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Accountancy > Accounting for Share Capital > Essentials of a Contract
Accounting for Share Capital

Essentials of a Contract

What makes a valid contract? A valid contract is enforceable by law and if a contract is not valid it may lead to obstruction of businesses and unlawful and insincere dealings. Let us learn about the essential features of a valid contract.

Essentials of a Valid Contract

A contract that is not a valid contract will have many problems for the parties involved. For this reason, we must be fully aware of the various elements of a valid contract. In other words, here we shall ponder on all the ramifications of the definition of the contract as provided by The Indian Contract Act, 1872.

The Indian Contract Act, 1872 itself defines and lists the Essentials of a Contract either directly or through interpretation through various judgments of the Indian judiciary. Section 10 of the contract enumerates certain points that are essential for valid contracts like Free consent, Competency Of the parties, Lawful consideration, etc.

Other than these there are some we can interpret from the context of the contract which is also essential Let us see.

Essentials of a Valid Contract

1] Two Parties

So you decide to sell your car to yourself! Let us say to avoid tax or some other sinister purpose. Will that be possible? Can you have a contract with yourself? The answer is no, unfortunately. You can’t get into a contract with yourself.

A Valid Contract must involve at least two parties identified by the contact. One of these parties will make the proposal and the other is the party that shall eventually accept it. Both the parties must have either what is known as a legal existence e.g. companies, schools, organizations, etc. or must be natural persons.

For Example: In the case State of Gujarat vs Ramanlal S & Co. – A business partnership was dissolved and assets were distributed among the partners as per the settlement. However, all transactions that fall under a contract are liable for taxation by the office of the State Sales Tax Officer. However, the court held that this transaction was not a sale because the parties involved were business partners and thus joint owners. For a sale, we need a buyer (party one) and a seller (party two) which must be different people.

2] Intent Of Legal Obligations

The parties that are subject to a contract must have clear intentions of creating a legal relationship between them. What this means is those agreements that are not enforceable by the law e.g. social or domestic agreements between relatives or neighbors are not enforceable in a court of law and thus any such agreement can’t become a valid contract.

3] Case Specific Contracts

Some contracts have special conditions that if not observed would render them invalid or void. For example, the Contract of Insurance is not a valid contract unless it is in the written form.

Similarly, in the case of contracts like contracts for immovable properties, registration of contract is necessary under the law for these to be valid.

4] Certainty of Meaning

Consider this statement “I agree to pay Mr. X a desirable amount for his house at so and so location”. Is this a valid contract even if all the parties agree to this term? Of course, it can’t be as “desirable amount” is not well defined and has no certainty of meaning. Thus we say that a valid contract must have certainty of Meaning.

5] Possibility Of Performance Of an Agreement

Suppose two people decide to get into an agreement where a person A agrees to bring back the person B’s dead relative back to life. Even when all the parties agree and all other conditions of a contract are satisfied, this is not valid because bringing someone back from the dead is an impossible task. Thus the agreement is not possible to be enforced and the contract is not valid.

6] Free Consent

Consent is crucial for an agreement and thus for a valid contract. If two people reach a similar agreement in the same sense, they are said to consent to the promise. However, for a valid contract, we must have free consent which means that the two parties must have reached consent without either of them being influenced, coerced, misrepresented or tricked into it. In other words, we say that if the consent of either of the parties is vitiated knowingly or by mistake, the contract between the parties is no longer valid.

7] Competency Of the Parties

Section 11 of the Indian Contract Act, 1872 is:

“Who are competent to contract — Every person is competent to contract who is (1) of the age of majority according to the law to which he is subject, and who is (2) of sound mind and is (3) not disqualified from contracting by any law to which he is subject.”

Let us see these qualifications in detail:

  1. refers to the fact that the person must be at least 18 years old or more.
  2. means that the party or the person should be able to fully understand the terms or promises of the contract at the time of the formulation of the contract.
  3. states that the party should not be disqualified by any other legal ramifications. For example, if the person is a convict, a foreign sovereign, or an alien enemy, etc., they may not enter into a contract.

8] Consideration

Quid Pro Quo means ‘something in return’ which means that the parties must accrue in the form of some profit, rights, interest, etc. or seem to have some form of valuable “consideration”.

For example, if you decide to sell your watch for Rs. 500 to your friend, then your promise to give the rights to the watch to your friend is a consideration for your friend. Also, your friend’s promise to pay Rs. 500 is a consideration for you.

9] Lawful Consideration

In Section 23 of the Act, the unlawful considerations are defined as all those which:

  1. it is forbidden by law.
  2. is of such a nature that, if permitted, it would defeat the provisions of any law, or is fraudulent.
  3. involves or implies, injury to the person or property of another
  4. the Court regards it as immoral or opposed to public policy

These conditions will render the agreement illegal.

Solved Example on Valid Contracts

Q: A agrees to help B build his house since they are friends. Is this a contract?

Ans: No this is not a contract. There is intention between A and B to create a legal relation, which is an essential of a contract. Hence this is not a contract in the eyes of the law.

 

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Abhirama
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Abhirama

Provision for tax accounting treatment

Robert
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Robert

What are the conditions of valid contact and difference between conditions of valid contact and elements of valid contact

Ayyanar m
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Ayyanar m

According to Indian contract act 1872, under section 10 defines,” all agreements are contracts if they are made by free consent of the parties competent to contract for a lawful object and with a lawful consideration and are not expressly declared to be void”

Yoj
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Add current yr provision to working note and subtract previous year’s provision from operating profit in cash flow statement

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