Basis of Contract, Classification of Contract, Standard Form of Contract | Indian Contract Act, 1872

Contracts are an essential part of modern legal and commercial life. They provide a legal framework through which individuals, businesses and other entities create rights and obligations between themselves. However, not every agreement has the same legal character. Depending upon the circumstances in which it is made, the manner in which it is formed, the extent to which it has been performed and the form in which its terms are presented, contracts may have different legal consequences.

The study of the basis and classification of contracts helps in understanding these differences. It explains when an agreement becomes enforceable, how contracts may be created, and whether the obligations under them have already been performed or remain to be performed.

Another important development of modern contract law is the widespread use of standard form contracts. Such contracts are generally prepared in advance by one party and used repeatedly in similar transactions. Although they provide convenience and efficiency, they may also raise concerns regarding unequal bargaining power and unfair contractual terms.

The following discussion therefore examines the basis of contract, major classifications of contracts, and the concept and legal control of standard form contracts.

Basis of Contract

The basic foundation of a contract is an agreement enforceable by law. Section 2(h) of the Indian Contract Act, 1872 defines a contract as “an agreement enforceable by law”.

Thus, two fundamental elements form the basis of a contract:

1. Agreement – There must first be an agreement between the parties. An agreement generally arises from a proposal and its acceptance. [Proposal + Acceptance = Promise]; [Promise/Reciprocal Promises = Agreement].
2. Enforceability by Law – The agreement must be legally enforceable. An agreement which does not create legal obligations or which the law declares void cannot become a contract merely because the parties have agreed to it.

Therefore, Contract refers to an Agreement with Legal Enforceability.

The enforceability of an agreement depends upon the requirements of law, including free consent, competency of parties, lawful consideration, lawful object and the absence of any statutory provision declaring the agreement void.

Freedom of Contract

An important principle underlying contract law is the freedom of contract. Parties are generally free to decide whether to enter into a contract and to determine its terms according to their mutual interests.

However, this freedom is not absolute. The agreement must remain within the limits prescribed by law. The object and consideration must be lawful, consent must be free, the parties must be competent, and the agreement must not fall within a category declared void by law.

Thus, the basis of modern contract law can be understood as a balance between Freedom of Contract and Legal Regulation; which provides for an Enforceable Contractual Relationship.

Classification of Contracts

Contracts may be classified on different bases. The principal classifications are:

1. On the basis of validity or enforceability;
2. On the basis of formation or mode of creation;
3. On the basis of performance or extent of execution; and
4. On the basis of form.

Certain modern classifications, such as e-contracts, may also be considered on the basis of the medium through which the contract is formed.

A. Classification on the Basis of Validity or Enforceability

1. Valid Contract

A valid contract is an agreement which satisfies all the essential requirements prescribed by law and is enforceable by law. A valid contract therefore creates legally enforceable rights and obligations between the parties.

For example, A agrees to sell his car to B for ₹5,00,000, and the agreement satisfies all the requirements of a valid contract. A is then legally bound to perform his promise and B is legally entitled to enforce the corresponding obligation.

2. Void Agreement and Void Contract

The distinction between a void agreement and a void contract is important.

• Void Agreement - Section 2(g) provides that, “An agreement not enforceable by law is said to be void.” A void agreement is therefore unenforceable from the beginning and never acquires the status of a contract. For example, an agreement which is expressly declared void by the Contract Act does not become a valid contract merely because the parties have consented to it.
• Void Contract - Section 2(j) provides, “A contract which ceases to be enforceable by law becomes void when it ceases to be enforceable.” A void contract is therefore a contract which was valid when it was formed but subsequently ceases to be enforceable because of a subsequent event or circumstance recognised by law. For example, A agrees to write a book for a publisher. Before the work is completed, A dies. Where the contract involves personal performance by A, his death may make further performance impossible and the contract may consequently become void under Section 56. Similarly, if performance of a contract becomes impossible or unlawful because of a supervening event, the contract may cease to be enforceable.

Important Distinction

Thus, the expression void ab initio is properly associated with an agreement which is void from the very beginning. A void contract, on the other hand, was initially a valid contract.

3. Voidable Contract

Section 2(i) defines a voidable contract as an agreement which is enforceable by law at the option of one or more of the parties thereto, but not at the option of the other or others. A voidable contract is therefore valid and enforceable unless and until the party entitled to avoid it exercises that option.

Such a situation may arise where the consent of one party has been obtained through circumstances such as coercion, undue influence, fraud or misrepresentation, subject to the specific provisions of the Act.

For example, if A obtains B’s consent to an agreement by coercion, B may have the legal right to avoid the contract.

Difference between Void Contract and Voidable Contract

4. Illegal Agreement

An illegal agreement is an agreement whose object or consideration is unlawful or which is prohibited by law. An illegal agreement is therefore void, but every void agreement is not necessarily illegal. For example, an agreement to commit an offence is illegal because its object is unlawful.

The distinction is important because an illegal agreement may also affect transactions connected with it.

Difference between Void Agreement and Illegal Agreement

Thus, all illegal agreements are void, but all void agreements are not illegal.

The legal impact on collateral transactions forms the primary practical distinction between a void agreement and an illegal agreement. An agreement that is merely void (such as a wagering agreement under Section 30 or a minor’s agreement) does not taint collateral or connected agreements; a loan taken to finance a void agreement remains enforceable. Conversely, an illegal agreement (such as an agreement to commit a crime under Section 23) is corrupt at its core, thereby tainting all collateral agreements. Consequently, any secondary contract entered into to assist, facilitate, or finance an illegal transaction is also rendered void and unenforceable by the courts under the maxim ex turpi causa non oritur actio (“no action arises from a disgraceful cause”).

5. Unenforceable Contract

An unenforceable contract is one which may be valid in substance but cannot be enforced in court because of some technical or procedural defect. Such a defect may relate, depending upon the circumstances, to requirements such as writing, registration or limitation.

For example, where the law requires a particular transaction to be in writing or registered and the prescribed form has not been followed, the transaction may become unenforceable.

An unenforceable contract should therefore be distinguished from a void agreement; the former may fail because of a technical defect in enforceability, whereas a void agreement is not enforceable by law.

B. Classification on the Basis of Formation or Mode of Creation

1. Express Contract

Under Section 9, a promise is express when the proposal or acceptance is made in words. A contract is therefore an express contract when its terms are communicated through spoken or written words.

For example, A offers by telephone to sell his house to B for ₹20,00,000 and B expressly accepts the offer. The contract is express.

2. Implied Contract

An implied contract arises from the conduct of the parties or the circumstances of the transaction rather than from express words. Section 9 recognises implied promises where the proposal or acceptance is made otherwise than in words.

For example, when a passenger boards a bus and travels to a particular destination, the circumstances and conduct of the parties imply an obligation on the passenger to pay the prescribed fare and an obligation on the transport provider to provide the service.

Similarly, where a customer orders food at a restaurant and consumes it, the circumstances may give rise to an implied contractual obligation to pay for the food.

3. Tacit Contract

The word “tacit” means silent or unexpressed. A tacit contract is one which is inferred from the conduct of the parties without any express communication in words. In this sense, a tacit contract is generally regarded as a form of implied contract, rather than a completely separate category.

For example, a customer withdrawing money from an ATM acts upon an arrangement with the bank through conduct and the functioning of the banking system. Similarly, in an auction, the fall of the hammer may signify acceptance of the highest bid according to the circumstances and rules of the auction.

Thus, every tacit contract is essentially implied, but every implied contract need not necessarily be described as tacit.

4. E-Contract

An e-contract is a contract formed through electronic means. With the development of electronic commerce, contracts may be entered into through:

• e-mail;
• websites and online platforms;
• electronic data interchange (EDI);
• electronic forms; and
• “click-wrap” or “mouse-click” arrangements.

An e-contract is not a fundamentally different species of contract merely because electronic means are used. The ordinary principles governing formation, consent, capacity, lawful consideration and object, and enforceability continue to apply, subject to the laws governing electronic transactions.

Thus, the distinguishing feature of an e-contract is primarily the electronic medium through which the agreement is formed.

5. Quasi-Contract

A quasi-contract is not an actual contract, because it does not arise from an agreement between the parties. The Contract Act refers to such situations as “certain relations resembling those created by contract”. In these cases, the law imposes an obligation upon a person in order to prevent unjust retention of a benefit.

For example, where money is paid to a person by mistake, the person receiving it may be required to repay it under Section 72.

Similarly, the law imposes certain obligations upon a finder of goods.

Therefore, quasi-contractual obligations resemble contractual obligations but do not arise from offer, acceptance or mutual consent.

C. Classification on the Basis of Performance or Extent of Execution

1. Executed Contract

A contract is an executed contract when the obligations arising under it have been completely performed and nothing remains to be done by the parties.

For example, A purchases a book from a bookseller, pays the price and receives the book immediately. The obligations of both parties have been performed, making it an executed contract.

2. Executory Contract

A contract is an executory contract when the obligations under it remain wholly or partly to be performed in the future.

For example, A agrees to provide tuition to B from the following month and B promises to pay ₹1,000 per month. Since the obligations are to be performed in the future, the contract is executory.

An executory contract may involve obligations remaining on both sides or, depending upon the stage of performance, on one side only.

Unilateral and Bilateral Contracts

The terms unilateral and bilateral are often discussed along with executed and executory contracts, but they should not be confused with them. They primarily refer to the nature of the promises and the obligations outstanding.

• Unilateral Contract - A unilateral contract involves a promise in return for the performance of an act. For example, A announces a reward of ₹5,000 to anyone who finds and returns his missing dog. When B finds and returns the dog in accordance with the offer, B becomes entitled to the reward. Such a transaction is often described as unilateral because the obligation to pay the reward arises upon performance of the specified act.
• Bilateral Contract - A bilateral contract involves mutual promises, with obligations undertaken by both parties. For example, A agrees to sell his plot to B for ₹10,00,000, while B agrees to pay the price. Both parties undertake corresponding obligations. A bilateral contract may therefore remain executory until the respective promises are performed.

D. Classification on the Basis of Form

1. Ordinary Contract

An ordinary contract is one in which the terms are generally discussed and agreed upon by the parties according to their mutual understanding. The parties ordinarily have an opportunity to negotiate the terms, modify them and determine their respective rights and obligations.

Such contracts generally involve a greater degree of individual bargaining and negotiation.

2. Standard Form Contract

A standard form contract is a contract in which the terms are prepared in advance by one party and are intended to be used repeatedly in a large number of similar transactions.

Examples include insurance policies, railway and transport tickets, banking agreements, telecommunications agreements and various online terms and conditions.

The party accepting the contract generally has little or no opportunity to negotiate individual terms and may have to accept the terms as they are if he wishes to obtain the relevant goods or services.

Such contracts are sometimes referred to as “take-it-or-leave-it” contracts or contracts of adhesion.

Standard Form of Contract

Modern business organisations often enter into a very large number of similar transactions. It would be inconvenient, expensive and time-consuming to negotiate an individual contract for every transaction. Therefore, the terms are drafted in advance in a standard form and used repeatedly.

A standard form contract may thus be understood as a contract containing pre-determined terms prepared by one party for repeated use, which the other party ordinarily accepts without individual negotiation.

The principal object of such contracts is to ensure speed, convenience, uniformity and economy in commercial transactions.

Characteristics of Standard Form Contracts

The important characteristics of standard form contracts are:

1. Pre-drafted Terms - The contractual terms are prepared in advance by one party before the individual transaction takes place.
2. Repeated Use - The same or substantially similar terms are used in a large number of transactions.
3. Limited Negotiation - The other party ordinarily has little opportunity to negotiate or modify individual terms.
4. Unequal Bargaining Power - In many cases, the party drafting the contract possesses greater economic or bargaining power than the party accepting it.
5. Take-it-or-leave-it Nature - The weaker party may practically have to accept the terms as presented or choose not to enter into the transaction.
6. Exemption and Exclusion Clauses - Such contracts frequently contain clauses which attempt to limit or exclude the liability of the party who drafted the contract.

Advantages of Standard Form Contracts

Standard form contracts are commercially useful because they:

• save time and expense;
• provide uniformity in similar transactions;
• simplify large-scale business dealings;
• reduce the need for repeated negotiations; and
• provide certainty regarding the terms applicable to the transaction.

They are therefore not inherently invalid or unfair merely because they are standardised.

Disadvantages of Standard Form Contracts

The major disadvantages arise particularly where there is a significant difference in bargaining power. Such contracts may:

• restrict the weaker party’s ability to negotiate;
• contain complicated or difficult-to-understand terms;
• include broad exemption or exclusion clauses;
• impose burdensome conditions upon the weaker party; and
• enable the stronger party to take unfair advantage of its bargaining position.

The principal concern is therefore not standardisation itself, but the possibility of unfairness arising from unequal bargaining power.

Judicial Control of Standard Form Contracts

Since standard form contracts may contain terms which the weaker party has not individually negotiated, courts have developed principles to regulate their use.

1) Reasonable Notice

A contractual term, particularly an exemption or exclusion clause, must be reasonably brought to the notice of the other party.

• Henderson v. Stevenson (1875) – In this case, the court held that a party could not be bound by conditions which had not been adequately brought to his notice.
• Government of Rajasthan (Finance), Jaipur v. Vedakantara Venkataramana Seshaiyer – In this case, it was held that the plaintiff was not bound by the terms printed on the reverse of the ticket. The terms on the ticket were in small print and they were not brought to the notice of the plaintiff either before or at the time of purchase of the ticket.

Thus, merely printing a term somewhere on a document may not be sufficient if the circumstances do not provide reasonable notice.

2) Notice Must Be Given Before or at the Time of Contract

Notice of a contractual term should ordinarily be given before or at the time the contract is made.

• Olley v. Marlborough Court Ltd. (1949) – In this case, an exclusion clause displayed inside a hotel room was held ineffective because the contract had already been concluded before the notice was brought to the customer’s attention.

Therefore, a term introduced only after the formation of the contract will ordinarily not become part of that contract merely because it is subsequently displayed.

3) Strict Interpretation of Exemption Clauses

Exemption and exclusion clauses are construed strictly by courts. Where the wording is ambiguous, the court may interpret the clause against the party seeking to rely upon it. This principle prevents a party from using vague or broadly worded terms to exclude liabilities which were not reasonably contemplated by the contractual language.

This rule of strict construction is embodied in the Latin legal maxim verba chartarum fortius accipiuntur contra proferentem (commonly known as the Contra Proferentem rule). Under this doctrine, if an exemption or exclusion clause in a standard form contract is ambiguous, vague, or capable of two reasonable interpretations, the court will strictly resolve the ambiguity against the proferens, that is, the party who drafted the contract and stands to benefit from the clause.

4) Fundamental Obligations Cannot Be Easily Excluded

An exemption clause should not ordinarily be interpreted in a manner which completely defeats the fundamental purpose or basic obligation of the contract. The courts may therefore scrutinise a clause which seeks to permit a party to escape the very obligation for which the contract was entered into.

A party cannot use a broadly drafted exemption clause to escape their primary performance or shield themselves from a fundamental breach that strikes at the root of the contract. This principle is clearly illustrated in Lily White v. R. Munuswami (AIR 1966 Mad 13), where a dry cleaner’s receipt contained a standard printed condition limiting recovery for lost garments to 15% of the market value. The Madras High Court held the condition void as being unreasonable and contrary to public policy, ruling that a bailee cannot contract out of their basic fundamental obligation to return the bailed goods in safety.

5) Unreasonable or Unconscionable Terms

Where there is substantial inequality of bargaining power, courts may examine whether a contractual term is unfair, unreasonable or unconscionable.

• Central Inland Water Transport Corporation Ltd. v. Brojo Nath Ganguly (1986) – In this case, the court struck down clause in a service agreement whereby the service of a permanent employee could be terminated by giving him a 3 months’ notice or 3 month’s salary.

The case is significant because it demonstrates that the principle of freedom of contract cannot always be applied mechanically where one party has no meaningful choice and the bargaining positions are substantially unequal.

6) Protection against Unfair Bargaining

In LIC of India v. Consumer Education & Research Centre (1995), the Supreme Court also recognised the relevance of inequality of bargaining power and the need to scrutinise unfair terms in appropriate circumstances.

However, the mere fact that a contract is in standard form does not automatically make it unfair. The court must consider the nature of the transaction, the relative bargaining positions of the parties and the particular contractual term.

Standard Form Contract and Freedom of Contract

The traditional doctrine of freedom of contract assumes that parties are free to negotiate and voluntarily determine the terms of their agreement. Standard form contracts sometimes challenge this assumption because the weaker party may have little practical opportunity to negotiate. Modern contract law therefore attempts to maintain a balance between commercial efficiency and protection against unfair contractual terms. Standard form contracts are consequently recognised as an important part of modern commerce, but their terms remain subject to the requirements of law.

Conclusion

Contracts may be classified according to their validity, mode of formation, extent of performance and form. Each classification helps to explain a different legal characteristic of contractual relationships.

A contract may be valid, voidable, void or unenforceable depending upon the circumstances affecting its enforceability. It may be express, implied or formed through electronic means depending upon the manner of its creation. Similarly, it may be executed or executory depending upon the extent to which the contractual obligations have been performed.

Among the different forms of contracts, standard form contracts have become particularly important in modern commercial transactions. They make large-scale transactions faster, cheaper and more convenient, but may also create the possibility of unfairness where the parties possess unequal bargaining power.

The law therefore does not prohibit standard form contracts. Instead, it seeks to ensure that their terms are properly incorporated, reasonably communicated and not used in a manner that is unlawful, unreasonable or unconscionable. In this way, contract law attempts to maintain a proper balance between freedom of contract, commercial convenience and protection against unfairness.