Formation Of Contract

The Indian Contract Act, of 1872 (hereinafter referred to as “the Act”) primarily deals with the formation of a contract in India. It gives the basic principles that establish a legally binding contract. The Act defines a contract as “an agreement enforceable by law.” The essentials that form a valid contract are given in different sections of the Act, such as offer, acceptance, consideration, free consent, and lawful purpose.

The primary purpose of the formation of a contract in business law is that all parties involved with the formation process will be in full knowledge of their rights and obligations, which may cut down misunderstandings and disputes that might arise. This article explains what constitutes a contract formation, what the proper sequence does, which are the basic elements that make up a valid contract, and an example illustrating these principles at work.

What Is Formation Of Contract In Business Law

The formation of a contract is the creation of a legally enforceable agreement between parties. This process is essential in business law as it gives form and structure to govern commercial relationships. Whether it is a simple purchase of goods, a service agreement, or a complex merger and acquisition, contracts play an indispensable role in defining the terms of engagement between parties.

Contracts may be oral or written; however, written contracts are preferred because they serve as better evidence of the agreement and the obligations of each party. The making of a contract usually follows a structured path so that all the legal necessities are met with.

The Correct Sequence In The Formation Of A Contract

The formation of a contract follows certain specific steps to complete the contract. These steps include

The formation of a contract follows specific steps to complete the agreement. These steps include:

1. Offer:
   An offer is the preliminary stage in forming a contract. It is a promise by one party to do something in return for something from the other party. The terms of the offer must be definite and certain for a contract to proceed.
   Example: If a seller agrees to sell 100 pieces of a commodity to a buyer at a fixed price, this constitutes an offer.
2. Acceptance:
   Once the offeror has made the offer, the offeree must accept its terms. Acceptance should be absolute and unconditional, clearly communicated by the offeree to the offeror.
   Example: When the buyer agrees to purchase the 100 units at the stipulated price, this is an acceptance.
3. Consideration:
   Consideration refers to the exchange of value between the parties. It can be money, goods, services, or a promise to do or refrain from doing something. Consideration distinguishes a legally binding contract from a mere promise or gift.
   Example: The supplier provides goods, and the buyer provides monetary remuneration. The consideration is the exchange of value.
4. Intention to Create Legal Relations:
   The parties must intend to create legal relations. This means both parties agree with the understanding that the contract has legal implications. In business transactions, this intention is generally presumed.
   Example: The supplier and buyer, by entering into the contract, are presumed to have the intention to create legal obligations under it.
5. Capacity to Contract:
   The parties must have the legal capacity to enter into a contract. They should be of legal age, mentally sound, and not under compulsion. Minors, individuals with impaired mental faculties, and those legally disqualified (e.g., insolvent persons) cannot enter enforceable contracts.
   Example: A contract made with a minor or a person declared insolvent is not enforceable by law.

Also Read : Capacity To Contract

1. Legality of Purpose:
   The purpose of the contract must be lawful. If the contract’s subject matter is illegal or against public policy, the contract is void.

Essential Elements Of A Contract

The Indian Contract Act, of 1872 details the following are the essential conditions to form a valid contract:

Offer And Acceptance (Proposal And Promise)

The first step towards the making of a contract is a proposal or offer by one party and acceptance by the other. Section 2(a) of the Act defines that when one person signifies to another, either directly or indirectly, his willingness to do or abstain from doing something with the intention of obtaining the assent of that other to such act or abstention, he is said to make a proposal. Acceptance, under Section 7 of the Act should be absolutely and unconditionally given. Once the other party accepts the offer, it becomes a promise.

Intention To Create Legal Relations

The parties to an agreement must have the intention of creating lawful obligations. Social or domestic agreements lack this intention as such agreements are not enforceable in a court of law. In the case of Balfour vs. Balfour (1919), the Court held that domestic agreements that are formed between spouses, are presumed not to be legally binding.

Lawful Consideration

The most important concept of contract law is “consideration.” According to Section 10 of the Act, for an agreement to become a contract, it must be supported by lawful consideration. A consideration is some kind of value, such as an undertaking to pay or to do something, but Section 25 of the Act provides some exceptions where an agreement made without consideration can still be valid. These include agreements made on account of natural love and affection between parties in close relations.

Competency Of Parties

According to Section 11 of the Act, every person is capable of entering into a contract if he is of sound mind, being of the age of majority, and not being disqualified by any law to which he is subject to. Where one of the parties lacks the capacity to contract, such as a minor or an idiot, having entered into a contract, then the agreement becomes void.​ Hence, such agreements are not enforceable by the law.

Free Consent

A valid contract should be entered with the free consent of parties. Section 13 explained that consent is a mutual assent between two or more persons with regard to the same thing in the same sense. Additionally, Section 14 of the Act provides that the consent is free when it is not caused by coercion, undue influence, fraud, misrepresentation, or mistake. The agreement is considered voidable​ if the consent is not a free consent.

Lawful Object

Section 23 of the Act provides that the purpose of the contract must be lawful. Contracts made for illegal purposes, for example, in regard to illegal activities, are void. The purpose of the contract must not be contrary to the legal provisions, must not be fraudulent or against public policy​.

Formation Of Contract Example

Let's follow an example explaining how a contract can be formed:

Example: A tire manufacturing company, Company A wants to purchase 500 tires from a tire manufacturer, Company B for Rs. 100,000. The following are the steps that the two companies need to undertake to form a contract between each of them:

1. Offer: It can be a written letter mailed by Company A to Company B with an offer to buy 500 tires at Rs. 100,000 for delivery within two weeks.
2. Acceptance: Company B accepts the offer by way of a written communication in return, indicating it agrees to the terms set out by Company A.
3. Consideration: This contract is considered based on exchanging goods (the 500 tyres) from company B for the payment of Rs. 100,000 from company A.
4. Intention to Create Legal Relations: The two companies through the commercial transaction are presumed to have an intention to create a legal relationship.
5. Capacity to Contract: Both the parties are registered businesses. Each has the capacity to enter into a contract. Neither of the parties is under duress or undue influence and have given free consent to enter into the contract.
6. Lawfulness of Object: The buying and selling of tyres is totally legal. There is no illegal motive involved in the transaction.

Once the steps above are accomplished the contract will be considered to be formed. Thereby two companies are legally obliged to fulfil their respective obligations. If either company fails to act as per the terms of the contract, the other party has the option to take another into court for the breach of the contract.

Conclusion

The Indian Contract Act, 1872 provides for a detailed framework for the formation and enforcement of contracts in India. While dealing with crucial elements that form a valid contract, it further looks at circumstances under which contracts may become void or voidable. A contract ought to be formed with free consent, lawful consideration, and between competent parties. The provision provided under the Act maintains the integrity of contractual relations in India. All the essential requirements enumerated by the Act must be fulfilled for a valid contract to be formed. Failing this, the contract becomes unenforceable or is declared void or voidable. This would protect the parties from entering into an unlawful or unfair agreement.