5. What are the principles of contract formation?

References

• www.shodhganga.inflibnet.ac.in/bitstream/10603/49009/10/10_chapter%202.pdf
• www.legalbites.in/types-contracts/
• www.upcounsel.com/formation-of-contract
• www.lawteacher.net/modules/contract-law/formation/