Contract : Meaning, Elements, Types and Purpose

What is a Contract?

Indian Contract Act, 1872 frames the contracts or agreements between different parties. An agreement involving legal enforceability is said to be a contract. It specifies the responsibilities of both the parties concerned. In every contract, the offeror makes an offer to enter into a contract with the offeree. The offeror agrees to do something in particular, and if the offeror accepts the offer, a contract is made. The contract itself must prove to have certain elements. 

Meaning of ‘Contract’ as per the Indian Contract Act, 1872

The Indian Contract Act, 1872 defines the term “Contract” under its Section 2(h) as “An agreement enforceable by law”. In other words, we can say that a contract is anything that is an agreement and enforceable by the law of the land. 

In the world of Law, a Contract is an agreement between a person or a group of people that creates legal obligations. This is the process where one party makes an offer to another party & the other party accepts that offer. To be valid, a contract must meet the essential elements as mentioned in the Indian Contract Act, of 1872.

Geeky Takeaways:

• Some types of contracts need to be in writing to be legally enforceable. For example, Real estate contracts, Rent agreements, etc.
• Contracts define the rights & obligations of each party to the agreement & provide a means of dispute resolution during the execution of the agreement.
• A breach of contract is when a party to a contract fails to perform its contractual duties as specified in the contract resulting in legal action.

Essential Elements of a Contract

A contract is the heart of most professional relationships. A contract is legally enforceable when it fulfills all the criteria of essential elements of a valid contract. It ensures that if one party fails to do what he or she has agreed to do, the other party can then proceed to court as a result of violation of the terms of the contract. However, a contract can be considered valid only if it satisfies certain essential terms and conditions under Indian Contract Act, 1872:

1. Offer: There must be an intent to initiate an offer and negotiate a contract under certain conditions.

2. Acceptance: The other party accepts the offer and the acceptance in return leads to the creation of an agreement.

3. Consideration: An exchange of value between two or more parties such as money, services, or promise. For a contract to be legally enforceable, each party must provide something of value to form a consideration.

4. Legal Capacity: Both parties to the contract must be legally competent to enter into a contract. This means that they must be of legal age.

5. Intent: Both parties must have intentions to create legal obligations. Casual promises & social agreements are generally not legally binding and are unenforceable in a court of law.

6. Legal Purpose: The scope of the contract & the activities covered by it shall not be unlawful to public policy. Generally, contracts involving unlawful activities are contrary to the law and are void.

7. Certainty & Possibility of Performance: The contract should contain terms & conditions that are clear & unambiguous and the agreed actions should be feasible to carry out.

Types of Contracts as per the Indian Contract Act, 1872

Indian Contract Act, 1872 provides different kinds of contracts based on their validity, such as:

• Valid Contract: This type of contract satisfies all the fundamental requirements of a contract to be enforceable such as offer, acceptance, legal tender, jurisdiction, and free consent.
• Void Contract: Void contract lacks enforceability of law from the outset. It holds no legal liability for either of the party.
• Voidable Contract: Such contracts are initially valid but may be declared void at the request of one of the parties as a result of duress, pressure, threat, coercion, bullying & fraud.
• Unenforceable Contract: It does not meet the legal requirements and such contracts cannot be enforced against any of the parties. For example, an agreement is not in writing as prescribed by the law & hence, it cannot be legally enforced.
• Illegal Contract: An agreement that leads to the breaking of a law by either of the parties or not abiding by the laws of the society is deemed to be illegal by the court.

Types of Contracts Commonly used in Business

Business contracts are highly complex, depending on their nature and they should be documented covering all the aspects and terms of business agreements. Different business requires different types of contracts to address different specific business needs. The most commonly used business contracts are as follows:

• Sales Contract: These agreements include terms & conditions for the sale of services between the seller & buyer, including pricing, quality criteria, delivery & payment terms.
• Service Contract: These contracts set out the terms & conditions for the provision of services. They define the scope of the work, the services to be provided, the payment terms & other relevant information.
• Employment Contract: These contracts govern the employment relationship between the employer & employee. They typically contain information about job duties, remuneration, length of service, competition laws & non-disclosure agreements.
• Partnership Agreement: These agreements define the terms of a business partnership between one or more parties & individuals. Most commonly it is termed a Partnership Deed under Indian Partnership Act, 1932.
• Licensing Agreement: These agreements authorize the use or utilization of Intellectual Property Rights under defined terms & conditions.
• Construction Contract: These contracts set out the terms & conditions for construction projects such as the scope of the project, timeframes, prices, materials & dispute resolution procedures.

Purpose of Contracts in Business

Contracts are essential in business for several important reasons. They create a clear understanding & formalize contracts between parties, defining the rights, duties & obligations of each party. Contracts reduce uncertainty & risk by defining terms & conditions relating to payment, performance & dispute resolution. Contracts also serve as the legal basis for a business relationship meaning that both parties agree on the terms & conditions of the agreement.

They protect by setting out penalties for breaches, thus protecting against poor performance & misconduct. Contracts also make it easier for parties to be held accountable & serve as proof in the event of a dispute allowing parties to take legal action if needed. All in all, contracts play an important role in building trust, transparency & predictability in business transactions. The main purpose of a contract in business are as follows:

• Legal Protection: The contract protects parties by setting out the rights & obligations of all parties involved reducing the chances of conflicts & misunderstandings.
• Clarity & Understanding: Contract sets out the terms of the agreement making it clear and transparent about what is expected of each party.
• Risk Mitigation: They help to reduce risk by clarifying delivery, payment, warranty & liability terms to reduce uncertainty.
• Confidentiality & Privacy: Contracts often contain confidentiality & privacy clauses to protect confidential information.

Conclusion

Contracts are at the heart of business. They define what is expected from parties, set out their rights, and obligations & reduce risk. They offer legal certainty, and clarity & define terms that build trust & accountability. Contracts provide clarity & dispute resolution, ensuring transparency & protection against breaches. In simple terms, contracts form the foundation of business relationships, building trust & facilitating transactions.

Contract – FAQs

What is a Contract?

Contract is a legally binding agreement between parties that creates obligations enforceable by law.

What are the most important things in a contract?

This includes but is not limited to the offer, acceptance, consideration, legal capacity, intention to establish legal relations & possibility of performance.

What are the most common types of contracts in business?

Sales, service, employment, partnership, licensing & construction contracts are commonly used in business.

Why are contracts used in business?

Contracts provide clarity, set out the rights & responsibilities of parties, reduce risk, protect their rights & settle disputes in business dealings.

What types of contracts are governed by the Indian Contract Act 1872?

There are various types of contracts based on their validity such as, valid contracts, void contracts, voidable contracts, unenforceable contracts and illegal contracts. Each type of contract has its own characteristics & legal consequences.