Business

LAW
Tanu Agrawal

PREFACE
This Business Environment & Law module seeks to discuss the concept of Business
Law & their application in the organization. The book is designed for use in graduate &
post graduate courses for self study for students and for the faculty as well. An attempt
has been made to relate theory to practice to make it understandable easily for students.
Each chapter is having various illustrations relating to each topic covered and followed
by numerous questions and multiple choice questions also, which are designed to
reinforce concepts & procedure presented in the body of chapter.
I wish to express my sincere thanks to many of the authors who have received due
acknowledgements, without whom, this module would not have been completed.
I have taken every possible effort to remove the errors either of principle or of printing.
Even then, if the reader comes across any error, he/she is requested to point out the same
to me.
I hope that many students will find this module interesting & helpful. Further suggestion
for the improvement of the module is solicited.
Tanu Agrawal
2009

Syllabus
BUSINESS ENVIRONMENT & LAW
Course Code:
Course Objective:
To give insight to various Business and corporate Laws so that the students are able to
interpret the provisions of some of the important laws and apply the same in commercial
and industrial enterprises.
Course Contents:
Module I: Legal Environment of Business
Environment of Business, Its importance, Legal environment of business
Module II: Indian Contract Act, 1872
Nature and kinds of Contracts, Concepts related to offer, Acceptance and Consideration,
Principles Governing Capacity of Parties and Free Consent, Legality of Objects,
Performance and Discharge of Contract, Breach of Contract and its Remedies, Basic
Elements of Laws Relating to Agency, Guarantee and Pledge.
Module III: Indian Sale of Good Act, 1930
Sale and Agreement to Sell, sale & Hire Purchase, sale & barter., sale & bailment, sale &
contract for work & material,
Goods Different types of Goods, effect of destruction of goods, Conditions and
Warranties, performance of contract of sale, Doctrine of Caveat emptor, Transfer of
property, Rights of an Unpaid Seller.
Module IV: Negotiable Instruments Act, 1881
Meaning of Negotiability and Negotiable Instruments Cheques, Bill of Exchange and
Promissory Note Crossing of Cheques , negotiation, Endorsement, assignment
Dishonour of Cheques.
Module V: Elements of Company Law
Meaning and types of companies, Formation of a company, Memorandum and Articles of
Association, Prospectus and Issue of Shares, Share Capital and Shareholders, Company
Meeting and Proceedings, Powers and Liabilities of Directors and Winding up of
Company.
Module VI: Consumer Protection Act, 1986
Need for Consumer Protection Meaning of Consumer- Different redressal agencies for
Consumers, Rights of Consumers, Unfair Trade Practices, Procedure for Filling
Complaints.

INDEX

Chapter No.

Chapter Name

Page No.

Chapter 1

Environment Of Business

Chapter 2

Legal Environment Of Business Introduction To Law

15

Chapter 3

Indian Contract Act, 1872

22

Chapter 4

Special Contracts

37

Chapter 5

Indian Sale of Good Act, 1930

57

Chapter 6

Negotiable Instruments Act, 1881

92

Chapter 7

Meaning And Types Of Companies

119

Chapter 8

Registration & Incorporation

134

Chapter 9

Share & Share Capital

146

Chapter 10

Prospectus

162

Chapter 11

Meetings

170

Chapter 12

Directors

181

Chapter 13

Winding Up

195

Chapter 14

Consumer Protection Act, 1986

209

Answer Key to end chapter questions

Syllabus
Bibliography

Page no 220
Page no 221
Page no 222

CHAPTER 1 ENVIRONMENT OF BUSINESS

After reading this lesson, you will be conversant with:
1.1 What is environment?
1.2 Relationship between business & environment
1.3 Characteristics of environment
1.4 Environmental scanning
1.5 Types of environment
1.6 Dimension of general environment
1.7 Benefits of environmental analysis
1.8 Limitations of environmental analysis
1.1 What is environment?
Environment literarily means the surroundings, external objects, influences or
circumstances under which someone or something exists. The environment of any
organization isthe aggregate of all conditions, events and influences that surround and
affect it-Davis, K, The Challenge of Business, (New york: Mcgraw Hill, 1975), P43
Environment refers to all external forces that have a bearing on the functioning of a
business. Jauch and Gluecke define environment thus: The environment includes factors
outside the which can lead to opportunities or a threat to the firm. Although there are
many factors, the most important of these sectors are socio-economic, technological,
supplier, competitor and the government
Business is all about reaping profits from the opportunities available in the environment
Opportunity can manifest themselves in the form of short supply, excess demand, latent
need or new better and economical sources of supply or manufacturing.
Every business operates in a particular environment and each business unit has its own
environment. A change in environment presents opportunity to some and threat to others.
Sometimes, in the same industry, a relevant change in environment can a favorable of the
opposite impact on different units of the same industry.
For instance, the General Agreement on Trade and Services (GATS) implemented in
India on January 1,2005, is an opportunity for research-based pharmaceutical companies
like Ranbaxy but a threat for smaller companies. In the long run, only those organizations
will survive that are able to forecast the environment early and can react in time to the
change in environment.

The recent changes in tariff rates have changed the toy industry of India with the market
now being dominated by Chinese products. A slight change in the Reserve Bank of
Indias monetary policy can increase of decrease interest rates in the market. A slight
shift in the governments fiscal policy can shift the whole demand curve towards the right
or the left.
Hindustan Lever Limited (HLL) took advantage of the new takeover and merger codes
and acquired brands like Kissanfrom the UB group. TOMCO (Tata Oil Mills Company)
and Lakme from Tata and Modern Foods from the government, besides many other small
takeovers and mergers.
The new moguls of the Indian business are those who predicted the changes in the
environment and reacted accordingly. Azim Premji of Wipro, Narayana Murthy of
Infosys, Subhash Goyal of ZEE, the Ambanis of reliance, L.N.Mittal of Mittal Steel, of
Bharti Telecom are some of them.
Even a small businessman who plans to open a small shop as a general merchant in his
town needs to study the environment before deciding where he wants to open his shop,
the products he intend to sell and what brands he wants to stock.
1.2 relationship between a business and an environment
The relation between a business and an environment is not a one way affair. The business
also equally influences the external environment and can bring about changes in It.
Powerful business lobbies for instance, actively work towards changing government
policies.
The business environment is not all about the economic environment but also about the
social and political environment. Politically, after the Congress government came to
power at the center with the support of the CPI in May 2004, the whole process of
disinvestments took a U-turn Similarly, a new sociological order in India today has
created a market for fast foods, packaged foods, multiplexes, designer names, valentine
day gifts and presents, and gymnasiums and clubs etc.
So it is quite obvious that success in a business depends upon better understanding of the
environment. A successful organization doesnt look at the environments on and ad hoc
basis but develops a system to study the environment on a continuous basis to try and
protect the organization from every possible threat and to take the advantage of every
opportunity. Some times better and timely understanding of the environment can even
turn threat into an opportunity.
1.3 Characteristics of Environment
1. Environment is Complex: The environment consists of a number of factors,
events, conditions and influences arising from different sources. All these interact
with each other to create new sets of influences.

2. It is Dynamic: The environment by its very nature, is a constantly changing one.

The varied influences operating upon it impart a dynamism to it and cause it ot
continually change its shape and character.
3. Environment is multi-faceted: The same environmental trend can have different
effects on different industries. For instance GATS that is an opportunity for some
companies but a threat for others.
4. It has a far-reaching impact: The environment has a far reaching impact on
organizations inn that the growth and profitability of organization depends
critically on the environment in which it exists.
5. Its impact on different firms with in the same industry differs: A change in
environment may have different bearings on various firms operating in the same
industry. In the pharmaceutical industry in India, for instance, the impact of the
new IPR (Intellectual Property Rights ) law will different for research-based
pharmacy companies such as Ranbaxy and Dr. Reddys Lab and will be different
for smaller pharmacy companies.
6. It may be and opportunity as well as a threat to expansion: Developments in
the general environment often provide opportunities for expansion in terms of
both products and markets. For example, liberalization in 1991 opened lot of
opportunities for companies and HLL took the advantage to acquire companies
like Lakme, TOMCO, KISSAN etc. Changes in environment often also pose a
serious threat to the entire industry. Like Liberalization does pose a threat of new
entrants to Indian firms in the form of Multi National Corporation (MNCs).
7. Changes in the environment can change the competitive scenario: General
environmental changes may alter the boundaries to an industry and change the
nature of its competition. This has been the case with deregulation in the telecom
sector in India. Since deregulation, every second year new competitors emerge,
old foes become friends and M&As follow every new regulation.
8. Sometimes developments are difficult to predict with any degree of accuracy:
Macroeconomic developments such as interest rate fluctuations, the rate of
inflation, and exchange rate variations are extremely difficult of predict on a
medium of a long term basis. On the hand, some trends such as demographic and
income levels can be easy to forecast.
1.4 Environmental Scanning
The process by which organizations monitors their environment to identify
opportunities and threats affecting their business, is known environmental scanning.
The following factors to be considered for environmental scanning.

1. Events: Important and specific occurrences that taking place in a certain sector.
2. Trends: The general tendencies or course of action along which these events take
Place.
3. Issues: the current concerns that arise in response to events and trends.
4. Expectations: The demands made by interested groups in the light of their
concern for issues.(Azhar Kazmi, TATA McGraw Hill,p118)
1.5 Type of Environment
The environment can be divided into three broad categories:
Internal Environment
Macro Environment (General Environment)
Micro Environment(Relevant Environment of Competitive Environment)
Internal Environment
Internal environment refers to that of the organization and is controllable. Some
internal factors are:
1. Culture and Value Systems: Organizational culture can be viewed as the system
of shared values and beliefs that shape a companys behavioral norms. A value is
an enduring preference as a mode of conduct or an end state. The value system of
the founders of the organization have a lasting impact on it. The value systems not
only influence the working of the company and the attitude of its people but also
the choice of its business.Values and cultures are inherited from seniors by juniors
in a organization. If a young man gets a job in a bureaucraic culture he gets
accustomed to a work routineof 10 to 6. On the other hand, if he gets a job in a
private concern he works till the work finishes. Similarly, for organizations
accustomed to and aggressive consumer goods sales culture, a foray into the
industrial goods segment proves difficult.
2. Mission and Objectives: The mission and objectives of the company guide the
priorities, direction of development, business philosophy, and business polivy.
3. Management Structure and Nature: Structure is the manner in which the tasks
and sub-tasks of the organization are related. Structure is concerned with the
hierarchical relationship and the relationship between the management od
different functional areas like the structure of the top management and the pattern
of share holding.
4. Human Resource: It concerns with factors like manpower planning, recruitment
and selection, compensation, communication and appraisal.
Besides this, internal environment also includes corporate resources,
production/operation of goods and services, finance and accounting systems and
methods, marketing and distribution.
Macro Environment

The Macro/General environment consists of factors external to the industry that may
have a significant impact on the firms strategies. Here we will look at six broad
dimensions: demographic, socio-cultural, political/legal, technological, economic and
global.
1.6 Dimensions in General Environment

Demographic
Socio Culture

Political/Leg
al

Business

Technologica
l

Economic

Global

All these dimensions of general environment are interrelated. These dimensions not only
influence businesses, but also influence each other. After a political change in 1991,
when congress government came to power, major economic change took place in the
form of LPG, i.e., Liberalization, Privatization, and Globalizations. This led to and
enhancement in the technological environment of the country. This technological and
economical change has transformed the socio-culture environment of the country.
Globalization has also enabled India to become the software superpower of the world. All
global organizations now have a new and vast market, as well as cheap manufacturing
hub, which has compelled them to change their global marketing and manufacturing
strategies.
With this, over the last ten years there has been a drastic change in the Indias
demography per capita incomes have risen. The number of young achievers and high
earners has increased drastically, which changed the entire demand schedule of products.
This shows that a single political in 1991 has changed all the components of the macro
environment. So while studying macro environment, one should not only concentrate on
how this factor will influence business but also on how this will influence other

components of the environment and what will be the impact of these changes in the
business. Only then can one design long term strategies.
1. Political Environment: It is the political environment of the country that decides
the fortune of businesses in a country. After the 1917 revolution in sudden
political change transformed the equation of doing business. After the change of
tegime in the USSR in late 1980s and early 1990s business equations changed
once again in Ressin.
In India in 1977, the janata government came to power because of which Coca
Cola and IBM had to leave the country. All liquor companies had to close their
operations. When P.V Narsimha Rao can to power and a new economic policy
was putin, that presented of new opportunities for Businesses, but at the same
time brought a threat for inefficient organizations.

Not only political philosophy but political stability too has a significance for
businesses. The more stable the political environment of a country, the more
conducive will be the environment for business. The consensus among various
political parties on key issues are also relevant in this case.
2. Regulatory and Legal Environment: The political environment governs the
legal and regulatory environment of country. The regulatory environment plays a
vital role by dictating the dos and donts of a business. Every county has a
different legal environment.
In India we have the Companies Act that governs Companies, the MRTP Act
which restricts monopoly,various laws regarding shares, the Consumer protection
Act, environmental laws, and the implementation of GATS.GATS has resulted in
the implementation of international laws regarding patents,.There are laws for
import and export, licensing etc. that have a drastic impact on business and the
future of organizations.
When an NRI Lord Swaraj Paul, a British Citizen, tried take over Escorts, its
owners, the Nandas approached the government to save their company. A law
restricting any NRI from purchasing shares of an Indian company came into
force, and Escorts was saved.
3. Demographic: It is the demographic environment which decides the marketing
mix for an organization. It decides the type of product the organization comes out
with. In India a lot of research and efforts are undertaken to reduce the cost of
products and to launch products at the cheapest possible rates. A one rupee sachet
of shampoo or a five rupee ice-cream cone are some examples. It is the
demography that decides the pricing, promotion and distribution strategies. 70%
of Indias population is lives in villages and of this, 70% are youth which is why
every business house is launching new products, specifically for rural market. ITC

launched its unique and ambitious programme called e-chaupal,targeted at the

rural market.
4. Socio Culture: Socio culture variables like the beliefs, value system, attitudes of
people and their demographic composition have a major impact on their
personality and behavior style. The consumers preferences have undergone a
drastic change through the 1990s This has led to the production of more cars,
refrigerators, air conditioners and other articles that were at one time considered
ostentatious and luxurious.
Not only this, this socio-cultute paradigms also dictates the preference of
consumer in different regions. For instance companies launch different products
in the south and north because of differing preferences. Companies have to
change their product portfolio because of cultural preferences as Mc Donalds and
KFC did when they launched their restaurant chain in India.
5. Technological: Technological forces present a wide range of opportunities and
threats that have to be accounted for in the process of business strategy
formulation. Technological advancement may dramatically affect an
Organizations products, services, markets, suppliers, distributors, competitors,
customers, manufacturing process, marketing practices, financial composition,
and competitive position. Some of the important factors that influence operating
in the technological environment are:

Sources of technology like company sources, external sources and foreign

sources, cost of technology acquisition, collaboration and transfer of
technology.

Rate of change in technology, of obsolesce

Impact of technology on human being, the man machine system, and the
environmental effect of technology.

Communication and infrastructural technology in management.

In fact, technology is today a decisive factor. From FMCGs to the microprocessor

industry is investing heavily technology. The technological knowledge of consumer the
decisions. Organizations have to modify products according to the level of technological
knowledge of the target costumer, because in developing nations complex household
machines that need programming will not work. So they have to be technologically more
and more focused.
6. Global Environment: The international environment consists of all factors
operate at the transnational, cross-cultural level and across the border. The world
is a global village today and it is getting closer and closer as far as business is
concerned.

10

For the sake of business, countries are burying their grievances and forging
economic relationships. Erstwhile adversaries like America and Russia are today
goods friends and China ad India are coming closer.
India has signed a bilateral treaty with sri Lanka, it is developing close economic
relationship with South Africa and Brazil, and is Planning to develop a road
network in South East Asia. India is also a close ally of ASEAN, nd is also
signatory of WTO which has a multilateral trade agreement among more than
100 nations.
India is in a process of laying down a gas pipeline from Iran via Pakistan. All this
is just glimpse of the present international environment. Every new bilateral and
multilateral agreement new vistas for business and also brings a new threat in the
form of global competition.
7. Economic Environment: The economic environment consists of macro level
factors related to the means of production and distribution of wealth, which have
and impact on the business of an organization.
The economic structure of a country, whether it is socialist, mixed or capitalist,
has drastic impact on the economy. Economic policies such as foreign trade
policy, industrial policy, fiscal policy, GDP growth tare, policy of licensing,
monetary policy, development of financial institutions, development of money
and stock market, and the extent of globalization are some of the aspects of an
economy that reflect on business in an economy. A slight change in monetary
policy can release crores of rupees into the economy that may result in a decrease
in interest rate, which further increases investment as well as inflation.
Also, banks lending rates decide the level of investment in any country. The
higher the interest rate, the lower the level of investment. In most industrialized
nations like the US, this interest tare is between 4% to 6%. In India in 1991, the
PLR (prime lending rate) was 17% to 18% which was reduced to 8% to 10% by
2000 because of a change in the countrys economic policy.
8. National Competitive Advantage: Despite globalization, industrialization is
clustered in a small and specific number of countries. Most successful computer
and biotechnology firms are based in the US, the successful chemical and
engineering industry is based in Germany, and the cream of the electronics
industry is based in Japan.
Similarly the successful call centers are clustered in India as are many of the
customized software companies. This suggests that nation and its environment in
which a company is based may have an important bearing of the competitive
position of that company in the global marketplace.

11

Michael Porters International Competitiveness Model

Firm Strategy, Structure

& Rivalry

Local Demand
Condition

Factor Endowment

Relating and Supporting

Industries

In a study national competitive advantage, Michael Porter identified four attributes of a

national of country-specific environment that have an important impact on the global
competitiveness of companies located within that nation.
a. Factor Endowments: A nations position in the factors of production such as
skilled labor, capital, technology or infrastructure necessary to compete in a given
industry.
b. Demand Condition: The nature of home demand for services.
c. Relating and Supporting Industry: The presence and absence in a nation of
supplier industries and related industries that are internationally competitive .
d. Firm strategy, structure and rivalry: The conditions in the nation that govern
how companies are created, organized and managed and the nature of domestic
rivalry.
Micro Environment

12

Micro environment of the competitive environment refers to the environment which and
organization faces in its specific arena. This arena may be an industry, of it may be what
is referred to as a strategic group.
Besides looking at primary demand and supply factors, firms examine the state of
competition they face because that determines whether that determines whether they will
remain in the same industry or start a new one. All the business decisions-what business,
pricing, distribution channel, promotion portfolio, etc. depends on competitive position of
the firm.
For instance, a new entrant in the glucose biscuit segment will have to study and consider
the marketing mix as well as strategy of existing players like Britannia, Parle, Priyagold,
etc., before deciding its marketing mix following are the key Micro Environment factors:
The Five Forces of Competition
Professor Michael Porter of the Harvard Business School has demonstrated the state of
competition in an industry as a composite of five composite of competitive forces.
According to Michael Porter the five forces of competition are:
a. Threat of Competitors: The rivalry among sellers in the industry.
b. Threat of New Entrants: The potential entry of new competitors.
c. Threat of Substitutes: Market attempts of companies in other industries to win
customers over to their own substitute products.
d. Bargaining Power of Supplier: The competitive pressure stemming from the
supplier-seller collaboration and resultant bargaining.
e. Bargaining Power of Buyers: The competitive pressure stemming from sellerbuyer collaboration and bargaining.
Michael Portes Five Forces Model

Threat of Substitutes

Bargain Power
of supplier

Threat of Competitor

Threat of New
Entrants

13

Bargain Power
of Buyer

1.7 Benefits of Environmental Analysis

Environmental analysis gives an idea of organizations environment.
Environmental analysis gives a brief about competitors.
Environmental analysis tells us about opportunities to reap profits.
Environmental analysis gives details about threats in the environment.
Environmental analysis keeps the manager informed and alert.
Business is all about making the right decision at the right time. Without proper
environmental analysis the right decision cant be made.
7. Environmental analysis helps in predicting the future.
8. Environmental analysis helps in suitable modification of strategies, as and when
required.
1.
2.
3.
4.
5.
6.

1.8 Limitations of Environmental Analysis

1. Today the environment is turbulent and dynamic and it is difficult to forecast of
predict the environment.
2. Business environment is global and any development in any part of the world can
influence the business. Even a small political move can have a drastic impact,
which in very difficult to scan and assess. A sudden disintegration of USSR had
very adverse impact on many exporters in India. A sudden attack of Al Qaeda on
the Twin Towers in the US resulted in the hike of global petroleum prices. After
Signing the WTO, all of a sudden the toy market of India was captured by
Chinese products. Today it is extremely difficult to predict the external
environment.
3. The Effectiveness of environmental analysis depends upon how it is practiced,
i.e., whether it is a systematic approach, ad hoc or processed. Under a systematic
approach, information for environmental scanning is collected, scanned and
monitored on a continuous basis and forecast and is assessed for the relevant
factor. In an ad hoc approach, an organization condusts special surveys and
studies to deal with specific environmental issues from time to time. In a
processed form approach, an organization uses information in a processed form,
available from different sources, both inside and outside the organization. For
effectiveness, an organization should use the combination of these approaches
instead of just following the tried formulas, because all have their importance
according to requirement.
Too much reliance is often placed on the information collected through
environmental scanning.

14

When there is overloading of information, one is likely to get lost and become
inactive-typical of paralysis through analysis syndrome.

MULTIPLE CHOICE QUESTIONES:

Q1 Q1 Environment includes:
a) Socio-economic sectors
b) Technological sectors
c) Competitive sectors
d) All of above
Q2 General Agreement on Trade and Services (GATS) was implemented on:
a) January 1, 2005
b) January 1, 2006
c) January 5, 2005
d) January 1, 2006
Q3 Which of the following characterizes business environment:
a) It is complex & dynamic
b) It is multi-faceted
c) None of the above
d) Both (a) & (b)
Q4 Which of the following factors is/are to be considered for environmental scanning:
a) Events
b) Trends
c) Issues
d) All of the above
Q5 Organizational culture can be viewd as:
a) The infrastructural environment of the company
b) The system of shared values and beliefs that shape a companys behavioral
norms.
c) Both (a) & (b) above
d) None of the above
Q6 Human resource is the part of:
a) Internal environment
b) Micro environment
c) Macro environment
d) Both (a) & (c)
Q7 Macro envirionment consists of factors:
a) Which are external to the industry

15

b) Which are internal to the industry

c) Which are external & internal to the industry
d) None of the above
Q8 Demographic is the part of
a) Internal environment
b) Micro environment
c) Macro environment
d) Both (b) & (c) above
Q9 Which of the following factors influence operating in the technological environment:
a) Sources of technology
b) Communication and infrastructural technology in management
c) Socio culture variables
d) Both (a) & (b) above
Q10 means of production and distribution of wealth is related to
a) Technological environment
b) Economic environment
c) Social environment
d) Internal environment

16

Chapter 2 : LEGAL ENVIRONMENT OF BUSINESS

-INTRODUCTION TO LAW
After reading this lesson, you will be conversant with:
2.1 The meaning of law
2.2 Nature & Definition of Law
2.3 Functions and Purpose of Law
2.4 Advantages of Law
2.5 Disadvantages of Law
2.6 Kinds of Laws
2.7 Sources of Law

2.1 Introduction:
Business laws are essential for the students of management to understand the legal rules
and aspects of business. Just like any other study even business management is
incomplete without a proper study of its laws. Any form of business needs legal
sanction. Therefore, it is imperative that a manager understands the various ways in
which businesses can be organized. This subject introduces some of the common forms
of business organizations, including some forms unique to India like the Joint Hindu
Undivided Family firm. Different types of organizations like Sole Ownership,
Partnership, Private Limited Company, Public Limited Company, Joint Stock Company
along with the rationale for adopting these forms are explored.
What form of business organization is the best under a particular set of conditions?
What advantage or disadvantage does it have over other forms of business? Formalities
to be gone through and some the quasi-legal processes required for starting a business
will be discussed in detail in this subject.
For the proper working of the society, there must exist a code of conduct. As you all
know, in the ancient times the society was not organized. The rights of the individuals
were not recognized. Gradually, the society evolved and the state came into being. As
we all know, to regulate the state, there should be a specific code of conduct, which
should be followed by everyone. As a result of which law evolved as a system of rights
and obligations including all the rules and principles, which regulate our relations with
other persons and with the state. These rules and regulations took the form of statutes.
To enforce the law and to resolve the conflicts arising there from, courts of law were
setup by the state. Laws were made to govern almost every walk of life. You all must
know that criminal laws were made to control criminal activities in the society like
Indian Penal Code, which enumerates which activities are considered criminal and what
will be the punishment for committing a crime. Likewise, mercantile law was evolved
to govern and regulate trade and commerce. Hence, the term mercantile law can be
defined as that branch of law, which comprises laws concerning trade, industry and

17

commerce. It is an ever-growing branch of law with the changing circumstances of

trade and commerce.
2.2 Nature & Definition of Law
Law is a social science that grows and develops with the growth and development of
society. The law is required to deal with the new developments, which create new
problems in the society. Thus, the definition of law given at a particular time cannot
remain valid for all times to come. The definition of law today may become very
narrow in future. Prof. Keeton rightly points out that, to attempt or to establish a single
satisfactory definition of law is to seek to confine jurisprudence within a straitjacket
from which it is continually striving to escape.
According to Austin, Law is the aggregate of rules set by men as politically superior,
or sovereign, to men as politically subject. In other words, law is the command of the
sovereign. It imposes a duty and is backed by a sanction. Command, duty and sanction
are the three elements of law.
According to Holmes, Law is a statement of the circumstances in which the public
force will be brought to bear upon men through courts. Again the prophecies of what
the court will do in fact and nothing more pretentious, are what I mean by law.
According to Woodrow Wilson, Law is that portion of the established habit and
thought of mankind which has gained distinct and formal recognition in the shape of
uniform rules backed by the authority and power of the government.
2.3 Functions and Purpose of Law
The main functions of law is:
1. To maintain law and order within a given society;
2. To maintain status quo in society ensuring stability and security of social order;
3. To enable individuals, maximum of freedom to assert themselves;
4. Determine the sphere within which the existence and activity of each individual
will be secure and free play;
5. The main goal of law is to secure justice; and
6. An important function of law is to ensure rule of law.
2.4 Advantages of Law
The main advantages of law are as follows:

18

1.The principles of law provide uniformity and certainty to the administration of

justice.
2.The existence of fixed principles of law avoids the dangers of arbitrary, biased and
dishonest decisions.
3.The fixed principles of law protect the administration of justice from the errors of
individual judgment.
4.These fixed principles are reliable than individual judgment.
2.5 Disadvantages of Law
Some of the disadvantages of law are:
1. The lack of flexibility in law results in hardship and injustice to people, which
needs to change according to the changing needs of the people.
2. Law is conservative in nature as the lawyers and judges favor continuation of
the existing law making it static.
3. Another disadvantage of law is formalism, which emphasis more on the form of
law than its substance.
4. Lastly, law is unduly and needlessly complex.
2.6 Kinds of Laws
The following are different kinds of law:
1. Imperative Law: It is a rule which prescribes a general course of action
imposed by some authority which enforces it by superior power either by
physical force or any other form of compulsion. Austin who is a chief advocate
of imperative law defines, Law as a command, which obliges a person or
persons to a course of conduct.
2. Physical or Scientific Laws: Physical laws or the laws of science are expression
of the uniformities of nature-general principles expressing the regularity and
harmony observable in the activities and operations of the universe.
3. Natural Law or Moral Law: Natural law or moral law is ought to have the
principles of natural right and wrong, i.e., to include the principles of natural
justice, if it is used in a wider sense, then the term justice is to include all forms
of rightful action.
4. Conventional Law: According to Salmond, conventional law means, any rule
or system of rules agreed upon by persons for the regulation of their conduct
towards each other.

19

5. Customary Law: According to Salmond, customary law means, any rule of

action which is actually observed by men any rule, which is expression of
some actual uniformity of some voluntary action. A custom may be voluntary
and still becomes or retains the features of law. Therefore, when a custom is
firmly established, it is enforceable by the authority of the state
6. Practical or Technical Law: Practical or technical law consists of rules, which
are made for the attainment of certain ends, for example, the law of health, the
laws of architecture, etc.
7. International Law: According to Starke, international law may be defined, for
its great part, as the principles and rules of conduct which the states feel
themselves bound to observe and therefore do commonly observe in their
relations with each other and includes: (i) the rules of law relating to functioning
of international institutions and organizations, their relations with each other and
their relations with states and individuals, and (ii) certain rules of law relating to
individuals so far it relates to their rights and duties are the concern of the
international community.
8. Civil Law: According to Salmond, civil law is, the law of the state or of the
land, the law of lawyers and the law courts.
Advantages of Legal Justice
The key advantages of legal justice are:
i.Legal justice ensures uniformity and certainty in the administration of justice;
ii.Impartiality in the administration of justice is another important advantage;
iii.Legal justice represents the collective wisdom of the community and it is always
to be preferred to the wisdom of any one individual.
Disadvantages of Legal Justice
Some of the disadvantages are:
i.

It is rigid, as it follows what has been laid down by precedents;

ii.

It is not always possible to adjust to the changing needs of the society;

iii.

Another defect of legal justice is its formalism or technicalities; and

iv.

Lastly, it is complex.

2.7 SOURCES OF LAW

According to Holland, the expression sources of law is employed to denote the
quarter from where we obtain our knowledge of law, for example, whether from statute
book, the reports or esteemed treatises. Sometimes it is used to denote the ultimate
authority, which gives them the force of law, i.e., the State.

20

John Austin refers to three meanings for the term sources of law: (a) the first term
refers to the immediate or direct author of the law which means the sovereign in the
country, (b) the second term refers to the historical document from which the body of
law can be known, and (c) the third term refers to the causes which have brought into
existence the rules which later on acquire the force of law.
According to Salmond, the two main sources of law were formal and material. The
legal sources consist of legislations, precedent (previous judgments of the court),
custom, agreement and professional opinion.
Formal Sources
The law derives its force validity from the formal sources.
The material sources of law is derived from the matter, which is composed of
(a)Legal sources and (b) Historical sources.
LEGAL SOURCES
These are the sources which are recognized by the law itself as authoritative, for
example, Statute Law, having its source in legislation; Case Law, having its source in
precedents; Customary Law, having its source in customs. All these are inherent sources
of law and have a binding force.
HISTORICAL SOURCES
The sources which have no binding force and which are not recognized by the law are
referred to as historical sources, for example, juristic writings, literary works, foreign
decisions. These are of a great persuasive force, but they are not binding law by
themselves.
Legislation
Etymologically, legislation means the making or the setting of law. In a wide sense, it
includes all methods of law-making and, therefore, would include laws made by judges
also. In the strict sense, it may be defined as the promulgation of legal rules by an
authority which has the power to do so. In modern times, legislation is the most
important source of law.
According to Salmond, legislation is that source of law which consists in the
declaration of legal rules by a competent authority.
According to Austin, there can be no law without a Legislative Act.

21

MULTIPLE CHOICE QUESTIONES:

Q1 Any rule or system of rules agreed upon by persons for the regulation of their
conduct towards each other is known as:
(a)
(b)
(c)
(d)

Imperative law
Moral law
Conventional law
Customary law

Q2 Something done or said which serves as an example or rule to authorize or justify a

subsequent act of the same or an analogous kind is known as the
(a)
(b)
(c)
(d)

Legislation
Precedent
Golden rule
Mischief rule

Q3 The law of the state or of the land, the law of lawyers and the law courts:
(a)
(b)
(c)
(d)

Imperative law
Moral law
Conventional law
Civil law

Q4 Which one is the function of law:

(a)
(b)
(c)
(d)

To entertain people
To stop crime in the country
to secure justice
all of the above

Q5 The sources which have no binding force and which are not recognized by the law:
(a)
(b)
(c)
(d)

Legal source
Historical law
Formal
Both (a) & (b)

Q6 Which law consists of rules, which are made for the attainment of certain ends:
(a) Practical or Technical Law

22

(b) Civil Law

(c) Historical Law
(d) Customary Law
Q 7 The definition Law is the aggregate of rules set by men as politically superior, or
sovereign, to men as politically subject is given by:
(a) Austin
(b) Holmes
(c) Woodrow Wilson
(d) None of above
Q8 Something done or said which serves as an example or rule to authorize or justify a
subsequent act of the same or an analogous kind is known as the:
(a)
(b)
(c)
(d)

Legislation
Precedent
Golden rule
Mischief rule

Q9 The source of law, which is recognized by law is:

(a)
(b)
(c)
(d)

Legal source
Historical law
None of the above
Both (a) & (b)

23

CHAPTER 3 INDIAN CONTRACT ACT, 1872

After reading this lesson, you will be conversant with:
3.1 Definition of a contract
3.2 Elements of contract
3.3 Essential elements of a valid contract
3.4 Restitution
3.5 Contingent Contracts
3.6 Persons who are Required to Perform Contracts
3.7 Discharge of Contract
3.8 Remedies for Breach of Contract
3.9 Quasi-contracts

The Indian Contract Act, 1872 provides the general principles and rules governing
contracts. All transactions that relate to the agreements and obligations of the
contracting parties, come under the purview of the Act. Special categories of contracts,
are governed by separate Acts. They are Partnership Act, Sale of Goods Act, Negotiable
Instruments Act, Insurance Act, etc. The Indian Contract Act (referred as Act hereafter),
which the law will uphold.
The Indian Contract Act, 1872 is one of the oldest Acts. It is one of the best drafted
enactments which have stood the test of time. The provisions of the Indian Contract Act
has laid down certain settled principles of law, which creates some rights and duties
between the parties. They are very well known and well accepted in the commercial
transactions. Initially, the Act contained provisions in respect of Sale of Goods and
Partnership also. Later, certain Sections (76-123) were repealed and a separate law was
passed on Sale of Goods as, Sale of Goods Act, 1930 and the Indian Partnership Act,
1932 was passed by repealing Sections (239-266).
3.1 Definition of Contract
Section 2(h) of the Act, defines a contract as an agreement enforceable by law. A
contract is defined as an agreement enforceable at law, made between two or more
persons, by which rights are acquired by one or more, to act on the part of the other. It
creates and defines obligations between the parties.
All agreements are not necessarily enforceable by law. An agreement to sell a house
may be a contract enforceable by law. However, an agreement to attend a party being of
a social nature is not enforceable.
It is not necessary that a contract need not be only in writing, unless there is specific
provision in law that it should be in writing. Certain contracts must be in writing as
otherwise they are not enforceable in law. Following are the examples of such contracts.
24

Contract for sale of immovable property must be in writing, stamped and registered.
Certain other contracts though are required to be in writing do not compulsorily be
require registration, for example, Bills of Exchange, Promissory Notes, Cheques, A
Trust created under the Indian Trust Act, A promise to pay a time-barred debt,
Contracts made without consideration with natural love and affection.
3.2 Elements of Contract
It may be noted that a contract essentially contains two elements: agreement and
enforceability by law. For a better understanding, let us elaborate on these two
elements. Section 2(e) of the Act defines agreement as, every promise and every set of
promises, forming consideration for each other. This essentially means that there
should be an offer and acceptance to form an agreement. It is important that before an
agreement is finalized there should be a consensus ad idem (consent to the matter)
between the two parties. Both the contracting parties should say and mean the same
without, which there cannot be a contract.
The other element of contract, enforceability by law, emphasizes the importance of
intention to create a legal obligation or duty to perform or abstain from performing
certain act(s). These acts could relate to social or legal matters.
The classic case of Balfour vs. Balfour (1919) elaborates this point. A husband working
in Ceylon, had agreed in writing to pay a housekeeping allowance to his spouse living
in England. On receiving information that she was unfaithful to him, he stopped the
allowance. It was held that the agreement was without any intention of creating a legal
obligation. Hence, there was no contract. It may be summed up that all contracts are
agreements, but all agreements are not contracts.
3.3 ESSENTIAL ELEMENTS OF A VALID CONTRACT
1. Offer and acceptance.
2. Intention to create legal relationship.
3. Capacity to contract.
4. Free consent.
5. Lawful consideration.
6. Legal object.
7. Certainty and possibility of performance.
Each of the essential elements are discussed in detail below.
1. Offer and Acceptance
A contract basically evolves from an offer by one party and acceptance of the same, by
the other party. The acceptance should be definite and without any qualification. There
should be a consensus ad idem between the two parties on the terms and conditions of
contract.

25

Conditions of Making an Offer

The following conditions that govern making an offer are:
1. The offer must be definite and not vague.
2. An offer should be differentiated from an invitation to make an offer. There are
occasions where a person may make some statements or give information with
an intention of inviting others to make an offer. For example, a catalogue with
prices indicated on it is not an offer to sell. On the contrary it is only an
invitation to make an offer. A person interested in buying the product specified
in the catalogue, may make an offer to buy and it is left to the discretion of the
seller to either accept or reject the same.
Lapse of Offer
Section 6 specifies the instances which results in the lapse of an offer:
I. An offer comes to an end if it is revoked by the offeror at any time before its
acceptance is complete as against him and not after its acceptance;
II. If either the offeror or the offeree dies or becomes insane and the offeree comes to
know about it, before acceptance. If the offeree accepts an offer in ignorance of
the death and insanity of the offeror, the acceptance is valid;
III. If the offer is not accepted within the specified time or within a reasonable time,
or if none of it is clearly specified then the law of limitation applies after that, if
none is specified (Law of limitation applies). In Ramsgate Victoria Hotel Co vs.
Montefiore, Montefiore agreed to take up shares in Ramsgate Victoria Hotel Co in
June. However, when he received the letter of acceptance in November, he
declined to take up shares. The offer had come to an end by lapse of time and
therefore he could not be compelled to take up the shares. When an offer is made
by an agent and it is accepted within a reasonable time, the contract will be
binding on the principal even though the agent may have been guilty of delay in
making the offer;
IV. On failure to fulfill a condition precedent to acceptance. In State of Madhya
Pradesh vs. Gobardhan Dass where the tender required acceptance of a tender to
be accompanied by payment of 25% of the amount and was fulfilled by the
successful tenderer to make the requisite payment the court held that the omission
did not give rise to a binding contract between the parties;
V. If it is not accepted in the mode prescribed or if no mode is prescribed, in some
usual and reasonable manner or if the offer is rejected by the distinct refusal of the
offeree;
VI. If the offeree makes a counter offer, it amounts to rejection of the original offer and
such an offer by the offeree may be accepted or rejected by the offeree;
VII. If law is changed making the offer illegal or incapable of performance. According
to the Indian Contract Act, an offer may be revoked at any time provided it is
communicated to the offeree before the acceptance. Also an offer to keep an offer
open for a specified time (option) is not binding unless it is supported by
consideration.

26

ACCEPTANCE
Under Section 2(b) of the Act, when a person to whom the proposal is made signifies
his assent thereto, the proposal is said to be accepted. Just as in case of offer,
acceptance may also be express or implied. An acceptance is said to be 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 the parties. In an auction sale, the highest bidder is assumed to be the buyer of the
goods once the deal is struck.
In order to convert an offer into a promise, acceptance should be absolute and
unqualified. It is also essential that the acceptance is given in some usual and
reasonable manner. If the offer prescribes the manner in which the acceptance is to be
given, then the acceptor should adhere to the prescribed mode. On failure to do so, the
offeror can insist that his offer will be accepted only if it is given in the prescribed
manner
Conditions of Acceptance
i.
An offer should be accepted only by the person to whom it is put forth. It is clear
by the rule of law that if A proposes to make a contract with B, C cannot substitute
himself with B without the consent of A. An acceptance may be withdrawn before it
reaches the offeror.
ii.

Acceptance of an offer should be absolute and unqualified and should conform

totally with the offer made. A conditional or qualified acceptance does not result in a
valid contract. By giving a conditional acceptance or counter offer, the original offer is
deemed to have been rejected. Once the original offer has been rejected by making a
counter offer, it cannot be accepted again, unless renewed. In Hyde vs. Wrench an
offer made for the sale of a farm for 1,000 pounds was not accepted in the first
instance. A counter offer was made wherein the plaintiff expressed his willingness to
buy the same for 950 pounds. When the counter offer was rejected, the plaintiff
consented to buy the farm for 1,000 pounds which was again rejected by the
defendant. A suit filed for breach of contract was not maintainable as the counter offer
implied that the original offer had been rejected. Hence, there was no valid contract
between the parties.

iii.
The acceptance must be communicated to the offeror. The acceptance must be in
the form specified or in some perceptible form if not specified. A mere intent of
acceptance will not suffice. In this regard, reference may be made to an American case,
Eliason vs. Henshaw the mode of acceptance as prescribed by the offeror was not
adhered to. The offeree sent the letter of acceptance by post when it was required to be
sent
by
wagon
as
indicated
by
the
offeror.
A deviation in the mode of acceptance clearly entitled the offeror to treat the
acceptance as invalid.
2. Intention to Create Legal Relationship:
The validity of a contract is dependent on the intention of the contracting parties. A
contract will be valid only when the parties to the contract intend to create a legal
relationship between themselves. Non-existence of such an intention will not give rise

27

to a valid contract. Agreements of social nature do not contemplate legal relationship

and hence they are not contracts.
The parties to a contract may either specifically lay down that the agreement entered is
not a formal or legal agreement or in certain cases the non-existence of an intention to
enter into a legal relationship can be implied from the agreement itself.
3. Capacity to Contract
Section 10 specifies that an agreement to be a contract, is to entered between the two
parties who are competent to contract. The persons declared to be incompetent to
contract are:
a. Minors: A minor is a person under the age of eighteen years, except when a guardian
of a minors person or property has been appointed by the court, in which case it is
twenty-one. The purpose of declaring minors as incompetent to enter into a contract is to
protect minors against their own inexperience. However, law tries not to cause
unnecessary hardships to persons who deal with minors..
b. Persons of Unsound Mind: Section 12 lays down a test of soundness of mind. It
states that a person is said to be of sound mind for the purpose of making a contract if, at
the time of making the contract, he is capable of understanding it and of forming a
rational judgment as to its effect upon his interests. A person who is a lunatic (who is at
times of sound mind) may enter into contract in these times. Persons who have
completely lost their mental powers or those who are drunken or intoxicated are
incapable of entering into a contract. The question of unsoundness has to be determined
based on unmistakable facts and not merely on speculation. The burden of proving
insanity will be on the person who alleges it. The question whether a contract is
invalidated because of unsoundness of mind will not depend upon the belief or disbelief
of the witness but largely based upon the inference to be drawn from evidence.
c. Persons Disqualified by any Law to which they are Subject: The following persons
are disqualified by law to enter into a contract:
1. Alien Enemies: They are those persons who are not subjects of Republic of India
and the country in which they reside, is not at peace with Republic of India. An
Indian who resides voluntarily in a country hostile to India is also considered as
an alien enemy. Contracts made before war may be either suspended or dissolved
depending whether their performance would benefit the enemy or not.
2. A special privilege is granted to the foreign sovereigns, their diplomatic staff and
accredited representatives of foreign states. Such persons can enter into contracts
and enforce their performance in Indian courts. However, they cannot be sued
unless these persons voluntarily submit to the Indian Law. An Indian citizen
needs to obtain the permission of the Central Government to sue such a person.
3. A contract entered into by a company beyond its authority, as prescribed in its
Memorandum of Association and the relevant provisions in the Companies Act,
is declared as void. A company formed under the Companies Act, 1956 has a
limited contractual capacity and any Act in excess of its powers whether

28

expressly conferred on it or derived by reasonable implication from its objects

clause in the Memorandum, is ultra vires the company and is void.
4. Any contract with a person adjudged insolvent is not valid. It is the official
receiver or official assignee of the insolvent who can enter into contracts relating
to his property and sue and be sued on his behalf.
5. A convict is incapable of entering into a contract while undergoing
imprisonment. The incapacity to contract, or to sue on a contract, comes to an
end when the sentence expires. Also, the convict does not suffer from the rigors
of the Law of Limitation as the period of the sentence is not included in the
lapsed time frame.
4. Free Consent
The fourth essential element of a valid contract is free consent. Consent is said to be
free when it is not caused by any of the following:
a. Coercion (Section 15)
Coercion is the committing or threatening to commit any act forbidden by the Indian
Penal Code, or unlawful detaining or threatening to detain, any property to the prejudice
of any person whatever with the intention of causing any person to enter into an
agreement. Unlawful detaining or threatening to detain any property is also an instance
of coercion. Threatening at gun-point, threatening to commit suicide and refusing to
hand over the account books of a business to an agent are some of the instances which
amount to coercion. The party whose consent is obtained by coercion has the right to
avoid performance of the contract. In Ranganayakamma vs. Alwar Setti the question
before the court was regarding the validity of the adoption of a boy by a widow aged 13
years. In the given case, the husbands dead body was not allowed to be removed for
cremation until the widow adopted the boy. It was held that the adoption was brought
about by coercion and was not binding.
b. Undue Influence (Section 16)
Undue influence is defined as follows: 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 that position to obtain
an unfair advantage over the other. It is to be noted that the emphasis is on the ability to
dominate the will of another. Such ability is said to be existing in cases, where a person:
1. Holds a real or apparent authority over the other. For example, income tax
authority and assessee, police and accused;
2. Stands in a fiduciary relation (relation of trust and confidence). Fiduciary
relationship implies a relationship of confidence and trust. Examples of fiduciary
relationship are solicitor and client, spiritual adviser and devotee, husband and
wife.

29

3. Makes a contract with a person whose mental capacity is temporarily or

permanently affected by reason of age, illness or mental or bodily distress. The
unconscientious use by one person of power possessed by him over another in
order to induce the other party to enter into a contract is referred as moral
coercion and is considered as a form of undue influence. In Lakshmi Amma vs.
Telengala, the executant who was aged and suffering from diabetes made a deed
of settlement of the entire property in favor of one of his grandsons to the
exclusion of his wife, his children and other grand children. The person in
whose favor the deed was made was unable to prove that the executant had
executed the deed without any external pressure while he was not of infirm mind
and was fully aware of the dispositions. The court held the settlement deed to be
invalid.
The following relationships raise the assumptions of undue influence:

Parent and child,

Guardian and ward,

Trustee and beneficiary,

Religious advisers and disciple,

Doctor and patient,

Solicitor and client, and

Fiance and fiancee.

c. Misrepresentation (Section 18)

Misrepresentation is the innocent or unconscious presentation of wrong facts by one
party which are taken into account by other party before entering into a contract. The
person making such a misrepresentation honestly believes that such statement is true.
Section 18 defines misrepresentation to be existing.
1. When a person positively asserts that a fact is true when his information does not
warrant it to be so, though he believes it to be so.
2. When there is any breach of duty by a person which brings an advantage to the
person committing it by misleading another to his prejudice.
3. When a party causes, however innocently, the other party to the agreement to
make a mistake as to the substance of the thing which is the subject of the
agreement.
d. Fraud (Section 17)
Fraud means and includes any of the following acts committed by a party to a contract,
or with his connivance (intentional active or passive acquiescence) or by his agent with
intent to deceive or to induce a person to enter into a contract.
The essential ingredients of fraud as contemplated by subsection (1) are as under:
1. There must be a False Representation of a Material Fact.

30

2. The Representation should be made with Knowledge of its Falsity.

3. The Other Party should have been induced to Enter into the Contract based on
the False Representation.
4. The Other Party should have relied upon the False Representation and should
have been deceived.
5. LAWFUL CONSIDERATION:
Consideration is an important element of a contract. In day to day life, quite often
promises are made without giving them a thought. In order to make an agreement
enforceable, law requires such agreements barring a few exceptions, to be backed by
consideration.
Consideration may be of following kinds:
i.Executory or future consideration, in return of a promise which is to be fulfilled
in future.
ii.Executed or present in which it is an act or forbearance made or suffered for a
promise. For example, in a cash sale, consideration is present or executed.
iii.Past consideration is the one which pays for a past act or forbearance. An act
constituting consideration which took place and is complete before the promise
is made.
As per Section 23, there has to be a lawful consideration for a legal object in every
contract. Hence, the following aspects should not exist in case of consideration and object
for the contract to be declared as legal and binding.
1. It should not be Forbidden by Law:
2. Performance should not Defeat the Provisions of any Law
3. It should not be Fraudulent
4. It should not be Considered Immoral

6. LEGAL OBJECT. The sixth essential element of a valid contract is legal object. By
object it is to mean the purpose of the contract. Contracts with unlawful objects are
void.
7. CERTAINTY AND POSSIBILITY OF PERFORMANCE: the agreements in
which the meaning is not certain, or is not capable of being made certain, are void. The
uncertainty may exist because of quality, quantity, price or title of the subject matter.
The terms of contract should be certain. In Keshavlal Lallubhai Patel vs. Lalbhai
Trikumlal Mills Limited, the workers of the respondent Mill went on a strike expressing
their support to the Quit India Movement. As a result, the respondent mill was closed
and could not supply the textile goods to the appellants as agreed. In a letter seeking
extension of time the respondent mill cited the reason for the failure to supply goods
and stated that the delivery time of the goods stands extended until the normal state of
affairs is restored.

31

In Guthing vs. Lynn, the buyer of a horse agreed to pay 5 pounds extra, if the horse
proved to be lucky. The agreement was held to be void for uncertainty. The definition
of void agreements includes the wager agreements. Section 30 defines wager as an
agreement between the parties by which one promises to pay money or moneys worth
on the happening of some uncertain event in consideration of the other parties promise
to pay if the event does not happen.
3.4 RESTITUTION
When a contract becomes void, any benefit derived out of the contract by one party is
required to be restored to the other. It is significant to note that the law of restitution
covers only benefits received and not losses incurred. The principle of restitution is that
the defendant who has been unjustly enriched at the expense of the plaintiff is required
to make restitution to the plaintiff. There cannot be restitution where the parties are
wholly incompetent to contract (where one of the parties is minor). Section 65 which
deals with restitution applies to contracts discovered to be void and contracts which
become void. A person who has received a benefit under any such contract will have to
restore the benefit to the person from whom it was received. In Dharamsey vs.
Ahmedbhai, a person hired a godown for a period of 12 months by paying an advance
for the entire period. When a fire broke out in the godown he was entitled to claim a
proportionate amount of rent paid in advance.
3.5CONTINGENT CONTRACTS:
Section 31 of the Act provides for such contracts and defines it as a contract to do or not
to do something, if some event, collateral to such contract, does or does not happen. In
Muthu vs. Secretary of State, a person was the highest bidder for a house which was put
up for sale. However, one of the conditions was that the sale could be confirmed only if
the Collector authorizes it. The Collector declined to confirm the sale. It was held that
there was no contract.
The event on which the happening of the contract is dependent should be uncertain.
Further, the event should be collateral to the contract. The event should not form part of
the consideration of the contract though the contract is made to depend upon it. Contracts
of indemnity and insurance are examples of contingent contracts.
3.6 PERSONS WHO ARE REQUIRED TO PERFORM CONTRACTS
Where personal considerations form the basis of a contract, the promisor alone should
perform the contract. Where personal considerations do not form the basis of a contract,
then the contract may be performed by the promisor or his agent or legal representatives
of the promisor in the event of his death.

Time and Place of Performance

32

A contract, which does not specify the time for performance should be performed
within a reasonable time.
When a promise is to be performed on a certain day, and the promisor has undertaken to
perform it, without application by the promisee, the promisor may perform it at any
time during the usual hours of business on such day and at the place at which the
promise ought to be performed.
When a promise is to be performed on a certain day, and the promisor has not
undertaken to perform it, without application by the promisee, it is the duty of the
promisee to apply for performance at a proper place and within the usual hours of
business.
A contract should be performed in the manner and at the time prescribed in the contract.
Devolution of Joint Rights and Liabilities
Where a joint promise is made, the promisee may compel any one of the joint promisors
to perform the whole of the promise. The joint promisor, who performs the contract
may claim contribution from the other joint promisors. Where any of the joint
promisors defaults in making his contribution, then the other joint promisors will have
to bear even the defaulted amount equally.
Appropriation of Payments
Where several debts are owed and where payment made is insufficient to discharge the
debt, the debtor may intimate the creditor as to the nature of appropriation. In such a case,
the creditor should follow the directions issued by the debtor.
Assignment of Contracts
Assignment of a contract means the transfer of rights and liabilities arising out of the
contract in favor of a third person either with or without the concurrence of other party
to a contract.
An assignment may take place either by the act of the parties or by operation of law.
3.7 DISCHARGE OF CONTRACT
We now come to the last stage of contracts. A contract is said to be discharged when the
rights and liabilities created by such contract come to an end. Contracts may be
discharged or terminated by:
1.
2.
3.
4.
5.
6.

Performance of the contract, or

By mutual consent, or
By lapse of time (by limitation), or
By operation of law, or
Impossibility of performance, or
By breach of contract.

Each of the various modes of discharge of contract are explained below:

33

1. Performance of Contract: The most obvious and meaningful way to discharge

a contract is to fulfill the terms and conditions agreed by each of the parties in the
contract. Section 38 provides for tender of performance. As per this section if the
promisor offers to perform his side of the contract, but the promisee does not
accept his performance the promisor is discharged from his liability. This is known
as attempted performance. The promisor may sue the promisee for the breach of
contract, if he so desires.
2. Discharge

by Mutual Agreement or Consent: The contract may be terminated

by mutual consent of both the contracting parties. Various cases of discharge by
mutual agreement are specified in Section 62 and Section 63. Section 62 provides
about the effect of novation as to where a new contract is substituted for an
existing contract by mutual agreement of both the parties, the new contract is
basically agreed upon to adjust the remedial rights arising out of the breach of the
old contract.
3. Discharge

by Lapse of Time: Any contract cannot be extended indefinitely.

The Limitation Act, 1963 provides for a certain time frame within which the
contract has to be performed (called period of limitation). If no action is taken by
the contracting parties within the period of limitation, no remedy at law will be
available. It provides for a definite time frame within which, the deprived party
may seek remedy at law.
4. Discharge

by Operation of Law: A contract may be discharged by the

operation of law in any of the following ways:
i. By Merger: When the parties agree to include the previous inferior contract
in a superior contract.
ii. Law does not permit any unauthorized alteration of the terms of a written
agreement. Any such act by any one of the parties will automatically make
the contract as discharged by operation of law.
iii. By Insolvency: When a person is adjudged insolvent, he is discharged from
all liabilities incurred prior to his adjudication.
iv. Death: Where a contract is entered into, based on personal consideration and
where it is required that performance of the contract should be made by the
promisor in person, the contract will be discharged on the death of the
promisor.
Discharge by Impossibility of Performance: A contract which is clearly
impossible to perform is discharged. A contract which has its subject as an act,
which is impracticable to perform by either of the parties is assumed to be
impossible to perform and hence the contract is discharged. Section 56 states that a
contract which is made impossible to perform due to subsequent changes is taken as
void and hence discharged. This is known as, supervening impossibility or
supervening illegality.
5.

Discharge by Breach of Contract: Breach of contract is often referred as the

easiest way of discharging a contract. When either of the parties does not fulfill
the duties and liabilities prescribed by the contract, the contract is said to be
breached. There are two types of breach of contract:
6.

34

i. Actual breach of contract. Actual Breach of contract may take place in two
instances:
a.

When the performance is actually due

b.

During the actual performance of the contract.

ii. Anticipatory breach of contract. Anticipatory breach of contract is stated to

have occurred if a breach has been committed before the time for performance.
When a party explicitly denies or abstains from performing the contract or does
some definite act, which makes the performance impossible, then such a breach is
an anticipatory breach of contract.
3.8 REMEDIES FOR BREACH OF CONTRACT
The following alternatives are available for the injured party in case of a breach of
contract.
a) Rescission: The injured party can rescind the contract and refuse the performance of
contract.
b) Restitution: As per Section 65, when a party treats the contract as rescinded, he
makes himself liable to restore any benefits that he has received, under the contract to
the party from whom such benefits were received. The court may refuse to rescind the
contract where the plaintiff has expressly or impliedly ratified the contract or where
only a part of the contract is sought and such part is not severable from the rest of the
contract. Section 75 provides relief to the person who sustains damages through nonfulfillment of the contract by entitling him to claim compensation for the same.
c) Claim Damages: Section 73 deals with the compensation for loss or damage caused
by breach of contract. The foundation of the claim for damages rests in the celebrated
case of Hadley vs. Baxendale (1854). The facts of the case are: A delivered a defective
shaft in his mill to B, a manufacturer, for making a new shaft-identical to the one that
is sent. A did not make known to B that delay would result in loss of profits. B by
his neglect delayed the delivery of the shaft beyond a reasonable time. As a result the
mill was idle for a longer period than it would otherwise have been, had there been no
such delay. It was held, B was not liable for the loss of profits during the period of
delay as the circumstances communicated to A did not show that the delay in the
delivery of the shaft would entail loss of profits to the mill. Damages cannot be awarded
if the injured party did not take any reasonable steps for the loss to be avoided. Section
74 allows for agreement of a sum to be paid as damages in case of breach of such
contract. If the contract contains any stipulation by way of a penalty for failure to
perform the obligations, the aggrieved party is entitled to receive from the party who
has broken the contract. The damages are classified into four categories:
i. General or Ordinary Damages: These are damages which naturally arise in the usual
course of things from such breach.

35

General Damages are usually assessed based on the actual loss suffered. The main aim
of providing general damages is to compensate the aggrieved party and not to punish the
party which is at fault.
ii Special Damages: These are awarded from a breach of contract under some peculiar
circumstances. At the time of entering into the contract the party has notice of special
circumstances, which makes special loss, the likely result of the breach in the ordinary
course of things. These are the damages which are claimed in addition to the damages
arising from the breach of contract.
In Simpson vs. London and N W Rail Co, Simpson entrusted a few specimens of his
goods to an agent of a railway company in order that the same be delivered at New
Castle where an agricultural show was to be held. The consignment note clearly
specified that the delivery was to be made in time. Because of default by the railway
company, the samples arrived late for the show. It was held that Simpson could claim
damages for loss of profits.
iii Vindictive or Exemplary Damages: These are discouraged by court of law.
However, in case of breach of a promise to marry and dishonor of cheque by banker
wrongfully when he possesses sufficient funds to the credit of the customer, exemplary
damages are awarded.
iv Nominal Damages: These are awarded merely to acknowledge that the plaintiff has
proved his case. Nominal damages are not awarded to compensate for the damages.
3.9 QUASI-CONTRACTS
Such type of contract where there is no element of contract but still it is considered as
contract is referred as quasi-contract. Quasi-contracts rest on the equitable principle that
a person shall not be allowed to enrich himself unjustly at the expense of another.
The Indian Contract Act provides for the following types of quasi-contracts:
a. Necessaries supplied to a person incapable of contracting or to anyone who is legally
bound to support. The persons who are incapable to contract may be minors and persons
of unsound mind.
b. Payment by an interested person on behalf of the actual party in pursuance of his own
interests is required to be reimbursed by the other party.
c. If any person lawfully does anything for another person without any intention to do it
gratuitously, such other person, has to reimburse the amount as per Section 70, though
there is no formal contract for such an act. This section does not apply to persons who
have no a capacity to contract.

36

Case: In Damodar Mudaliar vs. Secretary of State for India, the Government undertook
the repairs of an irrigation tank which was owned jointly by the Government and a
Zamindar. Later, the Government sued the zamindar for his share of the repairs. It was
held that the Government had carried out repairs not intending to do so gratuitously and
hence the zamindar was liable to pay compensation.
MULTIPLE CHOICE QUESTIONS:
Q1 Which of the following statements is false?
a) Consideration must be received by all the joint promisors, to bind the other joint
promisors.
b) Consideration may move from promisee or any othe r person.
c) Consideration may be an act, abstinence or forbearance or a return promise.
d) Consideration must be real
Q2 Which of the following offers constitute a valid offer?
a) An auctioneer displays a T.V. set before a gathering in an auction sale.
b) Shyam advertises in a newspaper that he would pay Rs 5000 to anyone, who
finds out & returns his lost briefcase contaning valuables.
c) Ram who is in a possession of three cars purchased in different years says I
will sell you a car
d) Ram communicates to Shyam that he will sell his car for Rs 1,50,000.
Q3 Anil aged 17 years, borrowed money from a moneylender by representing himself to
be of 21 years
a.
b.
c.
d.

Anil can be sued for fraud;

Anil can not be sued for fraud
Anil is liable to replay the amount
Guardian of Anil is liable to repay the amount

Q4 Which of the following is not a flaw in a contract?

a.
b.
c.
d.

Inadequacy of consideration
Wager in nature
Illegal object
Uncertainty of object

Q5 An agreement made under coercion, renders the contract

a.
b.
c.
d.

Valid
Void
Voidable
illegal

37

Q6 The type of damages awarded in case of breach of a promise to marry is

a. No damages
b.General damages
c. Nominal damages
d.Exemplary damages
Q7 Which of the following relationships does not raise presumption of undue influence?
a. Trustee & beneficiary
b.Doctor & patient
c. Solicitor & client
d.Landlord tenant
Q8 The contract entered with a lunatic during the times of his sound mind is
(a)
(b)
(c)
(d)

Valid
Void
Void abinitio
voidable

Q9 A accepts Bs invitation to dinner by phone. This is not a contract as

(a)
(b)
(c)
(d)

There is no consensus between the two parties

Acceptance is given orally
There is no intention to create a legal relationship
Both (b) & (c) above

Q10 A agreed to sell his car to B. His consent was given at gun point. This contract
is void as it involves
(a)
(b)
(c)
(d)

Undue influence
Compulsion
Coercion
extortion

38

CHAPTER 4 SPECIAL CONTRACTS

After reading this lesson, you will be conversant with:
4.1 Contracts Of Indemnity
4.2 Contracts Of Guarantee
4.3 Kinds Of Guarantee
4.4 Consideration Of Guarantee
4.5 Suretys Liability
4.6 Limitation Of Suretys Liability
4.7 Rights Of The Surety
4.8 Discharge Of Surety
4.9 Bailment & Pledge
4.10 Duties Of A Bailor
4.11 Duties Of Bailee
4.12 Rights Of Finder Of Goods
4.13 Termination Of Bailment
4.14 Pledge
4.15 Rights And Duties Of Pawnee
4.16 Rights And Duties Of Pawnor
4.17 Contract Of Agency
4.18 Agent
4.19 Classification Of Agents
4.20 Duties Of Agent
4.21 Rights Of Agent
4.22 Duties Of Principle To Agent
4.23 Rights Of Principal
4.24 Termination Of Agency
4.25 Irrevocable Agency

4.1 CONTRACTS OF INDEMNITY

According to Section 124, 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 a contract of indemnity. The person who promises or
makes good the loss is called the indemnifier (promisor) and the person whose loss
is to be made good is called the indemnified or indemnity holder (promisee).
A contract of insurance is an example of a contract of indemnity according to
English Law. In consideration of a premium the insurer promises to make good the
loss suffered by the assured on account of the destruction by fire of his property
insured against fire. However, a contract of life insurance does not come under the
category of a contract of indemnity. This is because, in the case of life insurance, the
insurer agrees to pay a certain sum of money either on the death of a person or on the
expiry of a stipulated period of time. The question of having suffered a loss does not

39

arise. Moreover, as the life of a person cannot be valued, the whole of the sum
assured becomes payable and for that reason also it is not a contract of indemnity.
The contract of indemnity in a real sense is a contingent contract. It must have all
essentials of valid contract. It can be expressed or implied. It is relevant to discuss
following cases in this regard:

The case of Goulston Discount Co. Ltd. vs Clark (1967), is an explicit example
of
express
contract
of
indemnity.
A and B go into a shop. B says to the shopkeeper let him (A) have the
goods, I will see you paid. The contract is one of indemnity.

The case of Adamson vs Jarvis (1927) explains an implied contract of

indemnity.
A on the instruction of T, sold certain cattle belonging to O. O held A
liable for it and recovered damages from him for selling it. It was held that A
could recover the loss from T, as a promise by T to A from any such loss
would be implied from his conduct in asking A to sell the cattle.

The definition given in Sections 124 and is 125 of the Contract Act are not
exhaustive of the law of indemnity as it does not include implied promises to
indemnify and cases where loss arises from accidents and events that are not
depending on the conduct of the promisor or any other person.
Certain rights have been granted to the indemnity holder under Section 125.
Rights of Indemnity Holder When Sued
The promisee in a contract of indemnity, acting within the scope of his authority, is
entitled to recover from the promisor:
a.

all damages within the scope of the terms of the indemnity;

b.
all costs which he may be compelled to pay in any such suit if, in bringing
or defending it, he did not contravene the orders of the promisor, and acted as it
would have been prudent for him to act in the absence of any contract of
indemnity, or if the indemnifier authorized him to bring or defend the suit; and
c.
all sums to be paid under the terms of any compromise of any such
suit, provided the compromise is not contrary to the orders of the
indemnifier, and should be authorized by him.
Though the Indian Contract Act does not grant specific rights to the indemnifier, we can
however, as in English Law, draw the rights of the indemnifier to be the same as those of
the surety which are detailed in the foregoing parts.
The Indian Contract Act does not specify the time of commencement of the indemnifiers
liability. Different courts have been following different rules with regard to this. Some
courts contend that the indemnifiers liability will begin only when the indemnity holder
actually suffers a loss. On the other hand, some have held that an indemnity holder may
compel an indemnifier to fulfill his promise even before actually incurring the loss. Buckley
L J in Richardson, ex parte etc. made the following observation Indemnity is not given by
repayment after payment. Indemnity requires that the party to be indemnified shall never
be called upon to pay.

40

4.2 CONTRACTS OF GUARANTEE

Section 126 deals with contract of guarantee. According to this Section 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.
The purpose of a contract of guarantee is to provide additional security to the creditor in
the event of default by the principal debtor. In a contract of guarantee, there are three
parties, i.e., the creditor, the debtor and the surety. Also, there are three contracts in a
contract of guarantee (i.e., between the creditor and the debtor, between the creditor and
the surety and between the debtor and the surety).
It should also be noted that a contract of guarantee presupposes the existence of a debt.
If there is no existing liability, there cannot be a guarantee. Therefore, if the debt to be
guaranteed is already time barred, guarantee given will not be valid and the surety will
be discharged from his liability.
4.3 KINDS OF GUARANTEE
A guarantee may be given retrospectively for an existing debt, or for future debt, or for
the good conduct or honesty of an employee, in which case the guarantee is called a
fidelity guarantee.
A guarantee may also be specific or continuing guarantee. A specific guarantee is one
which is given for a specific debt, and comes to an end when the debt is paid. A
continuing guarantee relates to a series of transactions where the surety remains liable
for a fixed sum till the continuance of guarantee. However, a continuing guarantee can
be revoked by the surety by giving due notice to the creditor. This can be explained by
referring to the case Wingfield vs de St Croix. In this case, the creditor (C) let out his
cottage to the principal debtor (P) on the condition that rent would be paid initially for
three months and thereafter from week to week. S, who was the surety guaranteed the
payment of rentals by P to C. After four months, the surety revoked his guarantee by
giving notice to the creditor. It was held that the surety was not liable for the rentals
which became due after revocation of the guarantee. The death of a surety also results in
revocation of continuing guarantee as far as future transactions are concerned.
A continuing guarantee may also be revoked by any of the modes:
a. novation;
b. variance in the terms of the contract;
c. discharge of the principal debtor;
d. compounding with the principal debtor;
e. creditors act or omission impairing suretys eventual remedy; and
f. loss of security.
The following illustration discusses the case of continuing guarantee: A, in
consideration that B will employ C in collecting the rents of Bs zamindari,
41

promises B to be responsible, to the amount of Rs.5,000 for the due collection and
payment by C of those rents. This is a continuing guarantee.
Just like other contracts, a contract of guarantee should also be supported by
consideration. Inadequacy of consideration is not a criterion to judge the validity of a
contract of guarantee. The only requirement is that there should be some consideration.
Further, it is not necessary that consideration should have passed between the creditor
and the surety. It is sufficient that the creditor has done something for the benefit of the
debtor. Past consideration will not be treated as good consideration for a contract of
guarantee.
4.4 CONSIDERATION OF GUARANTEE
Anything done, or any promise made, for the benefit of the principal debtor, may be a
sufficient consideration to the surety for giving the guarantee.
It is relevant to discuss following illustrations in this regard: B requests A to sell and
deliver to him goods on credit. A agrees to do so, provided C will guarantee the
payment of the price of the goods. C promises to guarantee the payment in consideration
of As promise to deliver the goods. This is a sufficient consideration of Cs promise.
A sells and delivers goods to B. C afterwards, without consideration agrees to pay
for them in default of B. The agreement is void.
In a contract of guarantee it is not necessary that all the material facts be disclosed
unless it is in nature of an insurance. In other words a contract of guarantee is not a
contract of Uberrimae Fidei.
The following case aptly describes this. London General Omnibus Co. vs. Holloway
(1912) C engaged P as a clerk to collect money for him. P misappropriated some of Cs
receipts and failed to account for them. This sum was made good by Ps relations and C
agreed to retain P in his service on having a fidelity guarantee. S gave his guarantee for
Ps duly accounting. C did not acquaint S with Ps previous dishonesty. Held, the
guarantee could not be enforced against S owing to the non-disclosure of Ps previous
dishonesty.
4.5 SURETYS LIABILITY
According to Section 128, the liability of the surety is co-extensive with that of the
principle debtor, unless otherwise provided by the contract.
The liability of the surety is normally to the same extent as that of the principal debtor.
The surety cannot however, be made liable beyond what he had earlier contracted to. The
surety may however, limit his liability to a part of the entire debt. The extent of liability
of a surety assumes importance when the principal debtor is declared insolvent.
A reduction in the liability of the principal debtor (for example, after the creditor has
recovered a part of the sum due from him out of his property) will result in a
proportionate scaling down of the suretys liability. In Narayan Singh vs Chattarsingh,
it was held that if the principal debtors liability is either reduced or extinguished in
part/whole, the suretys liability will also be proportionately reduced or extinguished in
part/whole. In the given case, the debt owed by an agriculturist was reduced by virtue
of a statute. The suretys liability was also reduced proportionately as it was held that if
42

the surety is made liable to pay the entire amount, he would recover the same from the
principal debtor which would in turn negate the benefit conferred upon the agriculturist.
It should, however, be noted that any illegality attached to the principal debtors
liability will in turn affect the liability of the surety. Hence, where the principal debtors
liability becomes unenforceable because of illegality, the surety cannot be made liable
on the said debt.
If the principal debtor defaults in making payment it is up to the creditor to proceed
against either the principal debtor or the surety or both of them. Unless otherwise
provided by the contract, the creditor can sue the surety without exhausting all his
remedies against the principal debtor. In Bank of Bihar vs Damodar Prasad, the
plaintiff bank advanced a loan to Damodar Prasad which was guaranteed by Paras Nath
Sinha. In spite of repeated demands, both the principal debtor and the surety failed to
make repayment. The plaintiff then, filed a suit against both the debtor and the surety. A
decree was passed in favor of the bank with the condition that the bank could proceed
against the surety only after exhausting all its remedies against the principal debtor. On
an appeal made by the bank, the Supreme Court, set aside the decree and allowed the
bank to enforce its claim against the surety immediately, without first exhausting its
remedies against the principal debtor.
It may be stated here that, the liability of a surety is an independent contract by itself.
Therefore, in case the contract between the creditor and principal becomes void or
voidable, the surety is however not discharged of his liability. Unless it has been
specifically provided in the contract that the suretys liability arises only when the
principal debtor is made liable, the surety continues to be liable in the given instances:
death of the principal debtor;
discharge of the principal debtors liability by operation of law;
creditors failure to sue the principal debtor within the period of limitation, and
release of one of the co-sureties by the creditor.
4.6 LIMITATION OF SURETYS LIABILITY
Sometimes a surety may limit his liability by providing guarantee only for a part of the
entire debt or may provide guarantee for the entire debt subject to a limit. The
difference between the two may be explained with the help of an example. Arun owes
Prem Rs.8,000 on a continuing guarantee given by Srinath. Srinath may have given this
guarantee in either of the following ways:
a.

I guarantee the payment of the debt of Rs.5,000 by Arun to Prem; and

b.
I guarantee the payment of any amount lent by Prem to Arun subject to
a limit of Rs.5,000.
In the first instance, the guarantee given is restricted to a part of the debt whereas in the
second instance the guarantee given is for the entire debt subject to a limit. As earlier
discussed the distinction becomes important in case the debtor is declared insolvent. In
the given example assume that Arun is declared insolvent and his estate pays a dividend
of 25 paise in a rupee.

43

This will result in the following consequences:

a.
where guarantee is given for a part of the debt. Here, Prem will be able
to recover Rs.5,000 from Srinath (surety) and Rs.750 (1/4th of the balance of
Rs.3,000) from Aruns estate. After making the payment, Srinath (surety) steps
in the shoes of the creditor and can recover Rs.1,250 (i.e., 1/4th of Rs.5,000)
from Aruns estate.
b.
where guarantee is given for the entire debt subject to a limit, Prem will
succeed in recovering Rs.5,000 from Srinath (i.e., the guaranteed amount) and
Rs.2,000 (1/4th of the entire debt of Rs.8,000) from Aruns estate. Srinath will
not get any dividend from Aruns estate till the full amount of Rs.8,000 is paid
to Prem.
4.7 RIGHTS OF THE SURETY
a. Right against the Creditor:
The surety can exercise the following two rights against the creditor:
a.
Section 141 provides that a surety is entitled to all the securities of the
principal debtor in the possession of the creditor at the time when the contract of
surety is entered into. This right can be exercised by the surety irrespective of
whether he is aware of the existence of the security or not.
b.
Secondly, in case the creditor loses or parts with the security without the
consent of the surety, then the surety is discharged to the extent of the value of
the security.
b. Rights against the Principal Debtor
According to Section 140 of the Contract Act, soon after discharging the liability of the
principal debtor, the surety steps into the shoes of the creditor and can exercise all the
rights which the creditor himself would have exercised against the principal debtor.
This right of the surety is called the right of subrogation.
c. Right to Indemnity
According to Section 145, in every contract of guarantee there is an implied promise by
the principal debtor to indemnify the surety, and the surety is entitled to recover from
the principal debtor whatever sum he has rightfully paid under the guarantee, but no
sums which he has paid wrongfully. Thus a surety is entitled to full indemnification
(i.e., he can recover not only the amount paid to the creditor but also any interest
thereon).
However, Section 145 lays down certain restrictions as to what the surety can claim.
a.
A surety can claim only that amount which he has actually paid to the
creditor.
44

b.

He cannot claim amounts paid by him negligently or wrongfully.

d. Suretys Right to Sue

i.A suit can be filed to declare that the debtor shall be the person liable to pay
debt before the payment of principal debt and on the payment of the principal
debt the surety will be placed in the position of the creditor.
ii.Rights of surety on payment or performance: Where a guaranteed debt has
become due, or default of the principal debtor to perform a guaranteed duty has
taken place, the surety, upon payment or performance of all that he is liable for,
is invested with all the rights which the creditor had against the principal debtor
(Section 140). He is also entitled to recover from the principal debtor whatever
sum he has rightfully paid under the guarantee, but no sums which he has paid
wrongfully (Section 145).
The following illustration aptly discusses this: F is indebted to E and N is
surety for the debt. E demands payment from N and, on his refusal, sues him
for the amount. N defends the suit, having reasonable grounds for doing so, but
is compelled to pay the amount of the debt with costs. He can recover from F the
amount paid by him for costs, as well as the principal debt.
iii.Suretys rights against the co-sureties: When a surety has paid more than
his share of debt to the creditor, he has a right of contribution from the co sureties who are equally bound with him in absence of any agreement to the
contrary. If they are bound in different sums, they are liable to pay equally as
far as the limits of their respective obligations permit (Section 147). As
between co-sureties, there is equality of burden and benefit.
A, B and C are sureties for a debt due by D to E. A restricts his liability
to Rs.10,000, B to Rs.20,000 and C to Rs.40,000. D makes default to the
extent of Rs.30,000. In such an event, A, B and C will be liable to the extent
of Rs.10,000 each. The position varies in case D makes default to the extent of
Rs.40,000. A shall then be liable to pay Rs.10,000 and B and C Rs.15,000
each.
4.8 DISCHARGE OF SURETY
Surety is Discharged from Liability:
i.

By Revocation:

A continuing guarantee can be revoked by the surety any time by giving notice to the
creditor. A notice given, discharges the liability of the surety with respect to all future
transactions. However, the surety will remain liable for those transactions prior to the
revocation.
ii by Conduct of the Creditor:

45

Any variance made without the suretys consent, in the terms of the contract between
the principal debtor and the creditor, the surety is automatically discharged from
liability as the subsequent transaction is at variance.
The following illustration aptly discusses this: S guaranteed C against the
misconduct of P in an office to which P is appointed by C and of which the duties
are defined by an Act of the legislature. By a subsequent Act, the nature of the office is
materially altered. Afterwards, P misconducts himself in respect of a duty not
affected by the latter Act. S is discharged by the change from future liability under his
guarantee.
iii By Invalidation of Contract:

A guarantee obtained by means of either misrepresentation or concealment of material

fact which the creditor was aware of, at the time of entering into the contract,
invalidates the guarantee and discharges the surety.

Where there is no consideration between the creditor and the principal debtor, the
surety is discharged.

Where a person gives guarantee on the condition that the creditor shall not act upon it
until another person joins in as co-surety, the guarantee is not valid if that other
person does not join.

4.9 BAILMENT & PLEDGE

Bailment and Pledge are special types of contracts which are regulated by Sections 148
to 181 of the Indian Contract Act, 1872. The word bailment takes its roots from the
French word bailor which means to deliver.
According to Section 148, 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 the bailee.
The following case and illustrations explain the concept of bailment clearly.
N R Srinivasa Iyer vs New India Assurance Co. Ltd. (1983)
An insurance company places a damaged insured car of A in possession of R, a
repairer. A is the bailor, the insurance company is the bailee, and R is the
sub-bailee. It is not necessary that a contract be entered for a bailor and bailee
relationship to be formed.
Essentials of a bailment can be summarized as under:
a.
Firstly, there should be delivery of goods for some purpose. The delivery
of goods should not be accompanied by transfer of ownership.

46

b.
Secondly, the goods should either be returned to the bailor after the
purpose has been accomplished or it should be disposed of according to the
bailors directions.
Classification of Bailment
Bailments may be for,
i.

exclusive benefit of the bailor;

ii.

exclusive benefit of the bailee;

iii.

mutual benefit of the bailor and the bailee;

iv.

gratuitous bailment; where there is no consideration between the parties; and

v.

non-gratuitous bailment or bailment for reward.

Duties and Rights of Bailor and Bailee

4.10 DUTIES OF A BAILOR
I. The bailor is bound to disclose, all the faults in the goods bailed to the bailee, of
which the bailor is aware, and that which materially interferes with the use of the
goods, or exposes the bailee to extraordinary risks. If he does not make such
disclosure, he is responsible for damage arising to the bailee directly from such
faults.
II. In a contract of bailment, the bailee will have to bear all the ordinary expenses
incurred, while the bailor will be responsible for any extraordinary expenses
incurred by virtue of the bailment. In case of a gratuitous bailment, it is the duty
of the bailor to bear the ordinary and reasonable expenses incurred by the
bailee.
III. The bailor is responsible to the bailee for any loss sustained by him in the
following instances:

Where the bailor is not entitled to make the bailment, or to receive back
the goods, or to give directions, regarding them.

Premature termination of a gratuitous bailment.

IV. It is the duty of bailor to receive back the goods after the purpose is achieved.
Rights of Bailor
i.The bailor is entitled to file a suit for enforcing all the liabilities or duties of the
bailee.
ii.The bailor can terminate the bailment if the bailee does, with regard to the goods
bailed, any act which is inconsistent with the terms of the bailment (Section
153).
iii.emand return of goods lent gratuitously.

47

iv.The bailor can sue a third party who by his act causes any injury or deprives the
bailee the possession and use of goods bailed.
4.11 DUTIES OF BAILEE
I. The bailee is duty bound to take reasonable care of the goods bailed, as he
would in similar circumstances take care of his own goods. According to
Section 151, the bailee should take such care of the goods as a man of ordinary
prudence would take of his own goods. If the bailee has not acted in a prudent
manner, he cannot be excused by pleading that he had taken similar care of his
own goods also, and his goods, have also been lost or damaged along with those
of the bailor, or that the bailor had the knowledge that his goods were being kept
in a negligent manner.
II. The bailee should not make any unauthorized use of goods.
III. The bailee should not mix the goods of the bailor with his own goods, but keep
them
separate
from
his
own
goods.
Where the bailee mixes the bailors goods with those of his own with the bailors
consent, then the bailor and the bailee shall have an interest in the mixed goods in
proportion to their respective shares.
Where he mixes the goods without the consent of the bailor, two possibilities may
arise:

The goods can be separated.

The goods cannot be separated

Where the goods can be separated: Where the goods of the bailor and the bailee
can be separated, then they will remain the owners in accordance with their
respective shares. However, the costs of separation as well as any damage arising
from the mixture will have to be borne by the bailee.
When the goods cannot be separated: The bailor can recover damages from the
bailee for the loss of the goods.
If, by mistake on the part of the bailee or by accident or by an act of God or by the
act of an unauthorized third party, goods of the bailor get mixed up with like
goods of the bailee, then the mixture belongs to the bailor and bailee in proportion
to their shares but the cost of separation will have to be borne by the bailee.
IV. The bailee should not set up an adverse title of the goods bailed claiming them
to be his.
V. The bailee not only has to return the goods bailed but also any accretion to the
goods.
Rights of Bailee
The duties of the bailor are the rights of the bailee:
i.

Delivery of goods to one of several joint bailors of goods.

48

According to Section 165, in case of several joint owners of goods, the bailee
may deliver them back to or according to the directions of, one joint owner
without the consent of all, in the absence of any agreement to the contrary.
ii.

Delivery of goods to bailor without title.

According to Section 166, if the bailor has no title to the goods, and the bailee, in
good faith, delivers them back to, or according to the directions of, the bailor, the
bailee is not responsible to the owner in respect of such delivery.
iii.Right to apply to court to stop delivery, where it is claimed by a person other
than the bailor.
According to Section 167, if a person other than the bailor, claims the goods
bailed, the bailee may apply to the court to stop the delivery of the goods to the
bailor, and to decide the title to the goods.

iv.

Right of action against trespassers.

According to Section 180, if a third person wrongfully deprives the bailee of the
use or possession of the goods bailed to him, he has the right to bring an action
against that party. The bailor can also bring a suit in respect of the goods bailed.
In Purushottam Das Banarsi Das vs Union of India delivery of certain goods
were obtained by a person on a forged railway receipt. The said person later
pledged the goods with a third party. It was held that the railway authorities could
recover the same from the third party.
v.The bailee is also entitled to recover necessary expenses incurred on bailment.
He can also recover compensation from the bailor in case he incurs a loss owing
to the defective title of the bailor.

vi.

Retain the goods (lien) till his dues are paid, in other words the bailee can
exercise a general lien. The bailee may also exercise a particular lien when the
contract requires him to use his skills.

4.12 RIGHTS OF FINDER OF GOODS

When a person finds an article and takes it into his custody, he assumes the role of a
bailee. He then has the same responsibilities like any other bailee.
We shall now discuss the rights available to him:
i.According to Section 168, the finder of goods can exercise lien over the goods
till the owner reimburses the expenses incurred for the safe custody of the
goods.
ii.Where the owner has announced a reward for recovery of the lost article, the
finder has the right to retain the goods till he receives the award.
iii.The finder has a right to sell the article:

if the owner cannot be found provided the bailee has made reasonable efforts;

if the owner refuses, upon demand, to pay the lawful charges of the finder;

49


the article is of perishable nature or that, which loses most of its value with
passage of time; or

if the lawful charges of the finder in respect of the goods found, amount to two
thirds of their value.
4.13 Termination of Bailment
A contract of bailment is terminated:

on the expiry of the bailment period;

when the purpose of bailment is achieved;

when the subject matter gets destroyed;

inconsistent use of the goods; and

4.14 PLEDGE
According to Section 172, bailment of goods as security for payment of a debt or
performance of a promise is called pledge. The bailor is, in this case, called the
pledger or pawnor and the bailee is called the pledgee or pawnee.
In a pledge, the pawnor deposits any type of movable property with the pawnee. In
other words, actual transfer of possession should take place.
Essentials of a pledge may be summarized as under:
a. There should be a delivery of goods.
b. The purpose of delivery should be to make the goods bailed, serve as security
for the payment of a debt, or performance of a promise.
4.15 RIGHTS AND DUTIES OF PAWNEE
i.The pawnee has a right to retain the goods not only for payment of the principal
debt or for performance of a promise but also for any expenses incurred or
interest accrued thereon.
ii.The pawnee can sue the pawnor to recover from him any extraordinary
expenses incurred by him for the preservation of the goods pledged.
iii.When the goods pledged have been obtained by the pawnor under a voidable
contract and where such contract has not been rescinded at the time of pledge,
the pawnee acquires a good title to the goods, provided he has acted in good
faith and has no knowledge of the defective title.
iv.When the pawnor defaults in payment of debt or fails to perform his part of the
promise, the pawnee can: (a) initiate a suit against the pawnor; (b) retain the
goods as a collateral security; (c) sell the goods pledged after giving the pawnor
a reasonable notice of sale, and (d) recover from the pawnor any deficit between
the debt due and sale price.
4.16 RIGHTS AND DUTIES OF PAWNOR
I. The pawnor can get back the goods pledged on his performance of promise or
repayment of loan and interest.

50

II. In case the pawnor makes default in payment, he can still pay the pledged
amount and redeem the goods pledged at any subsequent time. However, he can
exercise his right to redeem only before the pawnee has made an actual sale of
the goods. The right to redeem the pledged goods will be invalidated when the
pawnee sells the goods in exercise of his right under Section 176.
The right of redemption of goods also includes a right to any accretion to the
goods pledged. For e.g: if shares are pledged and during that period the company
issues bonus and right shares, then the pawnor will be entitled to the same on
redemption.
III. The pawnor can oversee whether the pawnee preserves and maintains the goods
properly.
IV. The pawnor has rights of an ordinary debtor which he has acquired by various
statutes for the protection of debtors.
4.17 CONTRACT OF AGENCY
According to Section 182 of the Contract Act, an agent is defined as a person employed
to do any act for another or to represent another in dealings with third persons. The
persons for whom such act is done, or who is so represented, is called the principal.
In a contract of agency, it is the agent who brings about a legal relationship between
two persons. It should be noted that an agent is not merely a connecting link between
the principal and a third person. The agent is also capable of binding the principal by
acts done within the scope of his authority.
An agent does not act on his own behalf but acts on behalf of his principal. He either
represents his principal in transactions with third parties or performs an act for the
principal. The question as to whether a particular person is an agent can be verified by
finding out if his acts bind the principal or not.
Essentials of Relationship of Agency
i.According to Section 183, any person who is of the age of majority and is of
sound mind may employ an agent.
ii.According to Section 184 of the Act, between the principal and the third
persons, any person may become an agent. But no person who is a minor and of
unsound mind can become an agent.
iii.
According to Section 185 of the Act, no consideration is necessary to
create an agency.
iv.It is not essential that a contract of agency be entered into. It is sufficient if a
person acts on behalf of another and is accepted by the latter.
Rules of Agency
Agency revolves around two important rules:
I. Whatever a person can do personally, he can do through an agent with exception
to very few personal acts like marriage etc.
51

II. Qui Facit Per Alium, Facit Per se, in other words what is done with the help of
another is the act of the person himself.
4.18 AGENT:

An agent is employed to bring the principal into legal relations with third
persons or to represent him in dealings with third persons.

An agent is bound to follow all the lawful instructions of the principal but he is
not subject to the direct control and supervision of the principal.

An agent may work for several principals at the same time.

A principal is liable for the acts of his agent done within the scope of his
authority.

Creation of Agency
i.Express agreement, i.e., an agreement is said to be express when it is given by
words spoken or written.
ii.Implied agreement, i.e., by inference from the circumstances of the case and
things spoken or written, or the ordinary course of dealing.
4.19 Classification of Agents
Special Agent: A special agent is one who is appointed to perform a special act or to
represent his principal in some particular transaction.
The authority of such an agent is limited and comes to an end as soon as the act is
performed. He cannot bind the principal in any matter other than that for which he is
employed.
General Agent: A general agent is one who has authority to do all acts connected with a
particular trade, business or employment. The principal may limit the authority of such an
agent. Unless the principal puts an end to the authority, it shall be assumed to be
continuous.
Universal Agent: A universal agent is one whose authority to act for the principal is
unlimited. He has authority to bind his principal by any act which he does, provided the
act (i) is legal, (ii) is agreeable to the law of the land.
Mercantile Agents: Section 2(9) of the Sale of Goods Act, 1930, defines a mercantile
agent as a mercantile agent having in the customary course of business as such agent,
authority either to sell goods, or to consign goods for the purpose of sale or to buy goods,
or to raise money on the security of goods. This definition covers factors, brokers,
auctioneers, commission agents, Del credere agents and bankers.

Factor: A factor is a mercantile agent entrusted with the possession of

goods for the purpose of selling them. He has a ostensible authority to do such
52

things as are usual in the conduct of business. He has a general lien on the
goods of his principal for the general balance of account between him and the
principal.

Auctioneer: An auctioneer is an agent appointed by a seller to sell his

goods by public auction for a reward generally in the form of a commission. He
is primarily the agent of the seller, but after the sale has taken place, he becomes
the agent of the purchaser also. He has the authority to receive the price of the
goods sold. He can also sue for the price in his own name.

Broker: A broker is an agent who is employed to buy or sell goods on

behalf of another. He is employed to bring about a contractual relation between
the principal and the third parties. He is not entrusted with the possession of the
goods in which he deals. He cannot act or sue in his own name. He has no right
of lien.
Commission Agent: A commission agent is employed to buy and sell goods, or
transact business generally for other persons receiving for his labor and trouble
a money payment, called commission.
Del credere Agent: A del credere agent is one who, in consideration of an extra
commission, guarantees his principal that the persons with whom he enters into
contract on behalf of the principal, shall perform their obligations.
Banker: The banker is the agent of his customer. The relationship between a
banker and his customer is really that of debtor and creditor.
Non-mercantile agents like insurance agents, advocates etc.
4.20 DUTIES OF AGENT
i.An agent is bound to conduct the business of his principal according to the
directions given by the principal, or in the absence of directions, according to
the custom which prevails in doing business of the same kind at the place where
the agent conducts such business. When the agent acts otherwise, if any loss is
sustained, he must make it good to his principal, and if any profit accrues, he
must account for it.
ii.

An agent is bound to conduct the business of the agency with as much skill as is
generally possessed by persons engaged in similar business unless the principal
has notice of his want of skill. The agent is always bound to act with reasonable
diligence, and to use such skill as he possesses; and to make compensation to his
principal, in respect of the direct consequences of his own neglect, want of skill
or misconduct, but not in respect of loss or damage which are indirectly or
remotely caused by such neglect, want of skill or misconduct.

iii.

An agent is bound to render proper accounts to his principal on demand.

iv.

It is the duty of an agent, in cases of difficulty, to use all reasonable diligence in

communicating with his principal and seeking to obtain his instructions (Section
214). If an agent deals on his own account in the business of the agency,
without first obtaining the consent of his principal and acquainting him with all

53

material circumstances which have come to his own knowledge on the subject,
the principal may repudiate the transaction, if the case shows, either that any
material fact has been dishonestly concealed from him by the agent, or that the
dealings of the agent have been disadvantageous to him. (Section 215).
v.

If an agent, without the knowledge of his principal, deals in the business of the
agency on his own account instead of on account of his principal, the principal is
entitled to claim from the agent any benefit which may have resulted to him
from the transaction. (Section 216)

vi.

An agent should not set up an adverse title to the goods which he receives from
the principal as an agent.

vii.
An agent is duty bound to pay sums received to the principal on his account.
viii.An agent should protect and preserve the interests of the principal in case of
his death or insolvency.
ix.An agent must not use confidential information entrusted to him by his principal
for his own benefit or against the principal.
x.The agent must not make secret profit from the extract agency. He must disclose
any extra profit that he may make.
The following case aptly discusses this: In Kimber vs. Barber (1875), An agent
sold his own stock to his principal without disclosing this fact, at the prevailing
market price. Held, he was bound to account for any profit he made in the
transaction.
xi.An agent must not allow his interest to conflict with his duty e.g. he must not
compete with his principal.
xii.An agent must not delegate his authority to a sub-agent. This rule is based on the
principle Delegatus non protest delegare A delegate cannot further delegate
Section 190. The exceptions to this rule, is, when delegation is allowed by the
principal or the trade custom or usage sanctions delegation or when delegation is
essential for proper performance or where emergency renders it imperative or
where nature of the work is purely ministerial and where the principal knows
that the agent intends to delegate.
4.21 RIGHTS OF AGENT
i.The agent has a right to retain any sums received on account of the principal in
the business of the agency, all moneys due to himself in respect of his
remuneration and advances made or expenses properly incurred by him in
conducting such business.
ii.The agent has a right to receive remuneration.
iii.

Right of Lien: In the absence of any contract to the contrary, an agent is entitled
to retain goods, papers and other property of the principal if it has been received
by the agent, whether movable or immovable, until the amounts due to himself
from commission, disbursements, and services in respect of the same has been
paid or accounted for.

54

In order to exercise the right of lien, the agent should have obtained possession
of goods not merely as bailee or consignee but as an agent.
iv.The employer of an agent is bound to indemnify him against the consequences
of all lawful acts done by such agent in exercise of the authority conferred upon
him.
v.

The agent has a right to receive compensation for injuries sustained due to
neglect or want of skill on part of the principal. Section 225 provides that an
agent can claim compensation under this section only if he proves:
(a) that some injury was caused to him; and (b) the injury was caused because of
the negligence of the principal.
In case the principal establishes the fact that the agent could have avoided the
consequences of the principals negligence by reasonable means and he failed to
do so, then the agent cannot recover compensation from the principal.
The agent cannot recover compensation from the principal if the injury has been
caused because of the nature of his employment.
vi.Right of stoppage of goods in transit: This right is available to the agent in the
following two cases:

vii.

where he has bought goods for his principal by incurring a personal liability, 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; and

viii.

where he is personally liable to the principal for the price of the goods sold, he
stands in the position of an unpaid seller towards the buyer and can stop the
goods in transit on the insolvency of the buyer.

4.22 DUTIES OF PRINCIPAL TO AGENT

i.The principal is bound to indemnify the agent against the consequences of all
lawful acts done by such agent in exercise of the authority conferred upon him.
(Section 222)
ii.The principal is required to indemnify the agent against the consequences of acts
done in good faith. According to Section 223 of the Contract Act, where one
person employs another to do an act and the agent does the act in good faith, the
employer is liable to indemnify the agent against the consequences of that act
though it causes an injury to the rights of third persons.
Thus, Section 223 entitles the agent to claim compensation in respect of acts done
in good faith though they cause injury to the rights of third persons.
Where a person employs another to do an act which is criminal, the employer is
not liable to the agent, either upon an express or an implied promise to indemnify
him against the consequences of that act.
iii.The principal must make compensation to his agent in respect of injury caused
to such agent by the principals neglect or want of skill.
iv.To pay the agent the commission or other remuneration agreed.
4.23 Rights of Principal
55

i.If the principal suffers any loss due to disregard by the agent of the directions by
the principal, or by not following the custom of trade in the absence of
directions by the principal, or where the principal suffers due to lack of requisite
skill, care, or diligence on the part of the agent, he can recover damages
accruing as a result from the agent.
ii.To obtain an account of secret profits and recover them and resist a claim for
remuneration.
iii.To resist agents claim for indemnity against liability incurred.
4.24 TERMINATION OF AGENCY
According to Section 201, an agency is terminated,
a. by an agreement between the parties; or
b. by the principal revoking his authority; or
c. by the agent renouncing the business of agency; or
d. by the business of agency being completed; or
e. by either the principal or the agent dying or becoming of unsound mind; or
f. by the principal being adjudicated an insolvent under the provisions of any Act
for the time being in force for relief of insolvent debtors.
4.25 IRREVOCABLE AGENCY

When an agency cannot be put an end to, it is said to be irrevocable

agency. An agency is irrevocable where the agent has himself an interest in the
property which forms the subject-matter of the agency. Such an agency cannot,
in the absence of an express contract, be terminated to the prejudice of such
interest.
The following example is relevant in this case: A gives authority to B, to sell
As land, and to pay himself, out of the proceeds, the debts due to him from
A. A cannot revoke this authority, nor can it be terminated by his insanity or
death.

When agent has incurred a personal liability the agency becomes irrevocable.
The principal cannot revoke the authority given to his agent after the authority
has been partly exercised, so far as regards such acts and obligations as arise
from acts already done in the agency. (Section 204)

The following example clearly explains this: A authorizes B to buy 1,000 bales of
cotton on account of A, and to pay for it out of As money remaining in Bs hands.
B buys 1,000 bales of cotton in his own name, so as to make himself personally liable
for the price. A cannot revoke Bs authority so far as regards payment for the cotton.

56

MULTIPLE CHOICE QUESTIONS:

Q1 The bailment of goods as security for payment of a debt is called
a)
b)
c)
d)

Lien
Mortgage
Hypothecation
Pledge

Q2 Which of the following agents are treated as non-mercantile agents?

a)
b)
c)
d)

Factors
Auctioneer
Broker
Insurance agent

Q3 In which of the following cases an agency is terminated other than by operation of

Law?
a)
b)
c)
d)

On performance of the contract

By mutual agreement
On the insolvency of the principal
On the destruction of the subject matter

Q4 The right of a person to retain possession of some goods belonging to another until
some debt or claim of the person in possession is satisfied, is known as
a)
b)
c)
d)

Bailment
Pledge
Hypothecation
Lien

Q5 Who enjoys the right of subrogation in a contract of indemnity?

a)
b)
c)
d)

Creditor
Principal debtor
Indemnifier
Indemnified

Q6 General Insurance is a
a)
b)
c)
d)

Voidable contract
Wager
Contract of guarantee
Contract of indemnity

57

Q7 Which of the following is not a contract of bailment?

a)
b)
c)
d)

Lease
Money deposited in a bank account
Acceptance of articles by post office as V.P.P.
Acceptance of goods by a transport company

Q8 If the goods of the bailor gets mixed up with the like goods of the bailee by the act
of an unauthorized third party, the cost of separation will have to be borne by
a)
b)
c)
d)

Bailor
Bailee
The third party
Bailor & bailee in proportion of their share of goods

Q9 In case of a pledge, the pawnee

a) Can retain the goods, until the debt is paid
b) Can retain the goods for payment of interest due on debt
c) \can not retain the goods for necessary expenses incurred in respect of goods
pledged
d) Both (a) & (b) above
Q10 The liability of a hotel keeper in respect of goods belonging to a guest is that of a
a)
b)
c)
d)

Pawnee
Surety
Bailee
Acceptor

58

Module III: CHAPTER-5 INDIAN SALE OF GOOD

ACT, 1930
After reading this lesson, you will be conversant with:
5.1 Definitions
5.2 Contract Of Sale
5.3 Sale And Agreement To Sell
5.4 Essentials Of A Contract Of Sale
5.5 Sale And Hire Purchase Agreement
5.6 Sale And Barter Or Exchange
5.7 Sale And Bailment
5.8 Sale And Contract For Work And Materials
5.9 Contract Of Sale How Made
5.10 Subject Matter Of A Contract Of Sale
5.11 Present Sale Of Future Goods
5.12 Contingent Goods
5.13 Effect Of Destruction Of Goods
5.14 Conditions & Warranties
5.15 Implied Conditions
5.16 Implied Warranties
5.17 Caveat Emptor
5.18 Transfer Of Property
5.19 Sale By Non-Owners
5.20 Performance Of Contract Of Sale
5.21 Delivery Of Goods
5.22 Resale Of Rejected Goods
5.23 Rights And Duties Of The Buyer
5.24 Rights Of An Unpaid Seller Against The Goods
5.25 Rights Of An Unpaid Seller Against The Buyer

The law relating to sale of goods can be found in the Sale of Goods Act, 1930. The sale
of goods is the most common of all commercial contracts and hence the law relating to
this, is bound to be of importance to all classes of the community.
The general rules applicable to contracts are applicable to contracts of sale of goods as
well. The general provisions of the Indian Contract Act, continue to apply to contracts
for the sale of goods in so far as they are not inconsistent with the express provisions of
the Sale of Goods Act. The Act has not defined the term sale but contemplates two
parties to the contract a buyer and a seller and that the buyer accepts the goods for a
price.
5.1 DEFINITIONS:

59

1.

Buyer means a person who buys or agrees to buy goods;

2.
Delivery means voluntary transfer of possession from one person to
another;
3.
Goods are said to be in a deliverable state when they are in such state
that the buyer would under the contract be bound to take delivery of them;
4.
Document of title to goods includes bill of lading, dock-warrant,
warehouse keepers certificate, wharfingers certificate, railway receipt,
[multimodal transport document,] warrant or order for the delivery of goods and
any other document used in the ordinary course of business as proof of the
possession or control of goods or authorizing or purporting to authorize, either
by endorsement or by delivery, the possessor of the document to transfer or
receive goods thereby represented;
5.

Fault means wrongful act or default;

6.
Future goods means goods to be manufactured or produced or
acquired by the seller after making of the contract of sale;
7.
Goods means every kind of moveable 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;
8.
A person is said to be insolvent who has ceased to pay his debts in the
ordinary course of business, or cannot pay his debts as they become due,
whether he has committed an act of insolvency or not;
9.
Mercantile agent means a mercantile agent having in the customary
course of business as such agent authority either to sell goods, or to consign
goods for the purposes of sale, or to buy goods, or to raise money on the security
of goods;
10.

Price means the money consideration for a sale of goods;

11.
Property means the general property in goods, and not merely a special
property;
12.

quality of goods includes their state or condition;

13.

Seller means a person who sells or agrees to sell goods;

14.
Specific goods means goods identified and agreed upon at the time a
contract of sale is made; and
15.
Expressions used but not defined in this Act and defined in the Indian
Contract Act, 1872, have the meaning assigned to them in that act.
5.2 CONTRACT OF SALE
As per Section 4(1) of the Sale of Goods Act, a contract of sale of goods is a contract
whereby the seller transfers or agrees to transfer the property in goods to the buyer for a
price. As per subsection (2), such contract of sale may either be absolute or conditional.

60

Subsection (3) deals with the concept of an agreement to sell and stipulates that where the
transfer of property in the goods is to take place at a future time, or subject to some
condition thereafter to be fulfilled, such a contract is an agreement to sell.
5.3 SALE AND AGREEMENT TO SELL
The distinction between a sale and an agreement to sell may thus be summarized as
follows:
1.
A contract which contemplates transfer of title to goods to the buyer
immediately is a sale while a contract which does not contemplate a transfer of
title to goods immediately is an agreement to sell.
2.
A contract of sale is an executed contract. It involves a contract plus a
conveyance of the property. When the property is transferred, the rights and
liabilities attached to the goods are also transferred. An agreement to sell, on the
other hand, is an executory contract. The property in the goods does not pass
until a certain time has lapsed or until a certain condition is fulfilled.
3.
In an agreement to sell, the seller remains the owner of the property until
it is actually transferred to the buyer at a future point of time. However, in a
contract of sale, the buyer becomes the owner immediately and all the risks
attached to the goods are passed on to him irrespective of the fact whether the
goods are delivered to him or not and whether the price is paid or not.
4.
In an agreement to sell, the seller agrees to sell the goods for a price and
the buyer agrees to buy the goods for a price. In a contract of sale, the seller sells
the goods to the buyer for a price.
5.

The consequences of a breach of an agreement to sell is as follows:

a.
n case the buyer defaults, the seller may sue for damages; in case the
seller defaults, the buyer has a personal remedy against the seller.
b.
Where there is a breach by any of the parties to a contract of sale, the
following will be the consequence.
If the buyer fails to pay the price, the seller may sue him; if the seller fails to
deliver the goods, the buyer may sue for delivery of the same or for conversion or
for damages.
6.
Violation of any of the conditions of an agreement to sell entitles the
buyer to rescind the contract.
However, in a sale, the breach of any condition will not be a ground for rejecting
the goods or treating the contract as rescinded. The breach can only be treated as
a breach of warranty.
7.
The property in the goods remains with the seller in the case of an
agreement to sell. He may sell the goods to a third party, although he will be
committing a breach.
In a sale, the goods cannot be resold by the seller. If he does so, the buyer can
recover the goods, sometimes from third parties.

61

8. The goods in an agreement of sale may not be specified or ascertained. In a sale,

the goods are specified and ascertained.
9.
A sale results in creation of a jus in rem (i.e., right to the buyer to enjoy
the goods as against the world at large including the seller) while an agreement
to sell results in jus in personam (i.e., right to the buyer against the seller to sue
for damages).
10.
In a contract of sale, in case the buyer becomes insolvent before making
payment, the seller is required to handover the goods to the official receiver or
the assignee. In such a situation, he can claim a rateable dividend for the price of
the goods.
The situation differs when it comes to an agreement to sell. Here, if the buyer
becomes insolvent and has not made payment, the seller is under no obligation to
part with the goods.
11.
In a contract of sale, if the seller becomes insolvent, the buyer can claim
the goods from the official receiver or assignee. In an agreement to sell, if the
seller is declared insolvent, the buyer can only claim a rateable dividend in case
he has already made payment
5.4 ESSENTIALS OF A CONTRACT OF SALE
The following are the essential ingredients of a valid contract of sale. There should be:
a.

a contract

b.

two parties (i.e., the buyer and the seller)

c.

transfer or agreement to transfer the property

d.

goods

e.

from the seller to the buyer

f.

for a price (i.e., money consideration).

Contract: The term contract means an agreement that is enforceable by law. It

excludes from its purview all void agreements. It also presumes the existence of
those elements necessary to constitute a valid contract.
Two Parties: The presence of two parties (the seller and the buyer) is essential to
constitute a contract of sale. Also, the two parties should be two different people
and should be competent to enter into a contract.
Transfer the Property: A contract of sale of goods contemplates a transfer of
general property and not special property. Where a person owns the goods he is said
to have general property in the goods. Where he has special property, he is a mere
pawnee of the goods.
Goods: Any kind of goods may be transferred unless provided otherwise by law.
Even the interest of a pawner and a pawnee comes within the definition of goods.
The transfer of goods should contemplate a transfer of the whole interest of the
seller in the goods.

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From the Seller to the Buyer: The transfer of property should be from the seller to
the buyer. If the seller has no right to sell the goods, then the buyer is not entitled to
receive the same and consequently there will be no contract.
For a Price: The consideration in a contract of sale should be money alone. The
price should be money, paid or promised. However, if the consideration is
something other than money, then the contract will not be one of sale.
5.5 SALE AND HIRE PURCHASE AGREEMENT
A hire purchase agreement basically involves two stages:
a. Firstly, goods are hired out according to the terms and conditions of the hire
purchase agreement.
b. Secondly, the hirer can become the owner of the goods by exercising his option
to purchase the goods, provided he has paid all the installments.
Thus, in a hire purchase transaction, the hirer is under no obligation to buy the goods.
He may either return the goods or become the owner by paying all the hire purchase
installments and exercising his option to purchase. The property in the goods
continues to remain with the seller until the hirer has exercised his option.
In case of a sale, the buyer cannot repudiate the contract by return of the goods.
However, in the case of a hire purchase agreement, the hirer has an option to repudiate
the contract by returning the goods.
In Finance Center vs. Sri Ram Prakash, it was held that a hire purchase agreement is
virtually a contract of bailment.
5.6 SALE AND BARTER OR EXCHANGE
In a barter or exchange, the element of price in money is lacking. Similarly, the
exchange of one form of money for another cannot be considered as a sale. Even where
foreign currency is bought and sold in Indian currency or vice versa, it does not
constitute a sale.
5.7 SALE AND BAILMENT
When goods are delivered by one person to another for some purpose, and where it is
agreed that on the accomplishment of the purpose, the goods will be returned or
disposed of according to the directions of the person delivering it, the goods are said to
have been bailed.
However, in case of a sale, the ownership of the goods is transferred from the seller to
the buyer.
5.8 SALE AND CONTRACT FOR WORK AND MATERIALS
The question as to whether a particular contract is one of sale or a work contract will
depend upon the facts of each case. Even though it is difficult to lay down any
specific rule to distinguish between the two, it should be remembered that if the

63

contract is for supply of materials at an agreed price and the work and the service is
incidental to the execution of the contract, the contract is for sale of materials.
In Dr Baretto vs. T R Pruce, it was held that the supply of artificial teeth by a dentist
was a contract of sale.
A works contract for supply of window frames and fixing them to the building was held
to be an indivisible works contract. It was held that the material supplied for execution
of the works contract was not sale but formed a part of the works contract Nanuram vs.
State of Rajasthan
5.9 CONTRACT OF SALE HOW MADE
Section 5 lays down that:
a. A contract of sale is made by an offer to buy or sell goods for a price and the
acceptance of such offer. The contract may provide for the immediate delivery of
the goods or immediate payment of the price or both, or for the delivery or
payment by installments or that the delivery or payment or both shall be
postponed.
b. Subject to the provisions of any law for the time being in force, a contract of sale
may be made in writing or by word of mouth, or partly in writing and partly by
word of mouth or may be implied from the conduct of the parties.
The presence of a buyer and seller is essential for a contract of sale.
Section 5 lays down that:
i. A contract of sale is made by an offer to buy or sell goods for a price and the
acceptance of such offer. The contract may provide for the immediate delivery of
the goods or immediate payment of the price or both, or for the delivery or
payment by installments or that the delivery or payment or both shall be
postponed.
ii. Subject to the provisions of any law for the time being in force, a contract of
sale may be made in writing or by word of mouth, or partly in writing and partly
by word of mouth or may be implied from the conduct of the parties.
The presence of a buyer and seller is essential for a contract of sale.
Who may sell: Any person who is competent to contract and who is the owner of the
goods may execute the sale. Also, the owner may authorize any person to do so on his
behalf. Where the goods have been attached, any sale of the same is void. Such goods
are liable to be confiscated and sold in execution of the decree.
A sale may also be made under the authority and with the consent of the owner. For
example, a sale by an agent acting within the scope of his authority. Similarly, it was
held in National Bank vs. Hampson, that sales made by persons with limited interest in
the ordinary course of business may also be valid, as sales of mortgaged goods by a

64

mortgagor who has been allowed by his mortgagee to carry on business to which such
sales are incident.
A sale may also be effected by a pawnee of goods. In this case, even though the pawnee
is not the owner of the goods, he can sell the goods by virtue of a special covenant.
Presence of Mutual Assent between the Parties
Mutual assent or consensus ad idem is an essential ingredient of every contract. The
parties to the contract should be of the same mind regarding the subject matter of the
contract. Mutual assent of the parties may be:
a. Express, or
b. Implied.
If express it may be oral or in writing. However, if it is implied it can be inferred from
the conduct, gestures or sometimes by the mere silence of the parties.
According to Section 5, contract of sale of goods may provide for,
a. immediate delivery of the goods, or
b. delivery of goods at some future time, or
c. delivery of goods by installments.
Also, there may be,
a. immediate payment of price, or
b. payment of price in future, or
c. payment of price by installments.
It also lays down another situation where,
a.

both delivery and payment may be simultaneous

b.

both delivery and payment will be postponed

c.

both delivery and payment will be made by installments.

5.10 SUBJECT MATTER OF A CONTRACT OF SALE

Goods form the subject matter of a contract of sale. As per Section 2(7) of the Sale of
Goods Act, goods means every kind of movable property other than actionable
claims and money; and includes stock and shares, etc.
According to Subsection (1) of Section 6, goods which form the subject matter of a
contract of sale may be either
a. Existing goods
1. Owned by the seller, or
2. Possessed by the seller.

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b. Future goods
It may be noted that the term existing goods is followed by the words owned or
possessed by the seller. Future goods are not qualified by any such expression as they
have no existence at the time of the contract.
Contract of Sale of Future Goods may be,
a.

Absolute, or

b.

Conditional.

When the contract is absolute, the seller undertakes to unconditionally sell the goods to
be acquired at a later stage. Where the contract is conditional, he contracts to sell goods
conditionally on their acquisition.
An absolute contract for sale of future goods can be categorized into:
a.

Present sale of future goods.

b.
Present sale of a chance of obtaining goods, or a sale of a mere
expectation dependent upon a chance.
5.11 PRESENT SALE OF FUTURE GOODS
a. In reality this is not a sale but an agreement to sell as one cannot transfer the property
in goods which is not in existence. In effect, this is provided by Subsection (3) of
Section 6, which states that such a contract is a mere agreement to sell.
In such contracts the property in the goods passes to the buyer at a later stage as in the
following cases:
i. If the seller after acquiring the goods, expresses an intention to execute the original
agreement.
In Lunn vs. Thornton, it was held that a deed of bargain and sale cannot pass the
property in goods which do not belong to the grantor at the time of execution of the
deed, unless there is some new act done by the grantor after he acquires the property,
indicating his intention that such subsequently acquired property should so pass.
ii. If the buyer gets control and possession of the goods under authority to seize them.
In Congreve vs. Evetts, growing crops were seized and taken possession under a bill of
sale. Before a sale could be executed, a judgment was delivered in favor of a creditor.
Consequently, the Sheriff seized the goods and sold them. The proceeds of the sale
were paid to the creditor. However, it was held that the purchaser of the bill of sale was
entitled to the proceeds.
iii.

Where the seller performs an act, thus irrevocably appropriating the goods to the
contract.

In Langton vs. Higgins, C agreed to sell to the plaintiff all the crop of oil of
peppermint growing on his farm in the year at a particular price. Subsequently, on Cs
request, the plaintiff sent bottles to C for filling the bottles with oil. C, having weighed
the oil, put it in those bottles, labeled them with the weight and prepared the invoices.

66

However, before all the bottles could be filled, he sold and delivered several of them to
the defendant. It was held that the putting of the oil was an act of appropriation and
hence the property vests in the plaintiff.
iv.

If the goods can be ascertained by description, the equitable interest in them

passes to the buyer as soon as they are acquired by the seller.

In Tailby vs. Official Receiver, a bill of sale assigned in favor of the mortgagor all the
book debts due and owing or which might during the continuance of the security
become due and owing. In this case, it was held that future property, possibilities and
expectancies are assignable in equity for value.
b. Present sale of a chance of obtaining goods: Here the sale is similar to an agreement to
sell. When the buyer agrees to such a sale, he takes the risk of the happening of the event.
The buyers contract is absolute. However, it is conditional on the part of the seller on the
existence of the chance. The subject matter in such an agreement may turn out to be of a
greater value or of a smaller value. This can be illustrated with the help of an example.
A pearl fisherman may haul oysters from the sea. The buyer of pearl oysters from a
pearl fisherman purchases a chance. The oysters may either yield pearls of a greater
value than the price paid or they may yield pearls of a lower value or even of no value.
Whatever be the outcome, the buyers contract is absolute. As he has purchased a
chance, he has to abide by its consequences.
Conditional Sale of Future Goods
A seller may also contract to sell goods conditionally on their acquisition. If the goods
do not arrive or fail, no action can be taken against the seller, except in a case where the
seller himself prevents the goods from coming into existence.
5.12 CONTINGENT GOODS
Subsection 2 of Section 6 lays down that a seller may also undertake to sell goods, the
acquisition of which is dependent upon a contingency.
In Jethalal C Thakkar vs. R N Kapur the defendant agreed to sell 1,000 shares of the
plaintiff within 12 months of the bank being converted into a Finance Corporation. In
case the first event failed to occur, he himself would take the 1,000 shares at the agreed
rate. The defendant failed to get the shares sold and consequently was sued by the
plaintiff.
In this case, it was held that a conditional obligation is a sort of quasi obligation
consisting of a possibility that a real obligation already exists, or may come into
existence in the future. The fulfillment of the condition is the transformation of the
potentiality into actuality. The failure of the condition is the failure of the chance to
become a fact.
5.13 EFFECT OF DESTRUCTION OF GOODS

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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 their description in the
contract.
Goods Perishing before Sale but after Agreement to Sell
According to Section 8, where there is an agreement to sell specific goods, and
subsequently the goods without any fault on the part of the seller or buyer perish or
become so damaged as no longer to answer to their description in the agreement before
the risk passes to the buyer, the agreement is thereby avoided.
5.14 CONDITIONS AND WARRANTIES
During negotiations, it is usual for the seller to make certain statements or
representations which induces the buyer to enter into the contract. Such representations
may take different forms. They may
a. elate to a fact, that is not material to the contract and does not give rise to any
legal action. In Geddes vs. Penington, the seller of a horse maintained that the
horse was sound. However, the place from where the horse was bought was
misrepresented to the buyer. It was held that this misrepresentation was
immaterial and would not affect the contract in any way.
b. Be expressions of opinion or a mere commendation of ones wares. Such
representations are not part of the contract and will not give any right of action.
c. Relate to a material fact, but may not be made an integral part of the contract.
They do not carry any legal consequences. Where the buyer shows that he
would not have given his consent to the contract, but for the belief that the
statement was true, such representations:
I. Operate as an estoppel, which the maker cannot later deny.
II. May amount to innocent misrepresentations and will be a valid ground for
rescission and for a claim for damages.
III. May amount to fraudulent misrepresentations giving rise to a claim for
damages and rescission.
d. Relate to a material fact and may be an integral part of the contract.
According to Section 12(1), a stipulation in a contract of sale with reference to
goods which are the subject thereof may be a condition or a warranty.
A condition is a stipulation essential to the main purpose of the contract, the
breach of which gives rise to a right to treat the contract as repudiated [Section
12(2)].

68

On the other hand, a warranty is a stipulation collateral to the main purpose of

the contract, the breach of which gives rise to a claim for damages but not a right to
reject the goods and treat the contract as repudiated. [Section 12(3)]
Whether a stipulation in a contract of sale is a condition or a warranty depends in
each case on the construction of the contract. A stipulation may be a condition,
though called a warranty in the contract. [Section 12(4)]
Difference between Condition and Warranty
The question as to whether a particular stipulation is a condition or a warranty will
depend upon the facts and circumstances of each case. All obligations are not of
equal importance. The same obligation may be viewed differently by different
persons and may, by the same person, be viewed differently in different
circumstances. Hence, it is essential to determine the intention of the parties. If a
stipulation is so vital, that it goes directly to the root of the transaction, breach of
which can be treated as a failure to perform the contract, such a stipulation is a
condition.
Warranties, on the other hand, are obligations which need to be performed.
However, a breach of warranty does not affect the substance of a contract so as to
result in a repudiation of the same. A breach of warranty can only give rise to a
claim for damages.
The breach of a condition can be treated as a breach of warranty. However, a breach
of warranty cannot be treated as a breach of condition.
When Condition should be Treated as Warranty (Section 13)
In the following circumstances, a condition can be treated as warranty:
Where the buyer waives a condition or elects to treat the breach of condition as
breach of warranty (Subsection 1).

Where a contract of sale is not severable and the buyer has accepted the goods or
part thereof, the breach of any condition to be fulfilled by the seller can only be
treated as a breach of warranty, unless provided for otherwise in the contract.
Nothing in this section shall affect the case of any condition or warranty, fulfillment
of which is excused by law by reason of impossibility or otherwise.
In addition to ensuring compliance with the conditions of the contract and rescinding
the contract in case of non compliance, the buyer of goods has the following two rights:
a. He may waive the breach of condition and may proceed with the contract.

69

b. He has the discretion to treat the breach of condition as a breach of warranty. In

such
a
case
the
contract
is
not
repudiated.
Where the buyer has chosen to waive the breach of condition, he cannot repudiate
the contract unless the seller commits another breach of condition. Also, where the
buyer rescinds the contract, he cannot proceed with the contract without the prior
approval of the promisor.
5.15 IMPLIED CONDITIONS
CONDITION AS TO TITLE
According to Section 14(a), in a contract of sale subject to a contrary intention, there is
an implied condition on the part of the seller that, in case of a sale, he has a right to sell
the goods and that, in the case of an agreement to sell, he will have a right to sell the
goods at the time when the property is to pass.
In Rowland vs. Divall, R purchased a car from D and used it for several months.
However, D did not have a good title to the car and subsequently R had to surrender
the car to the true owner. It was held that R could recover the consideration paid by
him, as the consideration was not for the use of the vehicle but for the lawful possession
of the same.
SALE BY DESCRIPTION (SECTION 15)
Where there is a contract for the sale of goods by description, there is an implied
condition that the goods shall correspond with that description.
Where goods are sold by description, the buyer is entitled to reject them, if the same does
not correspond to the given description.
Sale by description can take place not only in the case of unascertained or future goods,
but also in the case of specific goods.
Where the contract is for supply of goods of a specified description, it is essential that the
goods should correspond to the given description and should be of merchantable quality.
The same condition would be applicable in a situation where the buyer did not previously
inspect the goods.
SALE BY SAMPLE AS WELL AS BY DESCRIPTION
It is also provided by Section 15, that if the sale is by sample as well as by description, it
is not sufficient that the bulk of the goods correspond with the sample if the goods do not
also correspond with the description. It is essential that the goods should correspond with
the sample as well as with the description.
In Wallis vs. Pratt, there was a contract for sale of seeds referred to as Common English
Sainfoin. However, the seeds supplied to the buyer were of a different quality. The
defect also existed in the sample. The discrepancy in quality was discovered only after
70

the seeds were sown. The buyer could recover damages as there was a breach of
condition.
CONDITION AS TO QUALITY OR FITNESS [SECTION 16(1)]
Subject to the provisions of the Act and of any other law for the time being in force, there
is no implied warranty or condition as to the quality or fitness for any particular purpose
of goods supplied under a contract of sale, except as follows:
Where the buyer, expressly or by implication, makes known to the seller the particular
purpose for which the goods are required, so as to show that the buyer relies on the
sellers skill or judgment and the goods are of a description which it is in the course of
the sellers business to supply (whether he is the manufacturer or producer or not), there
is an implied condition that the goods shall be reasonably fit for such purpose [Section
16(1)].
CONDITION AS TO MERCHANTABILITY: [SECTION 16(2)]
According to Section 16(2), where goods are bought by description from a seller who
deals in goods of that description (whether he is the manufacturer or producer or not),
there is an implied condition that the goods shall be of merchantable quality.
Provided that, if the buyer has examined the goods, there shall be no implied condition
as regards defects which such examination ought to have revealed. (Proviso to subsection
2)
Provided that, if the buyer has examined the goods, there shall be no implied condition
as regards defects which such examination ought to have revealed. (Proviso to subsection
2)
Under Subsection 2, for implying a condition that the goods shall be of merchantable
quality, it is essential that the goods should have been bought by description and from a
seller who deals in goods of that description.
Merchantable Quality means that the goods are of a certain quality wherein a
reasonable man acting under reasonable conditions would, after full examination of the
same, accept the goods in performance of the offer to buy, either for his use or for sale.
Presence of defects in the goods make them unfit for the purpose for which they are sold
and consequently they cease to be merchantable.
Goods may also be unmerchantable not only because of a defect in the physical
condition but also when:
a.

A trade mark is infringed.

b.

Their use is dangerous or injurious.

c.

They are unfit for use.

CONDITION IMPLIED BY CUSTOM: SECTION 16(3)

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An implied condition as to quality or fitness for a particular purpose may be annexed by

the usage of trade.
In certain cases, the purpose for which the goods are needed may be ascertained either
from the conduct of the parties or from the nature of description of the article
purchased.
In Dr Baretto vs. T R Price, a set of false teeth were purchased from a dentist. The set
could not be used by the buyer as it did not fit the buyers mouth. He could reject the
set as the purpose for which it was required was known by the dentist.
5.16 IMPLIED WARRANTIES
Warranty of quiet possession
According to Section 14(b), in a contract of sale unless the circumstances of the
contract are such as to show a different intention there is an implied warranty that the
buyer shall have and enjoy quiet possession of the goods.
In fact, what this section means is that nobody can interfere with the possession of
goods by the buyer, because of a defective title of the seller. If the buyer is in any way
prevented from the quiet enjoyment of the goods, he can claim damages from the seller.
Warranty of freedom from encumbrances
According to Section 14(c), in a contract of sale unless the circumstances of the
contract are such as to show a different intention there is an implied warranty that the
goods shall be free from any charge or encumbrance in favor of any third party not
declared or known to the buyer before or at the time when the contract is made.

This section deals with the cases where the buyers title to the goods is disturbed by the
existence of encumbrances not known or disclosed at the time of the contract. The
implied warranty relates not to the existence of undisclosed encumbrances, but only that
the goods should be free of them. The warranty is not broken by the mere fact that
encumbrances exist. What is necessary is that the buyer should be affected by them. It
is the responsibility of the seller to ensure that the encumbrances do not affect the
buyer.
Warranty as to quality or fitness by usage of trade: [Section 16(3)]
According to this section, an implied warranty as to quality or fitness for a particular
purpose may be annexed by the usage of trade.
Warranty to disclose the dangerous nature of goods

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Where a seller of goods is aware of the fact that the goods are dangerous, he should
disclose this fact to the buyer. Otherwise, he will be held liable for damages.
In Clarke vs. Army & Navy Co-operative Society Limited, A sold a tin of disinfectant
powder to C knowing fully well that if the tin was not opened with care, it was likely
to cause injury. In spite of this, A did not warn C about the inherent danger. C was
injured while opening the tin. A was held liable for damages.
5.17 CAVEAT EMPTOR
The doctrine of caveat emptor is re-emphasized by Section 16. A buyer who intends to
buy a glass bottle capable of holding boiling sulphuric acid without cracking should
specify the purpose for which the bottle is required. If he fails to do so, he cannot
expect the seller to give him such a bottle.
The term caveat emptor means let the buyer beware. Caveat emptor is the general
rule applicable to sales so far as quality is concerned. A buyer purchases at his own risk
and it is his responsibility to examine the goods properly before purchasing the same. If
the goods are subsequently found to be defective, the seller cannot be held liable for it.
Example: A buys a horse from B for riding but did not mention this. The horse was
found fit only for carriage. A cannot claim damage.
However caveat emptor is subject to following exceptions:
1. One of the most important exceptions to the doctrine of caveat emptor are the
implied conditions of fitness for particular purpose and merchantability.

Where the buyer indicates to the seller the purpose for which the goods are required and
where he relies on the sellers judgment and skill and where the goods are those which
are dealt with by the seller in his course of business, then the doctrine of caveat emptor
will not apply. It is the duty of the seller to supply goods for the purpose for which it is
required.
In Bombay Burmah Trading Corporation vs. Agha Mohammad, a buyer of timber,
informed the seller that the timber was to be used for railway sleepers. It was held that
the buyer could reject the goods if it was found to be of an inferior quality.
2. Where the seller makes a false representation and conceals defects in the goods, and
the buyer relies on the sellers judgment, then the doctrine of caveat emptor will not be
applicable.
3. An implied condition as to quality or fitness for a particular purpose may be annexed
by the usage of trade

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5.18 TRANSFER OF PROPERTY

The performance of a contract of sale constitutes three stages:
I.
II.
III.

Transfer of ownership of goods (title) from seller to the buyer

Transfer of possession of the goods
Passing of risk.

The terms property and possession have different meanings. Even though the
property in the goods has passed to the buyer, the seller might still have possession of
the same. Property in the goods means ownership of the goods while possession of
the goods means mere custody or control of the goods. Thus, a servant or an agent
entrusted with goods has possession of the same, but not the property in them.
Time when Property Passes
The time when property in the goods passes from the seller to the buyer is of
considerable importance. According to Section 26, unless otherwise agreed, the goods
remain at the sellers risk until the property therein is transferred to the buyer, but when
the property therein is transferred to the buyer, the goods are at the buyers risk,
whether delivery has been made or not except that where delivery has been delayed
through the fault of either buyer or seller, the goods are at the risk of the party in fault
as regards any loss which might not have occurred but for such fault.
Transfer of Property as between Seller and Buyer
a. Goods must be ascertained:
According to Section 18, where there is a contract for the sale of unascertained goods,
no property in the goods is transferred to the buyer unless and until the goods are
ascertained.
As per this section, the ascertainment of goods should be done before the property in
the goods passes to the buyer. In Commissioner of Sales Tax vs. Hussenali Adamji &
Co, it was held that where the contract is for a sale of unascertained goods, the property
in the goods cannot pass until the goods are ascertained.
b. Property in the goods passes when intended to pass:
According to Section 19
i. Where there is a contract for the sale of specific or ascertained goods the
property in them is transferred to the buyer at such time as the parties to the
contract intend it to be transferred.
ii. For the purposes of ascertaining the intention of the parties, regard shall be had
to the terms of the contract, the conduct of the parties and the circumstances of the
case.
Section 19 is applicable only in case of ascertained or specific goods and is not
applicable to a contract of sale of unascertained goods.

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In State vs. Rattan Lal, an analysis of milk taken by sample revealed that the milk was
contaminated. However, action could not be taken against the vendor because at that
time the property had not yet passed to him. The vendor could not be held liable for
selling adulterated milk.
iii. Unless a different intention appears, the rules contained in Sections 20 to 24 are
rules for ascertaining the intention of the parties as to the time at which the property in
the goods is to pass to the buyer. [Section 19(3)]
Specific Goods
Section 20 lays down that where there is an unconditional contract for the sale of
specific goods in a deliverable state, the property in the goods passes to the buyer when
the contract is made, and it is immaterial whether the time of payment of the price or
the time of delivery of the goods, or both, is postponed.
A conditional sale is subject to some condition. An unconditional sale on the other hand
is one where there is no condition attached to it. In an unconditional sale of specific
goods, the property in the goods is transferred when the contract is made and nothing
remains to be done except the delivery of the goods or the payment of the price. It is
also essential to show that the goods were in a deliverable state when the contract was
made.
Illustration
In Tarling vs. Baxter, there was a contract for sale of a certain haystack on the sellers
land at the price of 145 pounds on 4th January. The price was to be paid on 4th
February and the hay was allowed to remain on the sellers land until 1st May. When
the hay was accidentally destroyed by fire, it was held that the property in the goods
had passed to the buyer at the time of making the contract and hence the buyer was
required to bear the loss.
WHERE GOODS ARE NOT IN A DELIVERABLE STATE
Where there is a contract for the sale of specific goods and the seller is bound to do
something to the goods for the purpose of putting them into a deliverable state, the
property does not pass until such thing is done and the buyer has notice thereof.
(Section 21)
The sale contemplated under this section relates to a conditional sale of specific goods,
the property in the goods passing to the buyer only on the fulfillment of the condition.
Thus the following conditions are essential for the applicability of Section 21.
i.The goods should be specific goods (whether existing or future).
ii.The seller should be required to do something so as to put the goods in a
deliverable state.

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iii.The seller should have fulfilled the obligation required by him as specified in
point (2).
iv.The buyer should have notice of the fact that the seller has done that thing which
has the effect of putting the goods in a deliverable state.
Illustrations:
I.

In Acraman vs. Morrice, there was a contract for sale of timber from oak
trees. The selected portions were marked out by the buyer. The seller was
required to sever the rejected portions of the trees. However, before he
could remove the rejected portions, the seller became bankrupt. It was
held that the buyer could not take away the selected portion as the
property in goods had not yet passed to him.

In Underwood vs. Burgh Castle Cement Syndicate, there was a contract

for sale of a fixed condensing engine. According to the contract, the
engine was to be severed and delivered free on rail at a specified price.
However, the goods were damaged before it reached the railway. It was
held that the property in the goods did not pass as the goods were not in a
deliverable state when it reached the railway
WHERE SPECIFIC GOODS ARE IN A DELIVERABLE STATE, BUT THE
SELLER HAS TO DO SOMETHING IN ORDER TO ASCERTAIN THE
PRICE: (SECTION 22)
II.

Where there is a contract for the sale of specific goods in a deliverable state, but the
seller is bound to weigh, measure, test or do some other act with reference to the goods
for the purpose of ascertaining the price, the property does not pass until such act or
thing is done and the buyer has notice thereof.

In Simmons vs. Swift, there was a contract for sale of a stack of bark. The contract
stipulated that the bark was to be weighed by the agent of the buyer as well as the seller.
Part of the bark was weighed and taken delivery. However, the other part was carried
away by floods before it could be weighed. It was held that loss incurred on the
unweighed portion was to be borne by the seller as the property in those goods had not
passed to the buyer.
Unascertained Goods and their Appropriation: Section 23
Where there is a contract for the sale of unascertained or future goods by description
and goods of that description and in a deliverable state are unconditionally appropriated
to the contract, either by the seller with the assent of the buyer or by the buyer with the
assent of the seller, the property in the goods thereupon passes to the buyer. Such assent
may be express or implied, and may be given either before or after the appropriation is
made. [Section 23(1)]
Where in pursuance of the contract, the seller delivers the goods to the buyer or to a
carrier or other bailee (whether named by the buyer or not) for the purpose of

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transmission to the buyer and does not reserve the right of disposal, he is deemed to
have unconditionally appropriated the goods to the contract. [Section 23(2)]
Section 23 requires that,
a. there should be an appropriation;
b. the appropriation should be unconditional;
c. the appropriation should be of goods of the description contracted for;
d. the appropriation should relate to goods in a deliverable state;
e. it should be done with the consent of the other party.
Goods on Approval or on Sale or Return: Section 24
When goods are delivered to the buyer on approval or on sale or return or other
similar terms, the property therein passes to the buyer,
When he signifies his approval or acceptance to the seller or does any
other act adopting the transaction.
II. If he does not signify his approval or acceptance to the seller but retains
the goods without giving notice of rejection then, if a time has been fixed
for the return of the goods, on the expiration of such time and, if no time
has been fixed on the expiration of a reasonable time.
I.

When goods are sold on approval basis, it means that the buyer takes temporary
possession of the goods with an option to return them in case they are not satisfactory.
The principle underlying a contract for sale or return, is that the buyer takes
possession of the goods. He has a choice of returning the goods. However, the property
in the goods will pass to him if he accepts the goods, or if he does any act adopting the
transaction.
Illustration 1:
In Municipal Commissioners of Hoogly, Chinsurah Municipality vs. Spencer Limited,
the buyer of a tractor was given an option to reject the tractor if it were found to be old.
The agreement between the buyer and the seller was an oral agreement. Considering the
fact that the purchaser had used the tractor and that reasonable time had elapsed from
the date of purchase, it was held that the property in the goods had passed to the buyer.
As per this Section, there is no sale until the buyer,
a. has signified his approval,
b. has retained the goods beyond a reasonable time, and
c. has made return impossible by his own fault.
Illustration 2:

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In Nirmalabai vs. State, certain ornaments were taken by a person on approval basis on
the condition that the ornaments would be returned by evening. In this case, the
following observations were made:
a. Where goods are delivered on approval basis, the property in the goods will pass
to the buyer, if the buyer fails to give approval or if the buyer retains the property
without giving notice of rejection.
b. If a time is fixed for return of the goods, the property will pass if goods are not
returned within that time.
c. If no time is fixed, the property in goods will pass on the expiration of a
reasonable time.
In the aforementioned case, the property in the goods had passed, as the ornaments
were not returned by evening and no notice of rejection was given to the seller.
Reservation of right of disposal: Section 25
Where there is a contract for the sale of specific goods or where goods are subsequently
appropriated to the contract, the seller may by the terms of the contract or
appropriation, reserve the right of disposal of the goods until certain conditions are
fulfilled. In such a case, notwithstanding the delivery of the goods to a buyer, or to a
carrier or other bailee for the purpose of transmission to the buyer, the property in the
goods does not pass to the buyer until the conditions imposed by the seller are fulfilled.
[Section 25(1)].
Where goods are shipped or delivered to a railway administration for carriage by
railway and by the bill of lading or railway receipt, as the case may be, the goods are
deliverable to the order of the seller or his agent, the seller is prima facie deemed to
reserve the right of disposal [Section 25(2)].
5.19 SALE BY NON-OWNERS
According to Section 27, where there is a sale of goods by a person who is not the owner
or where a person sells goods without the authority or consent of the true owner, the
buyer of such goods does not acquire a good title. In such a case, the title of buyer is no
better than that of the seller. (Subsection 1)
Subsection 1 is based on the principle nemo dat quod non habet which means that no
man can pass a better title than he possesses.
For example, at a public auction, there was a sale of a horse. The fact that the horse
was a stolen one was not known to the auctioneer. The person who purchased the horse
acquired it in good faith. However, it was held that the buyer did not get any title
against the true owner. Lee vs. Bayes.
Section 27, however, lays down certain exceptions to the rule nemo dat quod non
habet. The seller of goods can confer a better title to the buyer:

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a. Where he sells the goods with the authority and consent of the true owner.
Sales under this category include those made by agents acting within the scope of their
authority (whether express or implied) and sales made in the course of business by
persons holding a limited interest in the goods.
For instance, where goods are handed over to an agent by the principal for a particular
purpose, and the agent exceeding the authority given to him sells the goods, the
principal is entitled to recover the goods in spite of the disposal.
b. Where the true owner is prevented by his conduct from denying the sellers authority
to sell.
To establish the doctrine of estoppel it should be proved that the conduct of the true
owner was such, so as to lead an innocent buyer to believe that the seller was the true
owner. The true owner should have acted in a manner, so as to be precluded from
denying the lawfulness of the transaction. Mere carelessness on the part of the true
owner to protect or guard his goods will not serve as an estoppel.
In Mohambaram vs. Ram Narayan, the owner of a bus engaged an agent to ply the bus
for hire. A letter signed by himself and addressed to the District Magistrate requesting
for grant of G permit to the agent, along with the registration certificate of the vehicle
was left with the agent. The agent fraudulently altered the letter into one addressed to
the D.S.P requesting him to transfer the registration in the name of the agent. After the
vehicle was registered in the name of the agent, he sold it to a third person who took it
in good faith. It was held that the bus owner could not have contemplated fraud by the
agent and hence he could not be prevented from challenging the title of the buyer.
c. The buyer of goods from a mercantile agent who has no authority to sell, gets a good
title to the goods if (a) the agent is in possession of the goods or documents of title to
the goods with the consent of the owner. (b) the agent sells the goods while acting in
the ordinary course of business of a mercantile agent (c) the buyer acts in good faith (d)
the buyer has not at the time of sale notice that the agent has no authority to sell.
In Folkes vs. King, a car was delivered to a mercantile agent for sale at a price not less
than 575 pounds. However, the agent sold the car for 140 pounds. The buyer purchased
the vehicle in good faith and without knowledge of any fraud. The true owner sued the
buyer for recovery of the car. It was held that the agent was in possession of the car for
the purpose of sale with the consent of the true owner. The purchaser of the car
acquired a good title to it.
d.
Sale
by
one
of
the
joint
owners
If one of the several joint owners of goods has the sole possession of them by
permission of the co-owners, the property in the goods is transferred to any person who
buys them of such joint owner in good faith and has not at the time of the contract of
sale notice that the seller has no authority to sell them. (Section 28)

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Illustration
A, B and C, joint Hindu brothers are owners of certain cattle. A cow is left in the
possession of A by the other brothers, B and C. A later sells the cow to D who
purchases in good faith. D acquires a valid title to the cow
e Sale by person in possession under a voidable contract
Where the seller of goods has obtained possession thereof under a contract voidable
under Section 19 or Section 19-A of the Indian Contract Act, 1872, but the contract has
not been rescinded at the time of the sale, the buyer acquires a good title to the goods,
provided he buys them in good faith and without notice of the sellers defect of title.
(Section 29)
f. Sale by seller in possession after sale: [(Section 30(1)]
Where a person, having sold goods, continues or is in possession of the goods or of the
documents of title to the goods, the delivery or transfer by that person or by a
mercantile agent acting for him, of the goods or documents of title under any sale,
pledge or other disposition thereof to any person receiving the same in good faith and
without notice of the previous sale shall have the same effect as if the person making
the delivery or transfer were expressly authorized by the owner of the goods to make
the same.
g. Sale by buyer in possession after having bought or agreed to buy goods.
Where a person, having bought or agreed to buy goods, obtains with the consent of the
seller possession of the goods or the documents of title to the goods, the delivery or
transfer by that person or by a mercantile agent acting for him, of the goods or documents
of title under any sale, pledge or other disposition thereof to any person receiving the
same in good faith and without notice of any lien or other right of the original seller in
respect of the goods shall have effect as if such lien or right did not exist [Section 30(2)]
The applicability of this subsection is dependent on the fulfillment of the following
conditions:
i.The person who is to pass title should have bought or agreed to buy the goods.
ii.He should have obtained possession of the goods or document of title to the
goods with the approval of the seller.
iii.The goods or documents of title to the goods should have been delivered to a
third person under a contract of sale, either by the buyer or his mercantile agent.
iv.The person receiving the goods or the documents should have taken it in good
faith and without notice of the lien or the right of the original seller.
h.

Sale by an unpaid seller [Section 54(3)]

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Where an unpaid seller who has exercised his right of lien or stoppage in transit re-sells
the goods, the buyer acquires a good title thereto as against the original buyer,
notwithstanding that no notice of the re-sale had been given to the original buyer.
As per Section 54(3), the validity of a re-sale is dependent upon:
I. The seller being an unpaid seller.
II. The exercise of the right of lien or stoppage in transit by the unpaid seller. (i.e,
the unpaid seller should have possession of the goods and the possession should
be lawful).
5.15 PERFORMANCE OF CONTRACT OF SALE
Performance of a contract with reference to the seller means the delivery of the goods
by him and with reference to the buyer it means the acceptance and payment of the
same, as per the terms of the contract. [Section 31]
For the purpose of Section 31, the term acceptance is defined by Section 42 of the
Act. As per Section 42, the buyer is deemed to have accepted the goods when he
intimates to the seller that he has accepted them, or when the goods have been delivered
to him and he does any act in relation to them which is inconsistent with the ownership
of the seller, or when, after the lapse of a reasonable time, he retains the goods without
intimating to the seller that he has rejected them.
In a contract of sale, there is an implied undertaking that the seller will deliver to the
buyer and the buyer will accept the same and pay the price of the goods. Failure to
deliver the goods will make the seller guilty of breach of contract.
Unless otherwise agreed, delivery of the goods and payment of the price are concurrent
conditions, that is to say, the seller shall be ready and willing to give possession of the
goods to the buyer in exchange for the price and the buyer shall be ready and willing to
pay the price in exchange for possession of goods. (Section 32)
Where one party to the contract wrongfully refuses to discharge his obligation, the other
party is exonerated or discharged from fulfilling his promise.
Illustration:
In Pulgaon Cotton Mills vs. Gulabai, the plaintiff who had to take delivery of certain
goods on a particular date, made an application of insolvency before that date. The
interim receiver failed to act within a reasonable time to adopt the contract. It was held
that the application by the plaintiff made it clear that he did not intend to fulfill his
promise and the conduct of both the receiver and the plaintiff allowed the defendant to
treat the contract as rejected.
5.21 DELIVERY OF GOODS
Delivery of goods sold may be made by doing anything which the parties agree shall be
treated as delivery or which has the effect of putting the goods in the possession of the
buyer or of any person authorized to hold them on his behalf. (Section 33).

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As per Section 2, the term delivery means a voluntary transfer of possession from one
person to another. Delivery does not necessarily mean a physical transfer of goods from
the seller to the buyer.
Delivery may be
a. Actual, or
b. Symbolic, or
c. Constructive.
Where the goods are physically delivered to the buyer it constitutes actual delivery.
Symbolic delivery takes place where the seller does anything which has the effect of
putting the buyer in a position of control in respect to the goods. For example, handing
over the key of the godown to the buyer involves a symbolic delivery of the goods.
Where a third party who is in possession of the goods of the seller, at the time of the
sale, makes known to the buyer that he holds the goods on his behalf, it amounts to a
constructive delivery
Rules as to Delivery
I. Delivery should have the effect of putting the goods in possession of the buyer
or in the possession of any person authorized to hold them on his behalf. It may
be actual, symbolic or constructive.
II. According to Section 32, in the absence of a contract to the contrary, payment
and delivery are concurrent conditions.
III. Effect of part delivery: A delivery of part of the goods in progress of the
delivery of the whole, has the same effect, for the purpose of passing the
property in such goods as a delivery of the whole; but a delivery of part of the
goods, with an intention of severing it from the whole, does not operate as a
delivery of the remainder (Section 34).
Illustration:
In Hammond vs. Anderson, a delivery order in respect of certain goods sold was
given to the buyer. The goods were lying at a wharf. The buyer weighed the
whole but took delivery of only a part of the goods. It was held that a delivery of
part of the goods in this case constituted a delivery of the whole.
iv Buyer to apply for delivery: Apart from any express contract, the seller of
goods is not bound to deliver them until the buyer applies for delivery. (Section 35)
As per Section 35, it is the responsibility of the buyer to apply for delivery, before he
can bring a suit against the seller for non-delivery.
Where goods are to be imported and where delivery of the goods is to be given at the
jetty, the seller is required to intimate the buyer about the arrival of the goods. It is only
then, that the obligation of the buyer to apply for delivery arises.
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Illustration:
In M P V Sundarama Iyer & Co. vs. UVC Murgesa Mudaliar, the contract between two
parties provided a clause wherein it was agreed that if the buyer failed to take delivery
of the goods inspite of the sellers notice, the seller would have the right to dispose of
the goods by public auction at the buyers risk. It was held that Section 35 would not
have any application in this case because of the express contract between the two.
V Place of delivery: Whether it is for the buyer to take possession of the goods or for
the seller to send them to the buyer is a question depending in each case on the contract,
express or implied, between the parties. Apart from any such contract goods sold are to be
delivered at the place at which they are at the time of the sale, and goods agreed to be sold
are to be delivered at the place at which they are at the time of the agreement to sell, or, if
not then in existence, at the place at which they are manufactured or produced. [Section
36(1)]
VI Time of delivery: Where under the contract of sale the seller is bound to send the
goods to the buyer, but no time for sending them is fixed, the seller is bound to send
them within a reasonable time [Section 36(2)].
Demand or tender of delivery may be treated as ineffectual unless made at a reasonable
hour. What is a reasonable hour is a question of fact [Section 36(4)].
Illustration:
In Dinkarrai Lalitkumar vs. Sukhdayal Rombilas, on June 26, the defendants sold the
plaintiffs 33 bales of piece goods at the defendants option, ready and to be despatched
as early as possible. The plaintiffs took delivery of 22 bales while the remaining 11
bales could not be delivered by the defendants. It was held that the defendants were
guilty of breach of contract. A fortnights time from the date of contract was a
reasonable time and therefore July, 10 was to be taken as the due date of performance,
and any damages would have to be estimated based on this date.
VII Goods in possession of a third party: Where the goods at the time of sale are in
the possession of a third person, there is no delivery by the seller to the buyer unless
and until such third person acknowledges to the buyer that he holds the goods on his
behalf. However, where goods have been sold by issue or transfer of any document of
title to goods, the third partys consent is not required. [Section 36(3)].
Illustration:
On 15th April, a contract of sale was executed wherein A sold B, a certain quantity of
wool. On that particular day, the goods were in possession of a third person C. On
April, 19, C wrote a letter to B informing him that he would have no objection to the
goods being removed by B at any time. The letter of C was an acknowledgment by
him that he was in possession of the goods and that he held the goods on behalf of B. It
was held that there was a delivery of goods on April 19, as contemplated by Section
36(3). Premsingh vs. Debsingh
VIII Expenses of delivery: Unless otherwise agreed, the expenses of and incidental to
putting the goods into a deliverable state will be borne by the seller [Section 36(5)].

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IX Delivery of wrong quantity: The quantity of goods delivered should be in

accordance with the terms of the contract. Section 37 contemplates three different
situations, where the seller delivers more than that contracted for or less than that
contracted for, or mixes the goods with goods of a different description.
X Installment Deliveries: Unless otherwise agreed, the buyer of goods is not bound to
accept delivery thereof by installments [Section 38(1)].
Where there is a contract for the sale of goods to be delivered by stated installments
which are to be separately paid for, and the seller makes no delivery or defective
delivery in respect of one or more installments or the buyer neglects or refuses to take
delivery of or pay for one or more installments, it is a question in each case depending
on the terms of the contract and the circumstances of the case, whether the breach of
contract is a repudiation of the whole contract, or whether it is a severable breach giving
rise to a claim for compensation but not to a right to treat the whole contract as
repudiated [Section 38(2)].
XI Delivery to a carrier or wharfinger (Section 39): Where, in pursuance of a
contract of sale the seller is authorized or required to send the goods to the buyer,
delivery of the goods to a carrier, whether named by the buyer or not, for the purpose of
transmission to the buyer or delivery of the goods to a wharfinger for safe custody is
prima facie to be a delivery of the goods to the buyer. [Section 39(1)]
Where a person chooses another person to do some work, the other person is usually the
agent of the former. However, Section 39 makes a provision wherein the seller can
choose a carrier on behalf of the buyer, whether approved by the buyer or not. In such a
case, the delivery of goods to the carrier implies a delivery to the buyer. In all these
cases, the buyer will have to bear any loss that might arise in the course of transit or
while the goods are in the custody of the wharfinger.
In Surajmal Chandammal vs. Fatehchand Jaimal Rai, on deterioration of certain goods
during transit, the buyer could recover from the seller, only damages and not the price
paid, as the property in the goods had already passed to him.
Buyers Right of Examining the Goods
Where goods are delivered to the buyer which he has not previously examined, he is not
deemed to have accepted them unless and until he has had a reasonable opportunity of
examining them for the purpose of ascertaining whether they are in conformity with the
contract [Section 41(1)].
Unless otherwise agreed, when the seller tenders delivery of goods to the buyer, he is
bound, on request to afford the buyer a reasonable opportunity of examining the goods
for the purpose of ascertaining whether they are in conformity with the contract.
[Section 41(2)]
Acceptance of Delivery (Section 42)

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As per Section 42, the buyer is deemed to have accepted the goods when he intimates to
the seller that he has accepted them, or when the goods have been delivered to him and
he does any act in relation to them which is inconsistent with the ownership of the
seller, or when, after the lapse of a reasonable time, he retains the goods without
intimating to the seller that he has rejected them.
The applicability of Section 42 arises when the buyer performs any of the above
mentioned acts. The acts cited above may be done by the buyer, any time during the
period of examination of the goods or after the expiry of the reasonable time for
examination. When such an act is done, the buyer is deemed to have accepted the goods
In Nannier vs. Rayalu Iyer, the buyer took delivery of part of the goods, but later
repudiated the whole contract on the ground that the goods were not delivered within the
time prescribed. The seller accepted the repudiation and instituted a suit for recovery of
damages. The buyer contended that (a) the goods tendered were not of the required
quality (b) the seller would not have been able to deliver the goods within the time
prescribed. The buyer was held liable on the latter ground.
.
BUYER NOT BOUND TO RETURN REJECTED GOODS
Unless otherwise agreed, where goods are delivered to the buyer and he refuses to
accept them, having the right to do so, he is not bound to return them to the seller, but it
is sufficient if he intimates to the seller that he refuses to accept them. (Section 43)
Where goods are sent to the buyer and where it is discovered that the goods do not
answer to the description given, the buyer has the right to reject the goods. However,
the buyer is not bound to return the goods to the seller. While the goods are in his
possession, he occupies the position of a bailee and is required to take care of them. The
responsibility of removing the goods from the buyers possession lies with the seller.
Also, while the goods are in the possession of the buyer, all risks attached to such goods
will lie with the seller.
It was held in Caswell vs. Coare, where the seller does not remove the rejected goods
from the buyers possession, the buyer can claim from the seller, any reasonable
expenses incurred for taking care of the goods.
However, it is the responsibility of the buyer to keep the goods at the disposal of the
seller.
5.22 RE-SALE OF REJECTED GOODS: T
he buyer has the right to sell the rejected goods in case the seller does not remove them
in spite of a notice of rejection. In such a case, the buyer may sell the goods
immediately, while the question as to whether the goods conformed to the contract or
not may be decided subsequently. Re-sale of rejected goods may also be resorted to,
where the goods are of a perishable nature or expensive to keep or of fluctuating value.

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In Chapman vs. Morton, certain goods were shipped to the buyer. After taking delivery
of the goods, the buyer informed the seller that the goods did not answer the description
given by the contract. He also indicated to the seller, that on failure to receive
instructions from him, the goods would be sold and consideration received would be
adjusted towards damages incurred. The seller contended that the sale was valid and
the buyer was liable for the price. The buyer, however, sold the goods in his own name
to a third person. The buyer was held liable for the price of the goods. In the given case
Lord Abinger made the following observation: If the defendant intended to renounce
the contract, he ought to have given the plaintiff distinct notice at once that he
repudiated the goods and that on such a day he should sell them by such a person for
the benefit of the plaintiff.
Burden of expense: Where a buyer incurs expenses as a bailee, he can recover the
same from the seller.
In Heilbutt vs. Hickson, under the terms of a contract, the buyer could reject the goods
in case the same were rejected by the sub-buyer. On rejection by the sub-buyer, the
buyer was entitled to recover the expenses incurred on sending the goods to and from
the sub-buyer and also those expenses incurred on warehousing and returning the goods
to the seller.
5.23 RIGHTS AND DUTIES OF THE BUYER
1. Right to have delivery of the goods as per the terms and conditions of the contract.
2. Where the goods delivered to the buyer are in excess or less than the quantity
contracted for, the buyer can (a) accept the whole (b) reject the whole (c) accept the
quantity ordered and reject the rest.
3. Unless there is a contract to the contrary, the buyer is not required to accept delivery
by installments.
4. Where goods are sent to the buyer by a route involving sea transit, the buyer has a
right to be informed of the same so as to enable him to insure the goods.
5. The buyer has the right to examine the goods before he accepts them.
6. In case of a breach of contract by the seller, the buyer has the following remedies:
Suit for damages
Under Section 57, he may sue the seller for recovery of damages due to nondelivery.
Suit for price
Where the price has been paid, but the goods have not been delivered, the buyer
may recover the price.
Suit for specific performance
Under Section 58, the buyer may also insist on specific performance of the
contract to sell.

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Suit for breach of warranty: 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
a. set-up against the seller the breach of warranty in diminution or
extinction of the price, or
b. sue the seller for damages for breach of warranty.
The fact that a buyer has set up a breach of warranty in diminution or extinction
of the price does not prevent him from suing for the same breach of warranty if
he has suffered further damage.[Section 59(2)]
Repudiation of the contract before the due date: (Section 60)
Where the seller repudiates the contract before the date of delivery, the other
may either treat the contract as subsisting and wait till the date of delivery, or he
may treat the contract as rescinded and sue for damages for the breach.
Suit for interest [Section 61(2)(b)]
In the absence of a contract to the contrary, the court may award interest at such
rate as it thinks fit on the amount of the price to the buyer in a suit by him for the
refund of the price in a case of a breach of the contract on the part of the seller
from the date on which the payment was made
Duties of the Buyer
1.
The buyer is required to take delivery of the goods and make payment
according to the terms and conditions of the contract.
2.
Apart from any express contract, it is the duty of the buyer to apply for
delivery.
3.
The buyers duty includes a demand to make delivery at a reasonable
hour.
4.
Where the seller agrees to deliver the goods at his own risk at a place
other than where they are sold, the buyer shall take any risk of deterioration in
the goods necessarily incident to the course of transit.
5.
It is the duty of the buyer to give notice of rejection of goods to the
seller.
6.
The buyer should take delivery of the goods within a reasonable time
after the tender of delivery.
7.
Where the property in the goods passes to the buyer, it is his duty to pay
the price according to the terms of the contract
8.
Where the buyer wrongfully neglects or refuses to accept and pay for the
goods, he will have to compensate the seller, in a suit by him, for damages for
non-acceptance (Section 56).
5.24 RIGHTS OF AN UNPAID SELLER AGAINST THE GOODS

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The term unpaid seller is defined by Section 45 of the Sale of Goods Act, 1930. As
per this section, the seller of goods is deemed to be an unpaid seller within the
meaning of the Act.
1. When the whole of the price has not been paid or tendered.
2. When a bill of exchange or other negotiable instrument has been received as
conditional payment and the condition on which it was received has not been fulfilled
by reason of the dishonor of the instrument or otherwise.
Rights of an Unpaid Seller
As per Subsection (1) of Section 46, subject to the provisions of this Act and of any
law for the time being in force notwithstanding that the property in the goods may have
passed to the buyer, the unpaid seller of goods, as such, has by implication of law,
1. A lien on the goods for the price while he is in possession of them.
2. In case of the insolvency of the buyer a right of stopping the goods in transit
after he has parted with the possession of them.
3. A right of re-sale as limited by this Act.
Where the property in goods has not passed to the buyer the unpaid seller has, in
addition to his other remedies, a right of withholding delivery similar to and
co-extensive with his rights of lien and stoppage in transit where the property has
passed to the buyer. [Section 46(2)].
Section 46(1) will be applicable only if the plaintiff proves that:
a. He is an unpaid seller.
b. The buyer is insolvent.
c. The goods were in transit.
d. The property in the goods has passed to the buyer.
Unpaid Sellers Lien (Section 47)
1. Subject to the provisions of this Act, the unpaid seller of goods who is in possession
of them is entitled to retain possession of them until payment or tender of the price
in the following cases, namely
a. Where the goods have been sold without any stipulation as to credit.
b. Where the goods have been sold on credit, but the term of credit has
expired.
c. Where the buyer becomes insolvent
2. The seller may exercise his right of lien notwithstanding that he is in possession of
the goods as an agent or bailee for the buyer.

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In Imperial Bank vs. London & St Katherine Dock Co., it was held that even though the
delivery of a bill of lading transfers legal property, it does not affect the sellers right of
lien on the goods as long as they are in his possession.
Goods sold without any stipulation as to credit:
When goods are sold without any stipulation as to credit, the seller can retain the goods,
until the payment is made.
Goods sold on credit, but the term of credit has expired:
When goods are sold on credit, the possession of the goods is transferred to the buyer
immediately. However, if the seller has retained possession of the goods until the expiry
of the period of credit, the lien which was not available to him during that period, will
accrue to him on the expiry of the credit period, even though the buyer is not insolvent
at that time.
Where the buyer becomes insolvent:
The third case where the seller has a lien on the goods, is where the buyer becomes
insolvent.
The sellers lien is revived in case the time for payment has not arrived and the buyer
becomes insolvent. This is based on the rule, that where one of the parties to the
contract is unable to fulfill the promise required of him, the other party is absolved from
performing his obligation.
In E C Edulji vs. Cafe John Brothers, a second-hand refrigerator was purchased for
Rs.120. Later it was agreed between the vendee and the vendor that the refrigerator
should be put in order at a cost of Rs.320. The vendee took delivery of the refrigerator
on February, 20 and informed the vendor that the refrigerator was in good working
condition. Later, he informed the vendor that the refrigerator was not in working order.
The vendor took away two parts of the refrigerator for further repairs. As the full cost of
the original repairs had not been paid, the vendor claimed a lien on the parts taken. It
was held that when the contract was fully performed and when the goods were handed
back (although the cost of repairs had not been fully paid) the lien had come to an end,
and could not be revived because the buyer asked for further repairs.
Part Delivery (Section 48)
Where an unpaid seller has made part delivery of the goods, he may exercise his right
of lien on the remainder, unless such part delivery has been made under such
circumstances as to show an agreement to waive the lien.
A part delivery of goods does not amount to a full delivery of goods. Hence, an unpaid
seller who has made part delivery, can exercise his right of lien over the remaining
goods. In such a case, the seller has a lien not only for the proportion of price to be paid
on account of goods retained, but also for whatever portion of price that remains

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unpaid. However, if delivery of part of the goods is intended to be a symbolic delivery

of the whole, the right of lien on the goods retained will come to an end.
TERMINATION OF LIEN (SECTION 49)
1.The unpaid seller of goods loses his lien thereon
a. When he delivers the goods to a carrier or other bailee for the purpose of transmission
to the buyer without reserving the right of disposal of the goods.
b. When the buyer or his agent lawfully obtains possession of the goods.
c. By waiver thereof.
2. The unpaid seller of goods, having a lien thereon does not lose his lien by reason only
that he has obtained a decree for the price of the goods.
Stoppage in Transit
Subject to the provisions of this Act, when the buyer of goods becomes insolvent, the
unpaid seller who has parted with the possession of the goods has the right of stopping
them in transit, that is to say, he may resume possession of the goods as long as they are
in the course of transit, and may retain them until payment or tender of the price.
(Section 50)
The following are the conditions required to be fulfilled for the applicability of Section
50.
a)
b)
c)
d)

The seller should be unpaid

The buyer must be insolvent
The property in the goods should have passed from the seller to the buyer
The goods should be in transit.

The right of stoppage of goods accrues to the seller because of the insolvency of the
buyer. Where during the course of transit, the seller discovers that the buyer is
insolvent, he may retake possession of the goods before the possession is transferred to
the buyer.
It should also be noted that the right of stoppage is exclusive of the right of lien.
5.25 RIGHTS OF THE
PERSONALLY

UNPAID

SELLER AGAINST

An unpaid seller has the following rights against the buyer personally.
a. Suit for price (Section 55)

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THE

BUYER

Where under a contract of sale the property in the goods has passed to the buyer and the
buyer wrongfully neglects or refuses to pay for the goods, according to the terms of the
contract, the seller may sue him for the price of the goods [Section 55(1)].
Where under a contract of sale, the price is payable on a certain day irrespective of
delivery and the buyer wrongfully neglects or refuses to pay such price, the seller may
sue him for the price although the property in the goods has not passed and the goods
have not been appropriated to the contract [Section 55(2)].
b. Suit for damages for non-acceptance (Section 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.
c. Suit for interest (Section 61)
Where the buyer wrongfully refuses to accept and pay for the goods, the court may
award interest at such rate as it thinks fit on the amount of the price to the seller in a suit
by him for the amount of the price from the date of the tender of the goods or from the
date on which the price was payable.
MULTIPLE CHOICE QUESTIONS:
Q1 Under the Sale of Goods Act, 1930,which of the following is/are the implied
warranty(ies)?
a)
b)
c)
d)

Warranty of quiet possession

Werranty of freedom from encumbrances
Warranty as to quality or fitness.
All (a), (b) & (c) above

Q2 The right available to an unpaid seller by implication of law is to

a)
b)
c)
d)

Retain the goods for the price when the goods are in transit
Recover the possession of goods
Recover the price
Recover the damage

Q3 The position of the finder of lost goods is that of a

a)
b)
c)
d)

Bailor
Bailee
Creditor
True owner

Q4 The right of lien exercised by an unpaid seller is to

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a)
b)
c)
d)

Retain possession
Recover possession
Recover price & other charges
damages

Q5 The buyer of goods from a mercantile agent who has no authority to sell gets a good
title to the goods if
a)
b)
c)
d)

The agent is in possession of the goods or documents of title to the goods

The buyer is aware of the fact that the agent has no authority to sell
The buyer acts dishonestly
Both (a) & (b) above

Q 6 Which of the following is/are necessary constituent(s) of a contract of sale?

a)
b)
c)
d)

Three distinct parties- seller, buyer & a mediator

Movable goods for a price
Transfer of general property
Both (b) & (c) above

Q7 Which of the following is not a requirement of Section 23 of the Sale of Goods Act
regarding uncertain goods and their appropriation?
a)
b)
c)
d)

There should be an appropriation

The appropriation can be conditional
The appropriation should be goods of the description contracted for
Both (b) & (c) above

Q8 Which of the following is not the duty of the buyer?

a) The buyer should examine the goods before he accepts them
b) The buyer has the right to give notice of rejection of goods to the seller
c) The buyer has the right to take delivery of goods within reasonable time after the
tender of delivery.
d) Where the property in the goods passes to the buyer, it is his duty to pay the price
according to the terms of the contract.
Q9 Where goods are required over a certain period, the tenders that may be invited, are
termed as
a)
b)
c)
d)

Cross offer
Counter offer
Standing offer
General offer

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Q10 Which of the following statements is false as per the provisions of Sale of Goods
Act?
a) The seller may exercise his right of lien notwithstanding that he is in possession
of the goods as an agent or bailee of the buyer
b) The lien depends on actual possession of title
c) The possession of the goods by the seller must not expressly exclude the right of
lien.
d) The lien can be exercised by the unpaid seller only for the price & not for any
other charges such as warehouse or dock charges.

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Module IV/; CHAPTER 6 : NEGOTIABLE

INSTRUMENTS ACT, 1881
After reading this lesson, you will be conversant with:
6.1 Definition Of Negotiable Instrument
6.2 Characteristics Of A Negotiable Instrument
6.3 Kinds Of Negotiable Instrument
6.4 Promissory Notes
6.5 Bills Of Exchange
6.6 Comparison Between A Promissory Note And A Bill Of Exchange
6.7 Bills In Sets
6.8 Cheques
6.9 Crossing Of Cheques
6.10 Modes Of Crossing
6.11 Capacity Of Parties
6.12 Parties To Negotiable Instruments
6.13 Liabilities Of Parties
6.14 Negotiation
6.15 Effect Of endorsement
6.16 Assignment
6.17 Endorsement
6.18 Dishonor Of A Negotiable Instrument

The Negotiable Instruments Act, 1881, (herein after referred to as Act), relates to
Promissory Notes, Bills of Exchange, Cheques and Hundies. The Act does not affect any
custom or usage nor does it affect the provisions of Section 31 and Section 32 of the
Reserve Bank of India Act, 1934. The provisions of Section 31 states that no other
person other than the Reserve Bank of India or the Central Government, can draw,
accept, make or issue any bill of exchange, hundi or promissory note payable to bearer
on demand nor make or issue any promissory note payable to the bearer of the
instrument. Section 32 provides that a person is punishable with fine if he issues a bill or
note payable to bearer on demand or a note payable to bearer.
6.1 DEFINITION OF NEGOTIABLE INSTRUMENT
According to Section 13 of the Act, Negotiable Instrument means a promissory note,
bill of exchange or cheque payable either to order or to bearer.
Justice Willis in his book The Law of Negotiable Securities has defined a negotiable
instrument as an instrument, the property in which is acquired by anyone who takes it
bona fide, and for value, notwithstanding any defect of title in the person from whom he
took it, from which it follows that an instrument cannot be negotiable unless it is such
and in such a state that the owner could transfer the contract or engagement contained
therein by simple delivery of instrument.

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6.2 CHARACTERISTICS OF A NEGOTIABLE INSTRUMENT

1. Free transferability is one of the most important characteristics of a negotiable
instrument. It can be transferred by mere delivery or by endorsement and
delivery. The former is known as payable to bearer and the latter payable to
order.
2. The holder of the instrument is presumed to be the owner of the property
contained therein.
3. The holder in due course (one who acquires the instrument in good faith and for
consideration) gets it free from all defects including fraud provided he was not
party to it.
4. The holder in due course is entitled to sue for recovery of the sum in his own
name.
5. The instrument is transferable till maturity and in case of cheque till it becomes
stale (on the expiry of six months from the date of the issue).
6. Under Sections 118 and 119 of the Act, negotiable instruments are subject to
certain presumptions in order to facilitate business transactions. It shall be
presumed that every Negotiable Instrument is drawn for consideration
irrespective of consideration mentioned in the document. Every bill is accepted
within reasonable time before maturity and transferred before its maturity. The
instruments were endorsed in the order in which they appear on it. It is
presumed that the holder of instrument is holder in due course. However, the
above presumptions are rebuttable by evidence to the contrary. The burden of
proof lies on defendant and not upon the plaintiff.
6.3 KINDS OF NEGOTIABLE INSTRUMENTS
Negotiable instruments may be
a.
Negotiable by Statute: The Negotiable Instruments Act recognizes only
three kinds of instruments under Section 13 promissory notes, bills of
exchange and cheques.
b.
Negotiable by Custom or Usage: Certain instruments have acquired the
character of negotiability by the usage or custom of trade. In India, Government
promissory notes, bankers drafts and pay orders, hundies, delivery orders and
railway receipts for goods have been held to be negotiable by usage or custom.
We shall however, restrict our study to those instruments covered under Section 13 of
the Act which are classified below.
Bearer Instrument: A promissory note, bill of exchange or cheque is payable to bearer
when it is expressed to be so payable or when the last endorsement on the instrument is
an endorsement in blank. A person who is the lawful holder of a bearer instrument can
obtain payment on the instrument.
Order Instruments: An order instrument is one which is expressed to be payable on
order and when it is expressed to be payable to a particular person it does not contain
any words prohibiting transfer or indicating the intention that it shall not be
transferable.

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Inland Instruments: An inland instrument is one which is drawn or made in India upon
any person resident therein, even though it is made payable in a foreign country.
Foreign Instruments: A foreign instrument is one which is not an inland instrument. A
foreign instrument must be drawn outside India and made payable outside or inside
India or it must be drawn in India and made payable outside India and drawn on a
person resident outside India.
Demand Instruments: An instrument like promissory note or a bill of exchange
wherein time for payment is specified or is payable at sight is an instrument payable on
demand.
Ambiguous Instrument [Section 17]: An instrument which in form is such that it may
either be treated by holder as a bill or as a promissory note, like when the drawer and
the drawee are the same person or where the drawee is a fictitious person the holder can
choose to treat the instrument either as a bill of exchange or a promissory note. Once
decided on the type of the instrument he is bound by his decision.
Illustration:
A draws a bill on B and negotiates it himself. B is a fictitious drawee. The holder
may treat the bill as a note made by A.
Inchoate or Incomplete Instrument: When one person signs and delivers to another,
a stamped instrument which is either wholly blank or incomplete, he thereby giv es a
prima facie authority to the holder thereof to make or complete, as the case may be,
upon it a negotiable instrument, for any amount specified therein, and not exceeding the
amount, covered by the stamp. Such an instrument is called an inchoate instrument.
A owes B Rs.5,000. He gives B a blank acceptance on a bill which is sufficiently
stamped to cover any amount up to Rs.2,000. B endorses the bill to H, a holder in
due course. H who fills up the amount as Rs.2,000 can recover the amount.
Escrow: When a negotiable instrument is delivered conditionally or for a special
purpose as a collateral security or for safe custody only, and not for the purpose of
transferring absolutely property therein, it is called an escrow. The following example
clearly illustrates this.
A, the holder of a bill, endorses it to B or order for the express purpose that B may
get it discounted. B negotiates the bill to C who takes it bona fide and for value. C
is a holder in due course, and he acquires a good title to the bill.
Accommodation Bill: A bill which is drawn, accepted or endorsed without
consideration is called an accommodation bill. The party lending his name to oblige the
other party is known as the accommodating or accommodation party, and the party so
obliged is called the party accommodated. The accommodated party cannot, after he
has paid the amount of the bill, recover the amount from any person who became a
party to the bill for his accommodation. An accommodation bill can be negotiated after
maturity provided the person to whom it is negotiated takes it in good faith and for
consideration. Dishonor or failure to give notice of dishonor does not discharge the
prior parties from the liability.

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Trade Bills: When a bill is drawn, accepted or endorsed for consideration it is called a
genuine trade bill.
Having understood the types and classifications of negotiable instruments we shall now
learn about promissory notes, bills of exchange and cheques.
6.4 PROMISSORY NOTES
Section 4 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. Section 1(4)(a) of IT Act 2000 excludes promissory notes, as
promissory note cannot be made by electronic means.
A promissory note normally states as follows:

I promise to pay S on order Rs.1,000.

I acknowledge myself to be indebted to S for Rs.2,000 to be paid on

demand, for value received.
Parties to a Promissory Note

There are basically two parties to a promissory note. The person making or executing
the note promising to pay the amount stated therein is called the maker.
The person to whom the amount is payable is called the payee.
Essentials of a Promissory Note
A promissory note should conform to certain requirements. They are:
i.

It must be in writing.
The basic objective of insisting that a promissory note should be in writing is to
exclude an oral agreement from the purview of the Act. The writing on the
promissory note may be either in pencil or ink and also includes printing,
lithography or any other form of depicting the words in a viewable form.
As long as the requirements of Section 4 are complied with, a promissory note will
be held valid. Further, it is the intention of the maker which has to be looked into.
The mere absence of the word promise will not render a note invalid provided the
maker has given an unconditional undertaking to make payment. On the other hand,
there are instances where a note may satisfy all the conditions as required by
Section 4 and may yet, not be a promissory
Note. For example, a bankers deposit note in the form Received of A Rs.1000 to
be accounted for on demand duly signed by the maker is not a promissory note.

ii.

It must contain an express promise to pay. An implied promise is not enough to

constitute a promissory note.
The following case of Bal Mukund vs. Munna Lal Ramji Lal (1970) aptly describes
this.
In the above case A executed a promissory note which stated I of my own
free will and accord approached B and borrowed from him the sum of Rs.100

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bearing interest at the rate of 50 paise percent per mensem. I have, therefore,
executed these few presents by way of a promissory note so that it may serve as
evidence and be of use when needed. Held, the instrument is not a promissory
note as it does not contain an express undertaking to pay the amount mentioned
in it.
The following have been held to be promissory notes:

iii.

In Yeruganti Chinna vs. Kota Egiri we shall order the borrowed moneys to be
repaid was held to constitute a promissory note.
Rs.1,200 balance due to you I am still indebted and do promise to pay.
I do acknowledge myself to be indebted to X in Rs.1,000 to be paid on
demand for value received.
The promise or undertaking to pay must be definite and unconditional.

In the case of Bardesley vs. Baldwin (1741), it was held that the promissory note
was a conditional one and hence, not enforceable. The facts of the case were: A
executed a promissory note stating I promise to pay Rs.1,000 to B, 30 days after
his marriage with C. It was held that this is not a promissory note as it is probable
that B may not marry C.
iv.
The negotiable instrument must be signed by the maker without which it is
taken as incomplete and ineffective. The signature signifies that the person is personally
authenticating and giving effect to the contract contained in the instrument.
It was held in George vs. Surrey, that where the maker of a note is unable to write, he
may sign by affixing a mark in lieu of his signature. In certain cases, marks and initials
have been held to be signatures if they were intended to be such.
v.
The negotiable instrument must clearly point out the maker. Another basic
requirement of a promissory note is that it should give a clear indication of the maker of
the note.
A promissory note may be made either jointly or jointly and severally. A promissory
note that reads I promise to pay and signed by two persons is deemed to have been
made jointly and severally by the two. A joint and several promissory note does not
consist of only one note. It consists of several notes. If three persons make a joint and
several promissory note, there are in fact four notes (i.e., one joint note of all the three
and three several notes of each of them).
vi.
The sum payable must be certain without any scope of contingent additions or
subtractions.
Ambiguous promises invalidate the promissory note. For example, I promise to pay S
Rs.1,000 and all the other sums due to him.

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The following have been held not to be promissory notes owing to uncertainty of the
sum payable.
a.

I promise to pay A Rs.300 and all other sums which may become due to him.

b.
me.

I promise to pay A, Rs.500 after deducting any amount which he may owe

c.

I promise to pay A, Rs.1,200 and all fines according to the rule.

In Official Liquidator vs. Bishan Singh, a document which acknowledged a debt and
contained an undertaking to repay the debt along with interest (interest rate was not
specified) was held not to be a promissory note as the sum payable was uncertain.
However, in Seth Tulsidass Lalchand vs. Rajagopal, it was held that where the interest
rate was not specified, a rate of six percent would be applicable as per Section 80 of the
Act.
vii.
The payment must be in money and not in kind. If the instrument contains
agreement to pay in kind then it cannot be considered as a promissory note.
I promise to deliver to B 1,000 bags of wheat is not a promissory note as there is no
promise to pay in money.
viii. The promissory note should clearly point out the person who is to receive
payment on the note. The name of the payee may be indicated anywhere on the note
and so long as he can be ascertained the instrument will be a valid promissory note
subject to fulfillment of other conditions as required by Section 4.
When, at the time of making the note, the payee is known with certainty, the absence of
his name on the instrument will not render the promissory note invalid.
Consideration, Date, Place etc.
The maker of a note usually specifies that the note is being made for value received.
However, the absence of this statement will not render a note invalid. The making of a
promissory note presumes the existence of consideration, until the contrary is proved.
A promissory note which does not state the place at which it is made is not invalid.
Also, a promissory note will not be invalid by the mere fact that it contains a promise to
pay at a certain place.
Likewise, an undated instrument is not invalid. Every undated instrument will be
deemed to have been dated on the date of its delivery. Under Section 118(b) of the Act,
every dated instrument will be presumed to have been made and drawn on the date it
bears unless proved otherwise. A bank note or currency note is not a promissory note.

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The maker of a note usually specifies that the note is being made for value received.
However, the absence of this statement will not render a note invalid. The making of a
promissory note presumes the existence of consideration, until the contrary is proved.
A promissory note which does not state the place at which it is made is not invalid.
Also, a promissory note will not be invalid by the mere fact that it contains a promise to
pay at a certain place.
Likewise, an undated instrument is not invalid. Every undated instrument will be
deemed to have been dated on the date of its delivery. Under Section 118(b) of the Act,
every dated instrument will be presumed to have been made and drawn on the date it
bears unless proved otherwise. A bank note or currency note is not a promissory note.
Ix The promissory note must be properly stamped in accordance with the provisions of
the Indian Stamp Act. Each stamp must be duly cancelled by the makers signature.
The stamp duty payable is dependent on the value of the note and whether the note is
payable on demand or at a future date. An unstamped promissory note is invalid and no
action can be entertained on such a note.
Section 17 of the Stamp Act, 1899 lays down that a promissory note should be stamped
before or at the time of its execution. Also, it is not compulsory to use adhesive stamps
while executing a promissory note. In case, an adhesive stamp is used, it should be
properly canceled so that it cannot be used again. A promissory note may also be
executed on paper on which adequate stamps have been embossed. In such a case, care
should be taken while writing the document. The matter should be written in such a
manner that the stamp appears on the face of the instrument and cannot be used for any
other instrument.
x It may be payable on demand or after a specified period.
Xi It cannot be made payable to bearer on demand.
6.5 Bill of Exchange
This form of negotiable instrument has been in usage for a very long time. It was
initially used for payment of debts by traders residing in one country to another country
with a view to avoiding transmission of coins. Now-a-days it is used as trade bills both
for domestic as well as foreign trade known as inland bills and foreign bills
respectively.
According to Section 5, A bill of exchange is 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. A bill of exchange cannot be made by electronic means and hence Section
1(4)(a) of IT Act applicable to cheques is not applicable to Bill of Exchange
Parties to a Bill of Exchange
There are basically three parties to a bill of exchange. They assume different roles
which are explained below:

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The person who draws the bill is called the Drawer.

The person on whom the bill is drawn is called the Drawee.

The person who accepts the bill (he may be the drawee or a stranger on behalf
of drawee) is called the Acceptor.

The person to whom the sum stated in the bill is payable (either the drawee or
any other person) is the Payee.

The person who is in lawful possession of the bill is called the Holder.

The person who endorses the bill in favor of another person is called Endorser.

The person in whose favor the bill is endorsed is called the Endorsee.
Essentials of Bills of Exchange
i. It must be in writing.
ii. It must contain an unconditional order to pay when a bill of exchange is drawn
by the drawer it is assumed that the drawee has funds with him to pay to the
drawer. A bill of exchange contains an order by the drawer to the drawee, to make
payment to the payee. Therefore, if a bill contains a request to make payment, it is
likely to cause inconvenience and uncertainty. However, the use of few
expressions of politeness will not affect the validity of the bill. In Ruff vs. Webb,
an instrument that read Mr. AB will much oblige Mr. CD by paying to the order
of P was held to be a good bill. Excessive terms of politeness should be
avoided as it may give an impression that the communication contained in the bill
was not an order.
iii.

It must be in writing.

iv.

It must contain an unconditional order to pay when a bill of exchange is drawn

by the drawer it is assumed that the drawee has funds with him to pay to the
drawer. A bill of exchange contains an order by the drawer to the drawee, to
make payment to the payee. Therefore, if a bill contains a request to make
payment, it is likely to cause inconvenience and uncertainty. However, the use
of few expressions of politeness will not affect the validity of the bill. In Ruff vs.
Webb, an instrument that read Mr. AB will much oblige Mr. CD by paying to
the order of P was held to be a good bill. Excessive terms of politeness
should be avoided as it may give an impression that the communication
contained in the bill was not an order.

v.

The sum payable must be certain.

vi.

It must comply with other formalities like number, date and consideration,
stamp, etc.

6.6 A comparison can be made between a promissory note and a bill of exchange.
This may be summarized as follows:

The liability of the maker of a note is primary and absolute whereas the liability
of the drawer of a bill is secondary and conditional.

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The maker of a note is in the same position as an acceptor of a bill. Therefore,

except in a case where the note is payable at a certain place, presentment of the
instrument and notice of dishonor is not required to make him liable.
A note cannot be made conditionally, whereas a bill may be accepted
conditionally. This is because in the case of a note, the maker is the originator of
the note whereas in the case of a bill, the role of the acceptor is secondary (i.e.,
he is not the originator of the bill).
The maker of a note stands in immediate relation with the payee where as the
drawer of a bill stands in immediate relation with the acceptor and not the payee.
A promissory note indorsed by the payee corresponds to an accepted bill payable
to the drawers order, the payee having the same rights and obligations as that of
the drawer of the accepted bill.

6.7 BILLS IN SETS

A bill may be drawn in sets when it has to be sent from one country to another. The
object is to avoid undue delay and unnecessary inconvenience which may arise due to
the loss or miscarriage of the bill during the transit and to ensure the safe transmission
of at least one part of the bill to the drawee. Bills are usually drawn in sets to avoid the
danger of loss. They are drawn in sets of three, each of which is called Via and as
soon as any one of them is paid, the others become inoperative.
A bill of exchange can be drawn in parts and all parts make a set and the whole set
constitutes only one bill. Each part must be numbered and must have reference to the
other parts, failure to do so will make that part a separate bill if it gets into the hands of
a holder in due course. When the payment is made on one of the parts the entire bill is
extinguished. All parts of the bill must be signed by the drawer and a stamp is affixed
on one part as only one part of the whole set needs to be accepted. When endorsement
is made to different persons, the endorsee and subsequent endorsers of each part are
liable on such parts as if these parts were separate bills. Where two or more parts of a
set are negotiated to different holders in due course, he who first acquires title to his
part is deemed to be the true owner of the bill.
A bill of exchange takes the form of a bank draft when it is drawn by one bank on
another bank, or on its own branch and is negotiable. It is almost like a cheque but
differs as it is drawn usually by a bank on its own branch and can easily be
countermanded and made payable to bearer.
At sight, On presentment, After sight: In a promissory note or bill of
exchange, the expressions at sight and on presentment means on demand. The
expression after sight means, in a promissory note, after presentment for sight, and, in
a bill of exchange after acceptance, or noting for non-acceptance, or protest for nonacceptance. (Section 21)
Maturity: The maturity of a promissory note or bill of exchange is the date at which
it falls due. (Section 22)
Days of grace: Every promissory note or bill of exchange which is not expressed to be
payable on demand, at sight or on presentment is at maturity on the third day after the
day on which it is expressed to be payable.

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Calculating maturity of bill or not payable so many months after date or sight: In
calculating the date at which a promissory note or bill of exchange, made payable at
stated number of months after date or after sight, or after a certain event, is at maturity,
the period stated shall be held to terminate on the day of months which corresponds
with the day on which the instrument is dated, or presented for acceptance or sight, or
noted for non-acceptance, or protested for non-acceptance, or the event happens, or
where the instrument is a bill of exchange made payable a stated number of months
after sight and has been accepted for honor, with the day on which it was so accepted. If
the month in which the period would terminate has no corresponding day, the period
shall be held to terminate on the last day of such month. (Section 23)
Calculating maturity of bill or note payable so many days after date or sight: In
calculating the date at which a promissory note or bill of exchange made payable a
certain number of days after date or after sight or after a certain event is at maturity, the
day of the date, or of presentment for acceptance or sight, or of protest for nonacceptance, or on which the event happens, shall be excluded. (Section 24)
When day of maturity is a holiday: When the day on which a promissory note or bill
of exchange is at maturity is a public holiday, the instrument shall be deemed to be due
on the next preceding business day. (Section 25)
Explanation: The expression Public holiday includes Sunday, and any other day
declared by the Central Government, by notification in the Official Gazette, to be a
public holiday.
6.8 CHEQUES
PROVISIONS IN RESPECT OF CHEQUES
A cheque is a bill of exchange drawn on a specified banker and not expressed to be
payable otherwise than on demand. Cheque includes electronic image of a truncated
cheque and a cheque in electronic form [Section 6]. The definition is amended by
Amendment Act, 2002, making provision for electronic submission and clearance of
cheque. The cheque is one form of bill of exchange. It is addressed to Banker. It cannot
be made payable after some days. It must be made payable on demand.
A cheque should be signed by the drawer and should contain an unconditional order to
a specified banker, to pay on demand, a certain sum of money to or to the order of a
specified person or to the bearer of the instrument. All cheques are bills of exchange
whereas all bills of exchange are not cheques. The fact that a cheque is ante-dated or
post-dated will not make it invalid. A post dated cheque is payable on or after the date it
bears. Even though the same rules are applicable to both bills and cheques, there are
some differences between the two. They are:
a. The drawee of a bill can be made liable on it, only after the bill is accepted by him.
On the other hand, a cheque does not require any acceptance and is intended for
immediate payment.

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b. Three days of grace are usually allowed in case of a bill except where a bill is
payable on demand. A cheque, however is not entitled to any days of grace.
c. The drawee of a cheque is always a banker, whereas the drawee of a bill may be any
one including a banker.
d. A bill of exchange should be presented for payment. Failure to do so, normally
discharges the drawer from his liability on the bill. Delay in presenting a cheque
does not discharge the drawer of the cheque from his liability, except in a case
where the drawer has incurred damages because of the delay.
e. A cheque may be crossed but a bill of exchange cannot be crossed.
f. In case of dishonor of a bill, a notice of dishonor should be given to the drawer in
order to charge him. Notice of dishonor of cheque to the drawer, may not be
necessary in a large number of cases. (for e.g. cheque dishonored for want of
drawers funds with the bank).
ELECTRONIC CHEQUE
Provisions of electronic cheque has been made by Amendment Act, 2002. As per
Explanation I(a) to Section 6, A cheque in the electronic form means a cheque which
contains the exact mirror image of a paper cheque, and is generated, written and signed
by a secure system ensuring the minimum safety standards with the use of digital
signature (with or without biometrics signature) and asymmetric crypto system.
Truncated Cheque
Provisions of electronic cheque has been made by Amendment Act, 2002. As per
Explanation I(b) to section 6, A truncated cheque means a cheque which is truncated
during the clearing cycle, either by the clearing house during the course of a clearing
cycle, either by the clearing house or by the bank whether paying or receiving
payment, immediately on generation of an electronic image for transmission,
substituting the further physical movement of the cheque in writing.
6.9 CROSSING OF CHEQUES
A cheque can be either an open cheque or a crossed cheque. Open cheques are those
cheques which can be encashed directly across the counter by presenting to the drawee
bank. In this case, as the cheque is not required to go through a bank before being
presented to the drawee bank for payment, there are certain risks attached to such
cheques. If such a cheque is lost or stolen, the finder or the thief may get it encashed
with the drawee bank unless the drawer has in the meanwhile countermanded
payment. The concept of crossing cheques was introduced with a view to avoid the
losses that may result because of open cheques.
Crossing of a cheque is a direction given to the paying bank to pay the money
generally to a bank or to a particular bank as the case may be. The basic intention of
crossing is to secure payment to a bank in order to be able to locate the person for

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whose use the money has been received and also to force the holder of the instrument
to present it through a source of recognized respectability.
It should be kept in mind that crossing of a cheque does not affect its negotiability
unless the words not negotiable are inserted in addition to the crossing. Where the
words not negotiable are added to the crossing, the cheque is not negotiable although
it remains transferable.
MODES OF CROSSING
According to Section 123, where a cheque bears across its face an addition of the words
and company or any abbreviation thereof, between two parallel transverse lines, or of
two parallel transverse lines simply, either with or without the words not negotiable,
that addition shall be deemed a crossing, and the cheque shall be deemed to be crossed
generally.
Where a cheque is crossed generally, it is the responsibility of the drawee bank not to
make payment otherwise than to a bank. (Section 126)
Special Crossing: According to Section 124, where a cheque bears across its face an
addition of the name of a banker, either with or without the words not negotiable that
addition shall be deemed a crossing, and the cheque shall be deemed to be crossed
specially, and to be crossed to that banker.
Where a cheque is crossed specially, the drawee bank is obliged to make payment only
to the bank to whom the cheque is crossed or to its agent for collection.
Restrictive Crossing: In Restrictive Crossing the words Account Payee are added to
the general or special crossing. The words Account Payee on a cheque are direction
to the collecting banker that the amount collected on the cheque is to be credited to the
account of the payee. Account Payee cheques are not negotiable.
Not Negotiable Crossing: According to Section 130 of the Act, the effect of the words
not negotiable on a crossed cheque is that the title of the transferee of such a cheque
cannot be better than that of its transferor. The addition of the words not negotiable
does not restrict the further transferability of the cheque. The object of crossing a
cheque not negotiable is to afford protection to the drawer or holder of the cheque
against miscarriage or dishonesty in the course of transit by making it difficult to get the
cheque so crossed cashed, until it reaches its destination.
CROSSING AFTER ISSUE OF THE CHEQUE
According to Section 125:

Where a cheque is not crossed, the holder of the cheque may cross it either
generally or specially.

Where the cheque is crossed generally, the holder may cross it specially.

Where the cheque is crossed either generally or specially, the holder may add
the words not negotiable to the crossing.

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A cheque that is crossed specially to a specified banker, may be crossed again by that
banker specially to another banker, his agent, for collection.
ILLUSTRATIONS:
The following is an illustration of how a cheque may be crossed:

A draws a cheque on his bank (i.e., Andhra Bank) by crossing it generally. B

is the payee of the cheque. He receives the cheque and indorses it. This cheque
cannot be encashed directly over the counter of the drawee bank. B can encash
this cheque only through a bank account. B pays this cheque into his own
account at the Indian Bank. The cheque is collected and Bs account is credited
with the said amount while As account is debited.

In case the cheque received by B is crossed specially by him to the Indian

Bank, the same result will follow. If the Indian Bank is unable to present the
cheque, it may cross the cheque specially to another banker, its agent say, the
Hyderabad bank, for collection of the same.

A person who takes a cheque that bears the words not negotiable acquires no
better title than that of his immediate transferor. The true owner of the instrument
can claim the instrument or the money from the said person. However, under
Sections 128 and 131, the paying and collecting bank will be exonerated from any
liability if it can be proved that the payment and collection were made in good faith
and without negligence.

For example, a cheque that is payable to bearer and crossed generally with the
words not negotiable is stolen and subsequently comes into the hands of B
who takes the instrument in good faith and gives value for it. B pays the
cheque into his own account and his bank collects the payment from the drawee
bank. By virtue of Sections 128 and 131, the drawee bank and the collecting
bank are exonerated from liability on the cheque. However, as B does not
acquire a good title to the cheque, he is liable to refund the money to the true
owner. The cheque in the given case is not negotiable and therefore as regards
the true owner, B is in no better position than his immediate transferor.

The protection available to the collecting banker under Section 131, is however subject
to the following conditions:
a. The collecting bank should have acted in good faith and without negligence. The
question as to whether a bank had acted negligently or not would depend on the
circumstances and facts of each case. It is not necessary that negligence should relate
only to collection of a cheque.
It was held in Central Bank of India Limited vs. Gopinathan Nair, that negligence in the
opening of an account of the customer may prevent the bank from seeking protection
under Section 131.
Similarly, in Orbit Mining and Trading Co. Limited vs. Westminister Bank Limited,
failure on the part of the collecting banker to make necessary inquiries about the
customer, his occupation, employer, etc., was held to constitute negligence. However, it

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was also held that the collecting bank is not required to continually keep itself updated
as to the identity of the customers employer.
b.
The collecting bank should have received payment on behalf of a customer.
Where the bank has received payment on behalf of a person who is not a customer of
the bank, then it cannot claim protection under Section 131.
c. Section 131 will not be applicable where the collecting bank is a holder for value.
This section affords protection to the bank only if bank is acting as an agent for
receiving payment. Where a bank advances money to the customer against the
cheque, even before the cheque is realized, then it is not an agent but is a holder for
value.
In Mclean vs. Clyesdale Banking Co., a customer had overdrawn his account with a
bank and later paid in a cheque to extinguish the overdraft. It was held that the bank
was a holder for value and not an agent for collection.
d.

Lastly, the cheque should be crossed and the crossing should have been made
before the collecting bank receives the said cheque. Where an uncrossed cheque is
given to the bank for collection and where the bank crosses it, Section 131 cannot be
invoked.
6.11 CAPACITY OF PARTIES
According to Section 26, every person is capable of contracting, according to the law to
which he is subject, may bind himself and be bound by the making, drawing,
acceptance, indorsement, delivery and negotiation of a promissory note, bill of
exchange or cheque.
This section lays down that the capacity of a person to incur liability on a negotiable
instrument is coextensive with his capacity to contract. A person who is not competent
to contract, cannot be made liable on the instrument. However, the incapacity of one of
the parties to the instrument will in no way reduce/absolve the liability of other
competent parties to the instrument.
Under Section 11 of the Indian Contract Act, a minors contract is void and cannot be
ratified by him after he attains majority.
According to Section 26, a minor may draw, indorse, deliver and negotiate such
instruments as to bind all parties except himself.
Nothing herein contained shall be deemed to empower a corporation to make, indorse
or accept such instruments except in cases in which, under the law for the time being in
force, they are so empowered.
Where several persons are mentioned in a negotiable instrument as makers, drawers,
acceptors, indorsers and one of them is a minor, except the minor, other competent
parties will not be discharged from their liability.
It was held in Burgess vs. Merill, that the holder of a negotiable instrument can sue all
the adult parties to a bill, to the exclusion of the minor.
A minor cannot bind himself by accepting a bill or making a note. However, all the
other competent parties to the instrument will be liable. In Sulochana vs. Pandyan Bank
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Limited, where a promissory note was jointly executed by a minor and her father, it was
held that the father was liable on the note.
Even though the minor cannot be made liable on a bill or a note, he can acquire all the
rights under it, and where the minor becomes the holder he is entitled to sue all the prior
parties to the instrument.
In Sathrurasu vs. Bassappa, it was held that a promissory note payable on demand and
executed in favor of a minor is not void so as to disentitle him to sue on it.
In Exp Margrett, re Soltykoff, it was held that a minor cannot bind himself by accepting
a bill or making a note for necessaries supplied to him. However, the person who
supplies the necessaries is entitled to claim reimbursement from the property of the
minor.
Also, where a minor obtains a loan on a promissory note by falsely representing his age,
he can neither be compelled to pay damages for the fraud nor can he be forced to pay
back the amount of the loan.
In Indra vs. Anthiappa a note made by a person on attaining majority in renewal of a
previous note executed by him when he was a minor was held to be a nullity for want of
consideration.
Other than minors, a promissory note or a bill of exchange executed by lunatics,
persons of unsound mind and drunken persons will be unenforceable against them,
though other competent parties to the instrument will be liable.
A person of unsound mind will be liable on an instrument executed by him during a
period where he was capable of exercising rational judgment. Similar would be the case
of a drunken person. An instrument executed by a drunken person will not bind him if it
can be proved that the instrument was executed by him in his drunkenness and he was
unaware as to what it was.
Section 26 states that a person competent to contract, binds himself on any note, bill,
etc., executed by him. However, there is an exception to this rule. According to the
proviso to Section 26, a corporation under this section cannot bind itself upon an
instrument unless empowered in this behalf by the law for the time being in force. The
power to bind itself upon an instrument may either be express or implied. For example,
a company incorporated for the purpose of carrying on trade has implied power to
make, draw, accept and indorse a bill or a note. Where such a power is not implied, the
contractual capacity of the corporation can be ascertained from the memorandum of
association of the company.
Suit by a Person other than the Holder
Judicial opinion differs as to whether a person other than the holder can bring a suit
upon a negotiable instrument. Some have held the view that Section 78 of the Act does
not prevent a person other than the holder of the instrument from bringing a suit upon a
negotiable instrument. Thus, the true owner of an instrument may bring a suit upon it if
he is in a position to obtain a good discharge of liability for the person liable thereon.
In Assuram vs. Niranjandass, a note executed in favor of the firm was allotted to one of
the partners without any indorsement at the time of partition of the firm. The partner
could sue upon the instrument.
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In Davvuru Jayarama Reddy vs. Revathi Mica Co., it was held that the firm could sue
upon the instrument, where a note was executed in favor of a person as partner of the
firm.
6.12 PARTIES TO NEGOTIABLE INSTRUMENTS
We have, while describing a promissory note, bill of exchange and cheque, also
discussed the various parties to each of these instruments. In addition, there are two
more parties common to these instruments holder and holder in due course.
Holder
According to Section 8 of the Act, a person is a holder of a negotiable instrument if
he is entitled in his own name (a) to the possession of the instrument, and (b) to
recover or receive its amount due from the parties thereto. To be a holder, the person
must be named in the instrument as the payee, or the endorsee or bearer thereof.
Holder in Due Course
A holder in due course can claim to be so, only if it can be proved that he acquired the
instrument for valuable consideration. According to the Indian Contract Act, one of the
essential requirements of a contract is the presence of consideration. It is also necessary
that the consideration is not illegal, immoral, opposed to public policy or injurious to a
third person. Further, Section 2(d) of the Indian Contract Act lays down that
consideration should pass at the desire of the promisor. Where consideration does not
pass at the desire of the promisor, the contract is not a valid contract
Time of acquisition of the instrument
The holder in due course should have acquired the instrument any time before the
amount became payable. Thus, if the instrument is acquired on the day the amount
becomes payable, the person taking it does not acquire the rights of a holder in due
course, as the said amount is payable at any time on that particular day.
Where a negotiable instrument is acquired by a person after the day the amount
becomes payable, such a person cannot take the place of a holder in due course. The
rights acquired by him are only coextensive with that of his immediate transferor.
It was held in Ramanadam Chettiar vs. Gundu Aiyyar, that a promissory note is a
continuing security and the fact that the note has been overdue for a long time at the
time of negotiation to the holder, will not prevent him as holder in due course from
enforcing the same.
Without notice of defect in title
A holder in due course should have acquired the instrument without having sufficient
cause to believe that any defect existed in the title of his immediate transferor.
According to English Law, a person can claim to be a holder in due course if he proves
that he has acquired the instrument in good faith irrespective of the fact that he was
negligent and reckless while acquiring the instrument.
Time of notice of defects
A person who takes an instrument fully aware of the defective title of his immediate
transferor is not a holder in due course. Notice of the defective title at the time when a
person takes the instrument is relevant. It is such notice which disqualifies him from

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acting as a holder in due course. Any notice received by him after he has perfected his
title to the instrument, will not affect his right as a holder in due course.
Payment in Due Course
According to Section 10 of the Act, payment in due course means payment in
accordance with the apparent tenor of the instrument in good faith and without
negligence to any person in possession thereof under circumstances which do not afford
a reasonable ground for believing that he is not entitled to receive payment of the
amount therein mentioned
It was held in Morley vs. Culverwell, that the payment of a bill by the drawee or the
acceptor before its maturity amounts to a purchase of the bill. The drawee/acceptor in
such a case cannot be prevented from reissuing the said bill.
Privileges of a Holder in Due Course
A holder in due course obtains title to the instrument free from equity. He also enjoys
certain privileges. They are:
i. A person who has signed and delivered to another, a stamped but otherwise
inchoate instrument, is prevented from asserting, as against a holder in due course,
that the instrument has not been filled in accordance with the authority given by
him, the stamp being sufficient to cover the amount. (Section 20)
ii. Until the instrument is duly satisfied, every prior party to a negotiable
instrument is liable thereon to a holder in due course.
iii. If a bill or note is negotiated to a holder in due course, the other parties to the
bill or note cannot avoid liability on the ground that the delivery of the instrument
was conditional or for special purpose only. (Section 46)
iv. Once the negotiable instrument passes through the hands of a holder in due
course, it gets cleansed of all its defects, provided the holder is not a party to the
fraud. (Section 53)
v. The defenses on the part of a person liable on a negotiable instrument cannot be
set-up against a holder in due course if that negotiable instrument has been lost, or
obtained from such person by means of an offense or fraud or unlawful
consideration.
vi. The law presumes every holder as a holder in due course, although the
presumption is rebuttable.
vii. The validity of the instrument as originally made or drawn cannot be denied by
the maker/drawer/acceptor for honor in a suit initiated by a holder in due course.
viii. The endorser of a negotiable instrument cannot, in a suit thereon by a
subsequent holder, deny the signature or capacity to contract of any prior party to
the instrument. (Section 122)
6.13 LIABILITIES OF PARTIES
Liability of Drawer
According to section 30, the drawer of a bill of exchange is bound, in case of dishonor
by the drawee or acceptor thereof, to compensate the holder, provided due notice of
dishonor has been given to, or received by, the drawer as hereinafter provided.

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The liability of the drawer on a bill of exchange is secondary in nature. It is the acceptor
of the bill who is primarily responsible to make payment. By drawing a bill, the drawer
undertakes that,
a. On presentment of the same to the acceptor, it will be accepted and duly
honored, and
b. If dishonored by the acceptor either by failure to make payment or by nonacceptance he will compensate the holder or any indorser provided due notice of
dishonor has been given to him.
The liability of a drawer arises only when there is a dishonor of the bill. Until then the
drawer is not liable on the bill. In case the bill is dishonored and notice of the same is
given to him, the drawer will be liable to make payment to the payee
Liability of Drawee
The relationship between a banker and a customer is one of a debtor and creditor. In
addition, the banker also undertakes to honor the customers cheques as long as there
are funds available in the customers account. The banker while fulfilling the obligation
to honor the customers cheques may permit him to overdraw to a certain limit
(provided there is a valid agreement to that effect).
Similarly, the customer undertakes to draw cheques in a proper manner so as to enable
the banker to honor the same
Where a customer has two accounts at a bank, the banker cannot transfer funds from
one account to the other without obtaining the approval of the customer Greenhalgh vs.
Union Bank of Manchester.
Following are some of the instances where a banker may refuse to honor the
customers cheques.
i. Where a postdated cheque is presented for payment prior to the date it bears,
then the banker will be justified in refusing to honor the cheque.
ii. Where a customer does not have sufficient funds to his credit (i.e., there are no
funds or funds available are not enough to cover the amount of the cheque), then
the banker may dishonor the cheque.
iii. If the funds of the customer are subject to a lien by the banker, the customers
cheque is likely to be dishonored.
iv. A banker will also be justified in dishonoring a cheque that is ambiguous,
unclear or contains a material alteration.
v. The cheques of a customer who has been declared insolvent is also liable to be
dishonored.
vi. Similarly, where the customer has countermanded payment, the banker is
justified in refusing payment of the customers cheques.
vii. Where the banker receives notice of either the customers death or insanity, he
may refuse payment. However, any payment made before notice of death will be
valid.

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Liability of the Drawee Bank for Wrongful Dishonor

A drawee bank is liable to make payment only if the cheque is presented to it during the
usual banking hours. Where the bank holds sufficient funds of the customer but
wrongfully dishonors the customers cheque, then it is liable not only for any monetary
loss suffered by the customer but also for loss or injury to the reputation of the
customer.
It should be noted that a drawee bank is liable only to the drawer in case of wrongful
dishonor of a cheque. Thus, the holder of a cheque cannot enforce payment upon the
same from the bank as there is no privity of contract between the two. This is the case,
even when the bank has sufficient funds of the customer. The remedy of the holder of a
cheque lies against the drawer of the cheque and not against the bank.
Liability of the Drawee Bank where the Drawers Signature is Forged
It is the responsibility of the drawee bank to get acquainted with its customers
signature and hence when payment is made on a cheque that bears the forged signature
of the customer, the bank cannot claim statutory protection. This is the case, even when
the forgery cannot be distinguished from the customers signature as per the banks
records. On the other hand Section 85 of the Act provides protection to a drawee bank
paying a cheque that carries a forged indorsement. According to this section, where a
cheque payable to order purports to be indorsed by or on behalf of the payee, and the
bank on which it is drawn makes payment in due course, then the bank is discharged
from its liability notwithstanding the fact that the indorsement of the payee might turn
out to be forged.
Liability of Endorser (Section 35)
According to Section 35, in the absence of a contract to the contrary, whoever, indorses
and delivers a negotiable instrument before maturity, without, in such indorsement,
expressly excluding or making conditional his own liability, is bound thereby to every
subsequent holder, in case of dishonor by the drawee, acceptor or maker, to compensate
such holder for any loss or damage caused to him by such dishonor, provided due
notice of dishonor has been given to, or received by, such indorser as hereinafter
provided.
Every indorser after dishonor is liable as upon an instrument payable on demand.
An indorser of a negotiable instrument is in the position of a new drawer and his
relationship with the holder of the instrument is conditional. By endorsing a bill, the
endorser undertakes that the instrument will be accepted and paid according to its tenor
on presentment and in case it is dishonored, he will compensate the holder or a
subsequent indorser who is compelled to pay for it, subject to due notice of dishonor
being given to him.
It should be noted that the indorsers liability under this section will not commence
until the indorsed instrument is delivered to the transferee. Also due notice of dishonor
of the instrument should be given to him in order to make him liable on the instrument.
In LLoyd vs. Howard, it was held that an indorsee for collection cannot maintain a suit
against the indorser.
Liability of Prior Parties (Section 36)

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According to Section 36, every prior party to an instrument will remain liable to every
subsequent party, until the instrument is duly discharged or satisfied. When the liability
of all the parties to the instrument is extinguished and when payment is made at or after
maturity either by the acceptor/maker as the case may be, then the instrument will be
deemed to be duly satisfied. A payment which is made prior to the date of maturity does
not result in a discharge of the instrument. Such an instrument can be re-negotiated by
the acceptor. However, he cannot enforce payment on it from a party to whom he was
previously liable.
Liability of Acceptor of Forged Endorsement (Section 41)
Where the acceptor of a bill, accepts it fully aware of the fact that the indorsement on the
bill is a forgery, he cannot later deny his liability by pleading that the indorsement was a
forged one. In such a case, he cannot challenge the holders title to the bill on the ground
of forgery, when he himself has accepted the bill knowing fully well that the
indorsement was a forged one. As a consequence, he will be liable to make payment
twice, i.e., to the holder of the bill and also to the true owner of the instrument
Acceptors Liability on a Bill drawn in a Fictitious Name
According to Section 42, an acceptor of a bill of exchange drawn in a fictitious name
and payable to the drawers order is not, by reason that such name is fictitious, relieved
from liability to any holder in due course claiming under an indorsement by the same
hand as the drawers signature, and purporting to be made by the drawer.
6.14 NEGOTIATION
Section 46 of the Act reads as follows:
The making, acceptance or indorsement of a promissory note, bill of exchange or
cheque is completed by delivery, actual or constructive.
As between parties standing in immediate relation, delivery to be effectual must be
made by the party making, accepting or indorsing the instrument, or by a person
authorized by him in that behalf.
A promissory note, bill of exchange or cheque payable to bearer is negotiable by the
delivery thereof.
A promissory note, bill of exchange or cheque payable to order, is negotiable by the
holder by indorsement and delivery thereof.
For Example
1. A makes a promissory note in favor of B in respect of a debt owed by A to
B. After As death, the note is found among some of his papers. B cannot
recover the amount on this instrument, even if it is delivered to him.
2. A the drawee receives a bill from B who is the holder of the same. A accepts
the bill. However, on learning that the drawer has become bankrupt, he cancels his
acceptance and returns the bill to the holder. B cannot recover the amount from A
as A had never delivered the accepted bill to B.
3. A makes a note in favor of B and hands it over to his agent for delivery. B
does not acquire a right to the note until it is delivered to him. On the other hand,
A can revoke the note any time before it is delivered.

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Negotiation by Indorsement (Section 48)

According to Section 48, subject to the provisions of Section 58, a promissory note, bill
of exchange or cheque (payable to order), is negotiable by the holder by indorsement
and delivery thereof.
Instruments payable to order are negotiable only if they are indorsed by the holder
followed by delivery of the instrument. Where such an instrument is delivered by the
holder without indorsing it, the instrument is said to have been merely assigned and not
negotiated. A person taking such an instrument only acquires the rights of an assignee
of an ordinary chose-in-action.
The holder of a negotiable instrument indorsed in blank may, without signing his own
name, by writing above the indorsers signature a direction to pay to any other person
as indorsee, convert the indorsement in blank into an indorsement in full; and the holder
does not thereby incur the responsibility of an indorser. (Section 49)
For example, A who is the holder of an instrument that has been indorsed in blank by
B, writes the words Pay to C or order above Bs signature. Here, a blank
indorsement is converted into full. A will not be liable as indorser. The indorsement
made by him serves as an indorsement in full from B to C.
6.15 EFFECT OF INDORSEMENT
The indorsement of a negotiable instrument followed by delivery transfers to the
indorsee the property therein with the right of further negotiation but the indorsement
may, by express words, restrict or exclude such right, or may merely constitute the
indorsee an agent to indorse the instrument, or to receive its contents for the indorser, or
for some other specified person. (Section 50)
According to Section 50, indorsement may be either unconditional or restrictive. Where
there is an unconditional indorsement of an instrument followed by an unconditional
delivery so as to transfer the property in the instrument to the indorsee, then the
indorsee will be vested with the right to sue all the parties whose names appear on the
instrument. Further, he may negotiate the bill with anyone he pleases. However, he
cannot sue third parties on the original consideration.
Similarly, an indorsee of a promissory note can sue prior parties on the note itself and
cannot sue them (an exception being his immediate transferor) on the original
consideration unless he is also the assignee of the original debt.
Where an instrument is indorsed restrictively, it implies that the instrument cannot be
negotiated further. The person to whom the bill is restrictively indorsed, can deal with the
bill only as directed by the indorser. By this, he is empowered to receive payment on the
bill and to sue any party whom the indorser could have sued. However, he cannot transfer
his rights to any other person unless authorized to do so.
Section 50 lays down that where a bill is indorsed with an intention of restricting its
further negotiability, then such an indorsement should contain express words to that
effect. The mere fact that a special indorsement is not accompanied by words of
negotiability does not make it restrictive.
In Rahmath Bi vs. Angappa Raja, a note was indorsed for collection. In this case, it was
observed that though the indorsement was without consideration, the indorsee could file
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an insolvency petition against the maker for non-payment of the note. It was also held
that the indorser could join in as an additional petitioner.
Where a restrictive indorsement permits further transferability of the instrument,
then all the subsequent indorsees who take the instrument will be vested with the
same rights and liabilities as the first indorsee under the restrictive endorsement.
Conditional Indorsement
The indorser of a negotiable instrument may, by express words in the indorsement,
exclude his own liability thereon, or make such liability or the right of the indorsee to
receive the amount due thereon depend upon the happening of a specified event
although such event may never happen.
Where an indorser so excludes his liability and afterwards becomes the holder of the
instrument, all the intermediate indorsers are liable to him (Section 52).
INSTRUMENT INDORSED IN BLANK
An instrument that is previously payable to order may be later indorsed in blank and
delivered so as to convert it into an instrument transferable by mere delivery and one
payable to the bearer.
Unlike Section 49 which deals with conversion of a blank indorsement into full, Section
55 deals with the effect of a blank indorsement followed by a full indorsement.
Where an indorsement in blank is followed by an indorsement in full, the instrument
remains payable to bearer and is negotiable against all the parties prior to the indorser in
full. The indorser in full is liable to the holder who acquires the instrument by
indorsement and any subsequent person who derives title to the instrument from the
holder.
For example, A who is the payee holder of a bill indorses it in blank to B who
indorses it in full to C as Pay C or order. C later transfers the instrument to D
without any indorsement. D as the bearer of the instrument can either recover the
amount or he may sue the drawer, the acceptor or A, but he cannot sue B or C.
PARTIAL INDORSEMENT
According to Section 56, no writing on a negotiable instrument is valid for the purpose
of negotiation if such writing purports to transfer only a part of the amount appearing to
be due on the instrument; but where such amount has been partly paid, a note to that
effect may be indorsed on the instrument, which may then be negotiated for the balance.
For Example
A the holder of a bill for Rs.1,000 indorses it as Pay B or order Rs 700. The said
indorsement is partial and not valid.
A the holder of a bill for Rs.1,200 makes the following indorsement. Pay Rs.700 to B
or order and Pay Rs.500 to C or order. Even though the total amount of the bill has
been negotiated, B and C are indorsees for only a part of the amount and hence the
indorsement is invalid.
6.16 ASSIGNMENT
When a person transfers his right to receive the payment of a debt, assignment of the
debt takes place.
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Difference between the Assignment and Negotiation

a. Assignment is made in writing and signed by the transferor. Negotiation
requires mere delivery of a bearer instrument and endorsement and delivery of
an order instrument to effectuate a transfer.
b. Notice of transfer of actionable claim (debt) must be given by the transferee to
the debtor in case of assignment in order to complete his title. No such notice is
necessary in case of negotiation.
c. The title of the assignee is subject to all the defects, equities of the assigner. In
case of negotiation the title of the transferee is better than that of the transferor.
d. Consideration is presumed in case of negotiation. In case of assignment, the
transferee must prove consideration for the transfer.
6.17 ENDORSEMENT
Section 15 of the Act defines endorsement as the writing of a persons name on the face
or back of a negotiable instrument or on a slip of paper (called allonge) annexed
thereto, for the purpose of negotiation.
An endorsement can be blank or general, special or full, restrictive, partial and
conditional or qualified. An endorsement is said to be blank or general if the endorser
signs his name only on the face or back of the instrument. If the endorser signs his
name and adds a direction to pay the amount mentioned in the instrument to, or to
the order of a specified person, the endorsement is said to be special or in full. An
endorsement is restrictive which prohibits or restricts the further negotiation of the
instrument. An endorsement is partial which purports to transfer to the endorsee
only a part of the amount payable on the instrument. An endorsement is conditional
or qualified which limits or negatives the liability of the endorser
6.18 DISHONOR OF A NEGOTIABLE INSTRUMENT
Non-acceptance of a bill or non-payment results in dishonor of the instruments.
Dishonor by Non-acceptance
A bill of exchange is dishonored by non-acceptance:
i. When the drawee does not accept it within 48 hours from the time of
presentment for acceptance.
ii.

When presentment for acceptance is excused and the bill remains unaccepted.

iii.

When the drawee is incompetent to contract.

iv.

When the drawees acceptance is a qualified one.

v.

When the drawee is a fictitious person or after reasonable search cannot be

found.
Where a bill has been dishonored by non-acceptance, the holder of the instrument
acquires an immediate right to proceed against the drawer and other indorsers. He is not
required to wait till the date of maturity of the bill or present it for payment.

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Dishonor by Non-payment
promissory note, bill of exchange or cheque is said to be dishonored 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. (Section 92). An instrument is
also dishonored by non-payment when presentment for payment is excused and the
instrument when overdue remains unpaid. (Section 76)
Notice of Dishonor
When a negotiable instrument is dishonored either by non-acceptance or by nonpayment, the holder of the instrument or some party liable thereon must give a notice of
dishonor to all the prior parties whom he wants to make liable. Each party receiving
notice of dishonor must, in order to render any prior party liable to himself, give notice
of dishonor to such party within a reasonable time unless such party otherwise receives
due notice. Notice of dishonor is so necessary that an omission to give it discharges all
parties. If the instrument deposited with an agent for presentment is dishonored, the
notice of dishonor may be given either by the agent or by the principal himself. The
agent may give notice to his principal within a reasonable time, and the principal may
give notice within a reasonable time to the parties sought to be held liable.
Notice of dishonor must be given to all the parties whom the holder seeks to make
liable. It need not be given to the acceptor of a bill or to the maker of a note or the
drawee of a cheque. It may be given to the party liable or his duly authorized agent or
where he has died, to his legal representative, or where he has been declared insolvent,
to his assignee. When the party to whom notice of dishonor is dispatched is dead, but
the party dispatching the notice is ignorant of his death, the notice is sufficient.
Notice of Dishonor when Unnecessary
i.

When notice is expressly waived:

Notice of dishonor may be expressly waived by the person entitled to it. Waiver
may be indicated on the instrument itself by using words such as notice of
dishonor waived or any other similar expression. Waiver can be either express
or implied. It may be made at the time of drawing or indorsing the instrument,
before the time for giving notice has arrived or after the omission to give notice.
For example, where the drawer of a bill informs the holder that the bill will be
dishonored on presentment, notice of dishonor is dispensed with.

ii.

Where the drawer countermands payment:

When the drawer countermands payment, there is no need for a notice of
dishonor. The reason behind this is that the drawer himself is responsible for
preventing the holder from obtaining payment.

iii.

When the party is not likely to suffer any damage for want of notice:

It is not necessary either to present the instrument nor give a notice of dishonor if it can
be shown that when the bill was drawn there were no funds of the drawer in the hands
of the drawee.

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For example, A has a balance of Rs.200 in his bank account. In spite of not having
authority to overdraw, he draws a cheque for Rs.800. In this case, notice of dishonor
can be dispensed with.
Similarly, where a cheque that is presented for payment, is returned unpaid with the
words refer to drawer, notice of dishonor by the holder is not necessary to charge the
drawer. The payee or the indorser will be discharged only if due notice of dishonor is
not given to him in time.
In Chunilal vs. Chandra, it was held that where a cheque was dishonored because of the
closure of the drawers account with the bank, notice of dishonor was not required as
the drawer would not suffer any damage for want of notice.
iv.

When the party entitled to notice cannot after due search be found:
Notice of dishonor need not be given, where in spite of the reasonable efforts and
enquiries made by the holder, the party entitled to receive notice cannot be
located or traced.
v.Where the party required to give notice, is unable to do so, without any
fault of his:
Where notice of dishonor could not be given due to accident, sickness or any
other calamity involving the holder or his agent, such omission is excusable.
Also, where delay in giving notice of dishonor is due to extraneous factors
beyond the control of the holder, such delay is excused. However, due notice will
have to be given once the cause of delay comes to an end.

vi.

When one of the drawers is also an acceptor:

Where one of the drawers is also an acceptor, notice of dishonor is not required to
be given to him, as he must have been aware of the fact of dishonor.

vii.

When the note is not negotiable:

When a promissory note that is not negotiable is indorsed, the indorsee is only an
assignee and cannot enforce any claim against the maker and the indorsers. In
such a case, failure to give notice of dishonor, is unlikely to affect the interest of
any party.

viii.

When notice of dishonor is waived impliedly:

Notice of dishonor is said to have been waived impliedly, where the person
entitled to receive notice, having full knowledge of facts, agrees, after dishonor,
to unconditionally make payment of the amount due on the instrument.
Noting and Protest
According to Section 99, noting means the recording of the fact of dishonor by a notary
public upon the instrument within a reasonable time after dishonor.
Noting of the instrument, helps in substantiating the fact of dishonor. It is left to the
discretion of the holder whether to opt for noting or not. In case the holder does not opt
for noting of the instrument, his rights as a holder are in no way affected. Where the
holder goes in for noting, the notary or his clerk first makes a demand upon the drawee
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either for acceptance of the instrument or for payment and on refusal by the drawee,
notes the bill. A bill that is noted must contain the fact of dishonor, the date of dishonor,
the reasons for dishonor, if the instrument is not expressly dishonored the reason why
the holder treats it as dishonored and the notary charges.
It was held in Bombay City Bank vs. Moonjee Hurridoss Bourke, that mere noting of the
bill cannot be treated as evidence of presentment or dishonor of the bill, even if it bears
the name of the notary in full.
Protest
When a promissory note or bill of exchange has been dishonored by non-acceptance or
non-payment, the holder may, within a reasonable time cause such dishonor to be noted
and certified by a notary public. Such certificate is called a protest. (Section 100)
When the acceptor of a bill of exchange has become insolvent, or his credit has been
publicly impeached, before the maturity of the bill, the holder may, within a reasonable
time, cause a notary public to demand better security of the acceptor, and on its being
refused may, within a reasonable time, cause such facts to be noted and certified as
aforesaid. Such a certificate is called a protest for better security.
MULTIPLE CHOICE QUESTIONS:
Q1 Under which of the following instances, the banker cannot refuse to honor its
customers cheque?
a)
b)
c)
d)

Where a post dated cheque is presented for payment prior to the date it bears.
Where the customer does not have sufficient funds to his credit
Where the customer has countermanded payment
Where the bank holds sufficient funds of the customer.

Q2 The grace period allowed in case of a bill, except where it is payable on demand is
a) 2 days
b) 3 days
c) 5 days
d) 7 days
Q3 Which of the following is not considered as material alteration of a negotiable
instrument?
a)
b)
c)
d)

Alteration relating to date

Alteration relating to place of payment
Alteration relating to rate of interest
Filling blanks of an inchoate instrument

Q4 When a promissory note or bill of exchange has been dishonored by non-acceptance

or non-payment, the holder may, within a reasonable time cause such dishonor to be
noted and certified by a notary public. Such certificate is called a/an
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a)
b)
c)
d)

Protest
Noting
Endorsement
estoppel

Q5 If a cheque drawn by a person is dishonored for insufficiency of funds, the drawer of

the cheque will be punishable with
a)
b)
c)
d)

Fine up to the amount of cheque or one year imprisonment or with both

Find upto twice the amount of cheque or two year imprisonment or with both
Fine of Rs 50,000
Imprisonment upto two years

Q6 Which of the following is an example of general crossing of cheques?

a) Bank of India
b) A/c payee
c) & Company
d) Bank of India- not negotiable
Q7 The manager of a private sector bank has wrongfully dishonored the cheque of its
customer, though the customer has sufficient funds/balance in his account. The
customer can sue for
a) General damages
b) Special damages
c) Exemplary damages
d) Nominal damages
Q 8 When is a notice of dishonor of a negotiable instrument unnecessary?
a) When the drawer countermands payment
b) When the notice is expressly waived
c) When the party is not likely to suffer any loss or damage for want of notice
d) All the above
Q9 Which of the following is true regarding a cheque?
a) An ante dated cheque is invalid
b) A cheque is valid for six months from the date of the cheque
c) A cheque is negotiable by statute
d) Both (b) & (c) above
Q10 Inchoate
a) Is an incomeple instrument
b) Is an instrument delivered for a special purpose as a collateral security
c) Is essentially a case of estoppel
d) Both (a) & (b) above

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Module V: Elements of Company Law

CHAPTER-7 MEANING AND TYPES OF

COMPANIES
After reading this lesson, you will be conversant with:
7.1 Meaning And Nature Of A Company
7.2 Features Of A Company
7.3 Kinds Of Companies
7.4 Private Companies
7.5 Public Companies
7.6 Conversion Of A Private Company Into A Public Company
7.7 Limited Company
7.8 Unlimited Company
7.9 Government Company
7.10 Foreign Company
7.11 Indian Company
7.12 Holding Company &Subsidiary Company
7.13 Other Classification

The Companies Act, 1956 provides a broad legal framework for the operation of
companies registered under this Act. Before the advent of this legislation, Companies
Act, 1913 which was extensively amended in 1936 on lines of the English Companies
Act, 1929, was in force. The Indian version of the Companies Act is the result of the
recommendations of the Company Law Committee formed under the Chairmanship of
Mr. H.C. Bhaba, which was constituted in 1950.
7.1 MEANING AND NATURE OF A COMPANY
Section 3(1) of the Companies Act defines a company as a company formed and
registered under this Act, or an existing company as defined under Section 3(1)(ii)
which lays down that an existing company means a company formed and registered
under any previous Company Law. Lord Justice Lindley defines a company as an
association of many persons who contribute money or monies worth to a common stock
and employed in some trade or business and who share the profit and loss arising
therefrom. The common stock so contributed is denoted in money and is capital of the
company. The persons who contributed to it or to whom it pertains to are the members.
The proportion of capital to which each member is entitled is his share. The shares are
always transferable although the right to transfer is often more or less restricted.

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A company may be formed by coming together of a certain number of members and

getting the same registered and incorporated under the Companies Act.
7.2 FEATURES OF A COMPANY
The following are the characteristic features of a company:
1. Separate Legal Entity
One of the important features of a company is its separate legal entity once it is
incorporated or registered under the Companies Act. It exists as an independent legal
person and has its own entity distinct from the persons who constitute it. The company
enjoys rights and liabilities, which are not same as that of its members. No member can
claim to be the owner of the company or claim any ownership rights in the assets of the
company either during its existence or on its winding-up once incorporated. The
company has to bear its own liabilities and the shareholders are under no liability for
anything the company does. Being a distinct legal entity, the company has the capacity
to sue and be sued.
CASELET:
The case of Salomon vs. Salomon & Co. Ltd. (1897), is noteworthy in the light of this
discussion. Salomon was a prosperous leather merchant who converted his company
into a limited company named as Salomon & Co. Ltd. The company so formed
consisted of Solomon, his wife and five of his children as members. The company
purchased the business of Salomon for 39,000, and the purchase consideration was
paid in terms of debentures worth 10,000 conferring a charge over the companys
assets, and 20,000 shares of 1 each fully paid-up. The balance in cash. The company in
less than one year ran into difficulties and liquidation proceedings commenced. The
assets of the company were not even sufficient to discharge the debentures and nothing
was left for the unsecured creditors. The unsecured creditors contended that though
incorporated under the Act, the company never had an independent existence; it was in
fact an alter-ego of Salomon, the other directors being his sons under his control.
It was held by the House of Lords that the company had been validly constituted since
the Act only required seven members holding at least one share each. It said that
nothing about their being independent, or that there should be anything like a balance of
power in the constitution of the company. The company is a different person at law and
though it may be that after incorporation the business is precisely the same as before,
the same persons are managers, and the same hands receive the profits, the company is
not, in law their agent or trustee. Hence, the business belonged to the company and not
to Salomon.
Prior to the pronouncement of the judgement in the case of Salomon vs. Salomon &
Co., the Calcutta High Court has in 1886, recognized the principle of separate entity in
Re Kondoli Tea Co. Ltd. In this case, the members of the company had transferred a tea

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estate to it. Thereafter they claimed exemption from ad valorem duty on the ground that
the transfer was nothing but from them to themselves under a different name.
Rejecting this, the court observed that the company was a separate person, a separate
body altogether different from the shareholders and the transfer was as much as
conveyance, a transfer of property, as if the shareholders had been totally different
persons.
Lifting the Corporate Veil (Exceptions to Salomon Case)
As it can be seen from the case of Salomon vs. Salomon & Co Ltd., a company is given
a distinct legal entity in comparison to the individuals who are managing the affairs of
the company. This provides a veil for the persons who run the incorporated company
as its arms and heads. The courts generally consider themselves bound by the
principle of separate legal entity and adopt a cautious approach while piercing a
corporate veil.
However, there have been instances where the courts lift the corporate veil of an
incorporated company either to expose the ingenuous persons behind the company or to
find out the real purpose of incorporating it. The corporate veil is said to be lifted or
pierced when the court ignores the company and concerns itself directly with the
members or management.
The circumstances under which the court may lift the corporate veil can be broadly
grouped under two heads: Statutory provisions and Judicial interpretations.
Statutory Provisions
The Companies Act, 1956 expressly provides for the following provisions pertaining to
the lifting of the corporate veil:
i.Reduction of Membership: Section 45 specifies that If any time the number
of members of a company is reduced, (i) in the case of a public company, below
seven, (ii) or in the case of private company, below two and (iii) the company
carries on business for mor
ii.is a member of the company... and is cognizant of the fact... shall be severally
liable for the payment of the whole debts of the company contracted during that
period. In this case, the privilege of limited liability of shareholders is lost and
the law pierces the corporate veil making persons behind the company
personally liable despite their limited liability. It must be noted that Section 45
provides for a grace period of six months for bringing back the number of
members to the required number.
iii.Misrepresentation in the Prospectus (Section 62): In case of
misrepresentation in a prospectus, every director, promoter and every other
person, who authorizes the issue of such a prospectus incurs liability towards
those who subscribe for shares on the faith of the untrue statement.
iv.Failure to Refund Application Money [Section 69 (5)]: If the directors of the
company fail to comply with the deadline for refunding the application money
with interest to unsuccessful applicants then they are severally and jointly liable.
This is provided by the SEBI guidelines also. The deadline is of 130 days from
the day of opening of the issue.
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v.Mis-description of Company Name (Section 147): The person(s) signing a

contract on behalf of the company would be held liable if the companys name
is not properly published by law as required. The contract may be any
contract, bill of exchange, hundi, promissory note, cheque or order for money.
vi.

Fraudulent Conduct [Section 542(1)]: If it appears in the course of windingup of the company that some business of the company has been carried on with
intent to defraud creditors, then the courts may declare that any persons who
were knowingly parties to the carrying-on of the business in this way are
personally responsible without any limitation of liability.

vii.

Holding and Subsidiary Companies: A subsidiary company is considered as a

separate legal entity in the eyes of law without any affiliation to the parent
company; except under certain circumstances. This viewpoint is reaffirmed by the
decision in the case of Freewheel (India) Ltd vs. Dr. Veda Mitra (1969). A
company with a 52% stake of the parent company, offered to issue further capital
to the existing holder of equity shares. The holding company objected and sought
for subsidiary to be restrained from going ahead with the issue, as it would
deprive the holding company of its controlling interests and would also result in
depreciation in the value of shares. The Court refused to issue the injunction
following the principle of corporate veil.

2. Common Seal
The case of Salomon vs. Salomon & Co. Ltd., also recognized the principle of limited
liability. The members of a limited company are only liable to contribute towards
payment of its debt to a limited extent. No member can be called upon to pay anything
more than the unpaid value of the shares held by him or the amount guaranteed by him.
In the case of companies formed with unlimited liability of members, the liability of the
members in such cases is not limited only to the extent of the face value of their shares
and the premium, if any, unpaid thereon but members will also be required to contribute
further to meet the debts of the company in the event of winding-up.
3. Separate Property
The wealth of the shareholders and the wealth of the company are separate. A member
does not even have an insurable interest in the property of the company. An
incorporated companies wealth is clearly distinguished from that of its members. As
Palmer puts it: The property is vested in the company as a body corporate, and no
changes of individual membership affect the title. The property, remains vested in the
company, and the company can convey, assign, mortgage, or otherwise deal with it
irrespective of these mutations.

4. Transferable Shares

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The Companies Act provides that the shares or other interests of any member in a
company shall be movable property, transferable in the manner provided by the articles
of the company. A member may sell his share in the market without having to
withdraw the capital from the company.
7.3 KINDS OF COMPANIES

On the basis of membership pattern/size

Companies

(1)
Public

(2)

(3)

Private

Government

(a)

(b)

(a)

(b)

Unlisted

Listed

Independent

Subsidiary
of Public
Co.

On the basis of liabilities of the members and directors:

Companies

With Limited liability

With unlimited liability

(1)

(2)

( a)

(b)

(c)

Limited
By shares

Limited
byLimited by
Guarantee
&Guarantee
having
share
capital

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On the basis of place of registration:

Companies

(1)

(2)

Indian
(Incorporated in India)

CompanyForeign
Company
(Company
incorporated
outside
India
but
having
place
of
business in India)

On the basis of control over the management:

Companies

(1)

(2)

(Holding Company)

(Subsidiary Company)

These types of companies have been explained as under:

7.4 PRIVATE COMPANIES
A private company should have at least two persons (Section 12) to subscribe their
names to Memorandum and Articles of Association. Section 26 provides that a private
limited company must have articles of its own.
As per Section 3(1)(iii), a private company means a company which has a minimum
paid-up capital of one lakh rupees or such higher paid-up capital as may be prescribed,
and by its articles,
a.

Restricts the right to transfer its shares, if any;

b.

Limits the number of its members to fifty not including

i.Persons who are in the employment of the company; and

ii.Persons who having been formerly in the employment of the company, were
members of the company while in that employment and have continued to be
members after the employment ceased;
c.
Prohibits any invitation to the public to subscribe for any shares in, or
debentures of the company.

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d.
Prohibits any invitation or acceptance of deposits from persons other
than its members, directors or their relatives.
However, where two or more persons hold one or more shares in a company jointly, they
shall, for the purposes of this definition, be treated as a single member.
Every private company, existing on the commencement of the Companies
(Amendment) Act, 2000, with a paid-up capital of less than one lakh rupees, shall
within a period of two years from such commencement, enhance its paid-up capital to
one lakh rupees.
According to Section 3(6), a company registered under Section 25 before or after
commencement of Companies (Amendment) Act 2000 shall not be required to take
minimum paid-up capital as specified in this section. Section 3(5) indicates that where a
private company or a public company fails to enhance its paid-up capital after 14th
December, 2002 in the manner as stated above, such company shall be deemed to be
defunct company within the meaning of Section 560 and its name shall be struck off
from the register by the Registrar.
a.
Restriction on transfer of shares: A private company is normally a
closely knit company with a very few members. Hence free transferability of
shares is restricted. It should be noted that it is a restriction imposed and not
prohibition. The articles usually provide that directors may in their absolute
discretion and without assigning any reason thereof decline to register a transfer
of any share whether fully paid or partly paid. The articles may also provide that
a member wanting to dispose of his holding should first offer them to the
existing shareholders at a price determined according to the articles. Only when
no existing member agrees to buy his holding, can the member sell them to an
outsider. This restriction is not applicable in case of a company incorporated as
a pure guarantee company.
b.
Limitation on the number of members: The number of members of a
private company is to be compulsorily limited by its articles to fifty. The
membership will be arrived at by considering joint holders as single member.
Also, present employees who are members and former employees who had
become members during their employment and continued to be members even
after they have ceased to be employees will be excluded.
c. Prohibition upon issue of prospectus: As per Section 3(1)(iii)(c), a private
company cannot issue a prospectus inviting the public to subscribe for shares in
or debentures of, the company. However, there is nothing to prevent a private
company from soliciting investment in its shares or debentures by private
means. Investment by private approach would mean giving opportunity of
investment to the person approached and not to others through him if those
others are likely to be members of the general public rather than a restricted
circle of known persons such as his relatives.
d. Privileges enjoyed by private companies: As there are restrictions on raising
money and maximum number of members in a private company, there is not
much public accountability. Therefore a private company need not be subjected
to such a rigorous surveillance as in the case of a public company. The

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exemptions enjoyed by a private company under Companies Act are mentioned

below.
7.5 PUBLIC COMPANIES
According to Section 3(1)(iv) of The Companies Act, 1956, public company means a
company which
a.
Is not a private company.
b.
Has a minimum paid-up capital of five lakh rupees or such higher paidup capital, as may be prescribed.
c.
Is a private company which is a subsidiary of a company which is not a
private company.
d.
Is incorporated with a minimum of 7 subscribers as required.
e.
Has a minimum 3 directors as stipulated.
Every public company, existing on the commencement of the Companies (Amendment)
Act, 2000, with a paid-up capital of less than five lakh rupees, shall within a period of
two years from such commencement, enhance its paid-up capital to five lakh rupees.
As per Section 3(6), a company registered under Section 25 of the Companies Act,
1956 before or after the commencement of Companies (Amendment) Act, 2000 shall
not be required to have minimum paid-up capital as specified above.
7.6 CONVERSION OF A PRIVATE COMPANY INTO A PUBLIC COMPANY
A private company is converted into a public company in either of the circumstances
mentioned below. Whatever may be the circumstances under which a private company
is converted into a public company, it will cease to enjoy all the privileges that are
allowed to a private company.
CONVERSION BY DEFAULT (SECTION 43)
Any private company making a default in compliance with the statutory requirements
as laid down in Section 3(1)(iii) of the Act will be automatically converted into a public
company. The Central Government, under specific circumstances, may grant relief from
any of the consequences that may arise in case of conversion by default. A departure
from the conditions of Section 3(1)(iii) attracts penalty applicable to a public company
for contravention of the provisions of the Companies Act. This section does not specify
any fixed time limit or impose any special penalty.
In case a company contravenes or does not comply with the conditions laid down by
Section 3(1)(iii), a petition for relief may be filed in case such contravention was
accidental or due to inadvertence. Such a petition should be made to the Central
Government and accompanied by the documents:
i.Copy of memorandum and articles of association.
ii.Copy of document showing that the default has been committed in complying
with the conditions laid down in clause (iii) of Subsection (1) of Section 3.
iii.Affidavit verifying the petition.
iv.Bank draft evidencing payment of application fee.
v.Memorandum of appearance, shall be filed in Form 5 of Annexure-I.

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CONVERSION BY CHOICE (SECTION 44)

There is always a choice for the company to convert itself into a public company.
Conversion of a private limited company into a public limited company by choice will
necessarily involve a change in the name of the company. Any change in the name will
require the passing of a special resolution as provided by Section 21.
In addition to the passing of a special resolution, the following requirements will have
to be fulfilled:
a.
The company will have to alter its articles so as to delete the provisions of
clause (iii) of Subsection (1) of Section 3. On the date of such alteration, the
company will cease to be a private company.
b.
The company shall within thirty days from the passing of the resolution,
file a prospectus or a statement in lieu of prospectus with the Registrar.
c.
If the number of members is less than seven, such number should be
raised to at least seven.
d.
The number of directors should be raised to not less than three in case it
is less than three.
7.7 CONVERSION OF PUBLIC LIMITED COMPANY INTO A PRIVATE
LIMITED COMPANY
Proviso to Section 31(1) read with Section 31 and (2A) provides that no alteration
made in the articles which has the effect of converting a public company into a private
company shall have effect unless such alteration has been approved by the Central
Government. Every such company after obtaining the approval of the Central
Government has to file a printed copy of the altered articles with the Registrar within 30
days of receipt of the approval.
Approval of the Central Government must be obtained through an application within
three months from the date when the special resolution altering the articles was passed.
The application should be in Form IA or in any other form as near thereto as
circumstances warrant.
7.7 LIMITED COMPANY
A company can limit its liability either by shares or by guarantee.
i.Companies Limited by Shares [Section 12(2) (a)]: In this type of a company,
the liability of the members is limited to the amount remaining unpaid on the
shares. Hence, holders of shares that are fully paid-up, cannot be called upon for
any further contribution. The liability of the members holding partly paid-up
shares exists even if the company is in the process of winding up.
ii.Companies Limited by Guarantee not having Share Capital: In this type of
company, the memorandum limits the members liability. It is limited to such
amount as he may have undertaken by the memorandum of association to
contribute
in
case
of
winding
up.
The form of memorandum and articles of a company limited by guarantee and not
having a share capital is contained in Table C of Schedule I. This form may be

129

adopted either in toto or as near thereto as circumstances warrant. The proviso to

Section 29 states that a company is permitted to include additional matters in its
articles provided it is not inconsistent with the provisions contained in Table C.
In P C Arvindhan vs. M A Kesavan, it was held that a provision in the articles of a
guarantee company that prevented its members from participating in the annual
general meeting was illegal and void.
iii.

Companies Limited by Guarantee having Share Capital: If the company is

limited by guarantee while having its own share capital, the liability of members
would be towards guarantee as specified in the memorandum of association and
in addition any sums remaining unpaid on the shares held by him.
The form of memorandum and articles of a guarantee company having share
capital can be found in Table D of Schedule I. The memorandum of such a
company should also specify the amount of share capital with which the
company is to be registered and the amount of each share.

7.8 UNLIMITED COMPANY

Unlimited Companies do not have any limit on the extent of liability of its members.
The liability of each member extends to the whole amount of the companys debts and
liabilities. However, the members cannot be sued upon directly by the companys
creditors. This is in contrast to the liability of the partners in a partnership firm where
partners can be sued directly. In case of winding up, the official liquidator may call
upon the members to discharge the debts and liabilities without limit.
This type of a company may be formed where heavy liabilities are not likely to be
incurred. An unlimited company may increase and decrease its share capital (if it exists)
without any restriction by passing a special resolution. Also, the company may buy its
own shares which is not allowed for a limited company by virtue of Section 77.
A company which is registered as an unlimited company may get itself re-registered as
a limited company under Section 32 of the Act. There would not be any change in any
debts, liabilities, obligations or contracts of the company existing at the time of
conversion and such debts will be enforceable.
The articles of association of a company must state the number of members with
which the company is registered and the amount of share capital (if any) [Section 27].
7.9 GOVERNMENT COMPANY
Section 617 defines a Government Company as any company which has at least 51% of
the paid-up share capital held either by the Central Government, or by any State
Government or Governments or partly by the Central Government and partly by one or
more State Governments. As the concept of government company has been introduced
in the Companies Act, 1956, it follows that a government company will mean a
company registered and incorporated under the Companies Act, 1956.
A statutory corporation formed under a statute of the legislature, like Life Insurance
Corporation, Air India, etc., are neither companies coming within the purview of the
Companies Act nor are they Government Companies.

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7.10 FOREIGN COMPANY

As per Section 591, a foreign company means a company incorporated outside India
but having a place of business in India. Thus, if a company is incorporated outside
India, but employs agents in India without establishing a place of business here, it
cannot be considered as a foreign company. In Deverall vs. Grand Advertisement Inc.
(1954), it was held that a company shall be said to have a place of business in India if it
has a specified or identifiable place at which it carries on business such as an office,
storehouse, godown or other premises having some concrete connection between
locality and its business.
It may also be noted that if a company is incorporated outside India, has Indian
shareholders but does not have a place of business in India, then such company will not
be included within the purview of a foreign company. Likewise, a company that is
incorporated in India but which has foreign shareholders is an Indian company and not
a foreign company.
If 50 percent or more of the paid-up share capital (whether equity or preference or
partly equity and partly preference) of a company incorporated outside India is held
by one or more citizens of India or/and by one or more Indian companies, singly or
jointly, such company shall comply with such provisions as may be prescribed as if it
were an Indian company.
7.11 INDIAN COMPANY
Indian company means a company formed and registered under the companies act, 1956.
Any company formed and registered under any law relating to companies formerly in
force in any part of India, other than Jammu and Kashmir and the union territories as
specified or a corporation established by or under a central, state or provincial act or any
institution, association or a body which is declared by the board to be company under
section 2 (17) are referred as Indian company. In the case of state of Jammu and
Kashmir, a company formed and registered under any law for the time being in force in
the state. Similarly in case of union territories.
7.12 HOLDING AND SUBSIDIARY COMPANY ON THE BASIS OF EXTENT
OF CONTROL
As per Section 4 of the Companies Act, a company shall be deemed to be a subsidiary
of another, if and only if: (i) that other company controls the composition of its board of
directors, or (ii) the other company holds more than half in nominal value of its equity
share capital, or (iii) if it is a subsidiary of a third company which itself is subsidiary of
the controlling company.
The composition of the board of directors of a company shall be deemed to be
controlled by another if the latter has the power, without the consent or concurrence of
any other persons, to appoint or remove the holders of all or a majority of the

131

directorships. A company shall be deemed to have the power to appoint the holder to a
directorship in the following cases:

If a person cannot be appointed to a directorship without the exercise in his favor

of the power of appointment held by the company.
If a persons appointment to directorship follows necessarily from his
appointment as director, managing agent, secretaries and treasurers or manager to
any other office or employment in the company.
If the directorship is held by an individual nominated by the company or by any
of its subsidiaries.

Under Section 212, the holding company is under the obligation to attach the accounts
of the subsidiary with its own accounts though the holding company and its subsidiary
are incorporated companies, each having its own separate legal entity.
A subsidiary company cannot be a member of its holding company. However, if it was
a member before becoming a subsidiary, it shall not have voting rights at meetings of
any class of the holding company, unless it is holding the shares either as a legal
representative of a deceased member or as a trustee of a person. The subsidiary
company can continue to be a member, but by virtue of Subsection (1) cannot be
allotted any shares including rights or bonus. However, in the event of a scheme of
amalgamation it is permitted to buy the shares in its holding company.
7.13 OTHER CLASSIFICATION
Investment Companies
Section 372(10) of the Companies Act defines this type of company as a company
whose principal business is the acquisition of shares, stock, debentures or other
securities. Such type of companies buy shares and other instruments so that they can
be sold at a higher price at a later date or selling them with a view to buy at lower price.
The companies also earn dividend and interest on these instruments.
A company which carries on its business of manufacturing may invest subject to the
objects clause of the memorandum of association. All investments of such a company
are to be made in the companies own name.
Public Financial Institutions
Companies Act specifies that the following financial institutions shall be regarded as
public financial institutions:

The Industrial Credit and Investment Corporation of India. (ICICI)

The Industrial Finance Corporation of India. (IFCI)

The Life Insurance Corporation of India. (LIC)

The Unit Trust of India. (UTI)

The Industrial Development Bank of India. (IDBI)

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Defunct Company
A defunct company means a company which never commenced business or which is
not carrying on business and has either no assets or has such assets as shall not be
sufficient to meet the costs of liquidation. However, a company is not considered as
defunct if the cessation of business is due to the conduct of winding up. Also, the
mere reduction of members below statutory minimum does not render a company
defunct.
Under Section 3(5) the existing public company which could not raise minimum
required capital after 14th December 2002 also treated as defunct company within
the meaning of Section 560.
Section 560 provides for the restoration of a companies name previously struck off the
register. However, the application must be made by the company, member or creditor to
the tribunal before the expiry of 20 years from the publication in the Official Gazette.
The effect of an order of restoration shall be that the company shall be deemed to have
continued in existence as if its name had not been struck off.
Closely Held Company
A public company which has raised capital only from the members, directors, relatives
and kith and kin of the promoters and not raised capital from the public.
Widely Held Company (A Listed Company)
A Public Company which has raised capital from the public by issue of prospectus
and its shares are dealt in two or more Stock Exchanges.
MULTIPLE CHOICE QUESTIONS:
Q1 The corporate veil of a company can be lifted
a) When revenue of the state is to be protected
b) To determine the character of an enemy company
c) When the company does not refund the application money on failure, to make
allotment
d) All the above
Q2 The liability of members in a company limited by shares
a)
b)
c)
d)

Is limited to the called up value on shares

Is nil, if the shares are fully paid up
Is limited to the guarantee given by members
Is unlimited

Q3 Four out of eight members of a public company die. Such company

133

a) Becomes a defunct company

b) Becomes private company
c) Belongs to 4 living members along with the legal representatives of the
deceased members
d) Is taken over by the central government
Q4 Since a company is regarded as an entity separate from its members
a) The shareholders have insurable interest in the property of the company
b) The assets & liabilities of the company are also the assets & liabilities of the
members
c) The shareholders can enter into contracts with the company
d) The shareholders are the agents & trustees of the company.
Q5 If a company uses Corporation as a key word in its name, it must have a
minimum authorized share capital of
a)
b)
c)
d)

Rs 5 lakhs
Rs 10 lakhs
Rs 50 Lakhs
Rs 500 lakhs

Q6 A public company
a)
b)
c)
d)

Can not have more than 100 members

Can commence business immediately on incorporation
Need not hold the statutory meetings
must have at least 3 directors

Q7 A public company may be converted into a private company by

a)
b)
c)
d)

Passing an ordinary resolution

Passing a special resolution
Getting the approval of the central government
Both (b) & (c) above

Q8 A private company must have at least

a)
b)
c)
d)

Seven directors
Two directors
Three directors
Four directors

Q9 A public company, desirous of getting its securities listed on a recognized stock

exchange, shall apply to the

134

a)
b)
c)
d)

Stock exchange
SEBI
NCLT
Central government

Q10 Which of the following companies is covered under Section 25 of the Companies
Act, 1956?
a)
b)
c)
d)

Deemed public company

Companies limited by share
Association not for profit
Companies limited by guarantee having share capital

135

CHAPTER- 8 REGISTRATION &

INCORPORATION
After reading this lesson, you will be conversant with:
8.1 Promoters Of The Company
8.2 Procedure Of Incorporation
8.3 Memorandum Of Association
8.4 Articles Of Association

A company, association or a partnership consisting of more than 20 members (ten in

case of banking) will be termed as an illegal association unless it is registered as a
company under the Companies Act or is formed in pursuance of some other Indian
Law. This provision will not be applicable to a Joint Hindu Family carrying on
business. However, where two or more joint families carry on a business, this provision
will be applicable and registration would be mandatory in order to prevent being termed
as an illegal association. While arriving at the required number of 20, minors will have
to be excluded.
In Ruia V. V. vs. Dalmia, it was held that four basic conditions need to be satisfied to
come within the restrictions contained under Section 11(2). They are:
a.
There must be a company with more than 20 persons;
b.
Such a company is not registered under the Companies Act or any other
Indian Law;
c.
The objective of the company is to carry on business other than banking;
and
d.
For the purpose of acquisition of gain.
An association of more than 20 persons, unregistered at the time of its inception is
invalid and cannot be validated later by reducing the number of members to less than
20.
Similarly, a contract entered into by an illegal association before registration is void and
cannot be made valid on its subsequent registration.
However, illegality in constitution of an association will have no effect on its tax
liability or its chargeability.
A company is incorporated by promoters. The functions and legal position of promoters
is mentioned in the following paragraphs.
8.1 PROMOTERS OF THE COMPANY
The expression promoter has not been defined under the Companies Act but defined
under SEBI Act 1992. A Promoter is a person who conceives an idea to start a company
and gathers relatives and other members of Hindu Undivided Family for bringing the
subscription to the company or can be a body corporate. The definition given by
Companies Act is restricted to and meant for the purpose of prospectus alone: A

136

promoter is the person who originates the scheme for the formation of the company, has
the Memorandum of Association prepared, executed and registered, and finds the first
directors, settles the terms of preliminary contracts and prospectus and makes an
arrangement for advertising and circulating the prospectus and placing the capital.
Promoter is the person who possesses the intention to promote a company and who
takes the required steps for incorporation of the intended company. The promoter need
not participate in the formation of the company. Any person who agrees with the
intentions and objects of the company and who brings in capital into the company will
be regarded as a promoter. In India, promoters generally secure the management of the
company formed or are the persons who convert their own private business into a
limited company, public or private and secure for themselves more or less controlling
interest into the companies management.
However, a person who merely acts in a professional capacity on behalf of the
promoter, such as a solicitor who drafts up the agreement or articles, an accountant or
valuer who values the assets of a business on behalf of a promoter, and who is paid for
his services is not a promoter.
Legal Position of a Promoter
It has to be noted that the promoter is neither an agent nor a trustee of the proposed
company. The promoter stands only in a fiduciary position towards such company.
While in a fiduciary position, the promoter has two principal duties:
i.Not to make either directly or indirectly any secret profits at the expense of the
company which he is promoting without the knowledge and consent of the
company. In case of any violation of this rule, the company can compel the
promoter to account for it.
ii.Not to sell his property to the company at a profit unless all material facts have
been disclosed to an independent Board of Directors or to the shareholders of
the company and also in the prospectus. This disclosure relates to the payments
made in the last two years or to be made to the promoters. If a promoter
contracts to sell his own property to the company without making a full
disclosure, the company may either repudiate the sale or affirm the contract and
recover the profits earned by the promoters.
Remuneration of Promoters
The inability of the company to enter into contractual obligations, makes it impossible
for its promoters to obtain contractual rights to remuneration for their services rendered
before incorporation. Nor can the promoters enforce a contract based on the clause in
the Articles of Association directing that promoters shall be remunerated for their
services. However, as they (or their nominees) will usually be the first directors of the
company, there is little risk of power being not exercised in their favor. In practice, a
promoter is remunerated in any of the following ways:
i.He may sell his own property to the company for cash or against fully paid
shares in the company at an overvaluation after making full disclosure to an
independent Board of Directors or to the intended shareholders.
ii.

He may take commission on the shares sold.

137

iii.

He may be paid a lump sum by the company.

iv.

He may be given an option to buy further shares in the company at par.

Any remuneration or benefit received by the promoters should be disclosed in the

prospectus if it is paid within two years preceding the date of the prospectus.
8.2 PROCEDURE OF INCORPORATION
For incorporation of a company, the promoters have to inter alia decide the following
aspects:

Type of a company.

Name of the company.

Filing of the documents with the Registrar: (i) Memorandum of Association, (ii)
Articles of Association, (iii) List of Directors, (iv) Declaration stating that all
requirements of the Companies Act have been complied with, and (v) Preparation
of other Documents.

Payment of the required Fees.

Obtaining the Certificate of Incorporation.

Obtaining the Certificate of Commencement of Business.

Each of the above aspects are dealt in detail in the following paragraphs.
Type of a Company
The promoters have a choice of deciding the type of company to be incorporated viz.,
public company and private company. Also, the company may be limited by shares or
guarantee or may be unlimited.
Name of the Company
The promoters have to first obtain the availability of name from the Registrar of
Companies (ROC) of the state in which the company is proposed to be incorporated.
Though a company may be incorporated with any name as desired by the promoter, the
company cannot be registered by a name, which in the opinion of the Central
Government, is undesirable. Section 20 lays down the following rules that have to be
followed while choosing the name.
i.Every company, except a Section 25 Company, should suffix to its name the
word Ltd./Pvt. Ltd.
ii.The intended name should not be identical, or resemble the name of the
company in existence and which has been previously registered. This restriction
also covers names of those companies under dissolution or which have been
dissolved and two years has not lapsed since such dissolution.
A name is said to resemble an already existing companies name if:

The proposed name differs from the name of an existing company

merely with an addition or subtraction of word like New, Modern, etc.

The proposed name denotes a popular or abbreviated description or

names of important companies. For example, TISCO, ICI, etc.

138

The proposed name has a close phonetic resemblance to the name of a

company in existence. For example, Jay Kay Industries resembling J.K.
Industries.

The proposed name is different from the name of the existing company
only to the extent of having the name of place within brackets before the word
limited.
iii.The name should not mean any government participation or patronage unless
justified.
iv.The name should not imply association or connection with, or patronage of a
national hero or any person held in high esteem.
v.The name should not include the word like bank, banking, insurance,
investment trust unless the circumstances of a particular case justify the
inclusion of such a word.
vi.The name is not a general one and is not very common, like Cotton Textile
Mills Limited.
vii.The intended name should not produce a misleading impression regarding the
scope of its activities which would be beyond the resources at its disposal.
The Department of Company Affairs in its circular dated 7-3-1989, has clarified
that if a company uses any of the following keywords in its name under Sections
20 and 21, it must have a minimum authorized capital mentioned against the
keywords:
Keywords Required Authorized Capital (Rs.)
1.
Corporation
2.
International,
Globe,
Universal,
Continental,
Inter
Continental, Asiatic, Asia, being the first word of the name
3.
If any of the words at (2) above is used within the name (with
or without brackets)
4.
Hindustan, India, Bharat, being the first word of the name
5.
If any of the words at (4) above is used within the name (with
or without brackets)
6.
Industries/Udyog
7.
Enterprises, Products, Business, Manufacturing

5 crore
1 crore
50 lakh
50 lakh
5 lakh
1 crore
10 lakh

Filing of Documents with the Registrar

As mentioned above, preparation and filing of Memorandum and Articles of
Association constitutes one of the important tasks in formation and incorporation of the
company.
Memorandum of Association, inter alia, defines the area within which the company can
act and states the objects for which the company is being formed. It also states the
capital which it shall be allowed to raise, the nature of liability of its members, the
name of the state where the registered office of the company shall be located, etc.
Section 13 specifies the requirements with respect to Memorandum of association.

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Another important document that has to be filed with the Registrar is the Articles of
Association which contains the rules and regulations relating to the internal
management of the company that is being incorporated. The articles define the powers
of its officers and establishes a contract between the company and the members and
also between the members inter se.
Apart from the above documents the following documents also need to be filed with the
Registrar, wherever applicable:
i.A power of attorney that may be required for fulfilling various formalities for
incorporation of a company should also be filed. The promoters may execute a
power of attorney in favor of any one of them or in favor of an Advocate or
some other professional like Chartered Accountant or Company Secretary. The
power of attorney should be prepared on a non-judicial stamp of the value
prescribed by the State Stamp Laws.
ii.Consent of the directors vide Form 29 is required only for a public limited
company. Form 32 intimating the appointment of first directors, manager or
secretary can be filed either at the time of incorporation or within thirty days of
incorporation.
iii.The particulars of such directors whose names are given in the articles of
association as first directors.
iv.A notice of the address of the registered office should be filed with the Registrar.
This however, can be filed within thirty days of incorporation (Form-18).
v.A statutory declaration of compliance should be made in Form No.1 by any of
the persons specified for the purposes stating that all the rules and requirements
of the Companies Act have been complied with in respect of registration and
matters precedent and incidental thereto. The specified person may be an
advocate of Supreme Court or a High Court, or an Attorney or a pleader entitled
to appear before a High Court, or a Company Secretary or a Chartered
Accountant practicing in India and engaged in the formation of the company or
by a person named in the articles as a Director, Manager, or Secretary of the
company.
vi.Any agreement which the company proposes to enter for appointment of an
individual as Managing Director/Whole Time Director/ Manager.
Payment of Fees
The requisite registration and filing fee in accordance with Schedule X is required to be
paid at the time of filing the above mentioned documents.
Fees can be paid to the Registrar of Companies either by cash, or by postal order if the
amount does not exceed Rs.50, or by money order/demand draft/chque or any other
method specified for that purpose.
Obtaining the Certificate of Incorporation
Under Section 33(3) the Registrar after scrutinizing the documents that are filed and on
being satisfied that they are in order and also satisfied that other legal requirements are

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duly complied with, will enter the name of the company in the Register of Companies.
This will in effect bring the company into existence. The certificate so issued by the
Registrar is called the Certificate of Incorporation.
In case of Moosa Goolam Arif vs. Ebrahim Goolam Arif (1913), after the company
was issued a certificate of incorporation it was found that out of the seven persons who
signed the memorandum only two were adults, one of them signing as a guardian of the
other five members who were all minors at that time. It was held that the question
whether the formation of the company is null and void will not arise, in view of the
conclusiveness of the certificate of incorporation once it is issued. The certificate is
evidence of compliance of all the requirements as required by the Companies Act.
Therefore, the position is firmly established that if a company is born, the only method
to get it extinguished is not by assailing its incorporation, but by resorting to the
provisions of enactments, which provide for the winding up of companies.
Section 35 only prevents the reopening of the matters prior and contemporaneous to the
registration and incidental thereto, and places beyond doubt the existence of the
company as a legal person. This section does not insulate the company incorporated
with illegal objects. Such company may be forbidden to carry on any business in
furtherance of its illegal objects.
Certificate of Commencement of Business
A private company or a company not having share capital may commence business and
exercise its various powers immediately after it is incorporated. However, a public
company will have to obtain one more certificate i.e., certificate of commencement of
business.
Section 149 lays down some restrictions on the commencement of business by a public
company having a share capital depending on whether the company has issued a
prospectus or not.
a.
Where the company has issued a prospectus: Section 149(1) provides
that if a company having share capital has issued a prospectus, it shall not
commence its business or exercise its borrowing powers unless:
i.(a) Minimum subscription amount mentioned in the prospectus has been
received in cash, (b) Shares have been allotted, and (c) Where the shares are to
be listed, listing approval has been obtained from the exchange,
ii.Every director has paid the amount due on the shares he has taken or contracted
to be taken by him. The director is liable to pay the same proportion payable by
the public on application and allotment of the shares,
iii.No money is liable to be refunded either due to inadequate number of
applications or due to failure in obtaining permission of the stock exchange for
dealing in those shares U/S 73 of the Companies Act, 1956 and
iv.A duly verified declaration by any one of the directors of the company has been
filed with the Registrar stating that all the conditions in (i), (ii), and (iii) above
have been fulfilled.

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b.
Where the company has not issued a prospectus: Section 149(2) provides
that if a company does not issue a prospectus, it shall not commence any
business or exercise any borrowing powers, unless:
i.A statement in lieu of the prospectus has been filed with the Registrar,
ii.Every director has paid the amount due on the shares taken or contracted to be
taken by him, and
iii.A duly verified certificate by one of the directors declaring compliance of (i)
and (ii) above has been filed with the Registrar, Upon completion of the above
formalities to the satisfaction of the Registrar, the Registrar issues a certificate
of
commencement
of
business.
If any public company exercises borrowing powers or commences business
without complying with the above provisions, every person at fault is liable to
pay a fine of Rs.5,000 for each day of contravention.
8.3 MEMORANDUM OF ASSOCIATION
The Memorandum of Association is a document of great importance in relation to a
company. As per Section 2(28) of the Act: Memorandum means Memorandum of
Association of a company as originally framed or altered from time to time in
pursuance of any provisions of Company Law or of this Act. It is often described as the
charter of the company defining as well as confining the powers of the company. Any
act done beyond the scope of the memorandum is ultra vires the company and hence
null and void.
The Memorandum of Association should follow the conditions given below:
a.
Every memorandum should be printed electronically or otherwise as
may be prescribed,
b.

Divided into paragraphs and numbered consequently, and

c.
Signed by each subscriber in the presence of at least one witness who
shall attest the signature and shall likewise add his address, description and
occupation.
Section 13 of the Act prescribes that the memorandum of association of a
limited company should essentially have the following six clauses:
Name Clause
The memorandum of association should contain the name of a company, whether it is a
private or public company. Companies covered by Section 25 are exempted from the
use of word(s) Ltd./Private Ltd.
The name of the company has to appear in full and in a legible manner on all documents
and official publications, letter papers, etc. Default in affixing or printing the correct
name on official documents can make the directors personally liable.
Registered Office Clause
This clause should state the name of the State in which the registered office of the
company will be situated. Under Section 146, a company shall, as from the date of
which it begins its business, or as from the 30th day after the date of its incorporation,
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whichever is earlier, have a registered office; and a notice of the exact place of the
registered office must be given to Registrar within 30 days after the date of
incorporation.
Utmost care must be taken by the proposed company while opting this clause. The
location of Registered Office is crucial in the governance of the company since it is the
place where all the registers and documents are kept and Annual General Meetings are
held.
Change of registered office within a State (Section 17A)
No company shall change the place of its registered office from one place to another
within a state unless such change is confirmed by the Regional Director. To get
confirmation, the company shall make an application in the prescribed form to the
Regional Director. The Regional Director shall communicate the confirmation to the
company within four weeks from the date of receipt of the application. Then, the
company shall file, with the Registrar a certified copy of the confirmation by the
Regional Director for change of its registered office under this section, within two
months from the date of confirmation, along with a printed copy of the memorandum as
altered and the Registrar shall register the same and certify the registration under his
hand within one month from the date of filing of such document. The certificate shall
be the conclusive evidence that all the requirements of the Act with respect to the
alteration and confirmation have been complies with and henceforth the memorandum
as altered shall be the memorandum of the company.
Objects and Powers Clause
The objects clause defines the objects of the company and indicates the sphere of
activities. The objects must be divided into three sub-clauses, namely:
Main Objects:
i.This clause has to state the main objects to be pursued by the company on its
incorporation.
ii.Objects incidental or ancilliary to the attainment of main objects.
iii.Other objects: This sub-clause must state other objects which are not included
in the above clauses.
Doctrine of Ultra Vires
Ultra Vires means beyond the scope or in excess of legal authority or power.
Scope of the company: The objects clause of the MOA fixes the boundary within
which the company has to act. If the company crosses this limit, it amounts to Ultra
Vires. All Ultra Vires acts are void even when such acts are ratified by all the members
of the Company
The powers exercisable by a company are to be confined to the objects specified in the
memorandum. While the objects are to be specified, the powers exercisable in respect
of them may be express or implied and need not be specified. However, it is prudent to
include the following powers expressly in the objects clause:

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i.To acquire any business similar to companies own business,

ii.To enter into agreements with other persons or companies for carrying on
business in partnership or for sharing profits, joint venture or other
arrangements,
iii.To take shares in other companies having similar objects,
iv.To promote other companies and help them financially,
v.To use funds for political purpose, and
vi.To give gifts and make donations or contributions for charities not relating to
the objects stated in the memorandum.
Caselet
In Ashbury Rly Carriage Co. vs. Riche (1878), a company had been formed with the
object of carrying on business as Mechanical Engineers and General Contractors. The
company entered into an agreement for financing the construction of a railway line in
Belgium. Later the company repudiated the contract since it was an ultra vires one
Consequences of Ultra Vires Transactions
i.Injunction may be obtained by any shareholder to restrain the company from
carrying out an ultra vires act.
ii.Directors are personally liable for any diversion of the funds for purposes other
than what is specified in the companys memorandum. A shareholder can bring
about an action against the directors for restoration of company funds used for
ultra vires objects. They can also be held personally liable for breach of
warranty of authority.
iii.In case the companys money has been spent ultra vires in purchasing some
property, the companys right over that property must be held secure as it
represents the companys funds. Hence, any property legally and by formal
transfer or conveyance transferred to a corporation, is in law, duly vested in
such corporation, even though the corporation was not empowered to acquire
such property.
iv.The rule of ultra vires was devised for the protection of the companies interest
and it is not capable of being used against the companies interest. Therefore,
others cannot sue on the ground of ultra vires the claim of a company which has
matured. We will clarify this point with the help of a decided case. A company
purchased and operated a rice mill beyond its powers. The rice was consigned to
certain persons who had paid the price. The consignees had to sell the rice,
owing to its inferior quality, at a considerable loss. The company gave them
drafts promising to pay for the loss. The company went into liquidation and the
question about the enforceability of the drafts arose. The court held that trading
in rice was a transaction ultra vires to the company, the directors, therefore,
could not bind the company, and the consignees could not recover.
Liability Clause
The fourth clause states the nature of liability that the members incur. If the company is
incorporated with limited liability, the clause must state that the liability of the
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members shall be limited by shares. This means that no member can be called upon to
pay anything more than the nominal value of the shares held by him. If the company is
limited by guarantee, this clause shall state the amount which every member undertakes
to contribute to the assets of the company in the event of its winding up.
8.4ARTICLES OF ASSOCIATION
The articles usually contain the provisions relating to the following matters:
i.Share capital including sub-division thereof, rights of various shareholders, the
relationship of these rights, payment of commission, share certificates.
ii.Lien on shares.
iii.Calls on shares.
iv.Transfer of shares.
v.Transmission of shares.
vi.Forfeiture of shares.
vii.Surrender of shares.
viii.Conversion of shares into stock.
ix.Buy-back of Securities.
x.Share warrants.
xi.Alteration of share capital.
xii.General meetings and proceedings.
xiii.Voting rights of members.
xiv.Directors, including first directors or directors for life, their appointment,
remuneration, qualification, powers and proceedings of board of directors
meetings.
xv.Dividends and reserves.
xvi.Account and audit.
xvii.Borrowing powers.
xviii.Winding up.
xix.Adoption of Preliminary Contracts.
Procedure of Alteration of the Articles
Any alteration in the Articles of Association can be effected by passing a special
resolution in a general meeting. A copy of the resolution so passed has to be filed
with the Registrar within one month from the date of the meeting along with Form 23.
The alteration should however not contravene any provision of the Act and be subject
to the conditions stated in the memorandum.
Limitations on Alterations of Articles u/s 31

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Where the articles of association has the effect of converting a public company into a
private company, the company should be approved by the Central Government and
copy of the approval has to be filed with the Registrar within one month of its receipt.
Stock Exchanges need to be intimated in case the company is a listed company.
MULTIPLE CHOICE QUESTIONS:
Q1 Which of the following is essential to alter the objects clause of the Memorandum
of Association?
a)
b)
c)
d)

Ordinary resolution is to be passed

Special resolution is to be passed
Special resolution is not to be passed
Special resolution & confirmation of the NCLT

Q2 A certified copy of the order of the Central Government confirming the alteration of
Memorandum of Association is to be registered with the Registrar of Companies within
_______ of its alteration.
a)
b)
c)
d)

One month
Two months
Three months
Six months

Q3 When a private company is converted into a public company it has to file

a/an_______ with the Registrar of Companies.
a)
b)
c)
d)

Information memorandum
Shelf prospectus
Red herring prospectus
Statement in lieu of prospectus

Q4 Memorandum of Association
a)
b)
c)
d)

Is the constitution of company

Enables outsiders to know what power of company is
Indicates to what extent powers have been delegated
Both (a) & (b) above

Q5 which of the following requires an alteration to the Memorandum of Association?

a)
b)
c)
d)

Reduction of share capital

Reorganization of share capital
Making the liability of the directors unlimited
All of above

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Q6 shifting of registered office from one state to another

a) Requires an ordinary resolution to be passed at the general meeting of
shareholders
b) Requires a special resolution to be passed at the general meeting of
shareholders
c) Must be confirmed by NCLT
d) Both (b) & (c) above
Q7 A company will be considered as a subsidiary of another when
a)
b)
c)
d)

It holds more than in the nominal value of equity share capital of the latter
The latter controls the composition of board of Director of the former
The former can remove directors of the latter at its own discretion
Both (a) & (c) above

Q8 Subscribers to the Memorandum become members

a)
b)
c)
d)

After the company commences business

Immediately after incorporation
Only when their names are entered in the registers of members
Only when shares are allotted to them

Q9 Articles of Association of a company

a)
b)
c)
d)

Contains the ancillary objects of the company

Is superior to the memorandum of association
Contains rules beyond the scope of the memorandum
Governs the way in which the objects of the company are to be carried out

Q10 An Act is said to be ultra-vires a company when it is beyond the powers

a)
b)
c)
d)

Conferred on the company by the articles

Of the directors
Of the directors but not the company
Of the company

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CHAPTER- 9 SHARE & SHARE CAPITAL

After reading this lesson, you will be conversant with:
9.1 Types Of Share Capital
9.2 Preference Shares
9.3 Equity Or Ordinary Shares
9.4 Bonus Shares
9.5 Book Building
9.7 Public Issue By Unlisted Companies
9.8 Public Issue By Listed Companies
9.9 Allotment
9.10 Brokerage
9.11 Issue Of Shares At A Discount
9.12 Issue Of Shares At A Premium
9.13 Issue Of Sweat Equity Shares (Section 79a)
9.14 Share Certificate
9.15 Share Warrant
9.16 Calls On Shares

According to Section 2(46) of the Companies Act, a share means share in the share
capital of a company, and includes stock except where distinction between stock and
shares is expressed or implied. By a share in a company it also means a right to
participate in the profits made by a company, while it is a going concern and declares
dividend, and in the assets of the company when it is wound up.
9.1 TYPES OF SHARE CAPITAL
As per Section 85 of the Companies Act, 1956, the share capital of the company limited
by shares formed after the commencement of this Act shall be of two kinds: Preference
shares and Equity shares.
According to section 86 of the Companies Act, 1956, the new issues of share capital of
a company limited by shares shall be of two kinds only, namely: a.

equity share capital:

i.with voting rights; or

ii.with differential rights as to dividend, voting or otherwise in accordance with
such rules and subject to such conditions as may be prescribed.
b.

preference share capital.

9.2 PREFERENCE SHARES

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Section 85(1) of the Act describes a preference share as one which satisfies the following
criteria:
a.
With respect to dividend, it carries or will carry, a preferential right to be
paid a fixed amount or an amount calculated at fixed rate, which may be either
free of or subject to income tax.
b.
With respect to capital it carries, on a winding up or repayment of
capital, a preferential right to be repaid the amount of the capital paid-up or
deemed to have been paid.
Types of Preference Shares
i.Participating Preference Shares: Participating preference shares are those
shares which are entitled to fixed preferential dividend and which carry a right
to participate in the surplus profits along with equity shareholders after dividend
at a certain rate has been paid to equity shareholders. In the event of winding up,
surplus left after paying back to both the preference and equity shareholders will
be distributed to the participating preference shareholders.
ii.

Cumulative and Non-cumulative Shares: With regard to the payment of

dividends, preference shares may be cumulative or non-cumulative. A
cumulative preference share confers a right on its holder to claim fixed dividend
of the past and the current year(s) out of future profits and the dividend is
accumulated till the time it is paid. Whereas non-cumulative preference share
gives right to its holder to a fixed amount or a fixed percentage of dividend out
of the profits of each year. Preference shares are cumulative unless expressly
stated to be non-cumulative.

iii.

Redeemable Preference Shares: Redeemable preference shares are those

which are redeemed either at a fixed date or after a certain period of time during
the life time of the company.

iv.

Fully or partly convertible preference shares are the shares which are converted
into ordinary shares at the some time in future on prescribed conditions and
terms.
Voting Rights for Preference Shareholders
Every member of a company limited by shares and holding any preference share capital
therein shall, in respect of such capital, have a right to vote only on resolutions placed
before the company, which directly affect the rights, attached to his preference shares.
In other words, any resolution for winding up the company or for the repayment or
reduction of its share capital shall be deemed directly to affect the rights attached to
preference shares.
9.3 EQUITY OR ORDINARY SHARES
Equity share capital means all the share capital which is not preference share capital.
That is, equity shares are those shares which do not enjoy any preferential right in the
matter of payment of dividend or repayment of capital. The equity shareholders are
entitled to dividend after the payment of dividend to the preferential shareholders (if

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any). Also, the dividend on the equity shares is not fixed and may vary from year to
year depending upon the recommendations of Board of Directors of the company and as
declared by the shareholders in the annual general meeting.
The equity shareholders are entitled to vote in proportion to the paid-up equity capital
subject to the provisions of Section 87.
Provision for prohibition of issue of new shares with disproportionate rights (Section
88) has been omitted by the Companies (Amendment) Act, 2000.
Methods of Raising Capital by Issue of Shares
Every company requires capital for running its business. Issue of shares is one mode of
raising the required capital. It may be done in any of the following ways:
i.By issue of prospectus: One of the most popular means of raising equity capital
is by issue of prospectus.
ii.By an offer for sale or by deemed prospectus: Any document issued by the
Issuing House is treated as a prospectus issued by the company. The provision
regarding this procedure is mentioned in Section 64. The company allots shares
or debentures at a predetermined price to a financial institution or an Issuing
House for sale to the public. The Issuing House publishes a document called an
Offer for Sale attached to the application form, offering to the public shares
for sale at a higher price. On receipt of applications from the public, the Issuing
House announces the allotment of the shares in favor of the applicants who
become direct allottees.
iii.Issue of shares to the existing shareholders: The capital may also be raised by
issue of additional shares to the existing shareholders. These rights shares are
required to be allotted as per Section 81. The shares are allotted in proportion to
the shares held by the existing shareholders
Private Placement of Shares
A private company is prohibited from issuing its shares to the general public and hence
raises capital by issuing shares to close friends and relatives of the promoters.
A public company too, can raise its capital from private sources instead of resorting to a
public issue of shares. Raising of funds from private sources is usually done by utilizing
the services of a broker or an underwriter who acts as an agent to procure buyers for the
shares. In such a case the company is not required to issue a prospectus, but needs to
file a statement in lieu of prospectus with the Registrar at least 3 days before making an
allotment.
9.4 BONUS SHARES
A company is allowed to capitalize profits by issuing fully paid-up shares to the
members thereby transferring the sums capitalized from the profit and loss account or
reserve account to the Share Capital. Such shares are known as bonus shares and are
issued to the existing members of the company free of charge. Bonus shares are also
called as capitalization shares. A company would like to have more working capital
but it need not go into the market for obtaining fresh capital by issuing fresh shares. The

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necessary money is available with it and this money is converted into shares which
really means that the undistributed profits have been ploughed back into the business
and converted into share capital.
Bonus shares can be issued only if the articles so permit. As most of the companies
adopt Table A of Schedule I of the Act, such a provision already exists in the articles.
An issue of bonus shares should be preceded by a board resolution approving the same.
It should also be sanctioned by the shareholders in the General Meeting on the
recommendation of the Board of Directors of the Company.
The guidelines relating to the issue of bonus shares is detailed in the SEBI guidelines
below.
Guidelines for Bonus Issues
A listed company proposing to issue bonus shares shall comply with the following:
a.
No company shall, pending conversion of FCDs/PCDs, issue any shares
by way of bonus unless similar benefit is extended to the holders of such
FCDs/PCDs, through reservation of shares in proportion to such convertible part
of FCDs or PCDs.
b.
The shares so reserved may be issued at the time of conversion(s) of
such debentures on the same terms on which the bonus issues were made.
The bonus issue shall be made out of free reserves built out of the genuine profits or
share premium collected in cash only. Reserves created by revaluation of fixed assets
are not capitalised. The declaration of bonus issue, in lieu of dividend, is not made. The
bonus issue is not made unless the partly-paid shares, if any existing, are made fully
paid-up.
The Company
a.
has not defaulted in payment of interest or principal in respect of fixed
deposits and interest on existing debentures or principal on redemption thereof,
and
b.
has sufficient reason to believe that it has not defaulted in respect of the
payment of statutory dues of the employees such as contribution to provident
fund, gratuity, bonus, etc.
A listed company proposing to issue bonus shares shall comply with the following:
a.
No company shall, pending conversion of FCDs/PCDs, issue any shares
by way of bonus unless similar benefit is extended to the holders of such
FCDs/PCDs, through reservation of shares in proportion to such convertible part
of FCDs or PCDs.
b.
The shares so reserved may be issued at the time of conversion(s) of
such debentures on the same terms on which the bonus issues were made.
The bonus issue shall be made out of free reserves built out of the genuine profits or
share premium collected in cash only. Reserves created by revaluation of fixed assets
are not capitalised. The declaration of bonus issue, in lieu of dividend, is not made. The
bonus issue is not made unless the partly-paid shares, if any existing, are made fully
paid-up.

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The Company
a.
has not defaulted in payment of interest or principal in respect of fixed
deposits and interest on existing debentures or principal on redemption thereof,
and
b.
has sufficient reason to believe that it has not defaulted in respect of the
payment of statutory dues of the employees such as contribution to provident
fund, gratuity, bonus, etc.
A company which announces its bonus issue after the approval of the Board of
Directors must implement the proposal within a period of six months from the date of
such approval and shall not have the option of changing the decision.
Further, the Articles of Association of the company shall contain a provision for
capitalisation of reserves, etc. If there is no such provision in the Articles the company
shall pass a Resolution at its general body meeting making provisions in the Articles of
Associations for capitalization.
Consequent to the issue of Bonus shares if the subscribed and paid-up capital exceed
the authorized share capital, a Resolution shall be passed by the company at its general
body meeting for increasing the authorized Capital.
9.5 BOOK BUILDING
Book building means a process undertaken by which a demand for the securities
proposed to be issued by a body corporate is elicited and built up and the price for such
securities is assessed for the determination of the quantum of such securities to be
issued by means of a notice, circular, advertisement, document or information
memorandum or offer document.
Offer document means prospectus in case of a public issue or offer for sale and letter
of offer in case of rights issue.
9.6 GREEN SHOE OPTION
Green Shoe option means an option of allocating shares in excess of the shares included
in the public issue. Its main purpose is to stabilize post listing price of the newly issued
shares. It is being introduced in the Indian Capital Market in the initial public offerings
using book building method. It is expected to arrest the speculative forces.
9.7 Public Issue by Unlisted Companies
1.
No unlisted company shall make a public issue of any equity share or
any security convertible at a later date into equity share unless the company has;
i.a track record of distributable profits in terms of Section 205 of Companies Act,
1956 for at least three out of immediately preceding five years; and
ii.a pre-issue net worth of not less than Rupees One crore in three out of preceding
five years, with the minimum net worth to be met during immediately preceding
two years.

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iii.The prospective investors are not less than 1000 members.

2.
An unlisted company which does not satisfy the above stated
requirement, can make a public issue of equity share capital or any security
convertible at later date into equity share capital, provided a public financial
institution or a scheduled commercial bank:
a.
has appraised the project to be financed through the proposed offer to the
public; and
b.
not less than 10% of the project cost is financed by the said appraising
bank or institution by way of loan, equity, participation in the issue of security
in the proposed issue or combination of any of them.
c.
the appraising bank or institution shall bring in the minimum specified
contribution at least one day before the opening of the public issue.
9.8 Public Issue by Listed Companies
A listed company shall be eligible to make a public issue of equity shares or any
security convertible at later date into equity share. However, if as a result of the
proposed issue, net worth of the company becomes more than five times the net worth
prior to the issue, the company shall satisfy either the provisions mentioned above [(1)
& (2)] before it can make the proposed public issue.
9.9 Credit Rating for Debt Instruments
No public or rights issue of debt instrument (including convertible instruments)
irrespective of their maturity or conversion period shall be made unless credit rating
from a credit rating agency is obtained and disclosed in the offer document. Where
credit rating is obtained from more than one credit rating agencies, all the credit
rating/s, including the unaccepted credit ratings, shall be disclosed. For a public and
rights issue of debt-securities of issue size greater than or equal to Rs.100 crore, two
ratings from two different credit rating agencies shall be obtained. All the credit ratings
obtained during 3 years preceding the pubic or rights issue of debt instrument
(including convertible instruments) for any listed security of the issuer company shall
be disclosed in the offer document.
9.10 ALLOTMENT
Allotment of shares by the company to successful allottees is an important aspect in
process of raising the share capital. Provisions relating to allotment contained in SEBI
guidelines and Company Law have to be complied with.
Section 72 of the Act deals with the application for and allotment of, shares and
debentures. Apart from this section the following are the statutory restrictions on
allotment of shares.
Prohibition of Allotment unless Minimum Subscription is Received
No allotment shall be made of any share capital of a company offered to the public,
unless the amount stated in the prospectus as the minimum amount is raised in order to

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provide for the matters specified in Clause 5 of Schedule II. And the sum payable on
application for the amount so stated has been paid to and received by the company,
whether in cash or in cheque or other instrument which has been paid. The clause 5 of
the Schedule II lays down a minimum of 90% of the whole issue offered to the public.
The amount payable on application on each share should not be less than 5% of the
nominal value of the share. Moreover, the share application money received from the
investors should be kept in a separate bank account in a scheduled bank
(a) until certificate to commence business has been obtained under Section 149
(b) where such certificate is already obtained, until the entire amount payable on
application for shares in respect of the minimum subscription has been received by the
company.
As per Section 69(5), if the minimum subscription has not been received within 120
days of the issue of the prospectus, the money received from the applicants must be
repaid without interest. The directors will be jointly and severally liable if the money is
not paid back within 130 days unless they can show that the default was not due to any
negligence or misconduct on their part.
Basis of Allotment on Oversubscription
The allotment shall be subject to allotment in marketable lots, on a proportionate basis
as explained below:
i.Applicants will be categorized according to the number of shares applied for.
ii.The total number of shares to be allotted to each category as a whole shall be
arrived at on a proportionate basis, i.e., the total number of shares applied for in
that category (number of applicants in the category x number of shares applied
for) multiplied by the inverse of the oversubscription ratio as illustrated below:
Total number of applicants in category of 1,500
100s
Total number of shares applied for

1,50,000

Number of times oversubscribed

Proportionate allotment to category

1,50,000 x 1/3
50,000

iii. Number of the shares to be allotted to the successful allottees will be arrived at on a
proportionate basis i.e. total number of shares applied for by each applicant in that
category multiplied by the inverse of the oversubscription ratio. (Please see Example)

154

Number of shares applied for by each applicant

100

Number of times oversubscribed

Proportionate allotment to each successful applicant

100 x 1/3= 33

(to be rounded off to 100)

iv.All the applicants where the proportionate allotment works out to less than 100
shares per applicant (say for example which may arise in issues with premium
of Rs.40 per share) the allotment shall be made as follows:
each successful applicant shall be allotted a minimum of 100 securities; and
the successful applicants out of the total applicants for that category shall
be determined by draw of lots in such a manner that the total number of
shares allotted in that category is equal to the number of shares worked out as
per (ii) above.
v.If the proportionate allotment to an applicant works out to a number that is more
than 100 but is not a multiple of 100 (which is the marketable lot), the number
in excess of the multiple of 100 would be rounded off to the higher multiple of
100 if that number is 50 or higher. If that number is lower than 50, it would be
rounded off to the lower multiple of 100. (As an illustration, if the proportionate
allotment works out to 250, the applicants would be allotted 300 shares. If
however, the proportionate allotment works out to 240, the applicant would be
allotted 200 shares). All applicants in such categories would be allotted shares
arrived at after such rounding off.
vi.If the shares allocated on a proportionate basis to any category is more than the
shares allotted to the applicants in that category, the balance available shares for
allotment shall be first adjusted against any other category, where the allocated
shares are not sufficient for proportionate allotment to the successful applicants
in that category. The balance shares if any remaining after such adjustment will
be added to the category comprising of applicants applying for minimum
number
of
shares.
Illustration
The applicants are applying for 500 shares. These applicants are entitled on
proportionate basis to be allotted 40,000 shares at 200 shares per applicant. However,
the number of shares allocated to that category on proportionate basis is only 33,300.
The deficit of 6,700 shares will be taken from the surplus available in category 4. In
that category as against total number of 30000 shares to be allotted the actual shares
allocated on proportionate basis is 40,000 shares leaving the surplus of 10,000 shares.
After adding 6,700 shares to the category no. 5. the balance of 3,300 shares will be
added back to the category no.1 which comprises of the applicants applying for

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minimum number of shares. As a result number of successful allottees in that category

will increase by 33 nos. from 500 to 533.
Example
Size of public offer

2,00,000 equity shares of Rs.10

each at a premium of Rs.40

No.of times oversubscribed

3 times

Total number of shares applied for

6,00,000 equity shares

S.
no.

No. of No. of
shares
applic
applied
ants
for
Category

Total no.
of shares
applied
by each
applicant
(2x3)

Proportio
nate
allocatio
n to each
category
(onethird)

Number
of shares
allotted
per
applicant
by
rounding
off

No. of
success
ful
applica
nts

Total
no.
of
shares
allotted
(6x7)

(Categor
y wise)
1

100

1,500

1,50,000

50,000
+3,300*

100

500
+33*

50,000
+3,300

200

400

80,000

26,700

100

267

26,700

300

300

90,000

30,000

100

300

30,000

400

300

1,20,000

40,000

100

300

30,000

500

200

1,00,000

33,300

200

200

40,000

600

100

60,000

20,000

200

100

20,000

6,00,000

2,00,000

2,00,000

Notes to the Example

In the above example the number of shares allocable to each category of the applicants
have been arrived at in column No. 5 in proportion to the number of times the issue has
been oversubscribed.
In the case of category No. 4 number of shares actually allotted is less than the number
of shares available for allotment in that category on proportionate basis. Further, in
category 5, shares allotted to the successful applicants in that category is more than the
shares available for allocation in that category. This is on account of rounding off to the
nearest hundred. With the result after making adjustment, 3300 shares remain to be

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allotted from the offering. This number has been included in the category 1, i.e., the
applicants who had applied for minimum number of shares.
In the case of applicants in categories 1 and 2 who have applied for 100 and 200 shares
respectively, the applicants in each of the above categories shall be entitled to 33 and 66
equity shares respectively which have been rounded off to marketable lots of 100 each.
As a result the successful applicants shall be getting 100 shares.
In the case of applicants in category 3, 4, 5 and 6, they should be respectively entitled to
allotment of 100, 133, 166 and 200 equity shares respectively. However, the actual
entitlement would be rounded off to 100 shares each of categories 3 and 4 and 200
shares of categories 5 and 6 respectively.
In case of over subscription, a minimum of 50% of the net offer of securities to the
public shall initially be made available for allotment to retail investors.
Prohibition of Allotment in Certain Cases unless Statement in lieu of Prospectus
Delivered to Registrar
A company having a share capital which does not issue a prospectus on its formation,
or which has issued such a prospectus but has not proceeded to allot any of the shares
offered to the public for subscription, shall not allot any of its shares unless at least
three days before the allotment a statement in lieu of prospectus signed by every person
who is named therein as a director has been filed with the Registrar. The statement
should be in the prescribed form (Schedule III) and should contain the particular and
reports set out in Schedule III.
Where a statement in lieu of prospectus delivered to the Registrar contains an untrue
statement, then every person who authorized the delivery will be punishable with
imprisonment for a term extending to two years or with a fine which may extend to
Rs.50,000 or both.
Such a person will be exonerated if he proves that the statement was immaterial or that
he had every reason to believe that it was true.
9.10 Brokerage
Brokerage is a reward paid to the broker for bringing about a bargain between the seller
and buyer of shares.
When compared to underwriting, a broker does not incur any liability in case he fails to
bring about a bargain between the two parties. However, brokerage can be paid only to
a professional broker and not to a person who casually induces an investor to subscribe
to shares of the company.
According to the Act, the brokerage paid or payable should be indicated in the
prospectus or a statement in lieu of prospectus as the case may be.
9.11 Issue of Shares at a Discount

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Issue of shares at a discount is governed by the provisions laid down by Section 79.
Issue of shares at a discount can be made only after one year from the date on which the
company is entitled to commence business. A company can issue shares at a discount
only if the issue is authorized by a resolution passed by the Company in a general
meeting and the approval of the Central Government is obtained fees prescribed
Rs.1,000 w.e.f. 1-4-2000. The maximum rate of discount as specified in the resolution
cannot exceed 10%. Where the company proposes to issue shares at a discount
exceeding 10%, the central government may, on an application made by the company
grant approval, if it is of the opinion that circumstances warrant a higher percentage of
discount. In Mare Steel Castings Private Limited, where the company was making
losses and needed to raise funds, the Central Government allowed the company to issue
shares at a discount of 25% as the circumstances justified the discount.
9.12 Issue of Shares at a Premium
Although the Company Law does not place any restriction on the issue of securities at a
premium, it has laid down guidelines for utilization of such premium. [Section 78(2)]
Premium is in the nature of capital reserve and can be used for:
a.

Issue of fully paid-up bonus securities

b.
Writing off preliminary expenses and any commission or discount
allowed on issue of securities
c.
Providing for premium payable on redemption of preference securities or
debentures of the company.
d.

To Buy-back Securities U/s. 77A(1) of the Companies Act.

The premium raised is not available for payment of dividend as it is not profit. If a
company distributes the amount lying in the account for purposes other than those
stated above, it shall amount to reduction in capital and provisions of Section 100 shall
apply. The law also requires that a company should transfer the amount of securities
premium (whether received in cash or in kind) to a separate account called the Security
Premium Account.
9.13 Issue of Sweat Equity Shares (Section 79A)
Sweat equity shares means equity shares issued by the company to employees or
directors at a discount or for consideration other than cash for providing know-how or
making available rights in the nature of intellectual property rights or value additions.
A company may issue sweat equity shares of a class of shares already issued if the
following conditions are fulfilled, namely:
a.
the issue of sweat equity shares authorized by a special resolution passed
by the company in the general meeting;
b.
the resolution specifies the number of shares, current market price,
consideration, if any, and the class or classes of directors or employees to whom
such equity shares are to be issued;
c.
not less than one year has, at the date of the issue, elapsed since the date
on which the company was entitled to commence business;
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d.
the sweat equity shares of a company, whose equity shares are listed on
a recognized stock exchange, are issued in accordance with the regulations
made by the SEBI.
However, in case of a company whose equity shares are not listed on any recognized
stock exchange, the sweat equity shares are issued in accordance with the guidelines as
may be prescribed.
9.14 SHARE CERTIFICATE
Share certificate is a document issued by the company and is evidence that the person
named therein is the holder of specified number of shares (as indicated in the
document) of the company. It can be issued only in pursuance of a Board Resolution
and on surrender of the letter of allotment if issued.
It is issued under the common seal of the company and should be signed by two
directors or persons authorized to sign on their behalf and the Secretary or any other
person appointed by the Board for the said purpose. The certificate is also subject to
stamp duty as per the relevant Stamp Act of the state in which the registered office of
the company is situated.
Of the two directors aforementioned, one of them should be a person other than a
Managing Director or a whole time director.
A share certificate issued by the company creates an estoppel as to title and an estoppel
as to payment.
An estoppel as to title means that a company cannot later deny the fact that the person
named as the holder of shares in the certificate is not the owner.
A buyer who purchases the shares relying on the share certificates can claim damages
from the company if the certificate is incorrect.
9.15 SHARE WARRANT
Share warrant is a bearer document issued by the company under its common seal
stating that the bearer of the warrant is the holder of shares specified in the document
(U/s. 114).
Issue of share warrants can be made by the company only if it is authorized by the
articles and prior approval of the Central Government is obtained.
When a share warrant is issued the name of the shareholder is struck off from the
register of members. Instead, details about the shares specified in the warrant and the
date of issue of warrant is recorded.
Even though the bearer of a share warrant is not a member, he may be allowed to
exercise the rights of a member, provided it is authorized by the articles. However, the
shares specified in the warrant cannot be considered as qualification shares for the
office of a director.
9.16 CALLS ON SHARES
A company fixes the price of its shares being offered either in a public or rights issue
depending upon its requirements of funds and other factors such as Market Value, etc.
It may choose to call the entire amount on application or may call for the share price in
installments.

159

A call is a demand made by the board of directors in accordance with the company
Articles calling upon the shareholders/debentureholders to pay the call amount within a
specified time.
A call may also be made by the liquidator in the course of winding up of the company.
The following are provisions pertaining to calls:
a. Section 91 lays down that calls on shares of same class are to be made on
uniform basis.
b. It must be ensured by the company that shares are made fully paid-up within 12
months of the date of allotment, where the size of the issue is up to Rs.100
crore. Where the size of issue exceeds Rs.100 crores, the amount to be called up
on application, allotment and on various calls should not in each case exceed
20% of the total quantum of issue.
c. A call must be made by serving upon members a notice of payment in
accordance with the provisions of Section 53. Every shareholder is under a
statutory obligation to pay the full amount of the shares he holds. Any amount
payable by any member of the company on shares that are held by him as
specified in Memorandum or Articles is considered as debt due.
d. Every call must be dated and called for by a duly appointed and qualified board
and for bona fide reasons.
e. Shares may be paid for in cash or in kind or in any manner that has the effect of
actual payment. A payment is an effective payment in moneys worth if the
consideration given by way of payment is something which is bona fide
recorded by the parties to the payment as fairly representing the sum which the
payment is to discharge. White Star Line Ltd; In re (1939).
f. Section 92 of the Act provides that the directors may, if authorized by the
Articles, allow shareholders to pay the whole or a part of the amount in advance.
On the amount so received, the company may pay interest at such a rate as may
be agreed upon between the Board and the member paying this sum in advance.
There would not be any voting rights in respect of the moneys so paid in
advance until the same becomes payable. If the articles permit, dividends may
be paid on advance calls.
9.17 FORFEITURE OF SHARES
Articles of most companies provide powers to directors to forfeit shares if the
shareholder fails to pay calls within a certain time. Regulations 29 to 35 of Table A
provides for forfeiture of shares and are to be followed where specific powers to forfeit
are not given in the articles. The provisions that are to be followed in forfeiture of
shares as given in Regulations 29 to 35 of Table A and other relevant sections is given
below:
i.In Accordance with the Articles: The forfeiture of shares should be strictly in
accordance with the articles of the company. Also, forfeiture should be only for
non-payment of any call and not for non-payment of other debts even though the
articles permit otherwise. It has been held in the case of Shyemchand v. Calcutta

160

Stock Exchange Association (1945), where it is specifically provided for in the

articles, fully paid-up shares, also can be forfeited in cases where, there is a
default in fulfilling any engagement between the members.
ii.Notice for Forfeiture of Shares: A notice has to be given to the shareholder
giving time of at least 14 days to pay-up the required amount. This is to give a
last chance to the shareholder to pay for the call money and interests due
thereon. The notice shall also state that in the event of non-payment the shares
are liable to be forfeited.
iii.Resolution: A board resolution is required to be passed for forfeiting the shares
on which calls remain unpaid beyond the stipulated period given for payment of
call amount.
iv.Power must be used in Good Faith: The power to forfeit shares should be
exercised in good faith and in the best interests of the company. The forfeiture
cannot be done at the request of the shareholder to relieve him of shares.
v.Liability towards Unpaid Calls: The liability of the original shareholder may
remain towards the unpaid calls for a period of three years from the date of
forfeiture, if the articles so provide. Such a shareholder may also be put on the
B list in the event of the company going in for liquidation within one year of
his membership.
The board may be empowered to cancel the forfeiture if the shareholder approaches the
board requesting the same and is willing to give the amount due with interest.
The forfeited shares may be reissued at any price provided that the total sum paid by the
former holder of the shares, together with amount paid on reissue and the amount
remaining unpaid on shares is not less than the par value.
9.18 SURRENDER OF SHARES
Surrender of shares involves voluntary return of shares by the shareholder to the
company for cancellation of the shares. Companies Act does not provide for provision
of the surrender of shares. A company may, however, accept surrender of shares if
provided for in its articles. In principle, surrender of shares have practically the same
effect as forfeiture.
MULTIPLE CHOICE QUESTIONS
Q1 Under which of the following occasions, does the allotment of shares become void?
a. When any of the stock exchanges refuses to grant permission
b. When the minimum subscription is not received
c. When the money received on application is less than 5% of the nominal value of
each share.
d. When the statement in lieu of prospectus is not filed with the registrar of
companies.
Q2 In a public issue by an unlisted company, the promoters shall contribute not less than
__ of the post issue capital

161

a.
b.
c.
d.

5%
10%
15%
20%

Q3 Share premium which is in the nature of capital reserve cannot be used for
a.
b.
c.
d.

Issue of fully paid up bonus share

Writing off preliminary expenses
Payment of dividends
Payment of premium payable on redemption of preference share

Q4 Equity shares issued by a company to its employees or directors at a discount or for

consideration other than cash for providing know-how or services are called
a.
b.
c.
d.

Bonus share
Sweat equity share
Share warrants
Premium share

Q5 issue of share warrants can be made by the

a.
b.
c.
d.

Private companies
Public companies
Companies limited by guarantee
Both (a) & (b)

Q6 In case of any issue of capital to the public, the minimum promoters contribution
shall be locked in for a period of
a)
b)
c)
d)

1 year
2 years
3 years
4 years

Q7 According to Section 79 of the Companies Act, 1956, a company can issue shares at
a discount only if the issue is authorized by a resolution passed by the company in
general meeting and the approval of the National Company Law Tribunal is obtained.
The maximum rate of discount as specified in the resolution cannot exceed
a)
b)
c)
d)

1%
2.50%
5%
10%

Q8 Capital invested in stock of goods is called

162

a)
b)
c)
d)

Called up capital
Fixed capital
Loan capital
Circulating capital

Q9 A company can issue preference shares

a) That can be redeemed after the expiry of a period of 20 years from the date of
issue
b) That are redeemable even if the articles do not provide for it
c) That can be redeemed out of profit which would otherwise be available for
dividend
d) Both (a) & (b) above
Q10 Bonus shares can be issued
a)
b)
c)
d)

Within 12 months of any public issue

Before partly paid up shares are made fully paid up
By capitalizing of revaluation reserves
Out of genuine profit alone

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CHAPTER-10 PROSPECTUS
After reading this lesson, you will be conversant with:
10.1 Matters to be Stated in the Prospectus
10.2 Registration of the Prospectus
10.3 Liability for Misstatements in the Prospectus
10.4 Remedies for Misrepresentation in Prospectus
10.5 Statement in Lieu of Prospectus

Section 2(36) defines a prospectus as 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 shares in, or debentures of a body corporate.
A prospectus is an invitation issued to the public to purchase/subscribe shares or
debentures of the company. The provisions of the Act relating to prospectus apply only
if it is issued to the general public. A single private communication will not be taken as
an issue of prospectus. In Pramatha Nath Sanyal vs. Kali Kumar Dutt (1925), a
newspaper advertisement stating that some shares were still available for sale according
to the terms of the prospectus of the company which could be obtained on application
was held to be a prospectus.
10.1 MATTERS TO BE STATED IN THE PROSPECTUS
Section 56 of the Act lays down that every prospectus issued by the company shall
conform to the requirements of Schedule II. As per the schedule, Part I shall disclose
matters specified therein and Part II shall set out certain reports. Explanatory statement
shall be given in Part III.
The matters that have to be stated in the prospectus are summarized below:
General Information
i.The name, and address of registered office of the company.
ii.Names of stock exchange(s) where listing application(s) have been made for the
issue.

iv.
v.
vi.
vii.

iii.Declaration about the issue of allotment letters/refunds within a period of ten

weeks and interest in case of any delay in refund at the rate prescribed under
Section 73(2)/(2A).
Declaration about refund of the issue if minimum subscription of 90 percent is
not received within 90 days from the closure of the issue.
Date of opening of the issue.
Date of closing of the issue including the date of earliest closing of issue.
Names and addresses of auditors and lead managers.

164

viii.
ix.
x.

xi.

xii.
xiii.

Whether rating from CRISIL or any rating agency has been obtained for the
proposed debentures/preference shares issue.
If no rating has been obtained, this should be answered as No. However, if
Yes, the rating should be indicated.
Names and addresses of the underwriters and the amount underwritten by them
together with declaration by the Board of directors that the underwriters have
sufficient resources to meet their respective obligations.
Consent of the Central Government about the present issue as also particulars of
letter of intent/industrial license making clear in the statement that the Central
Government does not undertake any responsibility for financial soundness or
correctness of the statement.
Punishment if application for shares is made under fictitious name(s).
Names and addresses of trustees of the debenture trust deed, in case of issue of
debentures.

xiv.

The Issuer Company may include in the offer document, the financial
statements prepared on the basis of more than one accounting standards (Ex:
Indian and US GAAP)
CAPITAL STRUCTURE OF THE COMPANY
a.

Authorized, issued, subscribed and paid-up capital.

b.
Size of present issue giving separately reservation for preferential
allotment to promoters and others.
c.

Paid-up capital

i.After the present issue

ii.After conversion of debentures (if applicable).
COMPANY MANAGEMENT AND PROJECT
i.History, main objects and present business of the company, as also name and
address of subsidiary, if any,
ii.Promoters and their background,
iii.Location of the project,

v.
vi.
vii.

viii.
ix.
x.

iv.Collaboration, if any, with details of any performance guarantee or assistance in

marketing,
Nature of the product(s), export possibilities, export guarantee,
Stock market data of shares including the high/low price for the last three years
and monthly high/low during the last six months, if applicable,
Names, addresses and occupation of managing director, whole time director,
other directors including nominee directors and manager mentioning any
directorship held in other company in each case,
Plant and Machinery, technology, process, etc.,
Approach to Marketing and Marketing set-up,
Schedule of implementation of the project giving all the relevant details,

165

xi.

Details about the expected capacity utilization during the first three years of
commercial production and the year as to when the company will start earning
profits.
Company and Management
Particulars in regard to the company and other listed companies under the same
management, which made any capital issue during the last three years. The particulars
shall include:
i.Name of the company
ii.Year of issue
iii.Type of issue (public/right/composite)
iv.Amount of issue
v.Date of closure of issue
vi.Date of completion of delivery of share/debenture certificates
vii.Date of completion of the project concern
viii.Rate of dividend paid.
Outstanding Litigations
a.
Outstanding litigations, if any, relating to matters that affect the
operations and finances of the company including tax liabilities (of any nature)
disputes.
b.
Any criminal prosecution against the company and its directors for
alleged offences under the provisions stated in paragraph I of Part I of Schedule
XIII to the Companies Act, 1956.
c.
Particulars of default, if any, such as arrears of dividend, and default in
meeting statutory dues, etc.
d.
Any material alterations after the date of the latest balance sheet and its
impact on the companies performance and prospectus of the company.
Experts Opinion
Section 57 allows mention of a statement by an expert provided such expert has
never been associated with the company before the public issue. Section 58 makes it
mandatory for the company to seek written consent of an expert to include his
statement in the prospectus. By consenting to the issue of the prospectus the expert
does not undertake the liability in respect of anything in the prospectus except his
own statement. Contravention of the provisions of both the sections shall be
punishable with fine which may extend to fifty thousand rupees.
However, an expert will not be held liable in respect of any wrong report or
valuation made by him in the prospectus if he can prove that
a.
He withdrew his consent before the prospectus was delivered to the
Registrar for registration.
b.
After registration but before any allotment could be made, on becoming
aware of the untrue statement, he withdrew his consent and gave a public notice
to that effect.

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c.

He had every ground to believe that the statement made by him was true.

10.2 REGISTRATION OF THE PROSPECTUS

The registration of prospectus is a condition precedent to its issue. No prospectus can be
issued unless it is registered with the Registrar.
The following documents must be attached to the copy of prospectus filed with the
Registrar:
a.
The consent of the expert whose report is to be published in the
prospectus,
b.
A copy of every contract relating to the appointment and remuneration
of a managing director or manager,
c.
A copy of material contract not being a contract entered into in the
ordinary course of business of the company or entered into two years prior to
the issue of prospectus,
All material contracts (whether executed or executory) should be disclosed,
d. A written statement relating to the adjustments, if any, in respect of figures of
any profits or losses and assets and liabilities, giving reasons and signed by an
expert,
e. Consent in writing of the person named in the prospectus as an auditor, legal
advisor, attorney, solicitor, banker, representative of the issue house to act in
that capacity,
f. The consent of director under Section 266 in respect of new director, if any,
named therein,
g. A copy of the underwriting agreement, if any, should also be filed as required
by Section 76(1)(b)(v).
The need for getting the prospectus registered is two fold:

A prospectus once registered should be issued within 90 days. This ensures that
the prospectus does not contain outdated information, and

Ensures that persons associating themselves with the company, do so after

having carefully considered the merits of the company, as the public does attach
importance to big names associated with a company.
Shelf Prospectus
Any public financial institution, public sector bank or scheduled bank whose main
object is financing shall file a shelf prospectus with the registrar of companies.
A company filing a shelf prospectus shall not be required to file prospectus within a
period of validity of such prospectus.
A company filing a shelf prospectus shall be required to file an information
memorandum on all material facts relating to new charges created, changes in the
financial position as has occurred between the first offer of securities and next offer of
167

securities within such time as may be prescribed by the Central Government, prior to
making of a second or subsequent offer of securities under the shelf prospectus.
Red-herring Prospectus
Means a prospectus which does not have complete particulars on the price of the
securities offered and the quantum of securities offered. (Section 60B)
Deemed Prospectus
The provisions of the Act relating to the prospectus are restricted to cases where the
invitation is made by or on behalf of a company for subscription to its shares or
debentures. However, Section 64 specifies instances where a document will be deemed
to be a prospectus of the company even though such document is not issued by the
company. This section is aimed at those companies which avoid the statutory provisions
relating to prospectus by allotting shares or debentures to the public through the
medium of Issue Houses. The shares or debentures of the company are first allotted to
these Issue Houses which in turn invite subscription from the public through their own
offer documents. In this way, the company indirectly raises subscription from the
members of the public without issuing an offer document or prospectus.
10.3 LIABILITY FOR MISSTATEMENTS IN PROSPECTUS
According to Section 65(1), an untrue statement is one that is misleading in the form
and context in which it is included. Also, where an omission of any matter from the
prospectus is intended to mislead, the prospectus can be held to be one in which an
untrue statement is included.
Civil Liability under Section 62 will arise in case of an untrue statement in the
prospectus. The following persons will be held liable u/s 62 in case a subscriber has
sustained loss because of an untrue statement in the prospectus.
a.
Every person who is a director of the company at the time of issue of
prospectus.
b.
Every person who has authorized himself to be named and is named in
the prospectus as a director, or as one having agreed to become a director, either
immediately or after an interval of time.
c.

Every promoter of the company.

d.
Every person (including an expert) who has authorized the issue of the
prospectus.
The misrepresentation should relate to a material fact. Where it is represented that
something will happen or be done in future, this does not amount to a representation of
fact. It is only an estimate or a forecast. Hence, there should be a misstatement relating
to an existing fact. In Bentley vs. Black it was held that a calculation of future profits is
not a representation of fact.
The Act provides certain defenses to the persons named u/s 62. Such persons shall not
be held liable where it can be proved that:
a.
A director had withdrawn his consent before the issue of the prospectus
and the same was published without his authority or consent,

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b.
A person named as a director on becoming aware gives a public notice to
the effect that his name is included without his knowledge/consent,
c.
A director after the issue of prospectus but before allotment on becoming
aware of any untrue statement contained in the prospectus, withdraws his
consent giving reasonable public notice,
d.
A director had reasonable ground to believe and did up to the time of
allotment believe the statement to be true; In Derry vs. Peek the directors of a
tramway company issued a prospectus stating that its carriages could be moved
by steam power with consent of the Board of Trade. The Act incorporating the
company provided for such permission to be sought by the company. However,
on refusal by the Board, the company was wound up. In this case the directors
were not held liable as they honestly believed that the statements made in the
prospectus were true,
e.
A director relied on the statement made by a competent expert or it was
a fair representation of a public document.
10.4 REMEDIES FOR MISSTATEMENT IN A PROSPECTUS
Any person who takes shares from the company relying on a prospectus containing
misstatements or omission of material facts may (a) rescind the contract to take the
shares, and (b) claim damages. Rescission of the contract can be resorted to only when
an investor subscribes to shares based on a material misrepresentation of fact in the
prospectus. The aggrieved investor should also ensure that he rescinds the contract
within a reasonable time.
In Shiromani Sugar Mills Limited vs. Debi Prasad it was observed that the right of
rescission should be exercised before the commencement of winding up proceedings.
Rescission will not be a remedy, if the investor has been induced to buy shares on a
material misrepresentation of law.
It must be noted that the allottee cannot both retain the shares and get damages from the
company. Damages are normally claimed from the directors, promoters and other
persons who had authorized the issue of the prospectus personally, or from experts who
had signed reports referred to in the prospectus.
Under Section 68(2), NCLT is empowered to impose penalty on a person who
fraudulently induce others to invest money.
10.5 STATEMENT IN LIEU OF PROSPECTUS
Section 70(1) requires a public company having share capital to file with Registrar a
statement called statement in lieu of prospectus in the following cases: (a) where the
company does not issue a prospectus, or (b) where it issues a prospectus but has not
proceeded to allot any of the shares offered to the public for subscription. A private
company, if it converts itself into a public company, must either issue a prospectus or
file a statement in lieu of prospectus (Section 94).
MULTIPLE CHOICE QUESTIONS:

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Q1 Under which of the following situations, is an expert not held liable, in respect of
any wrong statement made by him in the prospectus issued by a company?
a) When he withdraws his consent in writing before the prospectus is delivered to
the registrar for registration
b) After registration but before any allotment is made, on becoming aware of the
untrue statement, he withdraws his consent in writing & gives a public notice to
that effect
c) He had every ground to believe that that statement made by him was true
d) All of the above
Q2 A company issuing a prospectus should issue it within
a)
b)
c)
d)

30days after it is registered with the registrar of companies

45 days after it is registered with the registrar of companies
60 days after it is registered with the registrar of companies
90 days after it is registered with the registrar of companies

Q3 A company issuing a prospectus to the public must do it within _____ days of the
date on which a copy has been delivered to the Registrar for registration.
a)
b)
c)
d)

30
40
45
90

Q4 A shareholder loses the right to rescind a contract

a)
b)
c)
d)

When he attempts to sell the share

When he attends & votes at a general meeting by proxy
When the parties can not be relegated to their original position
All of the above

Q5 Every prospectus issued by an existing company should be signed by

a)
b)
c)
d)

The managing director of the company

The managing director & the secretary of the company
Majority of the directors of the company
All the directors of the company

Q6 A member purchased equity shares of a company through regional stock exchange.

If the prospectus of the company contained misstatements, which of the following
remedies is available to the member?
a) He can claim damages only but can not rescind the contract
b) He can rescind the contract only but can not claim damages

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c) He can sue every director responsible for issue of prospectus

d) He has no remedy against the company
Q7 A director shall be liable for misstatements in prospectus if he
a) Withdraws his consent before issue of prospectus & the same was published
without his consent.
b) Has reasonable grounds to believe that the statement was true
c) Relied on the basis of fair representation of a public document
d) Informs only the company that his name was included without his knowledge or
consent
Q8 A prospectus issued by some of the Directors of ABC Ltd. stated that the
company had paid a dividend every year during 2001-03; as a matter of fact the
company had sustained losses during the relevant period and had paid dividends only
out of secret reserves accumulated in the past. Which of the following statement(s)
is/are correct?
a)
b)
c)
d)

The directors who authorized the issue of prospectus are liable

All the directors of the company are liable
No director is liable
Payment of dividend out of secret reserves is also valid

Q9 Pravin an allottee of shares in Alfa (Tech) Ltd., came to know of the

misrepresentation in the prospectus on the basis of which he had applied for shares. But
he failed to take any action for a period of 5 months after that he want to repudiate the
allotment of shares in the company on the ground of misrepresentation in prospectus.
Which of the following statement(s) is/are correct?
a) Pravin can repudiate contract on the ground of misrepresentation
b) Pravin can not repudiate the contract on the ground of fraud
c) Pravin loses his right to repudiate the contract by making delay to initiate the
action
d) Both (b) & (c) above
Q10 ABC Ltd., was incorporated on 10 November, 2002 it entered into a contract for
supply of certain materials to Balaji & Co. The company failed to obtain Certificate to
Commence Business on failure to supply the materials the Balaji & Co. wants to sue
ABC Ltd., for breach of contract. Which of the following statement(s) is/are correct?
a)
b)
c)
d)

Balaji & Co can sue ABC Ltd

Balaji & Co can not sue ABC ltd
A company can not competently enter into a contract on its incorporation
Balaji & Co is not allowed to sue any person

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CHAPTER-11 MEETINGS
After reading this lesson, you will be conversant with:
11.1 Procedure and Requisites of Valid Meeting
11.2 Kinds of Meetings
In this lesson, we shall discuss the provisions relating to meetings of the members,
directors and creditors.
11.1 PROCEDURE AND REQUISITES OF VALID MEETING
Meeting Should be called by Proper Authority
Every company meeting has to be called by the directors except in the case when the
meeting has, in the event of default by the directors, been called by the requisitionists
or by the Central Government. The directors have to fix the date, time and place of the
meeting. Notice of a meeting given by the Secretary without the sanction of the Board
of Directors is invalid, but such a notice may be ratified by the directors before the
meeting.
Shareholders are also empowered u/s 169 to requisition holding an extraordinary
general meeting subject to compliance of the provisions of the said section.
Central Government is also empowered to call for a general meeting other than an
annual general meeting.
Section 167 empowers the Central Government to call for an annual general meeting
in case of default in holding the meeting in accordance with Section 166.
Proper and Adequate Notice
The second requirement of a valid meeting is that a proper notice should be given to
every member of the company. Deliberate omission to give notice to a single member
may invalidate the meeting. Accidental omissions can however, be ignored. It must
follow the General Rules in relation to notice and rules as laid down in the Articles
and the Companies Act.
The notice should be clear, explicit and unconditional, conveying to the person all the
required information like the date, time and place of meeting; statement of business
general and special business, that will enable the person to attend the meeting and take
part in the deliberations.
For a general meeting of any kind (statutory, annual or extraordinary), at least 21
days notice must be given to members (Section 171). If the notice is for the annual
general meeting, a shorter notice is allowed if all the eligible members (members who
are entitled to vote and not merely present) give their consent to it. In case of any other
meeting, a shorter notice will be valid if members holding at least 95 percent of the
voting power give their consent to it [Section 171(2)].

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The notice in writing shall be sent to the shareholders giving at least 21 clear days
time excluding the day on which the notice is issued, 48 hours for postal transit and
the day on which the meeting is to be held [Section 171 (1)].
Any resolution passed in the meeting called with shorter notice cannot be effective
unless the latter is ratified by all the shareholders. A person who is present and who
votes at the meeting, will not be entitled to challenge the resolution on the ground of
any invalidity in notice.
For the companies covered under Section 25, a general meeting may be called by
giving a notice in writing of less than 14 days.
Contents of the Notice
Section 172 lays down the contents and manner of service of notice and persons on
whom it is to be served. Every notice of meeting of a company shall specify the place,
the day and hour of the meeting, and shall contain a statement of the business to be
transacted thereat. An interesting judgment was made in case of Rathnavelusami vs.
Manickavelu Chettair (1951). On failure of the directors of a company to call a
meeting on a requisition, the requisitionists themselves sent a notice to all the
members for a meeting to be held at the registered office of the company. But the
managing director locked the premises of the registered office. It was held that the
resolutions passed thereat were valid.
If the notice is given by newspaper advertisement, the statement of material facts need
not be annexed to, but it should be mentioned that the same has been forwarded to the
members.
The notice should also state that a member is entitled to appoint a proxy who need not
be a member [Section 176(2)].
The notice must contain a statement of business to be transacted at the meeting.
Meeting to be Legally Constituted
A legally constituted meeting has a proper quorum, a proper person in the chair and
proper compliance with the relevant provision of the Articles of Association and the
Act.
Chairman: The articles may provide that the Chairman of the Board of Directors shall
also preside over the general meetings of the company. In the absence of such a
provision, the members may on a show of hands elect a person to chair the meeting.
Where a poll is demanded it shall be taken forthwith, with the Chairman elected on a
show of hands exercising all the powers of a Chairman relating to conduct of poll.
If no Chairman is designated beforehand or he is not present within fifteen minutes of
the appointed time of the meeting or is unwilling to act as chairman of the meeting
then the directors present shall elect one amongst themselves to be the chairman of the
meeting. If this is not possible by reason that no director is willing to act as a chairman
or if no director is present within 15 minutes after the appointed time, then the
members present may elect one amongst themselves to be chairman of the meeting. A
chairman is required to maintain order and decorum at a meeting, to give ruling on
points of order, to decide priority of speakers, to maintain relevancy and order in
debate, to adjourn a meeting, to exercise a casting vote in case of a tie and to ascertain
the sense of meeting and declare the result of voting.

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Quorum: Quorum is the minimum number of members who must be present at a

meeting required by Law/Rules. The idea is to avoid situations where decisions taken
by minority of people are imposed to the vast majority of members. A minimum of
five members should be personally present at meeting of a public company and a
minimum of two members in case of a private company. The members present as
quorum should be those members who are eligible to vote in respect of business on the
agenda of the meeting. The number may be higher as provided by the articles of the
company. Where the total number of members of a company is reduced to below the
quorum fixed by the articles, the rule as to quorum will be deemed to be satisfied if all
the members of the company attend the meeting in person. If the quorum is not present
within half an hour from the appointed time, (i) the meeting if called upon the
requisition of members shall stand dissolved; (ii) in any other case, the meeting shall
be adjourned to the same day in the next week at the same time and place or to such
other day, time and place as the Board of Directors may determine. As the adjourned
meeting is only a continuation of the original meeting, the requirement of issuing
notices can be dispensed with. However, if the Board fixes any other date for the
adjourned meeting, notices will have to be issued to every member in accordance with
the provisions relating to issue of notice for general meetings. If at the adjourned
meeting also, the quorum is not present within half an hour from the appointed time of
the meeting, the members present will be the quorum. As far as directors are
concerned, there should be a quorum of 1/3rd of the total strength of the Board or two
directors, whichever is higher
In case of following circumstances only one member can be allowed to constitute a
valid quorum:
i.if all the shares are held by one person, the single shareholder shall constitute a
valid quorum in case of a general meeting;
ii.where the Company Law Board directs under Section 167 or Section 186 that
one member present in person or by proxy shall constitute quorum.
Meeting to be Properly Conducted
Proper conduct of the meeting means that proper rules for ascertaining the sense of the
meeting, the rules for discussion and order in debate as must be observed. Voting rights
cannot be given to preference shareholders unless the resolution directly affects the
rights attached to the preference shares held by them.
Proxy (Section 176): A member who is entitled to attend and vote at a meeting can
appoint another person (whether a member or not) to vote on his behalf. A person so
appointed is a proxy. A proxy has no right to participate in the discussions in the
meeting. However, he may demand or join in a demand for a poll.
Section 176(1) will not be applicable in the following cases except if the articles
provide otherwise.
a.
Members of a company having no share capital will not be able to
attend and vote by proxy.
b.
A member of a private company cannot appoint more than one proxy to
attend the same meeting.
c.
A proxy may vote only on a poll. This implies that he is not eligible to
vote by show of hands
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Resolutions: A proposal made at a meeting by any member is called as Motion. A

motion when passed is called resolution. Motions may relate to closure of discussion or
postponement of the discussion.
With respect to general body meetings, there are two kinds of resolutions-ordinary
resolutions and special resolutions. As per Section 189 (1), a motion passed by simple
majority of the members voting at a general meeting is said to have been passed by an
ordinary resolution. An ordinary resolution is a simple majority resolution which
requires that votes cast in favor of the resolution should be more than votes cast against
the resolution. Also, the notice as per the provisions of the Companies Act must have
been duly given specifying the intention to propose the resolution as a special
resolution.
According to Section 189 (2), a resolution is a special resolution when
i.the intention to propose the resolution as a special resolution has been duly
specified in the notice calling the general meeting or other intimation given to
the members;
ii.the notice required under the Act has been duly given of the general meeting;
and
iii.the votes cast in favor of the resolution by members present (in person or in
proxy either by poll or by show of hand, as applicable) are not less than three
times the number of votes, if any, cast against the resolution. Abstentions, if
any, are not to be taken into account.
11.2 KINDS OF MEETINGS
Meetings under Companies Act, 1956 may be classified as follows:
a.
Shareholders Meetings:

Statutory meeting as per Section 165 of the Act;

Annual General Meeting (AGM) as per Section 166 of the Act;

Extraordinary General Meeting (EGM) (Section 169): Those convened

by the Board of Directors to transact business of special importance that arises
in between the two annual general meetings and justifies the convening and
holding a meeting of the shareholders; and

Class Meetings of Shareholders.

a.
Board Meetings.
b.
Meetings of the Committees of Board.
c.
Meetings with the Debenture holders.
d.
Meetings of Creditors.
Each of the above meetings are elucidated below.
Statutory Meeting
Section 165 of the Companies Act, 1956 lays down:
Every 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 nor more than six
months from the date at which the company is entitled to commence business hold a

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general meeting of the members of the company, which shall be called statutory
meeting. This is the first meeting of the shareholders of a public company and there
would be only one such meeting in the lifetime of the company.
Exemptions: This section is not applicable to:
i.a private company, whether independent or subsidiary of a public company;
ii.a public company not having share capital;
iii.a public company having liability of its members unlimited;
iv.a public company having liability of its members limited by guarantee and not
having share capital; and
v.a Government company, whether registered as a private company or a public
company.
However, if a private company becomes or converts itself into a public company
within a period of six months from the date of its incorporation, it will have to comply
with the provision of this section. If a private company becomes public company after
six months of its incorporation, it will not be required to hold the statutory meeting.
Purpose: The main purpose of this meeting is to enable the members to know at any
early date the financial position and prospects of the company. Also, the statutory
meeting provides an opportunity to the shareholders to discuss various aspects arising
out of the promotion and formation of the company.
Annual General Meeting
An annual meeting known as an annual general meeting is required to be held by every
company every year whether public or private, limited by shares or by guarantee, with
or without share capital or an unlimited company. Every annual general meeting shall
be held during business hours, not on a public holiday and at the registered office or at
some place within the city, town or village in which the registered office is situated.
Purpose: The object of the meeting is to allow shareholders to periodically review the
working of the company. It also provides a forum for the shareholders to exercise their
discretion in electing/re-electing new or retiring directors/auditors, and in having a
direct interaction with the members of the board regarding the progress made by the
company, and on matters relating to accounts or affairs of the company.
Time frame: According to Section 166(1), the first annual general meeting of a
company should be held within a period of 18 months from the date of its
incorporation. The period of 18 months will not be extended in any case. When a
meeting is so held, it will not be necessary for a company to hold any annual general
meeting in the year of its incorporation or in the following year.
Thus, if a company is incorporated in December, 1994, it may hold its first annual
general meeting in April, 1996 and that meeting will be deemed to be the annual
general meeting for 1994, 1995 and 1996.
Further, in compliance with Section 210(3), it should be ensured that the first annual
general meeting is held within 9 months of the close of the financial year.

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Other than the first annual general meeting, every company shall in each calendar year
hold an annual general meeting by giving due notice. The gap between two annual
general meetings must not be more than 15 months and the meeting must be held within
six months from the close of the financial year.
The annual general meeting should be held whether or not the annual accounts are
ready.
Taking into consideration Section 166 and 210 it may be noted that an annual general
meeting (other than the first) should be held on the earliest of the following dates:
a. fifteen months from the date of the last annual general meeting;
b. the last day of the calendar year;
c. 6 months from the close of the financial year.
Place and time of holding annual general meeting
According to Section 166(2)(a), a public or a private company which is a subsidiary of
a public company may fix the time for its annual general meeting either through its
articles, or it may also by passing a resolution in one annual general meeting fix the
time for the subsequent annual general meeting.
A private company which is not a subsidiary of a public company, may in like manner
and also by a resolution agreed to by all the members thereof, fix the time as well as the
place for its annual general meeting.
An annual general meeting should be held at a time during the business hours and in the
city, town or village in which the registered office is situated and not elsewhere.
Where an annual general meeting is adjourned, the board has the power to hold the
adjourned meeting at any place other than the place where the annual general meeting
was held. However, so far as possible, it should be ensured that the meeting is held at
the same place as the original meeting and if that is not possible, the meeting should be
held either at the registered office of the company or at a place within the city in which
the registered office is located.
Default: The Company Law Board may on its own or on the application of any director
of the company or of any member of the company entitled to vote at the meeting, call
for a meeting. This is permitted only when there occurs a default in holding the annual
general meeting or it is impracticable for the company to call, hold or conduct a general
meeting other than an annual general meeting.
Extraordinary General Meetings
All the general meetings of the company with the exception of the Statutory Meeting
and Annual General Meeting are Extraordinary General Meetings (EGM).
Object: The purpose of EGM is to transact special business defined in the previous
which arises between two annual general meetings. The special business transacted at
the EGM has to be urgent, which cannot be deferred to the next annual general meeting.
For instance, a change in the objects or shift of registered office or alteration of capital
or removal of a director/auditors require immediate attention which cannot be deferred
till the next annual general meeting.
An Extraordinary General Meeting may be called by,

The board of directors on its own or on the requisition of a specified

number of members entitled to vote.

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By the requisitionists themselves in case of failure by the board to call

for a meeting.

By the Company Law Board.

Class Meetings
Class meetings are those meetings which are held by holders of a particular class of
shares, e.g. preference shares. Need for such meetings arises when it is proposed to vary
the rights of a particular class of shares. Thus, for effecting such changes, it is necessary
that a separate meeting of the holders of that particular class is held. The meeting is
necessary only if the variation involves the curtailments of the rights of any classes of
shareholders.
It was held in House of Fraser v. ACGEE Investments Ltd.(1987) that a cancellation of
preference shares by repayment of the capital paid upon those shares and in accordance
with rights attached to those shares does not involve any modification or variation of
class rights so as to require a meeting of the preference shareholders.
Section 107 gives a right to a minority group of shareholders belonging to a class, not
being holders of less than ten percent of the issued shares of that class, to challenge the
variation of the rights attached to the shares of that class. That is, a class meeting
should be called if variation of the class of shares in question would unfairly prejudice
the shareholders of that class.
Board Meetings
The meetings of the Board of the Directors for the purpose of collectively taking
decisions for smooth functioning of the company are referred as Board Meetings.
Object: To formulate management policies, take decisions of importance pertaining to
running of the company, review of progress made by the company among other matters
related to the company.
Section 291 lays down that the Board can exercise all the powers which the company is
authorized to exercise.
However, where it is specifically provided that a power or act should be exercised by
the company in a general meeting, the board shall not exercise such power.
Moreover, the board shall not exercise any power or do any act which is inconsistent
with the provisions of the Act, or the Memorandum or the Articles of the company.
Section 291(2) provides that a regulation passed by the company in a general meeting
shall not invalidate any prior act of the board which would have been valid if that
regulation had not been made.
The power delegated to the Board of Directors will have to be exercised at properly
convened board meeting unless the articles provide otherwise.
Powers: Section 292 lays down that the following decisions have to be taken only at the
meeting of the board of directors:
i.make calls on shareholders in respect of unpaid money on their shares;
ii.to issue debentures;
iii.to borrow moneys otherwise than on debentures;

178

iv.to invest the funds of the company; and

v.to make loans.
It has to be noted that the meeting does not require any agenda for the meeting of the
directors. Any business whatsoever, thus can be transacted at a board meeting.
Frequency of Board Meetings: Section 285 provides that a board meeting should be
held at least once in every 3 calendar months. There should be at least four such
meetings in every year. This provision is applicable to every company except where the
Central Government notifies otherwise.
So long as the four board meetings are held in a calendar year, one in each quarter, the
interval between two meetings may be more than three months.
The Act does not make it compulsory for a director to attend all the board meetings.
However, the director can be held liable for any losses incurred by the company which
could have been avoided/prevented by his presence at the board meeting.
Place and Time of Board Meetings: There is no restriction as to the place at which the
board meeting should be held. Thus a board meeting need not be held at the registered
office of the company. It can be held at any place according to the convenience of the
board. It may also be held in a foreign country if circumstances warrant.
A board meeting may be held on any day (even a public holiday) or outside business
hours. However, according to Section 288, a board meeting adjourned for want of
quorum should be held on a day which is not a public holiday.
Notice of Meeting: A written notice of the board meeting should be sent to every
director for the time being in India and to his usual address in case of every other
director. The notice should be issued under the authority of the company.
An officer who fails to give such a notice will be punishable with fine which may
extend to rupees one thousand.
Any such failure to give notice will render the proceedings of the meeting invalid.
Quorum: The quorum for a board meeting shall be 1/3 of its total strength (any fraction
contained in that 1/3 being rounded off as one) or 2 directors whichever is higher.
Where the number of interested directors equals or exceeds 2/3 of the total strength,
then the remaining non-interested directors present at the meeting and being not less
than 2 in number will be the quorum during such time.
At a board meeting, presence of quorum is required at each and every stage of the
meeting.
In a situation, where all the directors are interested, it is advised to increase the number
of directors who are not interested or appoint additional directors not interested in the
contract, if authorized by the articles.
If this is not practicable, the proposed contract should be placed before the general
meeting for consent.
Meetings of Committee of Directors
Any meeting by the committee consisting of individuals who have been delegated the
powers as permitted by Section 292 is referred to as Meeting of Committee of
Directors. Section 292 allows the power to borrow money otherwise than on
securitites, power to invest funds of the company and power to make loans to be

179

delegated subject to the limits and terms and conditions as resolved by the Board of
Directors. The committee so formed cannot delegate its powers further.
The provisions relating to the meetings of a committee of directors and provisions
relating to directors meetings are by and large same as those of board meetings.
The minutes of the proceedings of a committee of directors is not open for inspection to
general public.
Meeting of Debenture Holders
As in the case of Class Meetings, if any variation is proposed to be made in terms of
security or to alter the rights of debentureholders in certain circumstances, then a
Meeting of Debenture holders is called. All the matters connected with the holding,
conduct and proceedings of the meetings of the debenture holders are given in the
Debenture Trust Deed. The decisions arrived at such meetings with the requisite
majority, are valid and binding upon the minority.
Meeting of Creditors
Meeting of creditors for certain arrangements with the company either in case of a
running concern or in the event of winding-up is referred to as Meeting of Creditors.
These kind of meetings are not company meetings in the real sense.
Section 391 to Section 393 authorize the company to enter into arrangements with the
creditors with the sanction of the Court. The court, on application, may order the
holding of a creditors meeting. If the scheme of arrangement is agreeable to, by
majority of creditors in number holding debts to the value of three-fourths majority, the
courts may sanction the scheme.
When a company goes into liquidation, a meeting of creditors and of contributors is
held to ascertain the total amount due by the company to its creditors and also to
appoint a liquidator to wind-up the affairs of the company.

MULTIPLE CHOICE QUESTIONS:

Q1 Which of the following is/are true?
a) Quorum is required only at the beginning of the meeting of the company
b) Quorum is required at the end of the meeting of the company
c) Quorum is required throughout the meeting of the company
d) Quorum is not required only for the meeting of the company
Q2 Quorum for the general meeting in case of a private company is
a) 2 persons
b) 3 persons
c) 5 persons
d) 7 persons

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Q3 The minimum number of board meetings to be held by a company other than a

charitable company, every year shall be
a) 1
b) 2
c) 3
d) 4
Q4 As per Section 217 of the Companies Act, 1956 the Boards report is to be adopted
in
a) AGM
b) Board meetings
c) Extra ordinary meetings
d) Class meetings
Q5 The quorum for a board meeting shall be
a) 1/2 of its total strength or 2 directors whichever is lower
b) 1/3 of its total strength or 2 directors whichever is higher
c) of its total strength or 2 directors whichever is lower
d) of its total strength or 2 directors whichever is higher
Q6 For a general meeting of any kind (statutory, annual or extraordinary) at least
______notice must be given to members.
a) 7 days
b) 10days
c) 15 days
d) 21 day
Q7 The first annual general meeting of a company should be held within
a) 6 months of its incorporation
b) months of its incorporation
c) 15 months of its incorporation
d) 18 months of its incorporation
Q8 As per Section 165 of the Companies Act, 1956, the statutory meeting is to be
held by
a) A private company
b) A public company
c) A public company having liability of its members unlimited
d) A private company that converts itself into a public company within a period of
six months from the date of its incorporation

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Q 9 Statutory meeting is mandatory for

a)
b)
c)
d)

Public company with unlimited liability

Government company
Public company limited by guarantee & having a share capital
Company limited by guarantee & not having share capital

Q10 A proxy
a)
b)
c)
d)

Is allowed to vote on a poll

Is allowed to vote by show of hand
Will be valid only if it is deposited 24 hours before the meeting
Has to be a member

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CHAPTER-12 DIRECTORS
After reading this lesson, you will be conversant with:
12.1 Position Of Directors
12.2 Disqualifications Of A Director
12.3 Restrictions On Number Of Directorships
12.4 Number Of Directors
12.5 Directors Not To Hold Office Or Place Of Profit
12.6 Power To Increase The Number Of Directors
12.7 Powers Of Board Of Directors
12.8 Appointment Of Directors
12.9 Duties Of A Director
12.10 Liability Of Directors
12.11 Vacation Of Office Of Director
12.12 Resignation By The Directors
12.13 Removal Of Directors
12.14 Remuneration Of Directors

On incorporation, a company becomes a legal entity. Being a legal entity, it conducts its
business with the help of representatives chosen by the shareholders. These
representatives are termed as directors. Section 2(13) defines a director as including
any person occupying the position of a director by whatever name called. In order to
determine if a person is a director or not, it is important to see if that person is
appointed and authorized by the articles to act on behalf of the company. It should be
noted that a person who performs all the functions of a director, but who is not duly
appointed as one cannot be considered as a director.
12.1 POSITION OF DIRECTORS
As a Trustee
A director of the company occupies a position of a trustee in relation to the company.
As a trustee, he should exercise his powers for the benefit of the company and its
shareholders. The fiduciary position of a director, makes it imperative on his part to
strictly follow the provisions of the articles and to exercise his power in a prudent
manner.
As Agents
The relationship between the company and its directors can also be construed as one of
principal and agent. When the directors act on behalf of the company, the company is
liable for all the acts performed within the authority of the directors. However, the
directors will be personally liable for any acts performed in excess of their authority.

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They will also be held personally liable when they

a.

Enter into contracts in their own names

b.

When they use the name of the company incorrectly

c.
When it is not clear as to who is signing the contract (that is, whether the
principal or the agent).
As Managing Partners
As they are entrusted with the responsibility of managing the affairs of the company,
their position can be likened to that of managing partners.
Qualification Shares
A director will have to take up qualification shares only if required by the articles of
association. According to Section 270, if the articles require a director to take up
qualification shares, then such a person to be eligible to act as a director must acquire
such qualification shares within two months of his appointment as director. On the
expiry of two months, he automatically vacates his office if he has failed to acquire
these shares. The nominal value of the qualification shares shall not exceed Rs.5,000 or
the nominal value of one share where it exceeds Rs.5,000. Also share warrants will not
count for purposes of share qualification. Section 270(2) specifies that any provision in
the articles requiring a person to obtain qualification shares before his appointment as
director or within a period shorter than two months of his appointment shall be void.
In a situation where a director is unable to take up qualification shares, because the
company has not issued a prospectus to the public or where a statement in lieu of
prospectus has not been filed with the Registrar within two months of the directors
appointment, it was held that shares cannot be allotted to the director in contravention
of Section 70.
The qualification shares to be taken up by the directors can be purchased from the open
market or from a friend and not necessarily from the company.
12.2 DISQUALIFICATIONS OF A DIRECTOR
Section 274 of the Companies Act, 1956 provides that the following persons shall not
be capable of being appointed as directors of any company:
a.
A person found by a competent court to be of unsound mind and such
finding remaining in force,
b.

An undischarged insolvent,

c.
A person who has been convicted by court of an offense involving moral
turpitude and sentenced in respect thereof to imprisonment for not less than six
months, and a period of five years has not elapsed from the date of the expiry of
the sentence,
d.

A person who has applied to be adjudged an insolvent,

e.
A person who has not paid any call in respect of shares of the company
held by him, whether alone or jointly with others and six months have elapsed
from the last date fixed for the payment of the call,
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f.
A person who has been disqualified by a court in pursuance of Section
203, which empowers the court to restrain fraudulent persons from managing
companies, unless the leave of court has been obtained for his appointment,
g.
Such person is already a director of a public company which
a.
Has not filed the annual accounts and annual returns for any continuous
three financial years commencing on and after the 1st day of April, 1999, or
b.
Has failed to repay its deposit or interest thereon on due date or redeem
its debentures on due date or pay dividend and such failure continuous for one
year or more.
Acts Done by Director Prior to Disqualification Valid
Section 290 of the Act specifies that acts done by a person as a director shall be valid,
notwithstanding that it may afterwards be discovered that his appointment was invalid
by reason of any defect or disqualification or had terminated by virtue of any provision
contained in this Act or in the Articles. However, acts done by a director after his
appointment if shown to be invalid can be reversed. Also, any acts ultra vires the
company and such other acts where the third party was aware of the irregularity, shall
not be entitled to be enforced against the company.
12.3 RESTRICTIONS ON NUMBER OF DIRECTORSHIPS
Section 275 limits the number of companies in which an individual can hold
directorship to fifteen. Where a person holding directorships in more than fifteen
companies, is appointed as director of another company, such appointment shall take
effect only if the director relinquishes within fifteen days in his office as director from
one of the companies in which he already was a director. Where he fails to do so, the
new appointment shall be void from the expiry of the said fifteen days. Section 277(2)
lays down that where the number of directorships held by a person is fourteen or less
and after the commencement of the Act he is appointed as a director of other
companies, he will have an option to choose the directorships he wishes to continue. He
should ensure that the total number of directorships he wishes to continue (both old and
new) does not exceed 15. All the new appointments made will be void if he does not
exercise his choice within 15 days of the day on which the last of them was made.
Section 278 specifies that in calculating, for the purposes of Section 275, 276 and 277,
the number of companies of which a person may be a director, the following companies
shall be excluded, namely:
a.
A private company which is neither a subsidiary nor a holding company
of public company,
b.

An unlimited company,

c.
An association not carrying on business for profit or which prohibits the
payment of a dividend, and
d.
A company in which such person is only an alternate director, that is to
say, a director who is only qualified to act as such during the absence or
incapacity of some other director.

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Section 279 levies a penalty of fifty thousand rupees in respect of each of these
companies after the first fifteen, if any person holds office, or acts as a director of more
than fifteen companies in contravention of the foregoing provisions.
12.4 NUMBER OF DIRECTORS
Section 252 of the Companies Act lays down that a public limited company shall have
at least three directors.
Companies other than a public limited company should have at least two directors.
However, a public company having, (a) a paid-up capital of 5 crore or more, (b) one
thousand or more small shareholders may have a director elected by such small
shareholders in the manner as may be prescribed. Here, small shareholders means a
shareholders holding shares of nominal value of Rs.20,000 or less in the public
company.
However, the articles of the company usually fix the maximum and minimum number
of directors for the company. For ascertaining the maximum number of directors for
purpose of determining whether the number has crossed the limit as stated in the
Articles or not, the following are not taken into account:
a.
Directors appointed by the Central Government under Section 408 of the
Act or by the Company Law Board under Section 397 or 398 of the Act,
b.

Nominee directors appointed by the financial institutions, and

c.
Special directors appointed by the Board for Industrial and Financial
Reconstruction under SICA.
12.5 DIRECTORS NOT TO HOLD OFFICE OR PLACE OF PROFIT
Section 314 imposes restrictions on the holding of office or place of profit in a company
by the directors and their associates. Under Subsection (3), any office or place of profit
shall be deemed to be an office or place of profit under the company within the
meaning of the section:
a.
In case the office or place is held by a director, if the director holding it
obtains from the company anything by way of remuneration over and above the
remuneration to which he is entitled as such director, whether as salary, fees,
commission, perquisites, the right to occupy free of rent premises as a place of
residence, or otherwise.
b.
In case the office or place is held by an individual other than a director
or by any firm, private company or other body corporate, if the individual, firm,
private company or body corporate holding it obtains from the company
anything by way of remuneration whether as salary, fees, commission,
perquisites, the right to occupy free of rent any premises as a place of residence
or otherwise.
12.6 POWER TO INCREASE THE NUMBER OF DIRECTORS

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The articles of association usually fix the maximum and minimum number of directors,
but in no case should the minimum number fall below the statutory requirement as laid
down in Section 252, i.e., at least 2 in case of a private company and 3 in case of a
public company.
The number of directors can be increased or decreased within the limits fixed by the
articles in that behalf by passing an ordinary resolution.

Where the maximum number of directors as specified in the articles is 12 or less

than 12, any increase in the number of directors up to 12, will require only an
ordinary resolution.

Where the maximum number of directors as specified in the articles is 12 or less

than twelve, any increase in the number of directors to more than 12 will require
an ordinary resolution as well as the Central Governments approval.

Where the maximum permissible number as fixed by the articles is already more
than 12, then only an ordinary resolution is required to increase the number
within the permissible limits fixed by the articles. However, where the increase
is beyond that permissible by the articles of association, then the Central
Governments approval is to be obtained in addition to the members ordinary
resolution.

12.7 POWERS OF BOARD OF DIRECTORS

An individual director cannot act on his own. All the decisions on behalf of the
company have to be routed through Board of Directors. Individual directors have only
those powers as are vested in them by the Memorandum or Articles. Thus, he has no
authority to institute suit on behalf of the company unless such a power is specifically
conferred on the director. Also, the decisions of the board of directors may be passed by
a majority vote unless it is specifically laid down by the Act that each director has to
consent the decision.
The Board of Directors possess the following powers on behalf of the company:
a.
The power to make calls on shareholders in respect of money unpaid on
their shares.
b.

The powers to issue debentures.

c.
The power to borrow money otherwise than on debentures. However, a
banking company can borrow from other banking companies or from the
Reserve Bank of India, the State Bank of India or any other banks established by
or under any Act.
d. The power to invest funds of the company. This power shall however be subject
to the provisions of Sections 293 and 372.
e. The power to make loans. Again this power is subject to the provisions
contained
in
Sections
295
and
370.
The decisions mentioned in (c), (d) and (e) may be delegated to any committee
of directors, managing director, the manager or any other principal officer of the

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company or in the case of a branch office of the company, a principal officer of

its branch by a resolution passed at a meeting.
f. The power of filling casual vacancies in the Board.
g. Sanctioning of a contract in which a director is interested.
h. The power to recommend the rate of dividend to be declared by the company at
the Annual General Meeting, subject to the approval by the shareholders.
i. The power to appoint a person, a managing director or manager who is holding
either office in another company.
j. The power to invest in any shares of any other body corporate.
12.8 APPOINTMENT OF DIRECTORS
Directors may be appointed by,
a.
Subscribing to the memorandum of association; Section 254, Regulation
64 of Table A.
b.

Shareholders in general meeting; Section 255, 256, 257, 265.

c.

Board of Directors; Section 260, 262, 313.

d.

Central Government; Sections 408, 409.

e.

Third parties.

Each of the ways of appointing the directors is elucidated below.

Appointment of First Directors
According to Section 254, subject to the provisions of the articles, the subscribers to the
memorandum of association will be deemed to be the first directors of the company,
until the directors are appointed in accordance with Section 255.
This means that if the articles, do not name the first directors, then the subscribers to the
memorandum will automatically be deemed to be the directors, until such time as the
directors are appointed.
Appointment of Directors by the Members at the General Meeting
Section 255 provides for appointment and retirement by rotation of directors of a
company. Subsection (1) deals specifically with public companies and private
companies which are subsidiaries of public companies. Further, this subsection is not
applicable if the articles of association provide for retirement of all directors at every
annual general meeting.
A careful reading of this subsection provides that not less than 2/3rds of the total
number of directors shall
a.
Be persons liable to retire by rotation at an annual general meeting of the
company, and
b.
Be appointed in a general meeting.

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It is to be noted that directors liable to retire by rotation, are to retire at an annual

general meeting, whereas, they can be appointed either at the Annual General Meeting
or at an Extraordinary General Meeting of the company.
Appointment of Directors by the Board
The Board may appoint the following directors in certain exigencies:
(i) Appointment of Additional Directors: The Board may, if authorized by the
articles, appoint additional directors who hold office only up to the date of the next
annual general meeting. The appointment of additional director may be made either at a
meeting of the Board or by passing a resolution by circulation as provided in Section
289. If the power to appoint additional directors has not been exclusively delegated to
the Board by the articles, then they can also be appointed by the company in general
meeting.
(ii) Filling up Casual Vacancies: According to Section 262, if the office of a director
appointed in a general meeting is vacated before the expiry of his term either by reason
of death, resignation, disqualification, failure of a director to accept the office or for any
other reason except that of retirement by rotation, then subject to the articles, the board
of directors may fill the vacancy at a meeting of the Board. This provision is applicable
to a public company and a private company which is a subsidiary of the public
company.
(iii) Alternate Directors: Section 313 lays down that the Board of Directors of a
company can appoint an alternate director in place of the original director during his
absence for a period of not less than three months from the date in which board
meetings are held. This power can be exercised, only if authorized by the articles or by
a resolution passed by the company in a general meeting.
Appointment by the Central Government
The Central Government has the power under Section 408 to appoint directors for the
purpose of prevention of oppression and mismanagement. This power comes into play
when a petition has been made to the National Company Law Tribunal (NCLT) for
prevention of oppression and mismanagement. Subsection (1) of Section 408 provides
that the Central Government may appoint such number of persons as the NCLT may,
by order in writing, specify as being necessary to effectively safeguard the interest of
the company, or its shareholders or the public interest to hold office as directors thereof
for such period, not exceeding three years on any one occasion, as it may think fit, if the
NCLT, on a reference made to it by the Central Government or an application of not
less than one hundred members of the company or of the members of the company
holding not less than one-tenth of the total voting power therein, is satisfied, after such
inquiry as it deemed fit to make, that it is necessary to make the appointment or
appointments in order to prevent the affairs of the company being conducted either in a
manner which is oppressive to any members of the company or in a manner which is
prejudicial to the interests of the company or to public interest.
Appointment of Directors by Third Parties
The articles may give a right to financial institutions and debenture holders, to
nominate directors on the Board with a view to ensure that the funds lent by them are

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used for the purpose for which they were borrowed. Normally, the nominee-directors
are non-retiring.
12.9 DUTIES OF A DIRECTOR
The duties of a director may be classified into four categories, viz., (a) fiduciary duties,
(b) duties of care, (c) statutory duties, and (d) other duties.
Fiduciary Duties
The first duty or obligation of directors is not to exceed their authority and powers and
to act with honesty and in good faith. They should not engage in any activity which is
ultra vires the company or illegal. In Boston Deep Sea & Ice Co. vs. Ansell (1888), a
director of a company, being also the member of another company, earned bonuses
from the other company by providing some business facility of his company. He was
held liable to account for such profits, although the company had itself lost nothing and
also could not have earned the bonus.
Duties of Care
A director of a company, like any other agent, is duty bound to exercise reasonable care
in the management of its affairs as is expected from the person occupying such position.
A director is not expected, however, to act in the best of skill and expertise. As long as
the directors act with conscientious fairness and morality, and are honest in purpose
which the law imposes on those who are under fiduciary obligations and
responsibilities, they are not liable for want of judgement or error of judgement. Mere
imprudence is not negligence remains the principle for determining whether the
director has taken proper care or not. Therefore, a director may (safely) be ignorant,
inexperienced and lacking in judgement so long as he is honest and careful or diligent.
It is sufficient if the director exhibits in the performance of his duty the same degree of
care and prudence that he would exercise on his own affairs.
Statutory Duties
According to Section 297, a director of a company or his relative, a firm in which the
director or his relative is a partner, or any other partner of a firm in which such director
is a member or director should not enter into contracts with the company for sale,
purchase or supply of any goods, materials or services unless with the consent of the
Board of Directors. [(Subsection (1)]
Other Duties
i.Duty not to delegate: Shareholders appoint a director because of their faith in
his skill, integrity and competence. Hence, the same faith cannot be delegated
by the director to another person on his own judgement. Delegation by director
is permitted to an extent u/s 292 by the Companies Act.
ii.Duty to attend board meetings: Directors are appointed by the shareholders to
manage the company. It is their duty to attend board meetings and review
periodically the progress of the company. Section 283(g) states that the office of
a director will be vacated if the director absents himself from three consecutive
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meetings of the board or from all meetings of the board for a period of three
consecutive months whichever is longer, without obtaining the leave or absence
of the board. Though it is not mandatory for a director to attend all board
meetings yet it is expected of the director to attend whenever it is possible.
Provisions of Section 283(g) attempt to negate habitual absence by a director by
stipulating stringent action viz. vacation of office.
iii.Convene Annual General Meeting (AGM), statutory and also
extraordinary meeting (Sections 165, 166 and 169): Calling of AGM,
statutory and extraordinary meeting is the duty and responsibility of the
directors.
12.10 LIABILITY OF DIRECTORS
The liability of a Director to the company may arise from:
]Breach of fiduciary duty: Where a Director acts dishonestly to the interest of the
company, he will be held liable for breach of fiduciary duty. Most of the powers of
Directors are powers in trust and, therefore, should be exercised in the interest of the
company and, not in the interest of the Directors or, any section of members. Thus, in a
case where the Directors, in order to forestall a take-over bid, transferred the unissued
shares of the company to trustees, to be held for the benefit of the employees, and an
interest-free loan from the company was advanced to the trustees to enable them to pay
for the shares, it was held to be a wrongful exercise of the fiduciary powers of the
Directors.
Ultra vires acts: Directors are supposed to act within the parameters of the provisions of
the Companies Act, Memorandum and Articles of Association, since these lay down the
limits to the activities of the company and, consequently, to the powers of the Board of
Directors. Further, the powers of the Directors may be limited in terms of specific
restrictions, contained in the Articles of Association. The Directors shall be held,
personally, liable for acts beyond the aforesaid limits, being ultra vires the company or
the Directors. Thus, where the Directors pay dividends or interest out of capital, they will
be liable to indemnify the company for any loss or damage, suffered due to such act.
Negligence: As long as the Directors act within their powers with reasonable skill and
care, as expected of them as prudent businessmen, they discharge their duties to the
company. But, where they fail to exercise reasonable care, skill and diligence, they shall
be deemed to have acted, negligently, in discharge of their duties and, consequently, shall
be liable for any loss or damage, resulting there from. However, error of judgment will
not be deemed as negligence. The Directors cannot be absolved of their liability for
negligence by any provisions in the Articles of Association.
Mala fide acts: Directors are the trustees for the money and property of the company,
handled by them, as well as for exercise of the powers, vested in them. If they dishonestly
or in a mala fide manner, exercise their powers and perform their duties, they will be
liable for breach of trust and, may be required to make good the loss or damage, suffered
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by the company by reason of such mala fide acts. They are also accountable to the
company for any secret profits they might have made in course of their performance of
duties on behalf of the company. Directors can also be held liable for their acts of
'misfeasance', i.e., misconduct or willful misuse of powers. However, misconduct, which
is not willful, shall not amount to 'misfeasance'.
Where a Director misapplies or misappropriates the money or properties of the company
or, has been guilty of breach of trust or misfeasance, the Court may order him to repay
the money or, restore the property or, to pay compensation.
Can a Director be made liable for the acts of his Co-Directors?
A Director is the agent of the company, except for matters to be dealt with by the
company in General Meeting and, not of the other members of the Board. Accordingly,
except in one instance, nothing done by the Board can impose liability on a Director, who
did not participate in the Board's action or, did not know about it. To incur liability, he
must either be a party to the wrongful act or, later acquiesce (consent) to it. Thus, the
absence of a Director from a meeting of the Board does not make him liable for the
fraudulent act of a co-Director, on the ground that he ought to have discovered the fraud,
except where he had the knowledge or, he was a party to confirm that action.
Where a Director is made liable for the acts of a co-Director, he is entitled to contribution
from the other Directors or co-Directors, who were a party to the wrongful act. However,
where the Director, seeking contribution alone, benefited from the wrongful act, he is not
entitled to contribution.
12.11 VACATION OF OFFICE OF DIRECTOR
Section 283 says that the office of director shall become vacant if:
a.
He fails to obtain within the time specified in Subsection (1) of Section
270, or at any time thereafter ceases to hold, the share qualification, if any,
required of him by the articles of the company,
b.
He is found to be of unsound mind by a Court of competent jurisdiction,
c.
He applies to be adjudicated an insolvent,
d.
He is adjudged an insolvent,
e.
He is convicted by a Court of any offense involving moral turpitude and
sentenced in respect thereof to imprisonment for not less than six months,
f.
He fails to pay any call in respect of shares of the company held by him,
whether alone or jointly with others, within six months from the last date fixed
for the payment of the call unless the Central Government has, by notification in
the Official Gazette, removed the disqualification incurred by such failure,
g.
He absents himself from three consecutive meetings of the Board of
Directors, or from all meetings of the Board for a continuous period of three
months, whichever is longer, without obtaining leave of absence from the
Board,
h.
He or any firm in which he is a partner or a private company of which he
is a director, accepts a loan, or any guarantee or security for a loan from the
company in contravention of Section 295,

192

i.
He fails to disclose to the Board his interest in any contract or
arrangement entered into by the company as required by Section 299,
j.
He becomes disqualified by an order of the Court under Section 203
which restrains fraudulent persons from managing companies,
k.
He is removed in pursuance of Section 284, or
l.
Having been appointed a director by virtue of his holding any office or
other employment in the company he ceases to hold such office or other
employment in the company.
12.12 RESIGNATION BY THE DIRECTORS
A director may resign from the office in the manner prescribed in the articles. The
Companies Act does not mention anything relating to the resignation of his office by a
director. If there is no provision in the articles regarding the resignation of the director,
the director may resign by giving reasonable time to the company. In absence of any
provision in the articles, a resignation once made will take effect immediately when the
intention to resign is made clear. Where a director is elected or has contracted to act for
a fixed period, his resignation, before the expiration of the period, may make him liable
for damages for breach of his contract, unless the articles permit such resignation, or
unless there is a good cause.
Where of the two directors, one died and the other wanted to resign, it was held that a
letter of resignation left at the office of the company under intimation to Registrar of
Companies was enough to make the resignation effective and it was not necessary that
the surviving director should first co-opt a director in exercise of power of co-option
under the articles and then hand over the resignation to him. [S.S. Lakshmana Pillai vs.
ROC (1977)]
The directors do not have the power to refuse the resignation of co-director unless such
a provision is contained in the Articles of Association of the company.
12.13 Removal of Directors
BY THE SHAREHOLDERS
Under Section 284 a company may, by ordinary resolution, remove a director before the
expiry of his period of office, provided the director is not appointed by the Central
Government in pursuance of Section 408. Special notice shall be required of any
resolution to remove a director under this section, or to appoint somebody instead of a
director so removed at the meeting at which he is removed. On receipt of notice of a
resolution to remove a director under this section, the company shall forthwith send a
copy thereof to the director concerned, and the director shall be entitled to be heard on
the resolution at the meeting.
BY THE CENTRAL GOVERNMENT
Under Sections 388B to 388E of the Companies Act, 1956, a director may be removed
by the Central Government on the recommendations of the NCLT. The Central
Government has the power to make a reference to the NCLT by stating a case against
any person concerned or connected with the conduct and management of the company,
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with a request to inquire into the case and record its decision whether or not he is a fit
and proper person to hold the office of a director or other managerial office. The NCLT
may direct by an interim order that the respondent shall not discharge the duties of his
office until further orders. At the conclusion of the inquiry, if the decision is against the
respondent, the Central Government shall by order remove him from office.
BY THE NATIONAL COMPANY LAW TRIBUNAL (NCLT) (SECTION 402)
A director may be removed by the NCLT on an application to it for prevention of
oppression and mismanagement. When the appointment of a director is so terminated
he cannot, except with the leave of the NCLT, serve any company in a managerial
capacity for a period of five years. Nor can he sue the company for damages for
compensation for loss of office.
12.14 REMUNERATION OF DIRECTORS
Payment of Managerial remuneration to the directors is guided by the provisions of
Sections 198, 309, and 310.
The remuneration of directors (including the managing director and a wholetime
director) will be determined either by the articles, or by a resolution of the general body
or by a special resolution, if required by the articles. [Section 309(1)]
This remuneration will not include any amounts paid to the director for services
rendered in any other capacity if
a.

The services rendered are professional in nature, and

b.
If the Central Government is of the opinion that the director possesses
the requisite qualification for practice of the profession. [Section 309(1)]
The explanation for Section 198 mentions that remuneration includes:
a.
Any expenditure incurred by the company in providing any rent free
accommodation or any other benefit or amenity in respect of accommodation
free of charge and any other expenditure incurred by the company in providing
any other benefit or amenity free of charge or at a concessional rate.
b.
Any expenditure incurred by the company in respect of any obligation or
service which but for such expenditure by the company, would have been
incurred by any of the persons aforesaid.
c.
Any expenditure incurred by the company to effect any insurance on life
of, or to provide any pension, annuity or gratuity for, any of the persons
aforesaid or his spouse or child.
A director of a company may receive his remuneration in any of the following ways:
a.
He is entitled to receive remuneration in the form of a fee for each Board
meeting attended by him.
However, if this fee was paid to him on a monthly basis before the commencement of
the Companies (Amendment) Act, 1960, then it may be continued to be paid on the

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same basis for a period of two years after the commencement or for the balance period
of his term as director, whichever is less. [Section 309(2)]
b.
According to Section 309(3) , a wholetime director or a managing
director may be paid remuneration either on a monthly basis or at a specified
percentage of the net profits of the company or partly by one way and partly by
the other.
c.
In the case of a director who is not a wholetime director nor a managing
director, remuneration may be paid either monthly, quarterly or annually with
the approval of the government. Remuneration may also be paid in the form of
commission, provided a special resolution is passed authorizing such payment.
The validity period of this special resolution is five years. However, the
company may renew this special resolution from time to time for periods not
more than five years at a time. [Section 309(4)].
Remuneration payable under Section II of Part II is as follows:
Where the Effective Capital of the
Company is

Monthly Remuneration Payable shall

Not Exceed

i. less than Rs.1crore

Rs.40,000

ii. Rs.1 crore to Rs.5 crore

Rs.57,000

iii. Rs.5 crore to Rs.15 crore

Rs.72,000

iv. Rs.15 crore or more

Rs.87,500

MULTIPLE CHOICE QUESTIONS:

Q1 Who among the following can become a director of a company?
(a)
Bodies corporate
(b)
Association of persons
(c)
Firms
(d)
Individuals
Q2 Qualification shares
(a) Are to be held by a director before his appointment
(b) Are to be acquired within a period of less than 2 months of appointment, if provided
by the articles of the company.
(c) Can be held jointly, unless the articles provided otherwise
(d) Can exceed a nominal value of Rs 5,000.
Q3 An alternate director can hold office
(a) Till the next annual general meeting after his appointment
(b) The date upto which the original director would have held office
(c) Only during the absence of the original director
(d) For a period longer than that permissible to the original director.

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Q4 A person cannot be a director at the same time in more than _____ companies.
(a) 10
(b) 15
(c) 20
(d) 25
Q5 A director who enters into a contract with the company for sale, purchase or supply of
goods under circumstances of urgent necessity
(a) Need not obtain the consent of the board
(b) Has to obtain the consent of the board within 2 months of the date of contract.
(c) Has to obtain the consent of the board within 3 months of the date of the contract
(d) Has to obtain the consent of promoters within one month of the date of contract
Q6 Total managerial remuneration payable by a public company to its directors
(a) Shall be less than 10% of net profit for the financial year
(b) Can not exceed 11% of gross profits for the financial year
(c) Can not exceed 11% of net profits for financial year
(d) Can exceed 11% but not 15% of gross profit
Q7 Total managerial remuneration to directors does not include
(a) Expenditure incurred in providing free accommodation
(b) Guarantee commission on the guarantee given for company loans
(c) Sitting fee payable for attending meetings
(d) Both (b) & (c) above
Q8 A director
(a) Has to take up qualification shares within a period of 1 month of his appointment, if
provided in the articles of association
(b) Need not take up qualification shares if there is no such provision in articles
(c) Has to take up qualification share before his appointment if such a provision is there in
the articles of association
(d) Has to take up qualification shares within a period of 15 days of his appointment, if
provided in the articles of association
Q9 A casual vacancy of a Director
(a) Can not be filled up
(b) Has to be filled up at the annual general meeting by passing an ordinary resolution
(c) Can be filled up at a meeting of the board
(d) Required a special resolution to be filled up
Q10 Which of the following powers of the board of directors cannot be exercised except with the
consent of the company in the General meeting?
(a) Power to issue debentures
(b) Power to invest the funds of the company
(c) Power to sell the whole of the undertaking of the company
(d) Power to make calls

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CHAPTER-13 WINDING UP
After reading this lesson, you will be conversant with:
13.1 Winding Up By NCLT
13.2 Voluntary Winding Up
A company comes into existence upon incorporation and continues to exist till it is
amalgamated with another or wound up. Prof. Gower in his book The Principles of
Modern Company Law defines winding up of a company as the process whereby its
life is ended and its property administered for the benefit of its creditors and members.
An administrator, called a liquidator, is appointed and he takes control of the company,
collects its assets, pays its debts and finally distributes any surplus among the members
in accordance with their rights.
Winding up precedes dissolution. Till a company is dissolved, its corporate status and
powers continue.
Section 425 of the Act provides for three modes of winding up:

Compulsory winding up by the order of the NCLT; or

Voluntary winding up.

13.1 WINDING UP BY NCLT

Section 433 of the Act empowers the NCLT to order winding up of a company under
specified circumstances. These circumstances are:
Special Resolution [Section 433(a)]
The NCLT may order winding up of a company, if the company has, by special
resolution resolved that it be wound up. The NCLT can exercise this power
discretionarily and may not order the companys winding up if in its opinion such
winding up is opposed to the interests of the company or the public.
Default in Holding Statutory Meeting [Section 433(b)]
If a public company defaults in delivering the statutory report to the Registrar or in
holding the statutory meeting, the court may order winding-up of the company. The
petition for winding up may be presented either by the Registrar or a contributory. The
petition should, however be filed within fourteen days after the last day on which the
statutory meeting ought to have been held. Instead of ordering winding up of the
company, the NCLT may order the delivery of the report or holding of the meeting, as
the case may be.
Failure to Commence Business [Section 433(c)]

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If the company does not commence its business within a year from its incorporation, or
suspends its business for a whole year, the NCLT may order winding up of the
company. Before deciding on the issue of winding up of a company, the NCLT
examines the circumstances due to which the company has been unable to commence
business or has suspended it and the possibilities or intention of starting or continuing
the business.
Caselet:
It was held in Paramjit Lal Badhwar vs. Prem Spinning and Weaving Mills Limited,
that a winding up order will not be made on the ground that the company has
discontinued one of the many business it was engaged in. Therefore, for a winding up
order to be made the suspension should be related to the entire business and not just a
part of it. Even in a case where the company suspends its entire business, the court will
examine whether the business can be restarted.
Reduction in Membership [Section 433(d)]
If the number of members is reduced, in case of a public company, below seven, and in
case of a private company, below two, the NCLT may order winding-up of the
company.
Inability to Pay Debts [Section 433(e)]
The NCLT may order winding up of a company if it is unable to pay its debts.
Just and Equitable Ground [Section 433(f)]
The last circumstance arises when a company may be wound up by NCLT, if in the
opinion of the Tribunal, it is just and equitable that the company should be wound up.
The section does not define the words just and equitable. It has to be construed having
regard to the provisions of the Act in relation to promotion, formation and management
of companies, the rights of shareholders, powers of the Registrar and the Central
Government. Based on the circumstances in which winding up has been ordered by the
NCLT, we shall discuss them under the following classifications.
i.
Deadlock : Where there is deadlock in the management of a company, it
becomes a just and equitable ground for winding up.
Caselet:
A well known case Yenidge Tobacco Co. Ltd. Re., illustrates this ground
Two persons carrying on same business separately amalgamated their business to form
a private company of which they were the only shareholders and directors having equal
voting rights. The articles of the company provided for arbitration in case of any
dispute. In an arbitration proceeding, one of the directors dissented from the award.
Both the directors became so hostile towards each other that they communicated
through a secretary. The NCLT held that as there was complete deadlock in the
management, it was just and equitable that the company be wound up.
ii. Loss of Substratum

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Every company is incorporated with the object of carrying on a specific object known
as the main object. Where, the main object does not materialize, the company is said to
have lost its substratum.
Caselet
In German Date Coffee Co. Re., a company was formed for the purpose of
manufacturing coffee under a patent to be granted by the Government of Germany and
other similar patents. The company was not granted the German patent and it embarked
other patents. A shareholder brought about a petition for winding-up. It was held that
the substratum of the company had failed, and it was impossible to carry out the objects
for which it was formed; and, therefore, it was just and equitable that the company should
be wound up.
iii. Losses
It is indeed just and equitable ground that a company be wound up where it is unable
to carry on business except at loss and there is no hope for making trading profit.
iv. Oppression of Minority
It is a just and equitable ground for winding up, where the majority shareholders adopt
an aggressive attitude towards the minority shareholders.
Instances where dividends have not been paid, shareholders meetings have not been
held, attempt is made for squeezing out the minority shareholders by buying out their
shares at an under value or where majority of the shareholders wish to dissociate
themselves from the new business being carried on have been held to be just and
equitable ground for winding upon. R. Sabapathi Rao. v. Sahapathi Press Limited and
Tivoli Free, Re. illustrate these points.
v. Fraudulent Purpose
Where a company has been incorporated for carrying on any fraudulent or illegal
business or one of its objects is illegal, then it is a just and equitable ground for winding
up.
vi. Incorporated or Quasi-Partnership
Where it is proved that a private company is nothing but an extension of a partnership
and there is abuse of power or breach of good faith, it is a ground for winding up under
just and equitable clause.
In American Pioneer Leather Co. Re., winding up was ordered when one of the
three members of a private company offered his interest for purchase and the other
members refused. In accordance, the member was entitled to petition for winding
up. The company was wound when the other two members refused to buy his
interest.
vii. Public Interest
A company may also be wound-up by the NCLT, if the winding up would be in public
interest.
We have seen the circumstances in which the NCLT can order winding up. We shall
now get down to discussing the procedural aspects of winding up.

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Who Can Apply for Winding up (Section 439)

An application to the NCLT for winding up of a company shall be by petition and can
be made by the following:
i. The Company [Section 439 (1)(a)]
A company may, at a meeting of its shareholders, pass a special resolution, to the
effect that the company shall be wound up. Where a valid resolution is passed by
the company, the courts may accept the same and pass orders for winding up of a
company.
ii.
By any creditor of the company including a contingent or a prospective
creditor [Section 439(1)(b)]
The term creditor means a creditor to whom money is owed by the company either
immediately or at a later date by virtue of an agreement entered into by the creditor
with the company. It includes the Government (both Central and State) or any other
authority to whom any tax or charge is due from the company.

iii.

Any contributory or contributories [Section 493(1)(c)]

According to Section 428, the term contributory means every person liable to
contribute to the assets of a company in the event of its being wound up, and includes
the holder of any shares which are fully paid up; and for the purposes of all proceedings
for determining, and all proceedings prior to the final determination of the persons who
are to be deemed contributories; and includes any person alleged to be a contributory.
iv.

All Parties [Section 439 (1)(d)]

As per this subsection, all or any of the parties specified in clauses (a), (b) and (c) can
petition either jointly or separately.
v.

The Registrar [Section 439 (1)(e)]

The powers of the Registrar to petition for winding up are linked with Section 433. A
Registrar can petition under clause (b), (c), (d), (e) and (f) of Section 433. However,
while petitioning under clause (e) of Section 433 relating to inability of the company to
pay its debts, the Registrar can do so only if, it appears to him either from the financial
condition of the company as disclosed in its balance sheet or from the report of a
special auditor appointed under Section 233-A or an inspector appointed under Section
235/237 that the company is unable to pay its debts. The Registrar shall obtain the prior
approval of the Central Government to present a petition on any of the grounds
aforesaid. The Central Government shall not accord its sanction, unless the company
has first been afforded an opportunity of making its representations, if any.
vi.

By the Central Government [Section 439 (f)]

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Where based on the report furnished by an inspector under Section 235 or 237 (b) (i)
and (ii), the Central Government decides to petition for winding up, it may do so under
Section 243. Clause (f) of Section 439 enables the person authorized by the Central
Government to petition on its behalf.
vii.

By the Official Liquidator

Where a company is being wound up voluntarily or subject to the supervision of the

NCLT, a petition for winding up by the court may be presented by any of the persons
specified in Section 439 and subject to its provisions or a liquidator. Section 440 (2)
provides that, the court shall not make a winding up order, unless it is satisfied that the
voluntary winding up or winding up subject to the supervision of the court cannot be
continued with due regard to the interests of the creditors or contributories or both.
When does Winding up Commence (Section 441)
Winding up Commences:
i.Where a resolution has been passed for voluntary winding up, before
presentation of the petition, winding up shall be deemed to have commenced at
the time of the passing of the resolution;
ii.In any other case, the winding up of a company by the NCLT shall be deemed
to commence at the time of the presentation of the petition for the winding up.
CONSEQUENCES OF WINDING UP
The winding up order made by the NCLT should be communicated to the Official
Liquidator and the Registrar (Section 444). On such an order being made, the official
liquidator becomes the liquidator of the company (Section 449). The Board of Directors
of the company will cease to hold office from the date of communication of the winding
up order. They will be directors only for the purpose of submitting the statement of
affairs of the company to the liquidator.
It may be noted that a winding up order will be construed as notice of discharge to the
officers and employees of the company, except when the business of the company is
continued.
Where a person has entered into a contract of service for a fixed term, and the said term
has not expired on the date the winding up order is made, then such a person can claim
damages for the resulting breach of contract.
Statement of Affairs (Section 454)
Where a winding up order has been made by the NCLT and where the official
liquidator has been appointed as the provisional liquidator, unless the NCLT otherwise
orders, a statement of affairs in the prescribed form and verified by an affidavit should
be submitted to the official liquidator.
The statement of affairs should give the following particulars:

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a. the assets of the company, stating separately the cash balance in hand and at the
bank, if any, and the negotiable securities, if any, held by the company.
b. its debts and liabilities.
c. the names, residence and occupations of its creditors, stating separately the
amount of secured and unsecured debts; and in the case of secured debts, particulars of
the securities given, whether by the 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, residence and occupations of the
persons from whom they are due and the amount likely to be realized on account
thereof.
e. such further or other information as may be prescribed, or as the Official
Liquidator may require.
Report by the Official Liquidator
The Official Liquidator should as soon as practicable after the receipt of the statement
of affairs and not later than six months from the date of the winding up order (or such
extended period as may be allowed by the NCLT) or in a case where the NCLT orders
that no statement need be submitted, as soon as practicable after the date of the order
submit a preliminary report to the NCLT.
a. as to the amount of capital issued, subscribed and paid-up, and the estimated
amount of assets and liabilities, giving separately under the heading of assets,
particulars of (i) cash and negotiable securities (ii) debts due from contributories
(iii) debts due to the company and securities, if any available in respect thereof,
(iv) movable and immovable properties belonging to the company and (v) unpaid
calls.
b. if the company has failed, as to the causes of the failure.
c. whether, in his opinion, further inquiry is desirable as to any matter relating to
the promotion, formation or failure of the company, or the conduct of the business
thereof.
Powers of the Liquidator (Section 457)
The liquidator in a winding up by the court shall have power, with the sanction of the
court.
a.
To institute or defend any suit, prosecution or other legal proceeding,
civil or criminal in the name and on behalf of the company;
b.
To carry on business of the company so far as may be necessary for the
beneficial winding up of the company;
c.
To sell the immovable and movable property and actionable claims of
the company by public auction or private contract, with power to transfer the
whole thereof to any person or body corporate or to sell the same in parcels;
d.
To sell whole of the undertaking of the company as a going concern;
e.
To raise on the security of the assets of the company any money
requisite;
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f.
To do all such other things as may be necessary for winding up the
affairs of the company and distributing its assets
Duties of the Liquidator
i.Where a winding up order is made, it is the duty of the liquidator to submit a
preliminary report to the NCLT as required by Section 455.
ii.He should keep in the manner prescribed, proper books in which he shall cause
entries or minutes to be made of proceedings at meetings and of such other
matters as may be prescribed [Section 461(1)].
iii.The liquidator shall convene a meeting of the creditors and the contributories as
required by Section 464.
iv.Every Official Liquidator shall, in such manner and at such times as may be
prescribed, pay the moneys received by him as liquidator of any company, into
the public account of India in the Reserve Bank of India [Section 552]. The
Official Liquidator or any other liquidator of a company shall not pay any
moneys received by him in his capacity as such into any private banking
account [Section 554].
v.The liquidator shall pay the dividends payable to any creditor which had
remained unpaid for six months after the date on which they were declared
and the assets refundable to any contributory which have remained undistributed
for six months after the date on which they become refundable, into the public
account of India in the Reserve Bank of India in a separate account to be
known as the Companies Liquidation Account [Section 555(1)].
vi.Subject to the provisions of this Act, the liquidator shall, in the administration of
the assets of the company and the distribution thereof among its creditors, have
regard to any directions which may be given by resolution of the creditors or
contributories at any general meeting or by the committee of inspection [Section
460(1)]. Any directions given by the creditors or contributories at any general
meeting shall in case of conflict, be deemed to override any directions given by
the committee of inspection [Section 460(2)].
vii.The Liquidator
a. may summon general meetings of the creditors or contributories, whenever he
thinks fit, for the purpose of ascertaining their wishes;
b. shall summon such meetings at such times, as the creditors or contributories, as
the case may be, may, by resolution, direct, or whenever requested in writing to do
so by not less than one-tenth in value of the creditors or contributories, as the case
may be.
viii.The liquidator shall submit the accounts for inspection to the Committee of
Inspection [Section 465(2)].
ix.The liquidator should present to the Tribunal an account of receipts and
payments. Also a printed copy of the audited accounts should be sent to every
creditor and contributory. A copy of the accounts should also be filed with the
Registrar.
x.

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Dissolution of Company (Section 481)

Where the affairs of the company are wound up or where the NCLT is of the opinion
that the liquidator cannot proceed with the winding up due to lack of funds and assets or
for any other reason whatsoever and further where the NCLT feels it is just and
equitable to do so, it may make an order that the company be dissolved from the date of
the order and the company shall be dissolved accordingly.
13.2 VOLUNTARY WINDING UP
Section 484 to 520 deal with voluntary winding up of a company. A company may be
voluntarily wound up either by passing an ordinary resolution or a special resolution.
a. A company may pass an ordinary resolution in a general meeting requiring the
company to be wound up voluntarily when the period, if any, fixed for the duration
of the company by its articles, has expired, or the event if any, has occurred, on the
occurrence of which the articles provide that the company should be dissolved.
[Section 484(1)(a)]
b. Under [Section 484(1)(b)], the company may also be wound up voluntarily by
passing a special resolution. This is when the members want to wind up the
company voluntarily, inspite of the company being solvent.
A voluntary winding up does not mean that the existence of the company comes to an
end. The company continues to exist until it is dissolved. The directors will continue to
exercise those powers to the extent allowed by the liquidator. Further, a voluntary
winding up will neither result in a stay of existing proceedings nor will it prevent the
institution of new proceedings.
The resolution passed for voluntary winding up of the company will not serve as a
notice of discharge of the employees of the company, if the business is continued by the
liquidator or the liquidation is only with a view to reconstruction.
Notice of the resolution passed by the company should be given by advertisement in the
Official Gazette and also in some newspaper circulating in the district where the
registered office of the company is situated. This notice should be given within fourteen
days of passing the resolution. The company and every officer who commits a default
in complying with this requirement will be punishable with fine which may extend to
five hundred rupees for every day during which the default continues.
A voluntary winding up will be deemed to have commenced from the date of the
passing of the resolution. From the commencement of the voluntary winding up, the
company will cease to carry on business except so far as may be required for the
beneficial winding up of such business. However, it retains its corporate status and
powers until it is dissolved.
Types of Voluntary Winding up
A voluntary winding up may be either a members or creditors winding up. Where the
directors make a declaration of solvency as required by Section 488, the winding up

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will be conducted as a voluntary winding up and only the members will have control
over the proceedings in such a case. However, where the directors do not make such a
declaration, the winding up will be a creditors winding up.
Procedure for Members Voluntary Winding up (Section 489)
The procedure for members voluntary winding up is as follows:
At the meeting of the board, the directors of the company or in case the company has
more than two directors, a majority of them should make a declaration of solvency in
Form No. 149, prescribed under the Companies (Court) Rules.
The declaration should be accompanied by the auditors report on the financial
statements of the company up to the date of the Board meeting or nearest possible date.
The declaration of solvency along with the auditors report should be filed with the
Registrar within five weeks before the passing of the resolution for winding up.
After complying with these formalities, the company would be required to pass a
special resolution at a general meeting (Section 484). The notice of the special
resolution should be advertised in the Official Gazette and also in a newspaper
circulating in the district where the registered office of the company is situated.
At the meeting where the special resolution is passed or at any subsequent general
meeting, a liquidator/s should be appointed and his remuneration fixed. The
remuneration so fixed cannot be increased in any circumstances, whether with or
without the sanction of the court.
Where a vacancy is created because of the death, resignation or otherwise in the office
of any liquidator, such a vacancy may be filled by the company in a general meeting,
subject to any arrangement with its creditors. For the said purpose of filling a vacancy,
the general meeting may be convened by any contributory or by the continuing
liquidator or liquidators if any.
The notice of the appointment of liquidator (also where a vacancy is filled) should be
given within 10 days of the appointment to the Registrar in Form No. 36(b) of
Companies (Central Governments) General Rules and Forms (Section 493). The
liquidator should also give the Registrar a notice of his appointment within thirty days
of his appointment [Section 516].
The liquidator shall then proceed to realize the assets, prepare lists of creditors, admit
proof, settle lists of contributories, make such calls as may be necessary, pay the
secured creditors, pay the costs including his own remuneration, pay preferential
claims, and when all the claims of the creditors are met, he should distribute the surplus
pro rata among the contributories.
In fulfilling the above, in case he faces any difficulty, he may make an application to
the Tribunal to determine the same.
Where the winding up proceedings extend to more than a year, the liquidator shall call a
general meeting of the company within three months at the end of the first year after the
date of commencement of winding up and the end of each succeeding year and put
before it an account of his acts and dealings [Section 496].

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It is also the duty of the liquidator to keep all moneys in a schedule bank and comply
with the provisions of Section 553 and Rules 324 to 326 of the Companies (Court)
Rules.
Creditors Voluntary Winding up (Section 499)
The provisions contained in Sections 500 to 509 will be applicable to a creditors
winding up.
According to Section 500(1), the company shall call for a meeting of the creditors on
the day, or the day next following the day, on which there is to be held the general
meeting of the company at which the resolution for winding up is to be proposed. The
company shall cause notices of the meeting of creditors to be sent by post to the
creditors simultaneously with the sending of the notices of the meeting of the company.
The notice of the meeting of creditors should be advertised at least once in the Official
Gazette and in two newspapers circulating in the district where the registered office or
the principal place of business of the company is situated [Section 500(2)].
At the meeting of the creditors, the Board of Directors shall lay a full statement of the
position of the companies affairs together with a list of the creditors of the company and
the estimated amount of their claims. The board should also appoint one of their
member to preside at the meeting [Section 500(3)].
The director so appointed should attend and preside at the meeting [Section 500(4)].
Where the meeting at which the resolution for winding up of the company is to be
proposed, is adjourned and the resolution is passed at an adjourned meeting, then any
resolution that is passed at the creditors meeting held in pursuance of Subsection (1)
will be valid and effective, as if it had been passed immediately after the passing of the
resolution for winding up the company. [Section 500(5)]
Notice of any resolution passed by the creditors at the creditors meeting in pursuance of
Section 500 shall be given by the company to the Registrar within ten days of the
passing thereof [Section 501].
The company in the general meeting and the creditors at the creditors meeting are
entitled to nominate a person as liquidator for the purpose of winding the affairs and
distributing the assets of the company [Section 502(1)].
Where the persons nominated by the company and the creditors are different, then the
one nominated by the creditors shall be the liquidator [Section 502(2)].
Section 502(2) also provides that any director, member or creditor of the company may,
within seven days after the date on which the nomination was made by the creditors,
apply to the NCLT for an order either directing that the person nominated as liquidator
by the company shall be liquidator instead of or jointly with the person nominated by
the creditors, or appointing the Official Liquidator or some other person to be liquidator
instead of the person appointed by the creditors.
In case the creditors do not nominate a person as liquidator, then the person nominated
by the company shall be the liquidator and where the company does not nominate a
person as liquidator, then the creditors nominee will be the liquidator.

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The creditors may if they think fit appoint a committee of inspection consisting of not
more than five persons at the meeting to be held in pursuance of Section 500 or at any
subsequent meeting [Section 503(1)].
Where such a committee is appointed, the company may, either at the meeting at which
the resolution for voluntary winding is passed or at any subsequent general meeting,
appoint such number of persons (not exceeding five) as they think it fit to act as
members of the committee. The creditor may if they think fit, resolve that the members
appointed by the company shall not be the members of the committee.
Upon such a resolution being made by the creditors, the persons mentioned in the
resolution will not be qualified to act as members of the committee unless the NCLT
directs otherwise [Section 503(3)].
On an application made to the Tribunal, the Tribunal may appoint other persons to act
as member of the committee instead of those mentioned in the creditors resolution
[Section 503(4)].
The remuneration of the liquidator may be fixed by the committee of inspection and
where there is no such committee, his remuneration may be fixed by the creditors
[Section 504(1)].
In case the remuneration is not fixed, it may be determined by the NCLT [Section
504(2)].
Under no circumstances can the remuneration of the liquidator once fixed as per
Subsections (1) and (2) of Section 504 be increased [Section 504(3)].
The appointment of a liquidator results in cessation of the powers of the board, except
in so far as the committee of inspection, or if there is no such committee, the creditors in
general meeting, may sanction the continuance thereof [Section 505].
If a vacancy occurs by death, resignation or otherwise, in the office of the liquidator
(other than a liquidator appointed by, or by the direction of, the NCLT), the creditors in
general meeting may fill the vacancy [Section 506].
Where the winding up proceedings extend to more than a year, the liquidator shall call a
general meeting of the company and a creditors meeting within three months or such
extended time as permitted by the Central Government at the end of the first year after
the date of commencement of winding up and the end of each succeeding year and put
before it an account of his acts and dealings [Section 496].
As soon as the affairs of the company have been wound up, the liquidator shall (a)
make up an account of the winding up showing the manner in which the winding up
was conducted and the way in which the assets of the company were disposed of (b)
call a general meeting of the company and a meeting of the creditors for the purpose of
laying the account before the meetings and giving any explanation thereof.
Provisions Applicable to Every Voluntary Winding up (Section 510)
i.

Distribution of property of company [Section 511]

The assets of the company are to be applied for payment of its debts and liabilities.
Subject to the provision of Sections 520 and 530 (relating to preferential payments), the
debts and liabilities of the company should first be paid in full, and if that is not possible,

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then settled on pari passu basis. Surplus if any, unless otherwise provided for in the
articles, should be distributed among the members in accordance with their rights and
interests in the company.
ii.

Statement of affairs [Section 511A]

Provisions under Section 454 apply to this section, except that the company is required to
submit the statement of affairs to the liquidator and not to the Tribunal.
iii.Powers and duties of liquidator in voluntary winding up (Section 512)
The powers are synonymous with the powers of an official liquidator in a winding up
by Tribunal. In addition, the liquidator is empowered:

to settle the list of contributories,

make calls, and

call general meeting of the company.

Power of NCLT to appoint or remove liquidator in voluntary winding up

(Section 515)

The NCLT may suo moto or on an application by any creditor or contributory or the
Registrar appoint or remove a liquidator. Where an Official Liquidator is appointed as
liquidator under Section 502(2), the remuneration payable to him shall be fixed by the
Tribunal and credited to Central Government.
v.Arrangement when binding on company and creditors (Section 517)
An arrangement entered between the creditors and a company about to be, or in the
course of its winding up, is binding upon the parties if:

sanctioned by a special resolution, and

acceded by 3/4 in value and number of creditors.

Any creditor or contributory may within three weeks of completion of arrangement,

appeal to the Tribunal, to amend any, confirm or set aside the arrangement.
vi.Costs of voluntary winding up
All costs, charges, expenses and remuneration of the liquidator shall, subject to the
rights of secured creditors, if any, be paid out of the assets of the company in priority to
all other claims.
MULTIPLE CHPICE QUESTIONS:
Q1 Which of the following is a just and equitable ground to wind-up a company by
court?
a)
Where there is a deadlock in the management of a company
b)
If the membership in a public company falls below the statutory
minimum of seven members
c)
If a company is unable to pay its debts

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d)
If a company does not commence its business within a year of its
incorporation
Q2 Which of the following is not a ground for winding up of a company?
a)
Default in holding statutory meeting by a public companyt limited by
shares
b)
Default in holding annual general meeting
c)
Failure to commence business within a
year of its incorporation\
d)
Inability to pay debts
Q3 Which of the following payments are not allowed to be paid as preferential payments
in winding up of a company?
(a)
Revenues, taxes, cesses to the government
(b)
Amount payable to financial institution
(c)
Accrued holiday remuneration payable to employees
(d)
Any compensation or liability under the workmens compensation Act,
1923
Q4 A petition for winding up, in case of failure to hold statutory meeting, can be filed by
the contributory
(a)
Before the expiry of 21 days from the date on which the statutory
meetings was to be held
(b)
Within the expiry of 14 days from the date on which the statutory meeting
was to be held
(c)
Any time after expiry of the date on which the meeting was to be held
(d)
After the expiry of 14 days from the day on which the meeting ought to
have been held
Q5 When the company is no longer able or never has been able to carry on the business for
which it was formed, the
(a) Court can wind up the company on the ground that it is just & equitable
(b) Court can not wind up the company on the ground that it is just & equitable
(c) Court can wind up the company only if majority shareholder approve
(d) Court can wind up the company only if a special resolution is passed by the company
Q6 Petition for winding up for failure to hold statutory meeting can be presented by a
(a) Company
(b) Contributory
(c) Registrar
(d) Both (a) & (c) above
Q7 When a resolution has been passed by the company, for voluntary winding-up, before the
presentation of a petition, winding-up commences
(a) At the time of presentation of petition
(b) When the petition is acknowledged by the court

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(c) From the date of resolution

(d) 14 days after the resolution has been passed
Q8 In a compulsory winding up, preliminary report of the official liquidator should be
submitted to the court
(a) Before the receipt of the statement of affairs
(b) 3 months after the date of order of winding up
(c) After receipt of statement of affairs & before 6 months from the date of order of windingup
(d) 3 months before the date of order of winding up
Q9 Period for submission of statement of affairs can be extended by the Court to a maximum
of ______ of appointment of official liquidator.
(a) 30mdays
(b) 2 months
(c) 3 months
(d) 4 months
Q10 In a members voluntary winding-up, the declaration of solvency should be made
(a)
After 5 weeks of passing a resolution for winding up
(b)
At the time of passing the resolution
(c)
Within 5 weeks immediately preceding the date of passing of resolution
(d)
When petition for winding up has been made to the court

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CHAPTER-14 CONSUMER PROTECTION ACT,

1986
After reading this lesson, you will be conversant with:
14.1 Introduction
14.2 Object of the Consumer Protection Act, 1986
14.3 Extend and Coverage of the Act:14.4 Definitions of Important Terms
14.5 Who is a consumer?
14.6 Who can file a Complaint?
14.7 Structure
14.8 What Constitutes a Complaint?
14.9 Where to file a complaint
14.10 State Commission
14.11 National Commission
14.12 How to File a Complaint
14.13 Relief Available to the Consumers
14.14 Procedure for filing the appeal :14.15 Speedy Disposal
14.1 INTRODUCTION
The earlier principle of Caveat Emptor or let the buyer beware which was prevalent has given
way to the principle of Consumer is King. The origins of this principle lie in the fact that in
todays mass production economy where there is little contact between the producer and consumer,
often sellers make exaggerated claims and advertisements, which they do not intend to fulfill. This
leaves the consumer in a difficult position with very few avenues for redressal. The onset on intense
competition also made producers aware of the benefits of customer satisfaction and hence by and
large, the principle of consumer is king is now accepted. The need to recognize and enforce the
rights of consumers is being understood and several laws have been made for this purpose. In India,
we have the Indian Contract Act, the Sale of Goods Act, the Dangerous Drugs Act, the Agricultural
Produce (Grading and Marketing) Act, the Indian Standards Institution (Certification Marks) Act,
the Prevention of Food Adulteration Act, the Standards of Weights and Measures Act, the Trade and
Merchandise Marks Act, etc which to some extent protect consumer interests.
However, these laws required the consumer to initiate action by way of a civil suit, which involved
lengthy legal process proving, to be too expensive and time consuming for lay consumers.
Therefore, the need for a more simpler and quicker access to redressal to consumer grievances was
felt and accordingly, it lead to the legislation of the Consumer Protection Act, 1986.
14.2 OBJECT OF THE CONSUMER PROTECTION ACT, 1986
The main objective of the act is to provide for the better protection of consumers. Unlike existing
laws, which are punitive or preventive in nature, the provisions of this Act are compensatory in
nature. The act is intended to provide simple, speedy and inexpensive redressal to the consumers
grievances, and reliefs of a specific nature and award of compensation wherever appropriate to the

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consumer. The act has been amended in 1993 both to extend its coverage and scope and to enhance
the powers of the redressal machinery. The basic rights of consumers as per the Consumer Protection
Act (CPA) are
1. The right to be protected against marketing of goods and services which are hazardous to life and
property
2. The right to be informed about the quality, quantity, potency, purity, standard and price of goods,
or services so as to protect the consumer against unfair trade practices
3. The right to be assured, wherever possible, access to variety of goods and services at competitive
prices
4. The right to be heard and be assured that consumers interests will receive due consideration at
appropriate forums
5. The right to seek redressal against unfair trade practices or restrictive trade practices or
unscrupulsous exploitation of consumers
6. The right to consumer education
14.3 EXTEND AND COVERAGE OF THE ACT:The salient features of the Act are summed up as under:- The Act applies to all goods and services unless specifically exempted by the Central Government.
- It covers all the sectors whether private, public or cooperative.
- The provisions of the Act are compensatory in nature. It enshrines the following rights of
consumers:- Right to be protected against the marketing of goods and services which are hazardous to life and
property.
-Right to be informed about the quality, quantity, potency, purity, standard and price of goods or
services so as to protect the consumer against unfair trade practices;
-Right to be assured , wherever possible , access to a variety of goods and services at competitive
prices;
-Right to be heard and to be assured that consumers interests will receive due consideration at
appropriate forums;
-Right to seek redressal against unfair trade practices unscrupulous exploitation of consumers; and
-Right to consumer education
-The Act envisages establishment of Consumer Protection Councils at the Central and State levels,
whose main objects will be to promote and protect the rights of the consumers.
The CPA extends to the whole of India except the State of Jammu and Kashmir and applies to all
goods and services unless otherwise notified by the Central Government.
14.4 DEFINITIONS OF IMPORTANT TERMS
Before studying the provisions of the CPA, it is necessary to understand the terms used in the Act.
Let us understand some of the more important definitions. Complainant Means
1. A consumer; or
2. Any voluntary consumer association registered under the Companies Act,1956 or under any other
law for the time being in force; or
3. The Central Government or any State Government, who or which makes a complaint; or
4. One or more consumers where there are numerous consumers having the same interest

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Complaint means any allegation in writing made by a complainant that :1. An unfair trade practice or a restricted trade practice has been adopted by any trader
2. The goods bought by him or agreed to be bought by him suffer from one more defects
3. The services hired or availed of or agreed to be hired or availed of by him suffer from deficiency
in any respect
4. The trader has charged for the goods mentioned in the complaint a price excess of the price fixed
by or under any law for the time being in force or displayed on the goods or any package containing
such goods.
5. Goods which will be hazardous to life and safety when used, are being offered for sale to the
public in contravention of the provisions of any law for the time being in force, requiring traders to
display information in regard to the contents, manner and effect of use of such goods ;with a view to
obtaining any relief provided by law under the CPA.
Goods means goods as defined in the Sale of Goods Act, 1930. Under that act, goods means every
kind of movable property other than actionable claims and money and includes stocks 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.
Service is defined to mean service of any description which is made available to potential users and
includes the provision of facilities in connection with banking, financing, insurance, transport,
processing, supply of electrical or other energy, board or lodging or both, housing construction,
entertainment, amusement or the purveying of news or other information but does not include the
rendering of any service free of charge or under a contract of personal service.
Consumer dispute means dispute where the person against whom a complaint has been made, denies
or disputes the allegation contained in the complaint.
Restrictive Trade Practice means any trade practice which requires a consumer to buy, hire, or avail
of any good or as the case may be, services as a condition precedent for buying, hiring or availing of
any other goods or services.
Unfair Trade Practice means unfair trade practice as defined under the Monopolies and Restrictive
Trade Practices Act. The MRPT act has defined certain practices to be unfair trade practices. The
detailed definition is given in the Consumer Protection Act, 1986 as amended by the Consumer
Protection (Amendment) Act. 1993. It means a trade practice which, for the purpose of promoting
the sale, use or supply of any goods or for the provision of any service, adopts any unfair method or
unfair or deceptive practice including any of the following practices, namely: (a) False or misleading representation,
(b) Bargain price
(c) Offering of gifts, prize, contest etc.
(d) Non compliance of product safety standard.
(e) Hoarding or destruction of goods.
The Act may be consulted before filing a complaint for unfair trade practice.
Defect means any fault, imperfection or shortcoming in the quality, quantity, potency, purity or
standard which is required to be maintained by or under any law for the time being in force or
under any contract, express or implied, or as is claimed by the trade in any manner whatsoever in
relation to any goods.

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Deficiency means any fault, imperfection or shortcoming or inadequacy in the quality, nature and
manner of performance which is required to be maintained by or under any law for the time being in
force or has been undertaken to be performed by a person in pursuance of a contract or otherwise in
relation to any service.
14.5 WHO IS A CONSUMER?
All of us are consumers of goods and services. For the purpose of the Consumer Protection Act,the
word Consumer has been defined separately for goods and services. For the purpose of
goods, a consumer means a person belonging to the following categories:
(i) One who buys or agrees to buy any goods for a consideration which has been paid or promised or
partly paid and partly promised or under any system of deferred payment;
(ii) It includes any user of such goods other than the person who actually buys goods and such use is
made with the approval of the purchaser.
Note :- A person is not a consumer if he purchases goods for commercial or resale purposes
however, the word commercial does not include use by consumer of goods bought and used by
him exclusively for the purpose of earning his livelihood, by means of self employment.
- For the purpose of services, a consumer means a person belonging to the following categories:
(i) One who hires or avails of any service or services for a consideration which has been paid or
promised or partly paid and partly promised or under any system of deferred payment;
i.It includes any beneficiary of such service other than the one who actually hires or avails of the
service for consideration and such services are availed with the approval of such person.
14.6 WHO CAN FILE A COMPLAINT
The following can file a complaint under the Act:- A consumer
- Any voluntary consumer organization registered under the Societies Registration Act,1860 or
under the Companies Act,1956 or under any other law for the time being in force.
- The Central Government
- The State Government or Union Territory Administrations.
- One or more consumers on behalf of numerous consumers who are having the same interest
(Class action complaints)
14.7 STRUCTURE
-To provide simple, speedy and inexpensive redressal of consumer grievances, the Act envisages a
three- tier quasijudicial machinery at the National, State and District levels.
National Consumer Disputes Redressal Commission - known as National Commission.
Consumer Disputes Redressal Commissions known as State Commission.
Consumer Disputes Redressal Forums- known as District Forum.
-The provisions of this Act are in addition to and not in derogation of the provisions of any other law
for the time being in force
14.8 WHAT CONSTITUTES A COMPLAINT?

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Under the Act, a complaint means any allegation in writing made by a complainant in regard to one
or more of the following:- Any unfair trade practice as defined in the Act or restrictive trade practices like tie-up sales adopted
by any trader.
- One or more defects in goods. The goods hazardous to life and safety, when used,are being offered
for sale to public in contravention of provisions of any law for the time being in force.
- Deficiencies in services.
- A trader charging excess of price.
(i) Fixed by or under any law for the time being in force; or
(ii) Displayed on goods; or
(iii) Displayed on any packet containing such good;
14.9 WHERE TO FILE A COMPLAINT
Consumer Protection Councils
The interests of consumers are enforced through various authorities set up under the CPA. The CPA
provides for the setting up of the
(a) Central Consumer Protection Council,
(b) the State Consumer Protection Council and
(c) the District Forum
(a) Central Consumer Protection Council
The Central Government has set up the Central Consumer Protection Council which consists of the
following members :(a) The Minister in charge of Consumer Affairs in the Central Government who is its Chairman, and
(b) Other official and non-official members representing varied interests
The Central council consists of 150 members and its term is 3 years. The Council meets as and when
necessary but at least one meeting is held in a year.
(b) State Consumer Protection Council
The State Council consists of :(a) The Minister in charge of Consumer Affairs in the State Government who is its Chairman, and
(b) Other official and non-official members representing varied interests
The State Council meets as and when necessary but not less than two meetings must be held every
year.
Redressal Machinery under the Act
The CPA provides for a 3 tier approach in resolving consumer disputes. The District Forum has
jurisdiction to entertain complaints where the value of goods / services complained against and the
compensation claimed is less than Rs. 5 lakhs, the State Commission for claims exceeding Rs. 5
lakhs but not exceeding Rs. 20 lakhs and the National Commission for claims exceeding Rs. 20
lakhs.
(c) District Forum
Under the CPA, the State Government has to set up a district Forum in each district of the State. The
government may establish more than one District Forum in a district if it deems fit. Each District
Forum consists of :-

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(a) A person who is, or who has been, or is qualified to be, a District Judge who shall be its President
(b) Two other members who shall be persons of ability, integrity and standing and have adequate
knowledge or experience of or have shown capacity in dealing with problems relating to economics,
law, commerce, accountancy, industry, public affairs or administration, one of whom shall be a
woman.
Appointments to the State Commission shall be made by the State Goverrnment on the
recommendation of a Selection Committee consisting of the President of the State Committee,
the Secretary - Law Department of the State and the secretary in charge of Consumer Affairs
Every member of the District Forum holds office for 5 years or upto the age of 65 years, whichever
is earlier and is not eligible for re-appointment. A member may resign by giving notice in
writing to the State Government whereupon the vacancy will be filled up by the State Government.
The District Forum can entertain complaints where the value of goods or services and the
compensation, if any, claimed is less than rupees five lakhs. However, in addition to jurisdiction
over consumer goods services valued upto Rs. 5 lakhs, the District Forum also may pass orders
against traders indulging in unfair trade practices, sale of defective goods or render deficient
services provided the turnover of goods or value of services does not exceed rupees five lakhs.
A complaint shall be instituted in the District Forum within the local limits of whose jurisdiction (a) The opposite party or the defendant actually and voluntarily resides or carries on business or has
a branch office or personally works for gain at the time of institution of the complaint; or
(b) Any one of the opposite parties (where there are more than one) actually and voluntarily resides
or carries on business or has a branch office or personally works for gain, at the time of institution of
the complaint provided that the other opposite party/parties acquiescence in such institution or the
permission of the Forum is obtained in respect of such opposite parties; or
(c) The cause of action arises, wholly or in part.
14.10 STATE COMMISSION
The Act provides for the establishment of the State Consumer Disputes Redressal Commission by
the State Government in the State by notification. Each State Commission shall consist of:(a) A person who is or has been a judge of a High Court appointed by State Government (in
consultation with the Chief Justice of the High Court ) who shall be its President;
(b) Two other members who shall be persons of ability, integrity, and standing and have adequate
knowledge or experience of, or have shown capacity in dealing with, problems relating to
economics, law, commerce, accountancy, industry, public affairs or administration, one
of whom must be a woman.
Every appointment made under this hall be made by the State Government on the recommendation
of a Selection Committee consisting of the President of the State Commission, Secretary Law Department of the State and Secretary in charge of Consumer Affairs in the State.
Every member of the District Forum holds office for 5 years or upto the age of 65 years, whichever
is earlier and is not eligible for re-appointment. A member may resign by giving notice in writing to
the State Government whereupon the vacancy will be filled up by the State Government.
The State Commission can entertain complaints where the value of goods or services and the
compensation, if any claimed exceed Rs. 5 lakhs but does not exceed Rs. 20 lakhs;

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The State Commission also has the jurisdiction to entertain appeal against the orders of any District
Forum within the State The State Commission also has the power to call for the records and
appropriate orders in any consumer dispute which is pending before or has been decided by any
District Forum within the State if it appears that such District Forum has exercised any power not
vested in it by law or has failed to exercise a power rightfully vested in it by law or has acted
illegallyor with material irregularity.
14.11 NATIONAL COMMISSION
The Central Government provides for the establishment of the National Consumer Disputes
Redressal Commission The National Commission shall consist of :(a) A person who is or has been a judge of the Supreme Court, to be appoint by the Central
Government (in consultation with the Chief Justice of India ) who be its President;
(b) Four other members who shall be persons of ability, integrity and standing and have adequate
knolwiedge or experience of, or have shown capacity in dealing with, problems relating to
economics, law, commerce, accountancy, industry, public affairs or administration, one
of whom shall be a woman
Appointments shall be by the Central Government on the recommendation of a Selection Committee
consisting of a Judge of the Supreme Court to be nominated by the Chief Justice of India, the
Secretary in the Department of Legal Affairs and the Secretary in charge of Consumer Affairs in the
Government of India.
Every member of the National Commission shall hold office for a term of five years or upto seventy
years of age, whichever is earlier and shall not be eligible for reappointment.
The National Commission shall have jurisdiction :(a) To entertain complaints where the value of the goods or services and the compensation, if any,
claimed exceeds rupees twenty lakhs:
(b) To entertain appeals against the orders of any State Commission; and
(c) To call for the records and pass appropriate orders in any consumer dispute which is pending
before, or has been decided by any State Commission where it appears to the National Commission
that such Commission has exercised a jurisdiction not vested in it by law, or has failed to exercise
a jurisdiction so vested, or has acted in the exercise of its jurisdiction illegally or with material
irregularity.
Complaints may be filed with the District Forum by :1. The consumer to whom such goods are sold or delivered or agreed to be sold or delivered or such
service provided or agreed to be provided
2. Any recognised consumer association, whether the consumer to whom goods sold or delivered or
agreed to be sold or delivered or service provided or agreed to be provided, is a member of such
association or not
3. One or more consumers, where there are numerous consumers having the same interest with the
permission of the District Forum, on behalf of or for the benefit of, all consumers so interested
4. The Central or the State Government.
On receipt of a complaint, a copy of the complaint is to be referred to the opposite party, directing
him to give his version of the case within 30 days. This period may be extended by another 15 days.
If the opposite party admits the allegations contained in the complaint, the complaint will be decided
on the basis of materials on the record. Where the opposite party denies or disputes the allegations or

217

omits or fails to take any action to represent his case within the time provided, the dispute will be
settled in the following manner :I. In case of dispute relating to any goods : Where the complaint alleges a defect in the goods which
cannot be determined without proper analysis or test of the goods, a sample of the goods shall be
obtained from the complainant, sealed and authenticated in the manner prescribed for referring to the
appropriate laboratory for the purpose of any analysis or test whichever may be necessary, so as to
find out whether such goods suffer from any other defect. The appropriate laboratory would be
required to report its finding to the referring authority, i.e. the District Forum or the State
Commission within a period of fortyfive days from the receipt of the reference or within such
extended period as may be granted by these agencies.
14.12 HOW TO FILE A COMPLAINT
Procedures for filing complaints and seeking redressal are
simple.
There is no fee for filing a complaint before the District Forum, the State Commission or the
National Commission. ( A stamp paper is also not required) There should be 3 to 5 copies of the
complaint on plain paper.
The complainant or his authorized agent can present the complaint in person.
The complaint can be sent by post to the appropriate Forum / Commission.
A complaint should contain the following information
(a) The name, description and the address of the complainant.
(b) The name , description and address of the opposite party or parties, as the case may be, as far as
they can be ascertained;
(c) The facts relating to complaint and when and where it arose;
(d) Documents, if any, in support of the allegations contained
in the complaint.
(e) The relief which the complainant is seeking.
The complaint should be signed by the complainant or his authorized agent.
The complaint is to be filed within two years from the date on which cause of action has arisen.
14.13 RELIEF AVAILABLE TO THE CONSUMERS
Depending on the nature of relief sought by the consumer and facts, the Redressal Forums may give
orders for one or more of the following reliefs:(a) Removal of defects from the goods,
(b) Replacement of the goods;
(c) Refund of the price paid;
(d) Award of compensation for the loss or injury suffered;
(e) Removal of defects or deficiencies in the services;
(f) discontinuance of unfair trade practices or restrictive trade practices or direction not to repeat
them;
(g) Withdrawal of the hazardous goods from being offered to sale; or
(h) Award for adequate costs to parties.
14.14 PROCEDURE FOR FILING THE APPEAL :- Appeal against the decision of a District Forum can be filed before the State Commission within a
period of thirty days. Appeal against the decision of a State Commission can be filed before the

218

National Commission within thirty days. Appeal against the orders of the National Commission can
be filed before the Supreme Court within a period of thirty days.
There is no fee for filing appeal before the State Commission or the National Commission.
Procedure for filing the appeal is the same as that of complaint, except the application should be
accompanied by the orders of the District/State Commission as the case may be and grounds for
filing the appeal should be specified.
14.15 SPEEDY DISPOSAL
The thrust of the Act is to provide simple, speedy and inexpensive redressal to consumers
grievances. To ensure speedy disposal of consumers grievances, the following provisions have been
incorporated in the Act and the rules farmed there under: It is obligatory on the complainant or appellant or their authorized agents and the opposite parties
to appear before the Forum/Commission on the date of hearing or any other date to which hearing
could be adjourned.
The National Commission, State Commission and District Forums are required to decide
complaints, as far as possible, within a period of three months from the date of notice received by the
opposite party where complaint does not require analysis or testing of the commodities and within
five months if it requires analysis or testing of commodities.
The National Commission and State Commissions are required to decide the appeal as far as
possible, within 90 days from the first date of hearing.

Read the following questions for a better understanding of the Act:

Q1. I have instituted a complaint before the Consumer Court against a Medical Practitioner. My
complaint has been challenge on the ground that a Medical Practitioner cannot be sued under the
Consumer Act. What does law provide?
Ans. Yes, a medical practitioner can be sued under the Consumer Protection Act 1986 for his or her
professional negligence resulting in damage to patient. Section 2 (d) in defining a consumer in
Clause (ii) uses the expression hires and avails of. The word hire means employ of wages or
fees. Secondly the words any service in s. 2 (d) (ii) in Consumer Protection Act. A eloquent to
bring the delinquent medical practitioners within the ambit of Consumer Protection Act.
Thirdly, s. 2 (o), Consumer Protection Act which defines service exempts only two types of services,
one service free of charge and another contract of personal service postulates a relationship of
master and servant. A medical man whose service is requisitioned for a patient answers the clause
contract of service but never a contract of personal service. So, a negligent medical professional
can be proceeded under the Consumer Protection Act 1986.
Q2. I had purchased seeds from a party. The seeds did not germinate. The other party took the plea
that I was not a consumer. Whether purchase of seeds for the purpose of agriculture is purchase for
commercial purpose?
Ans: Purchase made for agriculture is not for commercial purpose. Therefore, the complainant is a
consumer and entitled to seek redressal of his grievance in a Consumer Court against the party which
supplied defective seed to him.

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Q3. I had got a confirmed ticket on Sahara Airways. The flight was later cancelled on account of
technical snag. Is it a deficiency in service?
Ans: Cancellation of flight on account of technical snag is not deficiency in service as it is due to
unavoidable circumstances. However, you ought to be allowed refund of the fare but no
compensation can be granted on account of any loss suffered by you (if any) because of the said
cancellation.
Q4. I was allotted a Maruti Car. There was a delay in delivery ofthe car. Subsequently, the dealer
called upon me to make further payment as the price of the car had gone up. Am I liable to bear the
price increase on account of delay caused by the dealer?
Ans: You are not liable to pay any price increase in the above mentioned circumstances since the
increase in price is totally on account of the delay on the part of the dealer for which a consumer
cannot be made to suffer.
Q5. Does rejection of application for grant of loan by a Bank constitute deficiency in service for
which I can approach the Consumer Court?
Ans: The Bank has a wide discretion in the matter of granting loans and advances and continuing
disbursement of loans sanctioned .The Consumer Courts cannot sit in judgement over the discretion
exercised by the Bank and as such you will not succeed in any such action, if taken by you.

MULTIPLE CHOICE QUESTIONS:

Q1 On receipt of a complaint, a copy of the complaint is to be referred to the opposite
party, directing him to give his version of the case within within:
a) 30 days
b) 15 days
c) 20 days
d) 10days
Q2 basic rights of consumers as per the Consumer Protection Act (CPA) is/ are
a) The right to be informed about the quality & quantity of goods
b) The right to be protected against marketing of goods
c) The right to seek redressal against unfair trade practices
d) All of above
Q3 Complaint means
(a) any allegation in writing made by a complainant
(b) any allegation in writing made by a seller
(c) any allegation in verbal by a competitor
(d) both (a) & (b)
Q4 goods means:
a) means every kind of movable property except (b) & (c)
b) Money, stocks & shares
c) growing crops
d) All of above

220

Q5 unfair or deceptive practice includes:

a) False or misleading representation
b) Hoarding or destruction of goods
c) compliance of product safety standard
d) both (a) & (b)
Q6 Who is a Consumer?
a) Who buys or agrees to buy any goods for a consideration which has been paid or
promised or partly paid and partly promised or under any system of deferred
payment;
b) any user of such goods other than the person who actually buys goods and such
use is made with the approval of the purchaser
c) purchases goods for commercial or resale purposes
d) both (a) & (b)
Q7 Who Can file a Complaint
a) Consumer
b) Central Government
c) State Government
d) All of the above
Q8 Central Consumer Protection Council consists of:
a) The Minister in charge of Consumer Affairs in the Central Government
b) State Government or Union Territory Administrations
c) None of the above
d) Both (a) & (b)
Q9 State Consumer Protection Council
a) The Minister in charge of Consumer Affairs in the state Government
b) Other official and non-official members representing varied interests
c) None of the above
d) Both (a) & (b)
Q10 Every member of the District Forum holds office for:
a) 5 years or upto the age of 65 years whichever is earlier
b) 10 years or upto the age of 60 years whichever is earlier
c) 15 years or upto the age of 65 years whichever is earlier
d) 5 years or upto the age of 60 years whichever is earlier

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ANSWER KEY
CHAPTER 1
Q1 (d) Q2 (a) Q3 (d) Q4 (d) Q5 (b) Q6 (a) Q7 (a) Q8 (c) Q9 (d) Q10 (b)
CHAPTER 2
Q1 (a), Q2 (b), Q3 (d), Q4 (c). Q5 (b) Q6 (a) Q7 (a) Q8 (b) Q9 (a)
CHAPTER 3
1 (a), Q2 (d), Q3 (b), Q4 (a). Q5 (c) Q6 (d) Q7 (d) Q8 (a) Q9 (c) Q10 (c)
CHAPTER 4
1 (d), 2 (d), Q3 (b), Q4 (d). Q5 (c) Q6 (d) Q7 (b) Q8 (b) Q9 (d) Q10 (c)
CHAPTER 5
Q1 (d), Q2 (a), Q3 (b), Q4 (a), Q5 (a), Q6 (d), Q 7 (d), Q8 (a), Q9 (c ), Q10 (b)
CHAPTER 6
Q1 (d), Q2 (b), Q3 (d), Q4 (a), Q5 (b), Q6 (C), Q7 (c), Q8 (d), Q9 (d), Q10 (a)
CHAPTER 7
Q1 (d), Q2 (b), Q3 (c), Q4 (c), Q5 (d), Q6 (d), Q7 (d), Q8 (b), Q9 (a), Q10 (a)
CHAPTER 8
Q1 (b), Q2 (c), Q3 (d), Q4 (d), Q5 (d), Q6 (d), Q7 (b), Q8 (b), Q9 (d), Q10 (a)
CHAPTER 9
Q1 (a) Q2 (d) Q3 (c) Q4 (b) Q5 (b) Q6 (c) Q7 (d) Q8 (d) Q9 (c) Q10 (d)
CHAPTER 10
Q1 (d) Q2 (d) Q3 (d) Q4 (d) Q5 (d) Q6 (d) Q7 (d) Q8 (b) Q9 (d) Q10 (b)
CHAPTER 11
Q1 (a), Q 2 (a) Q3 (d) Q4 (a) Q5 (b) Q6 (d) Q7 (d) Q 8 (d) Q9 (c) Q10 (a)
CHAPTER 12
Q1 (d) Q2 (c) Q 3 (c) Q4 (b) Q5 (c) Q6 (c) Q7 (d) Q8 (b) Q9 (c) Q10 (c)
CHAPTER 13
Q1 (a) Q2 (b) Q3 (b) Q4 (d) Q5 (a) Q6 (d) Q7 (c) Q8 (c) Q9 (c) Q10 (c)
CHAPTER 14
Q1 (a) Q2 (d) Q3 (a) Q4 (a) Q5 (d) Q6 (d) Q7 (d) Q8 (a) Q9 (d) Q10 (a)

222

BIBLIOGRAPHY

Element of Mercantile Law -Gulshan SS (2003), Excel Books, N. Delhi

Principle of Mercantile Law -Avatar Singh
Business Law, Gulshan & Kapoor
Principle of Mercantile Law, Maheswari & Maheswari
SEBI Act.
Taxmans Company Act 1998
Company Law & Secretarial Law- Garg K.C., Chawla R.C.
Business Law- M C Kuchhal
Laws Relating to Monopolies, restrictive and unfair trade practices

223

ASSIGNMENTS
Subject code

subject Name:

Subject Name & code

Study centre
Permanent enrollment Number
Student Name
INSTRUCTIONS:
a) Students are required to submit three assignments
ASSIGNMENTS
Assignment A
Assignment B
Assignment C

DETAILS
Five subjective questions
Three subjective questions + case study
40 objective questions

MARKS
15
15
10

b) Total Weightage given to these assignments is 40%.

c) All assignments are to be completed in your own handwriting/ typed.
d) All assignments are to be completed by due dates.
f) The evaluated assignments can be collected from your study centre/ACel office
after six weeks. Thereafter, these will be destroyed at the end pf each semester.
g) The students have to attach a scan signature in the form.

Signature: ___________________________________
Date:_______________________________________
() Tick mark in front of the assignments submitted
Assignment A

Assignment B

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Assignment C

ASSIGNMENT A (Five analytical questions of 15 marks):

Q1 What is business environment? What are the benefits & limitations of
environmental analysis?
Q2 Define contract. Explain any four element of a contract.
Q3 What are the rights of a finder of a good under the Indian contract Act?
Q4 For every valid agreement there should be a consideration. Comment
Q5 Explain the rights of an unpaid seller under Indian sales of goods Act.
ASSIGNMENT B (3 Analytical questions & a case study of 15 marks)
Q1 What is a negotiable instrument, explain its characteristics.
Q2 Explain various types of companies.
Q3 What relief is/are available to the consumer under Consumer Protection Act.
CASE STUDY:
Case1
A dealer in radios gives a Murphy radio to a customer on the terms that Rs. 100
should be paid by him immediately and Rs 200 more in two monthly equal
installments. It was further agreed that if the radio is found defective the customer may
return it within a week but not later. The customer makes default in paying the last
installment. Can the radio dealer take back the radio on his default?
Case2
X sees a book displayed in a shelf of a book shop with a price tag of Rs. 85. X tenders
Rs. 85 on the counter and asks for the book. The bookseller refuses to sell saying that
the book has already been sold to someone else and he does not have another copy of
that book in the stock. Is the bookseller bound to sell the book to X?

ASSIGNMENT C (40 MULTIPLE CHOICE QUESTIONS of 10 marks)

Q1 Any person is a holder in due course if he has obtained the negotiable instrument
a) For consideration
b) By gift

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c) Before its maturity

d) Both (a) & (c) above
Q2 Michael Portes Five Forces Model includes:
a) Threat of Substitutes
b) Bargain Power of supplier
c) Bargain Power of Government
d) Both (a) & (b)
Q3 I had applied for subscription in Rajlakshmi scheme of UTI. The essence of the
scheme was that the sum of money deposited with the UTI would grow 21 times in 28
years. However subsequently, the UTI extended the maturity date by two years. Can I
approach a Consumer Court?
a) Yes you can seek relief in a consumer court
b) No you cant seek relief in a consumer court
Q4 Can Consumer Forums adjudicate disputes involving scale of pay?
a) Yes, Consumer Forums do adjudicate dispute-involving scale of pay
b) No, Consumer Forums do adjudicate dispute-involving scale of pay
Q5 In which of the following instances, the collecting banker shall not be liable for
conversion to the true owner under the Negotiable Instruments Act, 1881?
(a)The collecting bank advances money to the customer against the cheque even before
the cheque is realized
(b)The uncrossed cheque given to the collecting bank for collection is crossed by the
banker
(c)The payment is received by the collecting bank on behalf of a person who is not a
customer of the bank
(d)The collecting bank is a holder for value
(e)The collecting bank is acting as an agent for receiving the payment.
Q6 Which of the following amounts to reduction of share capital under section 100 of the
Companies Act, 1956?
(a)Redemption of redeemable preference shares under the provisions of Section 80 and
81 of the Companies Act, 1956
(b)Forfeiture of shares for non-payment of calls
(c)Payment of dividend out of share premium
(d)Surrender of shares to a company
(e)Reduction of nominal share capital of a company by canceling any shares which have
not been taken by any person.
Q7 Which of the following statements is false in respect of offer and its acceptance
under the Indian Contract Act, 1872?
(a) An offer will be valid only if it is communicated to the offeree
(b)A person who acts according to the terms of an offer which has not been
communicated to him will not be deemed to have accepted the offer

226

(c)The communication of the offer must be made with an intention to obtain the assent of
the offeree
(d)A mere intent of acceptance will not suffice, the acceptance must be communicated to
the offeror
(e)The mode of rejection of an offer must be specified in order to constitute a valid offer.
Q8 Mr. Dheeraj is a director of Laxmi Ltd., which failed to file its annual returns from
the year 2003-04. The
maximum period for which Mr. Dheeraj will be disqualified from becoming a director in
any public limited
company is
(a) 3 years
(b) 5 years
(c) 7 years
(d) 8 years
(e) 10 years.
Q9 Which of the following statements is false in respect of a contract of guarantee under
the Indian Contract Act,
1872?
(a) Guarantee given for a time barred debt is valid
(b) A guarantee may be given retrospectively for an existing debt
(c)A contract of guarantee presupposes the existence of a debt, therefore, if there is no
existing liability, there cannot be a guarantee
(d) There are always three parties in a contract of guarantee
(e)Where the principal debtors liability becomes unenforceable because of illegality, the
surety cannot be made liable on the said debt.
Q10 Which of the following statements is false in respect of a contract of sale under the
Sale of Goods Act, 1930?
(a)Title to goods is immediately transferred to the buyer
(b)A contract of sale is an executed contract
(c)In case of default by the seller, the buyer may rescind the contract
(d)In a sale, a breach of condition can only be treated as a breach of warranty
(e)In a contract of sale the goods are specified and ascertained.
Q11 The articles of association of Rathi Informatics Ltd. provided for a maximum of 18
directors on the Board. Presently there are 12 directors on the Board of the company. The
company wishes to increase the strength of its Board to 15. Which of the following
statements is correct in respect of these circumstances under the Companies Act, 1956?
(a)As the proposed increase is within the maximum permissible number fixed by the
articles only an ordinary resolution is required
(b)As the proposed increase is beyond 12, a special resolution is required

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(c)As the proposed increase is within the maximum permissible number fixed by the
articles only an ordinary resolution as well as approval of the Central Government is
required
(d)As the proposed increase is beyond 12, a special resolution as well as approval of the
Central Government is required
(e)As the proposed increase is beyond 12, a special resolution as well as approval of the
National Company Law Tribunal (NCLT) is required.
Q12 Which of the following statements is false in respect of dividend on preference
shares?
(a)Where there are two or more types of preference shares, the shareholders of the class
which has priority are entitled to their preferential dividend before any dividend is paid to
other shareholders
(b)Cumulative preference shareholders are entitled to receive all dividends which are in
arrears before any dividend is paid on equity shares
(c)Where cumulative preference shares have been issued at different times, the arrears of
dividend will have to be paid to all the preference shareholders equally
(d)In case of non-cumulative preference shares, only the amount of dividend which is due
in the current year will have to be paid to the holders
(e)The preference shareholder cannot sue the company for dividends, unless the company
has declared the same and did not pay the amount.
Q13 Which of the following statements is false in respect of consideration under the
Indian Contract Act, 1872?
(a) Consideration given at the behest of third parties will not be valid consideration
(b)Inadequacy of consideration invalidates a contract
(c) Consideration must be real and not illusory
(d) Performance of an existing legal duty will not constitute valid consideration
(e) Forbearance or abstinence amounts to valid consideration.
Q14 Which of the following statements in respect of bailment is false under the Indian
Contract Act, 1872?
(a)The bailor is bound to disclose, all the faults in the goods bailed to the bailee, of which
the bailor is aware
(b)The bailee will have to bear all the ordinary expenses incurred by vitue of the bailment
(c)The bailor is responsible to the bailee for any loss sustained by him in case the bailor
is not entitled to make the bailment or to receive back the goods
(d)The bailor is not responsible to the bailee for any loss sustained by him in case of
premature termination of a gratuitous bailment
(e)It is the duty of the bailor to receive back the goods after the purpose is achieved.
Q15 Which of the following statements is false in respect of dividend under the
Companies Act, 1956?
(a)Dividend is to be paid only in cash

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(b)Before payment of interim dividend a company must transfer to reserves the

prescribed percentage of estimated profits arrived at after providing for current years
depreciation and arrears of depreciation/loss
(c)A final dividend for any financial year can be declared and paid only when the balance
sheet and profit and loss account are presented to the shareholders at the AGM
(d)The shareholders can approve the recommended rate of dividend or lower the same,
but cannot increase the amount of dividend
(e)A dividend once declared cannot be revoked even with the consent of all the
shareholders.
Q16 Which of the following powers may be exercised by the board of directors without
obtaining consent of the company at a general meeting?
(a)Power to contribute to the welfare of its employees any amount less than Rs.50,000
(b)Power to borrow in excess of capital and reserves of the company
(c)Power to remit debt due by a director
(d)Power to invest compensation amounts received on compulsory acquisition of any of
the companys properties
(e)Power to appoint sole selling agents.
Q17 Which of the following agreements is not valid under the Contract Act, 1872?
(a)An agreement for training a minor in a particular trade
(b)An agreement between a minor agent and his major principal
(c)An agreement made by the certified guardian of a minor with authority for benefit of
minor
(d)An agreement made by a minor agent on behalf of his principal
(e)An agreement by a minor to repay a loan taken for supply of necessaries to him during
his minority.
Q18 As per section 166 of the Companies Act, 1956, the first annual general meeting of a
company should be held within
(a) 6 months of its incorporation
(b)12 months of its incorporation
(c)15 months of its incorporation
(d)18 months of its incorporation
(e)24 months of its incorporation.
Q19 Which of the following is not excluded for the purpose of counting maximum
number of directorships under section 275 of the Companies Act, 1956?
(a)Directorship in a private company
(b)Directorship in a private company which is the holding company of a public company
(c)Directorship in a unlimited company
(d)Directorship as an alternate director
(e)Directorship in an association not carrying on business for profit.
Q20 Which of the following is not a foreign bill under the Negotiable Instruments Act,
1881?

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(a) A bill drawn in Singapore upon a resident of India, payable in Kuala Lumpur
(b) A bill drawn in Kuala Lumpur upon a resident of Singapore, payable in India
(c) A bill drawn in India upon a resident of Kuala Lumpur, payable in Singapore
(d) A bill drawn in India upon a resident of India, payable in Kuala Lumpur
(e) A bill drawn in Singapore upon a resident of Singapore, payable in Kuala Lumpur.
Q21 A prospectus once registered with the Registrar Of Companies (ROC) should be
issued within
(a) 14 days from the date of registration with ROC
(b) 21 days from the date of registration with ROC
(c) 30 days from the date of registration with ROC
(d) 60 days from the date of registration with ROC
(e) 90 days from the date of registration with ROC.
Q22 Which of the following statements is false in respect of a pawnee under the Indian
Contract Act, 1872?
(a)When the pawnor defaults in payment of the principal debt , the pawnee can retain the
pledged goods as collateral security
(b)When the pawnor fails to perform his part of the promise, the pawnee may sell the
pledged goods after giving the pawnor a reasonable notice of sale
(c)When the pawnor defaults in payment of the principal debt the pawnee cannot recover
from the pawnor any deficit between the debt due and sale price
(d)When the pawnor defaults in payment of the principal debt, the pawnee can file a suit
for breach of contract against the pawnor
(e)The pawnee can sue the pawnor for any extraordinary expenses incurred by him for
the preservation of the goods pledged.
Q23 Mr. Pankaj who was appointed as an additional director at the Board meeting held
on December 31, 2005 continues to be in his office on the ground that the annual general
meeting of the company for the year 2006 was not held as required under the Act. Mr.
Pankaj was also appointed as a managing director for a period of five years with effect
from January 01, 2006 at the same Board meeting. Which of the following statements is
true in respect of an additional director under the Companies Act, 1956?
(a)Mr. Pankaj shall hold the office as an additional director till the completion of five
years
(b)Mr. Pankaj shall hold the office as an additional director upto the conclusion of any
general meeting
(c)Mr. Pankaj shall hold the office as an additional director as long as he intends to
(d)Mr. Pankaj shall vacate the office of the managing director
(e)Mr. Pankaj shall hold the office of the managing director till the completion of five
years.
Q24 Which of the following statements is false under the Companies Act, 1956?
(a) A director must be a member of the company
(b) Minimum seven persons are required for incorporation of a public company
(c) Proxy has no right to speak in the general meeting

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(d) Company having profits need not declare dividends

(e) A private company cannot issue prospectus.
Q25 Which of the following statements is false in respect of rights of a bailee under the
Indian Contract Act, 1872?
(a)Where the bailee has rendered any service or exercised his skill in respect of the goods
bailed, then he can retain the bailed goods until his dues are paid
(b)If the bailee has agreed to refrain from exercising the right of lien or has waived his
right, then he cannot exercise the same
(c)The right of particular lien will be revived, if the bailee gets possession of the bailed
goods after parting with the same in the first place
(d)The right of lien can be exercised so long as the bailee has the possession of the goods
(e)The bailee may retain not only those goods of the bailor in respect of which some
particular service has been rendered, but also other goods in the possession of the bailee
belonging to the bailor.
Q26 Section 165 of the Companies Act, 1956, in respect of conduct of statutory meeting
is applicable to
(a) A private company converted into a Public Company within 6 months of its
incorporation
(b) A private company, which is a subsidiary of a public company
(c) A public company having liability of its members unlimited
(d) An independent private company
(e) A government company registered as a private company.
Q27 Hiten Desai picked up a diamond ring from the floor of Divya Jewellers, Surat and
handed it over to Premchand Bhatia, the manager of Divya Jewellers, with a request to
hand it over to the true owner. The true owner could not be traced in spite of best efforts
of Premchand. Hiten Desai paid the expenses incurred by Premchand and asked him to
return the diamond ring to him. Which of the following statements is true under the
Indian Contract Act, 1872?
(a)Premchand is under no obligation to return the ring to Hiten Desai as the ring was
found on the floor of his shop
(b)Premchand is under an obligation to return the diamond ring only to the true owner
(c)Premchand and Hiten Desai can share the value of the diamond ring equally
(d)Hiten Desai being the finder of lost goods can retain the diamond ring against
everyone except the true owner
(e)Premchand can retain the diamond ring against everyone including the true owner.
Q28 Under the Companies Act, 1956, up to what date a director appointed to fill casual
vacancy shall hold office?
(a) The last day on which the annual general meeting should have been held
(b) Until the original director, in whose place he is appointed, returns back
(c) Till the date up to which the director in whose place he is appointed would have held
office
(d) Up to the next extraordinary general meeting

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(e) Up to the conclusion of the annual general meeting.

Q29 At a public auction a car was put up for sale and as Mr. Ramlal was the highest
bidder, he got the car. Later, it was discovered that the car was a stolen one. This fact was
also not known to the auctioneer. The true owner wishes to obtain possession of the car.
Under these circumstances which of the following statements is true under the Sale of
Goods Act, 1930?
(a)Mr. Ramlal did not get any title against the true owner
(b)The true owner cannot recover any possession as Mr. Ramlal had bought at a public
auction
(c)As Mr. Ramlal had purchased the car in good faith, Mr. Ramlal can enjoy possession
of the car
(d)The true owner can file a suit against the auctioneer for fraudulently selling a stolen
car
(e)The auctioneer is personally liable to the true owner for damages only and the true
owner has no right to
obtain possession of the car.
Q30 Which of the following statements is false under the Companies Act, 1956?
a)The Board of directors should authenticate the accounts before submission to auditors
(b)The Profit and Loss account should reveal the details of auditors remuneration
(c)The provision of depreciation is necessary to show true and fair picture of the accounts
(d)Company with a paid up capital of Rs.2 crores is required to form an audit
committee
(e)The first auditor usually holds office till the conclusion of the first annual general
meeting.
Q31 Which of the following instances is not treated as crossing under the Negotiable
Instruments Act, 1881?
(a)A cheque bearing across its face the words account payee without two transverse
parallel lines
(b)A cheque bearing across its face the words not negotiable with two transverse
parallel lines
(c)A cheque bearing across its face the words not exceeding rupees two hundred within
two transverse parallel lines
(d)A cheque bearing across its face the words HDFC Bank, Karol Bagh Branch, New
Delhi within two transverse parallel lines
(e)A cheque bearing across its face the words Citi Bank, Daryaganj Branch, New Delhi
without two transverse parallel lines.
Q32 Which of the following persons is incompetent to enter into a valid contract under
the Indian Contract Act, 1872?
(a)The official assignee of an adjudged insolvent
(b)A person of the age of twenty years for whose estate a guardian has been appointed by
the Court
(c)A person who is a foreign diplomat

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(d)A convict after the expiry of his sentence

(e)An Indian, voluntarily residing in a foreign country.
Q33 Which of the following statements is false in respect of qualification shares to be
held by a director of a company under the Companies Act, 1956?
(a)A director will have to take up qualification shares only if required by the articles of
association
(b)The nominal value of the qualification shares shall not exceed Rs.5,000 or the nominal
value of one share where it exceeds Rs.5,000
(c)The qualification shares required to be taken up by a director must be purchased from
the company
(d)Share warrants will not count for the purpose of share qualification
(e)Any provision in the articles requiring a person to obtain qualification shares before
his appointment as director or within a period shorter than two months of his appointment
shall be void.
Q34 Mr. Ankit, a creditor of Silktech Ltd. issued a demand notice by registered post at
the companys registered office to payback his loan amount worth Rs.1,50,000 (along
with interest). But the company neglected to reply/ respond for a period of two months.
Which of the following statements is true in respect of consequences of
failure of Silktech Ltd. to reply under the provisions of the Companies Act, 1956?
(a)Mr. Ankit has no remedy for the negligent conduct of the company
(b)Mr. Ankit can sell the assets of the company and take his money
(c)Mr. Ankit has to file a complaint to the Central Government
(d)Mr. Ankit can approach the National Company Law Tribunal (NCLT) for winding up
of the company
(e)Mr. Ankit has to conduct the general meeting and pass resolutions for changing the
directors.
Q35 Which of the following casual vacancies of directors cannot be filled by Board of
directors under the
Companies Act, 1956?
(a) A vacancy caused by the death of a director
(b) A vacancy caused by the resignation of a director
(c) A vacancy caused by the resignation of nominee director of a financial institution
(d) A vacancy caused due to disqualification of a director
(e) A vacancy caused due to failure of an elected director to assume office.
Q36 Which of the following agreements is voidable under the Indian Contract Act, 1872?
(a)Agreements by way of wager
(b)Agreements contingent on impossible events
(c)Agreements made under a mutual mistake of fact
(d)Agreement induced by fraud
(e)Agreements by incompetent parties.

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Q37 Which of the following statements is true under the Negotiable Instruments Act,
1881?
(a) Every holder is a holder in due course
(b) Every holder in due course is a holder for value
(c) Every holder for value is a holder in due course
(d) A holder in due course need not have taken the instrument in good faith
(e) Holder in due course may be party to the fraud.
Q38 Which of the following is an illegal agreement under the Indian Contract Act, 1872?
(a)Agreement by way of wager
(b)Agreeing to sell a house for paying money lost in gambling
(c)Hire of a truck knowingly for bringing goods which are prohibited
(d)Agreement not to enforce promise through legal means
(e)Agreements in restraint of trade.
Q39 Under the Negotiable Instruments Act, 1881, when a negotiable instrument is
delivered conditionally or for a special purpose as a collateral security or for safe custody
only, and not for the purpose of transferring absolutely property therein, it is called an
(a) Inchoate instrument
(b) Escrow
(c) Accommodation bill
(d)Trade bill
(e) Ambiguous instrument.
Q40 Which of the following matters requires passing of special resolution and also the
approval of the Central Government under the Companies Act, 1956?
(a) Increase in the paid up capital
(b) Rectification of name of the company under section 22 of the Companies Act,1956
(c) Payment of interest out of capital
(d) Sub-division of shares
(e) Appointment of company secretary.

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Answers of assignment C (1-40 MCQs)

Q1 (d)
Q7 (e)
Q13 (b)
Q19 (b)
Q25 (c)
Q31 (a)
Q37 (b)

Q2 (d)
Q8 (b)
Q14 (d)
Q20 (d)
Q26 (a)
Q32 (b)
Q38 (c)

Q3 (a)
Q9 (a)
Q15 (e)
Q21 (e)
Q27 (d)
Q33 (c)
Q39 (b)

Q4 (b)
Q10 (c)
Q16 (a)
Q22 (c)
Q28 (c)
Q34 (d)
Q40 (c)

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Q5 (e)
Q11 (a)
Q17 (b)
Q23 (d)
Q29 (a)
Q35 (c)

Q6 (c)
Q12 (c)
Q18 (d)
Q24 (a)
Q30 (d)
Q36 (d)