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2 Third edition published by Emile Woolf International Bracknell Enterprise & Innovation Hub Ocean House, 12th Floor, The Ring Bracknell, Berkshire, RG12 1AX United Kingdom Emile Woolf International, September 2017 All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, scanning or otherwise, without the prior permission in writing of Emile Woolf International, or as expressly permitted by law, or under the terms agreed with the appropriate reprographics rights organisation. You must not circulate this book in any other binding or cover and you must impose the same condition on any acquirer. Notice Emile Woolf International has made every effort to ensure that at the time of writing the contents of this study text are accurate, but neither Emile Woolf International nor its directors or employees shall be under any liability whatsoever for any inaccurate or misleading information this work could contain. Emile Woolf International ii The Institute of Chartered Accountants of Pakistan

3 Certificate in Accounting and Finance C Contents Syllabus objectives and learning outcomes Section A: Mercantile Law Chapter Page 1 Introduction to the legal system 1 2 Introduction to the law of contract 23 3 Offer and acceptance 33 4 Capacity of parties 43 5 Consideration 51 6 Free consent 59 7 Legality of object, consideration and agreements opposed to public policy 75 8 Void agreements 83 9 Contingent contracts Quasi contracts Performance of a contract Discharge of a contract Remedies for breach of contract Indemnity and guarantee Bailment and pledge Agency Partnership Act Negotiable instruments Act 223 v Emile Woolf International iii The Institute of Chartered Accountants of Pakistan

4 Page Section B: Company Law Chapter 19 Company Incorporation of company Share capital types and variation Share capital prospectus Mortgages and charges Meetings Management Investments and dividends Accounts and audit 353 Index 367 Emile Woolf International iv The Institute of Chartered Accountants of Pakistan

5 Certificate in Accounting and Finance S Syllabus objectives and learning outcomes ASSESSMENT OF FUNDAMENTAL COMPETENCIES BUSINESS LAW Objective To give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Learning Outcome The candidate will be able to demonstrate: 1 basic knowledge of the legal environment 2 comprehension of laws governing contracts, partnership and negotiable instruments 3 knowledge of the legal terminology of company law and the basics of company incorporation 4 familiarity with the provisions governing the issuance of shares 5 knowledge of the management of companies 6 familiarity with investment by companies, financial accounts and distribution of profit 7 knowledge of the appointment of auditors and their responsibilities and duties. Emile Woolf International v The Institute of Chartered Accountants of Pakistan

6 Grid Weighting Introduction to legal system 5-10 Mercantile law Contract Act Partnership Act Negotiable Instrument Act Companies Act, 2017 and Securities Act, 2015 Sections 1 to 56- of the Companies Act, Sections 57 to 112 of the Companies Act, 2017 and Sections 87 to 93 of Securities Act, Sections 118 to 196 of the Companies Act, Sections 199 to 245 of the Companies Act, Sections 246 to 251 of the Companies Act, Total 50 Syllabus Ref A Contents Level Learning Outcome Introduction to the Legal System Sources and process of legislation 1 Sources of law and an introduction to the Constitution of Pakistan 2 Process of legislation and legal system in Pakistan 1 LO1.1.1: Briefly describe sources of law in Pakistan LO1.1.2: Describe the basic structure of the constitution of the Islamic Republic of Pakistan. 1 LO1.2.1: Define legislation and describe its forms LO1.2.2: Briefly describe the process of legislation as per the Constitution LO1.2.3: Identify and briefly explain the structure of the courts in Pakistan LO Explain alternate dispute resolution (ADR) and its advantages and disadvantages. B Mercantile law a Contract Act Introduction to the Law of Contract 2 LO 2.1.1: Define contract, agreement and promise LO 2.1.2: Identify essential elements of a valid contract Emile Woolf International vi The Institute of Chartered Accountants of Pakistan

7 Syllabus objectives and learning outcomes Syllabus Ref Contents Level Learning Outcome LO 2.1.3: Be aware of factors which might affect the validity of a contract and their consequences LO 2.1.4: Identify different types of a contract. 2 Offer and acceptance 2 LO 2.2.1: Define offer and acceptance LO 2.2.2: Identify different types of offers LO 2.2.3: Explain how offer is different from invitation of an offer LO 2.2.4: Identify essential elements of offer and acceptance LO 2.2.5: Understand the timing of revocation and its communication LO 2.2.6: Identify circumstances when an offer lapses. 3 Capacity of Parties 2 LO 2.3.1: Identify circumstances when a person is not competent to contract LO 2.3.2: Be aware of consequences or enforceability of contracts with persons not competent to contract. 4 Consideration 2 LO 2.4.1: Define consideration and identify essentials of consideration LO 2.4.2: Understand rules relating to consideration LO 2.4.3: Identify agreements which are valid without consideration. 5 Free consent 2 LO 2.5.1: Define free consent LO 2.5.2: Know the effect of absence of free consent LO 2.5.3: Be aware of factors which may affect the consent LO 2.5.4: Identify and understand coercion, undue influence, fraud, misrepresentation and mistake. 6 Legality of object and consideration and agreements opposed to public policy 2 LO 2.6.1: Identify circumstances where object or consideration is unlawful LO 2.6.2: Identify agreements opposed to public policy. 7 Void agreement 2 LO 2.7.1: Be aware of circumstances or conditions when an agreement is considered as void LO 2.7.2: Identify different types of void agreements. 8 Contingent contract 2 LO 2.8.1: Define contingent contract LO 2.8.2: Identify characteristics of contingent contract LO 2.8.3: Understand rules regarding contingent contract LO 2.8.4: Understand the difference between contingent contact and wagering agreement. Emile Woolf International vii The Institute of Chartered Accountants of Pakistan

8 Syllabus Ref Contents Level Learning Outcome 9 Quasi contract 2 LO 2.9.1: Know meaning of quasi contract LO 2.9.2: Understand and apply rules regarding quasi contract LO 2.9.3: Be aware of different kinds of quasi contract. 10 Performance of a contract 2 LO : Explain performance and its types i.e. actual and attempted LO : Understand rules relating to joint and reciprocal contracts and appropriation of payment LO : Identify essentials of a valid tender LO : Define tender and explain its types and effects. Describe the essentials of a valid tender LO : Identify factors which may affect the performance of a contract LO : Understand and apply rules relating to joint and reciprocal promises LO : Understand the meaning of appropriation of payment and rules regarding appropriation of payment LO : Explain the assignment of contracts. 11 Discharge of a contract 2 LO : Understand the meaning of discharge of contract LO : Identify modes of discharge of a contract: discharge by performance, by consent, operation of law, impossibility of performance, lapse of time and breach (actual and anticipatory) LO : Understand rules relating to discharge of a contract. 12 Remedies for breach of contract 2 LO : Explain the remedy LO : Describe the various remedies available in case of breach of a contract LO : Understand rules relating to amount of damages LO : Identify different kinds of damages LO : Understand the remoteness of damages. 13 Indemnity and guarantee 2 LO : Define contract of indemnity and contract of guarantee. Differentiate between contract of guarantee and indemnity LO : Identify parties in a contract of indemnity and contract of guarantee LO : Differentiate between contract of guarantee and indemnity LO : Describe the rights of indemnity holder LO : Identify the essentials of the contract of guarantee Emile Woolf International viii The Institute of Chartered Accountants of Pakistan

9 Syllabus objectives and learning outcomes Syllabus Ref Contents Level Learning Outcome LO : Understand the kinds of guarantees i.e. specific and continuing, and revocation of continuing guarantee LO : Describe rights and responsibilities of surety LO : Explain how surety is discharged LO : Understand rules relating to indemnity, guarantee and surety. 14 Bailment and pledge 2 LO : Define bailment and identify the essentials of the contract of bailment LO : Explain the types of bailment LO : Identify duties and rights of the bailor and bailee LO : Explain how contract of bailment is terminated LO : Identify rights and duties of finder of goods LO : Explain pledge (pawn), pledgor (pawnor) and pledgee (pawnee) LO : Explain rights of pledgor and pledgee LO : Understand the rules of pledge by non-owners LO : Differentiate between bailment and pledge. 15 Agency 2 LO : Define agency, agent and principal and explain types of agents LO : Identify rights and duties of the agent and principal LO : Understand rules relating to agency LO : Differentiate between sub agent and co-agent LO : Explain how an agency can be created LO : Understand the circumstances when an agent is personally liable LO : Identify irrevocable agency LO : Explain how an agency can be terminated LO : Understand the meaning of undisclosed agency, position of agent, principal and third party. b Partnership Act Chapter I Preliminary 2 LO3.1.1: Define the terms. 2 Chapter II - The nature of partnership 2 LO3.2.1: Understand and describe the partnership relationship, its creation and identify and explain the types of partnership and the mode of determining existence of a partnership. Emile Woolf International ix The Institute of Chartered Accountants of Pakistan

10 Syllabus Ref Contents Level Learning Outcome 3 Chapter III - Relations of partners to one another 4 Chapter IV - Relations of partners to third parties 2 LO3.3.1: Determine and explain the rights and duties of partners of the firm under various circumstances LO3.3.2: Explain the provisions of the law relating to conduct of the business, property of the firm and personal profits earned by partners. 2 LO3.4.1: Describe the relationship of partners with third parties LO3.4.2: Identify and explain the concepts of implied authority of the partner in relation to third parties, partner s authority in an emergency, mode of doing act to bind the firm, effect of admissions by a partner, effect of notice to acting partner, liability of a partner for acts of the firm and liability of the firm for wrongful acts of a partner or misapplication by partners, principle of holding out in given situations LO3.4.3: Identify and explain the rights of transferee of a partner s interest and the rights and liabilities of a minor admitted to the benefits of partnership. c Negotiable Instruments Act Definitions and meanings (Section 1 to 25) 2 Discharge of liability (Section 82 to 90) 3 Provisions relating to cheques (Section 122A to 131C) 1 LO4.1.1: Define and explain terms LO4.1.2: Explain provisions relating to types of negotiable instruments and their maturity. 2 LO4.2.1: Identify and explain how the maker of a negotiable instrument is discharged from his liability under given scenarios. 2 LO4.3.1: Describe provisions relating to crossing of cheques LO4.3.2: Briefly describe and differentiate between a cheque crossed generally and a cheque crossed specially and their payment modes. C a Preliminary and incorporation (Sections 1 to 56) 1 Definitions (Section 2 and 118) 1 LO5.1.1: Define the terms which are relevant to the areas covered in the syllabus. 2 Meaning of subsidiary and holding company (Section 2 (37), (68)) 2 LO5.2.1: Explain subsidiary and holding company and when a company becomes a subsidiary or holding company of another company. Emile Woolf International x The Institute of Chartered Accountants of Pakistan

11 Syllabus objectives and learning outcomes Syllabus Ref Contents Level Learning Outcome LO5.2.2: Apply the concept of subsidiary in simple scenarios. 3 Powers and functions of the Commission (Section 7) 4 Business and objects of a company (section 26) 5 Memorandum of association (Section 27 to 35, 40, 41) 6 Registration of memorandum and articles of association (Section16-18, 36, 37-39) 7 Provisions with respect to names of companies/its change (Section 10-13) 8 Association not for profit (Section 42, 43) 9 Companies limited by guarantee (Section 45) 1 LO5.3.1: Demonstrate familiarity with the powers and functions of the Commission. LO5.4.1: Describe the business and objects of a company 2 LO5.5.1: Describe the memorandum of association and state its purpose LO5.5.2: List/explain the clauses of memorandums of association of various types of companies LO5.5.3: Describe the purpose and procedure of alteration to different clauses of a memorandum of association LO5.5.4: Describe the effect of alteration/noting of alteration of memorandum of association 2 LO5.6.1: Define the articles of association and state its purpose LO5.6.2: State the information which should be contained in the articles of various companies. LO5.6.3: Describe the procedure for alteration of articles LO5.6.4: Describe the procedure of registration of the memorandum and articles of association LO5.6.5: Describe the effects of registration of the memorandum and articles of association. L05.6.6: State the provisions relating to printing, signing and date of memorandum and article of association 2 LO5.7.1: Describe with examples the procedure / prohibitions with regard to the selection of the name of a company /change of name LO5.7.2: Identify/explain the actions and procedures needed to be taken by company and registrar, if a company is registered by a prohibited name. 1 LO5.8.1: Comprehend the nature of association not for profit./provisions relating to licensing/revocation of licenses granted under section 42 1 LO5.9.1: Understand the provisions regarding divisible profit and dividing the undertaking into shares or interest. Emile Woolf International xi The Institute of Chartered Accountants of Pakistan

12 Syllabus Ref b Contents Level Learning Outcome Allotment of shares, registration of charge etc. (Sections 57 to 112 of Companies Act 2017 and Sections 87 to 93 of Securities Act 2015)) 1 Prospectus, allotment, issue and transfer of shares and debentures, deposits, etc. 2 Share capital and debentures (Section 58 to 62, 85-87of Companies Act, 2017) 3 Registration of mortgages, charges etc. (Section 100, 105, 109, 110 and 112 of Companies Act, 2017) 1 LO6.1.1: Define a prospectus and explain its purpose (Section 57) LO6.1.2: Understand the requirements relating to a prospectus as laid down in Section 87(2),(4),(5),(6),(7), 88(1-8), 90, 91, 92 and 93 of the Securities Act 2015 LO6.1.5: Understand/explain the provisions regarding statement and consent of expert. 1 LO6.2.1: Provision relating to nature / number of shares and other securities LO6.2.2: Describe the classes and kinds of shares LO6.2.3: Describe with simple example the condition of fully paid shares LO6.2.4: State the provision relating to alteration of share capital / kinds of alterations that can be made to the share capital LO6.2.5: Understand the meaning of variation of shareholders rights LO6.2.6: Demonstrate familiarity with the procedure for cancellation of variation of shareholders rights. 1 LO6.3.1: Discuss the meaning of mortgage/charge with simple examples, and the duty of company and the procedure for registration of charges LO6.3.2: State the right of an interested party in respect of a registration of mortgage/charge LO6.3.3: State the duty and procedure of payment or satisfaction of mortgage/ charge LO6.3.4: Demonstrate familiarity with the right to inspect the instrument creating a mortgage/charge LO6.3.5: Discuss the consequences of registered and unregistered mortgages/ charges. Emile Woolf International xii The Institute of Chartered Accountants of Pakistan

13 Syllabus objectives and learning outcomes Syllabus Ref c Contents Level Learning Outcome Management and administration (Sections 19 to 25 and 118 to 196 of Companies Act, 2017) 1 Registered office, publication of names etc. (Section 21, 22, 24, 25) 2 Commencement of business by a public company (Section 19 and 20) 3 Meeting and proceedings (Section 131 to 152) 2 LO7.1.1: Discuss with simple examples the provisions with regard to having a registered office, publication of name and publication of paid-up capital. 1 LO7.2.1: State the conditions to be fulfilled before commencement of business by a company LO7.2.2: State the applicability and nonapplicability of the conditions on different kinds of company. LO7.2.3: State the consequences of noncompliance of Section 19 1 LO7.3.1: State the timing, matters and reports relating to statutory meetings LO7.3.2: State the timing, matters and reports relating to an annual general meeting using simple examples LO7.3.3: State who can call an annual general meeting LO7.3.4: State the timing, matters and reports relating to an extraordinary general meeting LO7.3.5: State who can call an extraordinary general meeting LO7.3.6: State the quorum for a general meeting LO7.3.7: State the entitlement of a member in respect of appointment of proxy and conditions applicable thereon LO7.3.8: Describe the provisions relating to agenda/ resolution / minutes of meetings. LO 7.3.9: State the circumstances in which proceedings of the general meeting may be declared invalid. 4 Directors (Section 153 to 185) 1 LO 8.4.1: Explain and apply in given scenarios, the legal provision with respect to directors : Eligibility/ineligibility Number First, subsequent and independent directors Term/tenure of office of directors Elections Removal/vacation of office Filling of casual vacancies Remuneration Emile Woolf International xiii The Institute of Chartered Accountants of Pakistan

14 Syllabus Ref Contents Level Learning Outcome Powers, duties, rights, liabilities and limitations Assignment of office and alternate directors Proceedings Code of Corporate Governance Passing of resolution LO8.4.2: State the legal provisions relating to loans to directors. 5 Chief executive (Section 186 to 196) 1 LO8.5.1: Explain the appointment of first chief executive and subsequent chief executives using simple examples d Investments, accounts etc. (Sections 199 to 244of Companies Act, 2017) LO8.5.2: State the provisions/ conditions applicable on appointment, removal, engagement in any business LO8.5.3: State the provisions relating to appointment of a chairman/ share registrar/ sole purchase/sales agents/ secretary. 1 Investment in associated companies and undertakings (Section 199) 2 Investment of companies to be held in its own name (Section 200) 3 Disclosure of interest by directors (Section 205) 4 Interest of other officers etc. (Section 206) 5 Interested director not to participate or vote in proceedings of directors (Section 207) 6 Accounts (Section 220, 223, 226, 227, 232 and 233 ) 2 LO9.1.1: Describe the conditions applicable to a company for making investment in associated companies and undertakings. 1 LO9.2.1: Discuss with simple examples as to how a company can hold its investment in names other than its own name. 1 LO9.3.1: Explain the requirements of disclosure of interest by director in contract / arrangement entered into by or on behalf of the company. 1 LO9.4.1: Explain the requirements of disclosure of interest by officers in contract / arrangement entered into by or on behalf of the company. 1 LO9.5.1: Describe the provisions relating to participation of interested director in the proceedings of directors in contract / arrangement entered into by or on behalf of the company. 1 LO9.6.1: Describe the provisions relating to the books of accounts to be kept by company. LO9.6.2: Explain the requirements with respect to the annual accounts and the balance sheet LO9.6.3: Describe directors report/ duty to prepare directors report and statement of compliance Emile Woolf International xiv The Institute of Chartered Accountants of Pakistan

15 Syllabus objectives and learning outcomes Syllabus Ref Contents Level Learning Outcome LO9.6.4: Describe the authentication of balance sheet and profit and loss account LO9.6.5: Discuss requirements of filing of balance sheets and profit and loss accounts with the registrar. 7 Dividend (Section 240 to 244) 1 LO9.7.1: Explain the requirements relating to declaration of dividend and identify/explain certain restrictions on declaration of dividend LO9.7.2: Describe the provisions applicable to payment of dividend. LO9.7.3: Describe the provision applicable to unclaimed share and dividend to vest with the Federal Government e Audit (Sections 246 to 251 of Companies Act 2017) 1 Audit (Section 246 to 251) 2 LO10.1.1: Explain the provisions applicable to Appointment, removal and remuneration of auditors Qualification and disqualification of auditors Powers/ duties of auditors and an auditor s right to access the record and information An auditor s duty to report and contents thereof Signature on an audit report. Emile Woolf International xv The Institute of Chartered Accountants of Pakistan

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17 Certificate in Accounting and Finance C H A P T E R 1 Introduction to the legal system Contents 1 Introduction to the legal system 2 Legislation 3 Structure of courts in Pakistan 4 Chapter review Emile Woolf International 1 The Institute of Chartered Accountants of Pakistan

18 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Introduction to the legal system LO On the successful completion of this paper, candidates will be able to demonstrate a basic knowledge of the legal environment LO Briefly describe sources of law in Pakistan LO Describe the basic structure of the constitution of the Islamic Republic of Pakistan LO Define legislation and describe its form LO Briefly describe the process of legislation as per the Constitution LO Identify and briefly explain the structure of the courts in Pakistan LO Explain alternate dispute resolution (ADR) and its advantages and disadvantages. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 2 The Institute of Chartered Accountants of Pakistan

19 Section A: Mercantile Law - Chapter 1: Introduction to the legal system 1 INTRODUCTION TO THE LEGAL SYSTEM Section overview Definition of Law Definition of Mercantile Law Why Chartered Accountants study law Where to apply law in practical life Sources of law in Pakistan Doctrine of Binding Precedent Criminal law and civil law 1.1 Definition of Law Law means a set of rules or a system of rules of conduct designed and enforced by the state to control and regulate the conduct of people. Law is not stagnant. As circumstances and conditions in a society change, laws are also changed as per the requirements of the society. The word law may have different meaning for different situations. It is often preceded by an adjective to give it a more clear meaning e.g. Civil Law, Criminal Law, etc. 1.2 Definition of Mercantile Law is the part of civil law which deals with the rights and obligations of persons dealing with each other. It includes laws relating to contracts, partnership, sales of goods, negotiable instruments etc. 1.3 Why Chartered Accountants study law The intention of studying law in Chartered Accountancy is not to become an expert lawyer dealing with complex legal issues. The objective of studying law in Chartered Accountancy is to be aware when legal problems arise, be able to judge when outside assistance is required, evaluate the financial implications of law and also communicate with the lawyers. 1.4 Where to apply law in practical life A general knowledge of some of the more important legal principles and how they apply to certain problems will help in avoiding conflict with the people around us. Civil law involves the problems that impact on people s everyday life like debts, tenancy issues, sale of goods etc. One should know the law to which he is subject because generally ignorance of law is neither excuse nor defence. 1.5 Sources of law in Pakistan The law consists of rules that regulate the conduct of individuals, businesses, and other organizations within society. The legal system is derived from English common law (Equity) and is based on the constitution of Pakistan 1973 as well as Islamic law (sharia). Thus we can say that in Pakistan the main sources of law are following: 1. Legislation 2. Precedent 3. Custom 4. Agreement Emile Woolf International 3 The Institute of Chartered Accountants of Pakistan

20 Legislation It is the law created by the Parliament of a country and other bodies to whom it has delegated authority. Precedent Precedent is a judgment or decision of a court which are binding on the subordinate courts. Customs With the passage of time as the society develops this source of law diminished its tendency as a source of law. In Pakistan, the customary law has been replaced by the Shariat Law. Agreement Parties in their agreement stipulate terms for themselves which constitute law for the contracting parties. 1.6 Doctrine of Binding Precedent The Doctrine of binding precedent means that a judge is bound to apply decisions from earlier cases to the facts of the case before him provided certain conditions are satisfied. A precedent is established in the following circumstances. The judicial decision that creates a precedent must be based on a proposition of law or principle of law. A precedent cannot be based simply on a question of fact. It is not the actual decision in a particular case that creates the precedent: the precedent is established by a principle of law or proposition of law of the decision. This proposition or principle of law must have been used by the judge in reaching his decision in the particular case. (The reason for reaching a decision in a particular way is called the ratio decidendi.) A judicial decision may also include a statement of law that was not a part of the ratio decidendi in the case. Any such statement of the law is irrelevant to the decision and such statements are sometimes called obiter dicta, which means said by the way. Statements of the law that are obiter dicta do not form part of the binding precedent. However, they may be treated as a persuasive authority, and taken into consideration by judges in later cases. Judges who must decide on subsequent cases are required to identify the judicial precedent (if any) that applies in the case. There are comprehensive law reports on decisions in earlier cases, and judges should refer to these and look for a similar case that sets a precedent. If a precedent is discovered that was set by a court of equal or higher status, the judge dealing with the current case should normally follow this precedent. There are rules for establishing the legal principle from the details of an earlier case, and applying the principle to the facts of the current case. The legal principle must form part of the judge s ratio decidendi. The facts in the case must be materially the same as in the case that is used as the precedent. If a judge decides that the material facts in a later case are different, he or she can avoid (ignore) the precedent set by the earlier case in reaching a decision. However, a precedent established by a lower court does not necessarily have to be applied by a higher court, although in practice it is unusual for a higher court to overrule the precedent set by a lower court, if the precedent is long-established. Types of precedent Original precedent is one which creates and applies a new rule. Binding precedent is one which is required to be followed Emile Woolf International 4 The Institute of Chartered Accountants of Pakistan

21 Section A: Mercantile Law - Chapter 1: Introduction to the legal system Persuasive precedent is one which is not required to be followed e.g. a decision by lower court, decision by courts of other countries. Declaratory precedent is the application of an already existing rule of law. How can precedents be altered or avoided? Precedents can sometimes be altered or avoided by judges. Overruling a precedent. A precedent established by a lower court can be overruled by a higher court. The higher court sets aside the decision of the lower court, and the precedent ceases to apply. Making a distinction between cases. A judge may avoid a precedent by identifying facts in the current case that make it different from a previous case. If the facts are sufficiently different, the judge in the current case does not have to follow the precedent of the previous case. Judges who do not wish to apply a precedent in a particular case may therefore try to identify distinguishing features in the case, and use these to justify a decision that ignores the precedent. Advantages and disadvantages of binding precedent There are several advantages in a system of law based on binding precedent. It can save time and expense. When a new legal dispute arises, time can be saved by considering how the court is likely to make its decision based on the relevant precedent. This may persuade one party to the dispute to reach an out-of-court settlement. If the case goes to court, the existence of a precedent means that the legal arguments do not have to be repeated in the current case, because they are already established. Another important advantage of precedent and case law is that judicial decisions should be consistent in all cases of a similar nature, because judges are required to treat similar cases in the same way, as established by the precedent. Consistency in judicial decisions is an important characteristic of a good system of law, because individuals and organisations who become involved in legal disputes can often know what to expect if they take their dispute to court. (They may dispute the facts of the case, but the legal principles should be well-established.) Flexibility in the law. Judges are able to interpret the existing law, including statute law, by creating new precedents. This gives some flexibility to the law, because judges are able to develop new law without the need for new legislation by statute. There are also some disadvantages with binding precedent and case law. The large number of precedents. There are a large number of reported legal cases that can be cited as precedents in a current case. Lawyers can therefore argue about which precedents should apply in a particular case. When there is uncertainty about which precedents should apply, there will be uncertainty about the outcome of the legal dispute. This is a weakness in the law. Unjust precedents. In some cases, a precedent might be unfair or unjust. Unless the precedent is overruled by a higher court, unfair decisions will be continued in future cases. The law is weakened when it is seen to be unfair. The judiciary makes the law. Although judges are interpreting the law when they create new precedents, they are also in effect making new law. It could be argued that the judiciary should not make new law, but should do no more than interpret the established law. 1.7 Criminal law and civil law There are several branches of the law. Each deals with a different area of law and legal relationships. Two major branches of the law are: criminal law civil law Emile Woolf International 5 The Institute of Chartered Accountants of Pakistan

22 Criminal law Criminal law establishes conduct that the State considers unacceptable, and which it wishes to prevent. Individuals or organisations that act contrary to the criminal law are threatened with punishment by the State, in the form of imprisonment and/or fines. With criminal law, the State establishes acceptable standards of behaviour, and represents the interests of society as a whole in doing so. Legal action may be brought by the State against individuals who are accused of being in breach of the criminal law. It is the responsibility of the State (and not private individuals) to bring these legal actions, in criminal trials. Civil law The civil law is a branch of the law that primarily deals with disputes between individuals and organisations (such as companies), and it regulates relationships between them regarding their rights and obligations. A violation of the civil law is a tort (a wrongdoing), but is not a crime. The civil law provides for remedies for civil wrongs (torts), but these do not include imprisonment. Civil law may be established by statute or by case law (common law), codification, interpretation of the law, consideration, and so on. Example: Civil law property disputes (Transfer of property act) work-related disputes (employment law) accusations of negligence (negligent behaviour) (Tort) claims by consumers against manufacturers or service providers commercial disputes between business entities (commercial law) copyright disputes claims of defamation of character (Tort) disputes about an alleged breach of contract (Contract Act) Legal proceedings in the civil law are initiated by an individual or private person against another. (In contrast, a criminal prosecution is brought to court by the State.) For example, an individual may bring a civil action against another person, claiming a wrongdoing by that person and seeking a settlement (for example, seeking money compensation in the form of damages.) A civil case might therefore be identified as: Tanveer v Khatri where a case is brought to the civil court by Tanveer (the plaintiff ) who is making a claim against Khatri (the claimant). Criminal law or civil law? Many of the legal aspects of commercial and business law are aspects of the civil law, but the criminal law may also apply. For example fraud and money laundering are criminal activities that may occur in business. It is also important to remember that the same action may be in breach of the criminal law and also a tort in civil law. In such a situation, the action may give rise to: criminal prosecution by the State and civil action by a private person, claiming a remedy such as damages. Example: Criminal law and Civil law Suppose that a train company operates a train service, and there is a major accident involving loss of life and injury to passengers. The State may claim that the train company or its senior managers are guilty of a breach of the criminal law and bring a case in the criminal court. Individuals who have been injured in the crash and individuals who have lost a relative killed in the crash may bring civil actions against the train company, demanding compensation. Business managers must therefore be aware of both the criminal law and civil law implications of their activities. Emile Woolf International 6 The Institute of Chartered Accountants of Pakistan

23 Section A: Mercantile Law - Chapter 1: Introduction to the legal system The burden of proof Another important difference between criminal law and civil law is the burden of proof that is required by a court. In criminal cases, the burden of proof is much greater than in civil law cases. The guilt of an accused person needs to be proved beyond all reasonable doubts. In contrast, in civil cases the court needs to be satisfied on the balance of probabilities that a person is liable. This means that an individual accused of a crime might be found not guilty in a criminal court, but the same individual may be sued in a civil court for the same may be found liable. Emile Woolf International 7 The Institute of Chartered Accountants of Pakistan

24 2 LEGISLATION Section overview President Prime Minister Senate National Assembly Process of Legislation Delegated Legislation Pakistan has a Federal Parliamentary System of government, with the President as the Head of State and popularly elected Prime Minister as Head of Government. The Federal Legislature is a bicameral Majlis-e-Shoora (Parliament), composed of the President, National Assembly (Lower House) and Senate (Upper House). 2.1 President The President of Pakistan is Pakistan s Head of State and is considered a symbol of unity. President must be a Muslim. President is elected for a five year term by Senate, National Assembly and members of Provincial Assemblies. President is eligible for re-election, but no individual may hold the office for more than two consecutive terms. The majority party in the National Assembly usually nominates and elects a person as the President. The President approves the statutes passed by the National Assembly and thereafter by the Senate. He guides the Prime Minister in the matters of national importance. 2.2 Prime Minister The Prime Minister must be nominated and elected by a majority of members in the National Assembly. That individual is then appointed as Prime Minister by the President. The Prime Minister is assisted by the Federal Cabinet. A council of ministers whose members are appointed by the President on the advice of the Prime Minister. Federal Ministers are supported by secretaries and other government officers appointed in each department for ensuring that policies formulated by the government are acted upon. 2.3 Senate The Senate is a permanent legislative body with equal representation from each of the four Provinces with representatives elected by the members of their respective Provincial Assemblies. The role of the Senate is to promote national cohesion and harmony and to alleviate fears of the smaller provinces regarding domination by any one province because of its majority, in the National Assembly. There are also representatives from the Federally Administered Tribal Areas and Islamabad Capital Territory. Emile Woolf International 8 The Institute of Chartered Accountants of Pakistan

25 Section A: Mercantile Law - Chapter 1: Introduction to the legal system Members are elected for a period of six years. Half the members retire after three years and are replaced by the equal number of newly elected senators. Senate is a permanent institution. The election of all members is not held at the same time and so it continues to be present on a permanent basis. The Chairman of the Senate under the constitution is next in line to act as President if the office becomes vacant and until such time a new President can be formally elected. The members elect from themselves a chairman and a Deputy Chairman. All statutes passed by the National Assembly are also approved by the Senate with the exception of money bills. Composition of Senate Punjab Sindh Khyber Pakhtokhwa Baluchistan Fata Federal Capital Total General Women Technocrats Minority Fourteen shall be elected by members each Provincial Assembly Four women shall be elected by members of each Provincial Assembly Four technocrats including Ulema shall be elected by the members of each Provincial Assembly. Eight shall be elected from the Federally Administered Tribal Areas in such manner as the President may by order prescribe. Two on general seats and one woman and one technocrat including aalim shall be elected from the Federal Capital in such manner as the President may by order prescribe. Four non-muslims, one from each Province, shall be elected by the members of each Provincial Assembly. 2.4 National Assembly The seats for the national assembly are determined on the basis of population of provinces. The members are elected for a period of five years on the basis of direct votes by the voters registered. The members elect from themselves Speaker, Deputy Speaker and Prime Minister. The most important function of the National Assembly is law making and formulation of policies. Composition of National Assembly Punjab Sindh Khyber Pakhtokhwa Baluchistan Fata Federal Capital Total General Women Minority Emile Woolf International 9 The Institute of Chartered Accountants of Pakistan

26 2.5 Process of Legislation When National Assembly is in session a bill in respect of any matter may originate in either house. Scenario 1: If it is passed by the house in which it is originated then it is transmitted to the other house and If the bill is also passed by the other house (without any amendment) then it is presented to the President for assent. Scenario 2: If the bill is transmitted to a House and is passed with amendments it shall be sent back to the House in which it originated and if that House passes the Bill with those amendments it shall be presented to the President for assent. Scenario 3: If a bill transmitted to a House is rejected or not passed within ninety days or a Bill sent to a House with amendments is not passed by that House with such amendments The bill at the request of the house in which it originated shall be considered in the joint sitting of both the house i.e. National Assembly and the Senate and If it is passed by the votes of the majority of the members present and voting in the joint sitting it shall be presented to the President for assent. Scenario 4: When the President has returned a Bill to the Parliament it shall be reconsidered by the Parliament in Joint Sitting and If it is again passed with or without amendment by the Parliament by the votes of the majority of the members of both Houses present and voting. It shall be presented to the President for assent. The President shall within ten days assent to the bill or return it to the Parliament for reconsideration (in case of a bill other than money bill) of any provision or any amendment therein. In case a bill is pending in the National Assembly or passed by it, is pending in the Senate. The bill shall lapse on the dissolution of National Assembly. But if the bill is pending in the Senate not passed by the National Assembly shall not lapse on dissolution of the National Assembly. Money bills A money bill shall originate in the National Assembly and after it has been passed by the Assembly it shall (without being transmitted to the Senate) be presented to the President for assent. Ordinance The President if deems necessary to take immediate action, he has power to make an Ordinance when the National Assembly is not in session. Such Ordinance promulgated thus, shall have the same force and effect as an Act of the Parliament. The Ordinance shall stand repealed after one hundred and twenty days if it is not presented or passed by the National Assembly in case of Money Bill and by both houses if it is other than Money Bill. Emile Woolf International 10 The Institute of Chartered Accountants of Pakistan

27 Section A: Mercantile Law - Chapter 1: Introduction to the legal system The chart below shows the process of legislation Process of Legislation When National Assembly is in session When National Assembly is not in session Money bills All other bills President National Assembly Senate National Assembly Ordinance President Assent Act / Law Reject / Amend Sent for reconsideration to Parliament (joint sitting of National Assembly and Senate) 2.6 Delegated Legislation In Delegated Legislation power is given to an Executive (a minister or public body to make subordinate or delegated legislation for specified purposes only). E.g. Local authorities are given statutory powers to make bye-laws which apply within a specific locality. Control over delegated legislation Parliament has some control over delegated legislation by restriction and defining the power to make rules. Rules made under delegated power to move legislation may be challenged in the courts on the grounds that it is ultra vires. In other words that it exceeds the prescribed limits or has been made without due compliance. If the objection is valid the court declares it void. Advantages of delegated legislation Time Parliament does not have time to examine matters in detail Expert opinion Much of the content of delegated legislation is technical and is better worked out in consultation with professional, commercial or industrial groups outside Parliament. Emile Woolf International 11 The Institute of Chartered Accountants of Pakistan

28 Flexible Delegated legislation is more flexible than an Act of Parliament. It is far simpler to amend a piece of delegated legislation than to amend an Act of Parliament. Disadvantages of delegated legislation The main criticism of delegated legislation is that it takes law making away from the democratically elected members. Power to make law is given to unelected civil servants and experts working under the supervision of a government minister. Because delegated legislation can be produced in large amounts the volume of such law making becomes unmanageable and it is impossible to keep up-to-date. Emile Woolf International 12 The Institute of Chartered Accountants of Pakistan

29 Section A: Mercantile Law - Chapter 1: Introduction to the legal system 3 STRUCTURE OF COURTS IN PAKISTAN Section overview Supreme Court High Courts Criminal Courts Civil Courts Federal Shariat Court Alternate Dispute Resolution The structure of courts in Pakistan has the following basis levels: Supreme court High courts Federal Shariat Court Criminal courts Civil courts Session court Magistrate court District court Civil court 3.1 Supreme Court The Supreme Court of Pakistan is the highest appellate court of the country and court of last resort. It is the final arbiter of the law and the Constitution. Its orders/decisions are binding on all other courts in the country. All executive and judicial authorities are bound to act in aid of the Supreme Court. The Constitution contains elaborate provisions on the composition, jurisdiction, powers and functions of the Court. The Constitution assigns the Supreme Court a unique responsibility of maintaining harmony and balance between the three pillars of the State, namely, the Legislature, the Executive and the Judiciary. As guardian of the Constitution, the Court is required to preserve, protect and defend this basic document. Jurisdiction of Supreme Court The Supreme Court exercises original, appellate and review jurisdiction. It possesses exclusive original jurisdiction for the settlement of intergovernmental disputes between Federal and Provincial Government(s) or Provincial Governments inter se. Under this jurisdiction, the Court pronounces declaratory judgments. The Supreme Court can also exercise original jurisdiction, with respect to the enforcement of fundamental rights, if the case involves an issue of public importance. The Court also exercises advisory jurisdiction, where under the President may obtain its opinion on a question of law. Under its appellate jurisdiction, the Court entertains appeals against orders and decisions of High Courts and other special courts/tribunals. Emile Woolf International 13 The Institute of Chartered Accountants of Pakistan

30 Criteria to be Judge of Supreme Court 3.2 High Courts A person with five years experience as a Judge of a High Court or Fifteen years standing as an advocate of a High Court is eligible to be appointed as Judge of the Supreme Court. There is one High Court in each province, and one in the federal capital, Islamabad, including: Lahore High Court, Lahore, Punjab Sindh High Court, Karachi, Sindh Peshawar High Court, Peshawar, Khyber Pakhtunkhwa Balochistan High Court, Quetta, Baluchistan Islamabad High Court, Islamabad, The High Court has supervisory role over other Courts subordinate to it. It may issue a writ of habeas corpus which is an order for the release of a person wrongfully detained, and also prerogative orders against inferior courts, tribunals and other bodies such as local authorities in so far as they have a duty to exercise a discretion fairly. Criteria to be Judge of High Court Ten years experience as an advocate of a High Court or Ten years service as a civil servant including three years experience as a District Judge or Ten years experience in a judicial office. There are three types of prerogative order. 1. Mandamus 2. Prohibition 3. Certiorari 1. Mandamus Mandamus requires the court or other body to carry out a public duty. E.g. a tribunal may be ordered to hear an appeal which it has wrongly refused to do. 2. Prohibition It prevents a court or tribunal from exceeding its jurisdiction. 3. Certiorari Certiorari orders a court or tribunal which has taken action to submit the record of its proceedings to the High Court for review. It is exercised when an inferior court has acted illegally, exceeding its jurisdiction or reached its decision contrary to the principles of natural justice, without giving the person concerned the right to know of and reply to the case against him. Areas of jurisdiction of the High Court Following are the few areas of jurisdiction of the High Court Original civil jurisdiction Appellate civil jurisdiction Appellate criminal jurisdiction Supervisory jurisdiction Constitutional jurisdiction Emile Woolf International 14 The Institute of Chartered Accountants of Pakistan

31 Section A: Mercantile Law - Chapter 1: Introduction to the legal system 3.3 Criminal Courts The criminal courts structure is given below: Courts Staff Jurisdiction Supreme Court of Pakistan High Court Chief Justice Justice Chief Justice Justice Discussed earlier Supervisory control Sessions Court Sessions Judge All other offences not covered in Judicial Magistrate Jurisdiction, but sentence of death is Additional Sessions Judge passed subject to the confirmation of High Court. Cases of enforcement of law relating to Hudood are also tried by sessions judges. Magistrates Court Assistant Sessions Judge Judicial Magistrate 1 st Class Judicial Magistrate 2 nd Class Judicial Magistrate 3 rd Class Special Judicial Magistrate Offences with punishment not exceeding seven years. Offences with punishment of imprisonment for a term not exceeding three year, fine not exceeding Rs. 15,000 and whipping. Offences with punishment of imprisonment for a term not exceeding one year, fine not exceeding Rs. 5,000. Offences with punishment of imprisonment for a term not exceeding one month, fine not exceeding Rs Provincial Government on recommendation of High Court confer upon any person powers of Judicial Magistrate. Sessions Judge Each province consists of sessions / divisions and every session division shall be a district or consists of districts. The Provincial Government established a Court of Session for every sessions / division and appoints a judge of such court called session judge. Additional Sessions Judges The Provincial Government may also appoint Additional Sessions Judges and Assistant Sessions Judges to exercise jurisdiction in one or more such courts. Magistrates courts Magistrates Courts are the subordinate criminal courts. In addition, they also exercise certain family law, administrative law and minor civil functions. District Magistrate In every district, the Provincial Government appoints a Magistrate of first class, who is called the District Magistrate. Subordinate Magistrate The Provincial Government appoints as many persons as it thinks fit besides the District Magistrate as Magistrates of the first, second or third class in any district and defines local areas within which such persons may exercise all or any of the powers as invested. Emile Woolf International 15 The Institute of Chartered Accountants of Pakistan

32 Criminal court Appeals Magistrates Courts Assistant Sessions Court Conviction for Sedition (trouble making) Sessions Court High Court Conviction for more than 4 years Division Bench of High Court Supreme Court of Pakistan 3.4 Civil Courts Courts Staff Jurisdiction Supreme Court of Pakistan High Court District Court Civil Court / Rent Controller / Family Court Chief Justice Justices Chief Justice Justices District Judge Additional District Judge Civil Judge 1 st Class Civil Judge 2 nd Class Civil Judge 3 rd Class Writ Jurisdiction in issues of public importance. Supervisory Control Company Bench Banking Court Certain suits of unlimited value of subject matter. Suit of unlimited value of subject matter. Suit having value of subject matter not exceeding Rs. 50,000. Suit having value of subject matter not exceeding Rs. 5,000. Additional District Judge In every district of a Province, there is a Court of District Judge which is the principal court of original jurisdiction in civil matters. Government in consultation with the High court, appoints as many Additional District Judges as may be necessary. An additional district judge discharges such functions of a District Judge as the District Judge assigns him and has the same powers like that of District Judge. Civil Judge Civil Judges function under the superintendence and control of District Judge and all matters of civil nature originate in the courts of Judges. The District Judge may, however, withdraw any case from any Civil Judge and try it himself. Emile Woolf International 16 The Institute of Chartered Accountants of Pakistan

33 Section A: Mercantile Law - Chapter 1: Introduction to the legal system Appeals against the judgments and decrees passed by the Civil Judges in cases where the value of the suit does not exceed the specified amount lie to the District Judge. Civil court Appeals Civil Courts Suits value below Rs.200,000 Suit value above Rs. 200,000 District Court High Court / Company Bench / Banking Court Division Bench of High Court Supreme Court of Pakistan Family Courts These courts deal with matrimonial cases. Most divorce cases are heard in the family court, family property cases and proceedings relating to children etc. Company Courts The court having jurisdiction under the Companies Act, 2017 is the High court having jurisdiction in the place at which the registered office of the company is situated. The Federal Government may empower any civil court to exercise all or any of the jurisdictions by this ordinance. In each High Court one or more benches known as the company bench are constituted by the chief justice of High Court. All the matters coming before the court under this Ordinance are disposed of within ninety days from the date of presentation. Industrial Tribunal Industrial Tribunals were established by the Industrial Relation Act, They have a wide jurisdiction over most disputes between employee and employer. Redress of individual grievances Complaints of unfair dismissal Pay claims Questions as to the terms of employment Appeals against health and safety notices. Terms to remember Juveniles: Any offence, other than one punishable with death or transportation for life, committed by any person under the age of fifteen years. The age is calculated at the date when he appears or brought before the court, may be tried by a District Magistrate working under the Reformatory Schools Act, Emile Woolf International 17 The Institute of Chartered Accountants of Pakistan

34 Decision reversed: If an appeal court gives its judgment in favour of the party making the appeal (the appellant) the original decision is said to be reversed. Court of first instance: It is the court where the case is originally heard in full. Appellate Court: It is the court to which an appeal is made against the judgment or the sentence. 3.5 Federal Shariat Court Courts Supreme Court of Pakistan Federal Shariat Court Staff Chief Justice Justices Chief Justice Justices Composition of Federal Shariat Court The Federal Shariat Court consists of not more than eight Muslim Judges including the Chief Justice who are appointed by the President in accordance with Article 175A. Out of the number not more than three shall be Ulema having at least fifteen years experience in Islamic law, research or instruction and not more than four each, one of them Process is or has been or is qualified to be a Judge of High Court. The judges hold office for a period of three years. However, the President may, extend such period. The Court may either of its own motion or on the petition of - citizen of Pakistan or - the Federal / Provincial Government examine and decide the question whether or not any law or provision of the law is repugnant to the Injunctions of Islam. If Federal Shariat court decides that a law or the provision of any law is repugnant to the Injunctions of Islam, it shall set out in its decision: The reasons for its holding that opinion and The extent to which such law or provision is so repugnant Emile Woolf International 18 The Institute of Chartered Accountants of Pakistan

35 Section A: Mercantile Law - Chapter 1: Introduction to the legal system And specify the day on which decision shall take effect. Provided that no such decision shall take effect before the expiration of the period within which an appeal may be preferred to the Supreme Court or where an appeal has been so preferred, before the disposal of such appeal. Appeal to Supreme Court A party aggrieved by the final decision of the court within sixty days of such decision may prefer an appeal to the Supreme Court. An appeal on behalf of the Federation or a Province may be preferred within six months of such decision. 3.6 Alternate Dispute Resolution Alternate Dispute Resolution (ADR) is any type of procedure or combination of procedures voluntarily used to resolve issues in controversy, other than court based adjudication. ADR is generally classified into following types: Negotiation In negotiation the participation is voluntary and there is no third party who facilitates the resolution process or imposes a resolution. Mediation In mediation there is a third party a mediator is a person who facilitates the resolution process but does not impose a resolution on the parties. Arbitration Arbitration is settlement of a dispute by an independent person usually chosen by the parties themselves. Conciliation It is a process in which conciliator meets with the parties separately to resolve the grievances. Advantages of ADR Speedy Arbitration is often faster than litigation in court. Cheaper and Flexible Arbitration can be cheaper and more flexible for businesses. Privacy The public and the press have no right to attend a hearing before an arbitrator. Appeal In most legal systems, there are very limited avenues for appeal of an arbitral award. Service of an expert The parties may choose the person who is an expert in the particular commercial field that they are in to settle their dispute. Disadvantages of ADR Appeal Limited Avenue for appeal means that an erroneous decision cannot be easily overturned. Expensive In countries where the cost of court action is not so high this might be more expensive to go to arbitration. Emile Woolf International 19 The Institute of Chartered Accountants of Pakistan

36 Applicability of law Rules of applicable law are not necessarily binding on the arbitrators, although they cannot disregard the law. Delay When there are multiple arbitrators on the panel, manage their schedules for hearing dates in long cases can lead to delays. Arbitration in Islamic way Islamic arbitration is known as Takhim. Qualification to be an arbitrator Must be a Muslim Male Knowledge in Sharia and Free from any defects that could affect his ability to arbitrate. Emile Woolf International 20 The Institute of Chartered Accountants of Pakistan

37 Section A: Mercantile Law - Chapter 1: Introduction to the legal system 4 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Briefly describe the sources of law in Pakistan Understand the civil and criminal law Explain the purpose and constituents of Parliament Explain the procedure followed for enactment of any law in Pakistan Discuss the structure of the courts in Pakistan Emile Woolf International 21 The Institute of Chartered Accountants of Pakistan

38 Emile Woolf International 22 The Institute of Chartered Accountants of Pakistan

39 Certificate in Accounting and Finance C H A P T E R 2 Introduction to the law of contract Contents 1 Introduction to the law of contract 2 Chapter review Emile Woolf International 23 The Institute of Chartered Accountants of Pakistan

40 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Introduction to the law of contract LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to Contract Act. LO Define contract, agreement and promise LO Identify essential elements of a valid contract LO Be aware of factors which might affect the validity of a contract and their consequences LO Identify different types of a contract. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 24 The Institute of Chartered Accountants of Pakistan

41 Section A: Mercantile Law - Chapter 2: Introduction to the law of contract 1 INTRODUCTION TO THE LAW OF CONTRACT Section overview Definition of a contract Essentials of a valid contract Classifications of contract 1.1 Definition of a contract Definition: Contract [Section 2(h)] An agreement enforceable by law is a contract. A contract is an agreement which legally binds the parties. The analysis of the above definition reveals that a contract has following two elements: Contract Agreement Enforceability Offer Acceptance Legal obligation These two essentials are discussed below: Definition: Agreement [Section 2(e)] Every promise and every set of promises forming the consideration for each other is an agreement. The analysis of the above definition reveals that an agreement comes into existence only when one party makes a proposal or offer to the other party and the other party signifies his acceptance thereto. Thus an agreement can be an accepted proposal. Definition: Promise [Section 2(b)] When the person to whom the proposal is made signifies his assent to it, the proposal is said to be accepted. A proposal, when accepted becomes a promise. The person making the proposal is called the promisor and the person accepting the proposal is called the promisee. Definition: Proposal [Section 2(a)] When one person signifies to another his willingness to do or to abstain from doing anything, with a view to obtaining the assent of that other to such act or abstinence, he is said to make a proposal. Emile Woolf International 25 The Institute of Chartered Accountants of Pakistan

42 Enforceability Every contract is an agreement, but every agreement is not always a contract. An agreement creating a legal obligation is said to be enforceable by law. The parties to an agreement must be bound to perform their promises and in case of default by either of them, must intend to sue. For an agreement to be enforceable by law there should be legal obligation instead of social, moral or religious obligation. Example: Enforceability A, offers to sell his furniture to B or Rs. 50,000. B accepts this offer. In this agreement if there is default by either party, an action for breach of contract can be enforced through a court of law provided all the essential elements of a valid contract are present in this agreement. A invites B to dinner. B accepts the invitation but fails to turn up. Here, A cannot sue B for damages because the parties to this agreement do not intend to create legal obligations. Thus, the law of contract covers such agreements where the parties intend to create legal obligations. In social, domestic, moral and religious obligation the usual presumption is that the parties do not intend to create legal obligations. 1.2 Essentials of a valid contract The essentials of a valid contract are shown below [Section 10]: These essentials are discussed below: Offer and acceptance There must be an agreement between parties to create a valid contract. An agreement involves a valid offer and its acceptance. Example: Offer and acceptance A offers to buy bike from B for Rs.50,000 to which B responds positively. Here A has made an offer and B has accepted it Emile Woolf International 26 The Institute of Chartered Accountants of Pakistan

43 Section A: Mercantile Law - Chapter 2: Introduction to the law of contract Offer and acceptance is discussed in detail in Chapter 3. Legal relationship A contract to become valid must have a legal relationship. In case of social or domestic agreements, the usual presumption is that the parties do not intend to create legal relationship but in commercial or business agreements, the usual presumption is that the parties intend to create legal relationship unless otherwise agreed upon. Example: Legal relationship A invited B on a dinner at his home. B accepted the invitation. It is a social agreement. If A fails to serve dinner to B than B cannot go to court for enforcing the agreement and similarly if B did not turn up than A cannot go to court for enforcing the agreement. Competency of parties As per section 11 the parties to an agreement must be competent to contract. In other words, the person must be of The age of majority Person of sound mind and Not declared as disqualified from contracting by any law to which he is subject. Example: Competency of parties A (Minor) borrowed Rs. 100,000 from B and executed mortgage of his property in favour of the lender. This is not a valid contract because A is not competent to contract. Competency of parties is discussed in detail in Chapter 4. Consideration As per section 23 an agreement must be supported by lawful consideration. Gratuitous (without consideration) promises are not enforceable at law. Consideration requires not only presence of consideration but also lawfulness of consideration. Example: Consideration A offers to buy IPAD from B for Rs. 50,000 to which B responds positively. Here A s promise to pay Rs. 50,000 is the consideration for B s promise and B s promise to sell the IPAD is the consideration for A s promise. Consideration is discussed in detail in Chapter 5. Free Consent As per section 14 an agreement must be made between parties by free consent. In other words, the consent must not be obtained from following: Coercion Undue influence Fraud Misrepresentation Mistake Example: Free consent A beats B and compels him to sell his bike for Rs. 20,000. Here, B s consent has been obtained by coercion because beating someone is an offence under the Pakistan Penal Code. Emile Woolf International 27 The Institute of Chartered Accountants of Pakistan

44 Example: Free consent (continued) A having advanced money to his son, B during his minority, upon B s coming of age obtains, by misuse of parental influence, a bond from B for a greater amount than the sum due in respect of the advances. A employs undue influence. Free consent is discussed in detail in Chapter 6. Lawful Object As per section 23 the object of an agreement must be lawful. An object is said to be unlawful when: It is forbidden by law Is of such a nature that if permitted would defeat the provisions of any law It is fraudulent It involves an injury to the person or property of another The court regards it as immoral, or opposed to public policy Example: Lawful object A, B and C enter into an agreement of the division among them of gains acquired, or be acquired, by them by fraud. The agreement is void, as its object is unlawful. A promises to obtain for B an employment in the public service, and B promises to pay Rs.10,000,000/-to A. The agreement is void as the consideration for it is unlawful. A, who knows that B has stolen goods amounting to Rs.500,000, receives Rs.100,000 from B in consideration of not exposing A. This agreement is illegal. Lawful object is discussed in detail in Chapter 7. Not declared as void As per section 24 to 30 an agreement which is not enforceable by law is called void agreement. There are certain agreements which have been expressly declared as void such as: Agreement, the consideration or object of which is partly unlawful Agreement made without consideration Agreement in restraint of marriage Agreement in restraint of legal proceedings Agreement in restraint of trade Uncertain agreements Wagering agreement Example: Not declared as void A and B carried on business in a certain locality in Karachi. A promised to stop business in that locality if B paid him Rs 1,000 per day. A stopped his business but B did not pay him the promised money. It was held that A could not recover anything from B because the agreement was in restraint of trade and was thus void (restraint of trade). A promises to pay Rs 10,000 to B if it rained today, and B promises to pay Rs 1,000 to A if it did not. The agreement is void because the happening and non-happening is dependent on future uncertain event (wager). Void agreements are discussed in detail in Chapter 8. Emile Woolf International 28 The Institute of Chartered Accountants of Pakistan

45 Section A: Mercantile Law - Chapter 2: Introduction to the law of contract Certainty As per section 29 an agreement may be void on the grounds of uncertainty. The meaning of the agreement must be certain or capable of being certain. Example: Certainty A agrees to sell to B "a hundred ton of oil." There is nothing whatever to show what kind of oil was intended. The agreement is void for uncertainty. A, who is a dealer in coconut oil, agrees to sell to B "one hundred ton of oil." The nature of A's trade affords an indication of the meaning of the words, and has entered into a contract for the sale of one hundred tons of coconut oil. A agrees to sell to B "all the grain in my granary at Peshawar." There is no uncertainty here to make the agreement void. A agrees to sell to B "one thousand mounds of rice at a price to be fixed by c." As the price is capable of being made certain, there is no uncertainty here to make the agreement void. A agrees to sell to B "my white horse for Rupees five hundred or Rupees one thousand." There is nothing to show which of the two prices are to be given. The agreement is void. Possibility of performance As per section 56 the terms of the agreement must be capable of being performed. An agreement to do an act impossible in itself is void. Example: Possibility of performance A agrees with B to discover treasure by magic. The agreement is void. Legal formalities As per section 25 an oral contract is a perfectly valid contract, except in certain cases where a contract must comply with the necessary formalities as to writing, registration etc. Example: Legal formalities An oral agreement for arbitration about present disputes is unenforceable because the law requires that such arbitration agreement must be in writing. 1.3 Classifications of contract The different classifications of contract are shown below: Formation Express contracts Implied contracts Quasi contracts Enforceability Valid contracts Void agreement Void contract Voidable contract Illegal agreement Unenforceable agreement Performance Executed contract Executory contract Emile Woolf International 29 The Institute of Chartered Accountants of Pakistan

46 The above classifications of contract are briefly discussed below: Express contracts Implied contracts Quasi contracts Valid contract Void agreement Section 2(g) Void contract Section 2(j) Voidable contract Section 2(i) Illegal agreements Unenforecable agreement Executed contract Executory contract Unilateral contract Bilateral contract A contract created by words i.e. verbally or in writing A contract created by conduct of a person or the circumstances of a particular case. An obligation imposed by law. An agreement which is enforceable by law. An agreement which is not enforecable by law. A contract which ceases to be enforceable by law becomes void when it ceases to be enforceable. An agreement which is enforceable by law at the option of the aggrieved party. An agreement the object of which is illegal. An agreement which is otherwise valid but due to some technical lacking, such as writing etc. remains unenforceable. A contract where both the parties have performed their respective promises. A contract in which something remains to be done. A contract is which a promise on one side is exchanged for an act on the other side. In such contract one party to a contract has performed his part and performance is outstanding against the other party. A contract in which a promise on one side is exchanged for a promise on the other. Example: Void contract A music hall was rented out for a series of concerts. The hall caught fire before the date of first concert. The contract was valid at the time of its formation but became void when hall caught fire. Example: Void agreement A (Minor) borrowed Rs. 100,000 from B and executed mortgage of his property in favour of the lender. This is a void agreement because A is not competent to contract and B cannot legally enforce against A. Example: Voidable contract A threatens to kill B if he does not sell his BMW for Rs 1 million to A. B contracted to sell his BMW to A and receives the payments. Here, B s consent has been obtained by coercion. Hence, this contract is voidable at the option of B but B has no right to insist that contract shall be performed. Example: Illegal agreement A, who knows that B has stolen goods amounting to Rs.500,000, receives Rs.100,000 from B in consideration of not exposing A. This agreement is illegal. Example: Unenforceable agreement An oral agreement for arbitration about present disputes is unenforceable because the law requires that such arbitration agreement must be in writing. Emile Woolf International 30 The Institute of Chartered Accountants of Pakistan

47 Section A: Mercantile Law - Chapter 2: Introduction to the law of contract 2 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Understand the meaning of a contract Discuss the essentials of a valid contract Explain the different classifications of contract Emile Woolf International 31 The Institute of Chartered Accountants of Pakistan

48 Emile Woolf International 32 The Institute of Chartered Accountants of Pakistan

49 Certificate in Accounting and Finance C H A P T E R 3 Offer and acceptance Contents 1 Offer 2 Acceptance 3 Revocation of offer and acceptance 4 Chapter review Emile Woolf International 33 The Institute of Chartered Accountants of Pakistan

50 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Offer and acceptance LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to offer and acceptance of a contract. LO Define offer and acceptance LO Identify different types of offers LO Explain how offer is different from invitation of an offer LO Identify essential elements of offer and acceptance LO Understand the timing of revocation and its communication LO Identify circumstances when an offer lapses. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 34 The Institute of Chartered Accountants of Pakistan

51 Section A: Mercantile Law - Chapter 3: Offer and acceptance 1 OFFER Section overview Definition of proposal / offer Essentials of an offer Types of offer 1.1 Definition of proposal / offer Definition: Proposal / offer [Section 2(a)] When one person signifies to another his willingness to do or to abstain from doing anything, with a view to obtaining the assent of that other to such act or abstinence, he is said to make a proposal. Thus, an offer is a proposal by one person to another for entering into a legally binding agreement with him. 1.2 Essentials of an offer The essentials of an offer are shown below: These essentials are discussed below: Two persons For a valid offer there needs to be two persons. A person cannot make an offer to himself. The person making the proposal is called offeror and the person to whom offer is made is called offeree. Certain and definite A valid offer is one which is certain and definite. Thus, no contract can come into existence if offer is uncertain. Emile Woolf International 35 The Institute of Chartered Accountants of Pakistan

52 Contractual intention An offer must be made with an intention to create a contract. Communication The offer must be communicated to the offeree. The communication is complete when it comes to the knowledge of the person to whom it is made. In case an offer is made by post, its communication will complete when the letter reaches the offeree. An offer can be made by words spoken or written or through conduct of the person. [Section 4] Objective of consent An offer must be made with a view to obtain the consent of the other person to proposed act or abstinence. Conditional An offer may be subject to some condition. It is on the sole discretion of the person to whom such offer is made to either accept or reject it. A conditional offer lapses when condition is not accepted. Negative confirmation An offer cannot be in the form of negative confirmation i.e. if it is not accepted within a specific time then it will be presumed to have been accepted. Invitation of an offer An offer is different from an invitation of an offer. The intention in invitation of an offer is to circulate information of his readiness to do the transaction. Such intentions are not offers and do not tantamount to promise on acceptance. In other words, an invitation of an offer means an intention of a person to invite others with a view to enter into an agreement. Example: Invitation of an offer Goods were displayed in a departmental store for sale and self-service system was there. One customer selected an item. Here the display of goods is an invitation to offer and selection by the customer is an offer to buy. Communication of special conditions When there are special terms and conditions in an offer they must be specifically communicated to the other party. 1.3 Types of offer Following are the different types of offer:. Specific Offer General offer Cross offers Standing / Open / Continuing offer / Tender If an offer is made to definite or a particular person or specific group of persons it is said to be specific offer. Such offer can be accepted only by that definite person or that specific group of persons. If an offer is made to the world or public than it is said to be general offer. Such offer can be accepted by any person. The contract is made with person who having the knowledge of the offer comes forward and acts according to the conditions of the offer. If two parties ignorant of each other s offer made similar offers to each other they are called cross offers. Cross offers are not equal to acceptance. If an offer is of on-going nature it is said to be a standing offer. A contract is entered only when the person signifies his acceptance on the basis of the tender. Emile Woolf International 36 The Institute of Chartered Accountants of Pakistan

53 Section A: Mercantile Law - Chapter 3: Offer and acceptance Example: Specific Offer A offers to buy bike from B for Rs.50,000. Example: General Offer A advertised in the newspaper that he would pay Rs.50,000 to anyone who traces his d o g. B, who knew about the reward traced that dog and sent a message to A that he had found his dog. It was held that A was entitled to receive the amount of reward. Example: Cross offers A of Karachi sends by post to B of Lahore offering to sell his bike for Rs.50,000. The letter is posted on 1 st December and on same day, B of Lahore sends a letter by post to A of Karachi offering to buy A s bike for Rs.50,000. Example: Standing / Open / Continuing offer / Tender A required a large quantity of certain goods during a year and offered this by an advertisement. B supplied those goods at a specific rate. Every supply of B is an acceptance of the standing offer of A. Emile Woolf International 37 The Institute of Chartered Accountants of Pakistan

54 2 ACCEPTANCE Section overview Meaning of acceptance Essentials of acceptance 2.1 Meaning of acceptance When the person to whom the proposal is made signifies his assent to it, the proposal is said to be accepted. [Section 2(b)] Thus, an acceptance means assenting to an offer made. An offer when accepted becomes a promise. 2.2 Essentials of acceptance The essentials of acceptance are shown below: These essentials are discussed below: Absolute and unconditional An offer should be accepted without any condition. If any condition is imposed on an offer then it turns out to be counter offer instead of acceptance. [Section 7] Communication The acceptance may be complete when it is communicated to the offeror. An offer can be accepted by words spoken or written or through conduct of the person. Further, a valid acceptance is communicated either by the offeree himself or any person authorized by him to communicate to the offeror. Emile Woolf International 38 The Institute of Chartered Accountants of Pakistan

55 Section A: Mercantile Law - Chapter 3: Offer and acceptance Postal rule The communication of acceptance by post is complete as against the proposer when it is put in a course of transmission. In case of acceptance made by post, the proposer becomes bound as soon as the letter of acceptance is posted even if such letter is lost or delay. The communication is complete as against the acceptor when it comes to the knowledge of the proposer. In case of acceptance by post, the acceptor becomes bound when the letter of acceptance is actually received, before that acceptor may revoke his acceptance. Contracts over telephone / telex / fax A contract by telephone / telex / fax is treated on the same principle as an oral agreement made between two parties when they are face to face with each other. In such cases, the contract will complete only when the acceptance is received by the proposer and not when it is transmitted by the acceptor. Reasonable time A valid acceptance is when it is accepted within the time specified or within a reasonable time where no time is specified. Reasonable mode Acceptance should be made in the manner specified or in a usual manner where no mode is specified. If the proposal prescribes a manner in which offer is to be accepted and the acceptance is not made in that manner. The offeror shall, in this case, when the acceptance is communicated to him, insist that his proposal shall be accepted in the prescribed manner and not otherwise. If the offeror fails to insist within a reasonable time it is deemed that he has accepted the performance. Awareness of proposal The acceptor must be aware of the proposal at the time of acceptance of the proposal. Before lapse of an offer The acceptance must be given before the offer lapses or is withdrawn. Negative confirmation A proposal is not accepted if the offeree remains silent. In cannot be in the form of negative confirmation i.e. if it is not accepted within a specific time than it will be presumed to have been accepted. Emile Woolf International 39 The Institute of Chartered Accountants of Pakistan

56 3 REVOCATION OF OFFER AND ACCEPTANCE Section overview Timing of revocation Communication of revocation Lapse of an offer 3.1 Timing of revocation According to Section 5 of the Contract Act: Timing of revocation of an offer Timing of revocation of an acceptance A proposal may be revoked at any time before acceptance or the communication of its acceptance is complete as against the proposer, but not afterwards. An acceptance can be revoked at any time before the communication of the acceptance is complete as against the acceptor i.e. when acceptance comes to the knowledge of the offeror, but not afterwards. 3.2 Communication of revocation The rules regarding the communication of revocation are as under [Section4]: As against the person who makes it As against the person to whom it is made When it is put in a course of transmission so as to be out of the power of the revoker. When it comes to the knowledge of the revokee. 3.3 Lapse of an offer An offer is lapsed in the following ways: Revocation An offer may be revoked before its acceptance by the offeree. [Section 5] Lapse of time An offer will come to an end if it is not accepted within the time specified or within a reasonable time where no time is specified. What is the reasonable time is a question of fact depending upon the subject matter and circumstances. [Section 6(2)] Death or insanity An offer comes to an end by the death or insanity of the offeror if the fact of his death or insanity comes to the knowledge of the acceptor before acceptance. [Section 6(4)] Non-fulfilment of condition precedent An offer comes to an end when the acceptor fails to fulfil the conditions precedent to the offer. [Section 6(3)] Counter offer An offer comes to an end if the counter offer is made. Emile Woolf International 40 The Institute of Chartered Accountants of Pakistan

57 Section A: Mercantile Law - Chapter 3: Offer and acceptance Non-acceptance according to requirement An offer comes to an end if it is not accepted according to the requirement (if any) of the offeror. Non-acceptance / Rejection An offer comes to an end if it is not accepted by the offeree. An offer is said to be rejected if the offeree expressly rejects. Subsequent illegality or destruction An offer comes to an end if it becomes illegal or the subject matter is destroyed before its acceptance. Emile Woolf International 41 The Institute of Chartered Accountants of Pakistan

58 4 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Define the offer and acceptance along with their essentials Discuss briefly the law relating to the communication of offer, acceptance and revocation Discuss the circumstances in which an offer lapses Emile Woolf International 42 The Institute of Chartered Accountants of Pakistan

59 Certificate in Accounting and Finance C H A P T E R 4 Capacity of parties Contents 1 Competent to contract 2 Chapter review Emile Woolf International 43 The Institute of Chartered Accountants of Pakistan

60 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Capacity of parties LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to competency / capacity of parties. LO Identify circumstances when a person is not competent to contract LO Be aware of consequences or enforceability of contracts with persons not competent to contract. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 44 The Institute of Chartered Accountants of Pakistan

61 Section A: Mercantile Law - Chapter 4: Capacity of parties 1 COMPETENT TO CONTRACT Section overview Who are competent to contract? Agreements with a minor Agreements by persons of unsound mind Agreements with persons disqualified by law 1.1 Who are competent to contract? According to Section 11 of the Contract Act every person is competent to contract: who is of the age of majority according to the law to which he is subject, and who is of sound mind, and is not disqualified from contracting by any law to which he is subject. The below chart shows the persons who are incompetent to contract: Incompetent to contract Minor Unsound mind Disqualified by law Alien enemies Foreign sovereigns and ambassadors Convicts Insolvent 1.2 Agreements with a minor In Pakistan a minor is a person who has not attained majority which is: 21 years where a guardian of a minor s person or property is appointed by the court of law under the Guardians and Wards Act, 1890; or 18 years in other cases. Position of agreements by a minor The law pertaining to agreements with a minor is given below: An agreement with a minor is void. Where an infant / minor represents fraudulently or otherwise that he is of the age of majority and induces another to enter into a contract with him, he will not be liable Since ratification has a retrospective application it is necessary that the minor must be competent to contract at the time when the contract is entered into. Therefore, an agreement with a minor cannot be ratified subsequently after he attains majority. Emile Woolf International 45 The Institute of Chartered Accountants of Pakistan

62 If a minor enters into an agreement jointly with a major person then such agreement can be enforced against the major person who has jointly promised to perform. A minor can be admitted for the benefits of partnership with the consent of all the partners. He cannot be a partner until he attains majority. [Section 30 of the Partnership Act] A minor can be agent but cannot be a principal but if anyone acts on behalf of minor principal, he will be personally liable. [Section 184] A minor cannot be declared insolvent because he is incompetent to contract. A minor can file a suit but cannot be sued. If the parent of a minor entered into on behalf of a minor being within the scope of the authority and for the benefit of the minor then such agreements can be enforced by or against the minor. A person who supplied necessaries to a minor is entitled to be reimbursed from the property of such minor. Such claim is against the property of the minor and not against the minor personally. [Section 68] 1.3 Agreements by persons of unsound mind Meaning of sound mind According to Section 12 of the Contract Act, a person is said to be of sound mind for the purpose of making a contract if at the time when he makes it, he is capable to understand the terms of the contract, to form a rational judgment as to its effect upon his interests. Thus, if a person is not capable of both, he is said to have suffered from unsoundness of mind. Example: Meaning of sound mind The examples of persons having an unsound mind include: specific persons/idiots lunatics and drunken persons. Specific persons/idiots A person who is so mentally deficient by birth as to be incapable of ordinary reasoning or rational conduct is said to be a specific person. Lunatic A person affected by lunacy is said to be 'lunatic'. A person can become lunatic at any stage of his life. Position of agreements with a person of unsound mind The positions of such agreements are given below: If a lunatic enters into a contract while he is of unsound mind, an agreement during this period is void. If a lunatic enters into a contract while he is of sound mind, an agreement during this period is valid. An agreement with a specific person is void. A person delirious from fever or drunken person cannot enter into a contract while such delirium or drunkenness lasts and he is not able to understand the terms of the contract or form a rational judgment. Emile Woolf International 46 The Institute of Chartered Accountants of Pakistan

63 Section A: Mercantile Law - Chapter 4: Capacity of parties A person of unsound mind can enforce a contract for his benefits A person who supplied necessaries to a person of unsound mind or his defendant entitled to be reimbursed from the property of such person of unsound mind. Such claim is against the property of the person of unsound mind not against the person personally. Position of a person who is usually of unsound mind but occasionally of sound mind A person who is usually of unsound mind but occasionally of sound mind may make a contract when he is of sound mind Example: Position of a person who is usually of unsound mind but occasionally of sound mind A patient in a lunatic asylum who is at intervals of sound mind may contract during those intervals. Position of a person who is usually of sound mind but occasionally of unsound mind A person who is usually of sound mind but occasionally of unsound mind may not make a contract when he is of unsound mind Example: Position of a person who is usually of sound mind but occasionally of unsound mind A sane man who is so delirious from fever or who is so drunk that he cannot understand the terms of a contract or form a rational judgment as to its effect on his interest cannot enter into contract while such delirium or drunkenness lasts. Burden of proof The rules regarding the burden of proof are following: If a person is usually of sound mind or in drunkenness or in delirium from fever then the burden of proof that he was of unsound mind lies on the person who questions the validity of contract. If a person is usually of unsound mind then the burden of proof that he was of sound mind lies on the person who confirms it. 1.4 Agreements with persons disqualified by law There are some disqualifications imposed on certain persons in respect of their capacity to contract which are discussed below: Alien enemies Foreign sovereigns and ambassadors Convicts An alien is a person who is the citizen of a foreign country. He can enter into a contract and be sued during peace time but if a war is declared than an alien enemy can neither enter into a contract or be sued during the period of war. Contracts entered before the declaration of war are either suspended or terminated during the period of war. Such persons have immunity unless they choose to submit themselves to the jurisdictions of our courts. They have a right to enter into a contract but can claim the privilege of not being sued. A convict while under imprisonment is incapable of contracting but this disability comes to an end after the expiry of the sentence or when he is on parole. Emile Woolf International 47 The Institute of Chartered Accountants of Pakistan

64 Insolvent A person declared as insolvent cannot enter into a contract as his property is dealt with by official assignee or official receiver. Note Companies A company is an artificial person and a contract entered into by a company will be valid only if it is within the powers granted by the Memorandum of Association. Emile Woolf International 48 The Institute of Chartered Accountants of Pakistan

65 Section A: Mercantile Law - Chapter 4: Capacity of parties 2 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Explain the capacity to contract and persons who are incompetent to contract Discuss the position of agreements entered by person incompetent to contract Emile Woolf International 49 The Institute of Chartered Accountants of Pakistan

66 Emile Woolf International 50 The Institute of Chartered Accountants of Pakistan

67 Certificate in Accounting and Finance C H A P T E R 5 Consideration Contents 1 Consideration 2 Chapter review Emile Woolf International 51 The Institute of Chartered Accountants of Pakistan

68 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Consideration LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to consideration of a contract. LO Define consideration and identify essentials of consideration LO Understand rules relating to consideration LO Identify agreements which are valid without consideration. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 52 The Institute of Chartered Accountants of Pakistan

69 Section A: Mercantile Law - Chapter 5: Consideration 1 CONSIDERATION Section overview Definition of consideration Essential elements of consideration Agreement, the consideration or object of which is partly unlawful Stranger to contract Agreements without consideration 1.1 Definition of consideration Definition: Consideration [Section 2(d)] When at the desire of the promisor, the promisee or any other person who has done or abstained from doing, or does or abstains from doing, or promises to do or to abstain from doing something, such act or abstinence or promise is called a consideration for the promise. When a party to an agreement promises to do something, he must get something in return. This something is in return of consideration. The analysis of the above definition reveals that a consideration may be the value by which promise is bought. Consideration may be following: An act i.e. doing of something An abstinence or forbearance i.e. abstaining or refraining from doing something. A return promise Example: Consideration A promises B to guarantee payment of price of the goods which B sells on credit to C. Here selling of goods by B to C on credit is consideration for A s promise. A asks B not to sue C for a year for his debts and promises in case of default of C, A would be liable. Here B not filing a suit for a year is abstinence, which is a sufficient consideration for A. A promises to deliver iphone to B and B promises to pay Rs. 85,000 on delivery. Here the consideration for A will be Rs. 85,000 on delivery and consideration for B will be delivery of goods 1.2 Essentials elements of consideration The essentials of consideration are shown below: Emile Woolf International 53 The Institute of Chartered Accountants of Pakistan

70 These are discussed below. Desire of the promisor An act or abstinence of promise constituting consideration must have been done or made at the desire or request of the promisor. Thus, an act done at the desire of a third party or without the desire of the promisor cannot constitute a valid consideration. Example: Desire of the promisor A saves B s goods from fire without being asked to do so. A cannot demand payment for his services. Move / from promisee or any other person In return consideration may be from the promisee himself or by any other person even by stranger. Example: Move / from promisee or any other person X transferred certain property to her daughter Y with a direction that Y should pay Z annuity. On the same day Y executed a deed in writing in favour of Z and agreed thereby to pay the annuity. Later, Y refused to pay the annuity on the plea that no consideration had moved from Z. Here Z is entitled to maintain suit because a consideration not necessarily move from the promisee, it may move from any other person (by X in this case). Consideration may be past, present or future The consideration may be past (done or abstained from doing), present (does or abstains from doing) or future (promises to do or to abstain from doing). The consideration which has moved before the formation of agreement is said to be past consideration. The consideration which moves simultaneously with the promise is called present consideration. The consideration which moves after the formation of agreement is called future consideration. Example: Consideration may be past, present or future A renders some service to B in the month of August. In September B promises to compensate A an amount of Rs. 10,000 for the services he rendered to him. Past services amount to past consideration. A can recover Rs. 10,000 from Y. A sells his car for Rs. 1 million and delivers the car at the time of payment. Here the consideration is moving simultaneously with the promise and is called present consideration. A promises to deliver certain goods to B after 5 days and B promises to pay after 5 days from the date of delivery. Consideration in this case is future. Consideration to have some value There is no requirement for the adequacy of consideration but it should have some value. There should be something in return and this something in return need not necessarily be equal in value to something given. Consideration must be real The consideration must be real and not illusory. Example: Consideration must be real A engages B to work as an accountant in his office and promises to make him happy. This promise is not enforceable because the consideration is not real but illusory. A promises to put life into B s dead wife and B promises to pay Rs. 1 million. This agreement is void because consideration is impossible to perform and not real. A engages B to work as an accountant in his office and promises to pay him Rs. 75,000 per month. This is a real consideration for both the parties. Emile Woolf International 54 The Institute of Chartered Accountants of Pakistan

71 Section A: Mercantile Law - Chapter 5: Consideration Something which the promisor is not already bound to do It may be an act, abstinence, forbearance or a return promise e.g. compromise of a disputed claim, composition with creditors. The consideration must be something which the promisor is not already bound to do because a promise to do what a promisor is already bound to do adds nothing to the existing obligation. Lawful The consideration must neither be unlawful nor opposed to public policy. Example: Lawful A promises B to pay Rs. 100,000 to beat C. B beats C and claims Rs. 100,000 from B. A refuses to pay. B cannot recover because the agreement is void on the ground of unlawful consideration. A promises B to obtain an employment in the public service and B promises to pay Rs. 100,000 to A. The agreement is void on the ground of unlawful consideration. 1.3 Agreement, the consideration or object of which is partly unlawful If a party of a single consideration for one or more objects, or any one or any part of any one of several conditions for a single object, is unlawful, the agreement is void. [Section 24] Example: Agreement, the consideration or object of which is partly unlawful A promises to superintends, on behalf of B, a legal manufacture of indigo, and an illegal traffic in other articles. B promises to pay salary to A of Rs. 10,000 per month. The agreement is void as the object of A s promise and the consideration for B s promise being in party unlawful. 1.4 Stranger to contract Generally a stranger to a contract cannot sue, while a stranger to consideration can sue. This rule is known as the doctrine of privity of contract. Privity of contract means the relationship subsisting between the parties who have entered into contractual obligations. It implied a mutuality of will and creates a legal bond between the parties to a contract. Exceptions The following are the exceptions to the rule that a stranger to a contract cannot sue: When an arrangement is made in connection with marriage, partition or other family arrangements and a provision is made for the benefit of a person, he may sue although he is not a party to the contract. The person who becomes an agent of third party by acknowledgement or estoppel, may be sued by such third party. Where a benefit under a contract has been assigned (other than one involving personal skill), the assignee can enforce the contract subject to all equities between the original parties to the contract. Where a charge in favour of a person has been created on specific immovable property, such charge is enforceable at the instance of the person beneficially interested, though he may not be a party to the document creating the charge. 1.5 Agreements without consideration According to Section 25 of the Contract Act, an agreement without consideration is void except under the following cases: Natural love and affection [Section 25(1)] Agreements made on account of natural love and affection without consideration will be valid if it is: expressed in writing, Emile Woolf International 55 The Institute of Chartered Accountants of Pakistan

72 registered under the law, made on account of natural love and affection, and between parties standing in a near relation to each other. Example: Natural love and affection A, for natural love and affection; promises to give his son, B, Rs. 10,000. A puts his promise to B into writing and registers it. This is a contract. Promise to compensate past voluntary services [Section 25(2)] Such promise made without consideration is valid if: it is a promise to compensate and the person who is to be compensated has already done something voluntarily or has done something which the promisor was legally bound to do. Example: Promise to compensate A finds B's purse and gives it to him. B promises to give A Rs.5,000. Now this promise of B is a contract. A supports B s infant son. B promises to pay A s expenses in so doing. This is a contract. Time barred debt [Section 25(3)] A promise to pay time barred debt is enforceable if: Gifts it is made in writing, it is signed by the debtor or his agent, and it relates to a debt which could not be enforced by a creditor because of law of limitation. The gifts which are accepted by the donee are called completed gifts and are valid. Example: Gift X transferred some property to Y by a duly written and registered deed as a gift. This is a valid contract even though no consideration given by Y. Contract of agency A consideration is not necessary for a contract of agency. [Section 185] Contract of bailment A consideration is not necessary for a contract of bailment i.e. gratuitous contract of bailment. Example: Gratuitous bailment Zaheer lends an IPAD to Imran for his work without any charge. Charitable subscription Where the promise on the strength of the promise makes commitments i.e. changes his position to the detriment. Contract of guarantee Consideration received by the principal debtor is sufficient for the surety and it is not necessary to result in some benefit to the surety himself. [Section 127] Example: Contract of guarantee 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 A s promise to deliver the goods. This is sufficient consideration for C s promise. Emile Woolf International 56 The Institute of Chartered Accountants of Pakistan

73 Section A: Mercantile Law - Chapter 5: Consideration 2 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Define consideration and essentials of a valid consideration Discuss the contracts where there is no consideration Emile Woolf International 57 The Institute of Chartered Accountants of Pakistan

74 Emile Woolf International 58 The Institute of Chartered Accountants of Pakistan

75 Certificate in Accounting and Finance C H A P T E R 6 Free consent Contents 1 Consent Consensus-ad-idem 2 Coercion 3 Undue influence 4 Fraud 5 Misrepresentation 6 Mistake 7 Chapter review Emile Woolf International 59 The Institute of Chartered Accountants of Pakistan

76 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Free consent LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to free consent of a contract. LO Define free consent LO Know the effect of absence of free consent LO Be aware of factors which may affect the consent LO Identify and understand coercion, undue influence, fraud, misrepresentation and mistake. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 60 The Institute of Chartered Accountants of Pakistan

77 Section A: Mercantile Law - Chapter 6: Free consent 1 CONSENT Consensus-ad-idem Section overview Definition of consent Effect of absence of consent Definition of free consent Effect of absence of free consent 1.1 Definition of consent Definition: Consent [Section 13] Two persons are said to consent when they agree upon the same thing in the same sense. Thus, the analysis of the above definition reveals that both the parties must be at the same frequency of mind at the time of entering into a contract i.e. Consensus ad ideur. 1.2 Effect of absence of consent The effect of absence of consent is that the agreement is not valid and is not enforceable by law. [Section 19] Example: Effect of absence of consent X has one Alto and one Coure. He wants to sell Coure. Y does not know that X has two cars. Y offers to buy X s Alto for Rs. 400,000. X accepts the offer thinking it to be an offer for his Coure. Here, there is no identity of minds in respect of the subject matter. Hence, there is no consent at all and hence there is no agreement. 1.3 Definition of free consent Definition: Free consent [Section 14] The consent is said to be free when it is not caused by: Coercion or Undue influence or Fraud or Misrepresentation or Mistake 1.4 Effect of absence of free consent The effect of absence of free consent is that the contract becomes voidable if the consent is obtained by coercion or undue influence or fraud or misrepresentation at the option of the party whose consent was so caused but if the consent is obtained by mistake then agreement may be void-ab-initio or contract is not voidable depending upon the nature of the mistake. [Section 19A] Emile Woolf International 61 The Institute of Chartered Accountants of Pakistan

78 2 COERCION Section overview Definition of coercion Effects of coercion 2.1 Definition of coercion Definition: Coercion [Section 15] Coercion is the: committing or threatening to commit any act which is forbidden by Pakistan Penal Code or unlawful detaining or threatening to detain, Any property with an intention of causing any person to enter into an agreement. The analysis of the above definition reveals that coercion may be compelling a person to enter into a contract under pressure or a threat. Example: Coercion A beats B and compels him to sell his bike for Rs. 20,000. Here, B s consent has been obtained by coercion because beating someone is an offence under the Pakistan Penal Code. A, on board an English ship causes B to enter into an agreement by an act amounting to criminal intimidation under the Pakistan Penal Code. A afterwards sues B for breach of contract at Karachi. A has employed coercion, although his act is not offence by the law of England and PPC was not in force at the time when or place where the act was done. Coercion may be exercised from any person, and may be directed against any person, even a stranger. Example: Coercion A threatens to kill C, B s daughter, if B refuses to sell his house to him. B agrees to sell his house. Here, B s consent has been obtained by coercion though C is not a party to the contract. A threatens to kill B if B refuses to sell his house to C. B agrees to sell his house. Here, B s consent has been obtained by coercion though A is not a party to the contract. 2.2 Effects of coercion The effects of coercion are given below: [Section 19, 64 and 72] The contract becomes voidable at the option of the party whose consent was so caused. The burden of proof lies on the party who rescinds the contract. The party rescinding a voidable contract shall, if he has received any benefit from another party, restore such benefit i.e. restitution. A person to whom money has been paid or anything delivered by coercion must repay or return it. Example: Effects of coercion A threatens to kill B if he does not sell his BMW for Rs 1 million to A. B contracted to sell his BMW to A and receives the payments. Here, B s consent has been obtained by coercion. Hence, this contract is voidable at the option of B but B has no right to insist that contract shall be performed. Emile Woolf International 62 The Institute of Chartered Accountants of Pakistan

79 Section A: Mercantile Law - Chapter 6: Free consent 3 UNDUE INFLUENCE Section overview Definition of undue influence Nature of relationship Effect of undue influence Difference between coercion and undue influence 3.1 Definition of undue influence Definition: Undue influence [Section 16] 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 unfair advantage over the other. Thus the analysis of the above definition reveals that an undue influence means dominating in a relationship the will of the other person to obtain an unfair advantage. A contract is said to be induced by undue influence: Where the relations between the parties are such that one of them in a position to dominate the will of the other and uses that position to obtain an unfair advantage over the other. 3.2 Nature of relationship A person is in a position to dominate the will of another where he: holds the real or apparent authority over the other e.g. parent and child stands in a fiduciary relation to the other e.g. already indebted makes a contract with a person whose mental capacity is temporarily or permanently affected by reason of age, illness or mental or bodily distress e.g. medical attendant and patient. Example: Undue influence A having advanced money to his son, B during his minority, upon B s coming of age obtains, by misuse of parental influence, a bond from B for a greater amount than the sum due in respect of the advances. A employs undue influence. A, a man enfeebled by disease or age, is induced, by B s influence over him as his medical attendant, to agree to pay B an unreasonable sum for his professional services. B employs undue influence. A being in debt to B, the money lender of his village, contracts a fresh loan on terms which appear to be unconscionable. It lies on B to prove that the contract was not induced by undue influence. A applies to a banker for a loan at a time when there is stringency in the money market. The banker declines to make the loan except at a unusually high rate of interest. A accepts the loan on these terms. This is a transaction in the ordinary course of business, and the contract is not induced by undue influence. 3.3 Effect of undue influence The contract becomes voidable at the option of the party whose consent was so caused. The burden of proof is on the party who was in a position to dominate the will of the other party not all cases [Section 19]. Emile Woolf International 63 The Institute of Chartered Accountants of Pakistan

80 In the following relationships it is presumed that a person is in a position to dominate the will of another person: Father and son Guardian and ward Employer and Employee Trustee and beneficiary Teacher and student Doctor and patient Solicitor and client Fiancé and fiancée Pardanasheen lady (Completely secluded) In the following relationship there is no presumption that a person is in a position to dominate the will of another person: Landlord and tenant Creditor and debtor Husband and wife (non parda observing) Rebutting presumption The presumption of undue influence can be rebutted by showing that the: Dominant party has made a full disclosure of all the facts to the weaker party before making the contract Price was adequate Weaker party was in receipt of competent independence advice before entering into the contract. The contract may be set aside either absolutely or if the party who was entitled to avoid it has received any benefit, upon such terms and conditions as to the Court may seem just. [Section 19A] 3.4 Difference between coercion and undue influence S.no Coercion Undue influence 1 Definition A contract is said to be caused by coercion when it is obtained by: committing or threatening to commit any act which is forbidden by Pakistan Penal Code or unlawful detaining or threatening to detain. 2 Consent Consent is obtained by giving a threat of an offence or committing an offence. A contract is said to be induced by undue influence: Where the relations between the parties are such that one of them in a position to dominate the will of the other and uses that position to obtain an unfair advantage over the other. Consent is obtained by dominating the will. Emile Woolf International 64 The Institute of Chartered Accountants of Pakistan

81 Section A: Mercantile Law - Chapter 6: Free consent S.no Coercion Undue influence 3 Nature of pressure It involves physical pressure. 4 Relationship Parties to a contract may or may not be related to each other. 5 Reason The objective is to compel a person to enter into a contract. 6 Criminal liability Criminal liability is incurred, therefore it is illegal. 7 On whom Coercion may be employed on a person other than a party whose consent is desired, for instance his son. 8 By whom It can be excercised by a stranger to the contract. 9 Onus of proof The onus of proof is on the party who wants to relieve himself of the consequences of coercion. 10 Restoration of benefit The aggrieved party has to restore the benefit received. It involves moral pressure. Parties to a contract are related to each other under some sort of relationship. The objective is to obtain an unfair advantage. Criminal liability is not incurred. Undue influence may only be employed on the party whose consent is desired. It can only be exercised by a party to the contract and not by a stranger. The onus of proof is on the party in a position to dominate the will of the other party. The party avoiding the contract may or may not restore benefit. Emile Woolf International 65 The Institute of Chartered Accountants of Pakistan

82 4 FRAUD Section overview Definition of fraud Essentials of fraud Effects of fraud Silence as to fraud 4.1 Definition of fraud Definition: Fraud [Section 17] Fraud means and includes any of the following acts committed. by a party to a contract, or with his connivance, or by his agent with intent to deceive another party to it or his agent, or to induce to enter into a contract By false assertion A false representation of a fact made Knowingly or Without belief in its truth Example: False assertion A sells to B locally manufactured goods representing them to be imported goods charging a higher price, it amounts to fraud. Active concealment The active concealment of a fact by one having knowledge or belief of the fact such as, where steps are taken by a seller concealing some material facts so that the buyer even after a reasonable examination cannot trace the defects, it will amount to fraud, Example: Active concealment Z a furniture dealer conceals the cracks in furniture sold by him by using some packing material and polishing it in such a way that the buyer even after reasonable examination cannot trace the defect, it would amounts to fraud through active concealment. Empty promise A promise made without any intention of performing it constitutes to fraud. Example: Empty promise Buying goods under a contract of sale with an intention of not paying the price is fraud. Declared act Any such act or omission as the law specially declares to be fraudulent Fitted act Any other act fitted to deceive. Emile Woolf International 66 The Institute of Chartered Accountants of Pakistan

83 Section A: Mercantile Law - Chapter 6: Free consent 4.2 Essentials of fraud The essentials of fraud are shown below: These essentials are discussed below: Party to a contract The fraud must be committed by a party to a contract or by anyone with his connivance or by his agent. Thus, the fraud by a stranger to the contract does not affect its validity. False representation It means that a false representation is made with the knowledge of its falsehood. It will equal to fraud if a true representation is made but becomes untrue at the time of formation of contract the fact is known to the party who made the representation. Representation as to fact A mere opinion does not amount to fraud. A representation must relate to a fact than it amount to fraud. Actually deceived A deceit, which does not deceive is not fraud. The fraud must have actually deceived the other party who has acted on the basis of such representation. Suffered loss Loss has been suffered by the party who acted on the representation. 4.3 Effects of fraud The effects of fraud are as follows [Section 19]: The contract becomes voidable at the option of the party whose consent was so caused. The party whose consent was so caused may insist on performance of the contract. The party whose consent was so caused is entitled to claim damages. Emile Woolf International 67 The Institute of Chartered Accountants of Pakistan

84 Exceptions to rescind the contract A party cannot rescind the contract where: silence amounts to fraud and the aggrieved party had the means of discovering the truth with ordinary diligence the party gave the consent in ignorance of fraud the party after becoming aware of the fraud takes a benefit under the contract an innocent third party before the contract is rescinded acquires for consideration and in good faith some interest in the property passing under the contract, the parties cannot be restored to their original position. 4.4 Silence as to fraud Mere silence as to facts likely to affect the willingness of a person to enter into a contract is not fraud, unless the circumstances of the case are such that parties stands in fiduciary relationship or where silence itself is equivalent to speech. [Section 17] Example: Silence as to fraud A sells by auction to B a horse which A knows to be unsound. A says nothing to B about the horse's unsoundness. This is not fraud by A. B is A's daughter and has just come of age. Here, the relation between the parties would make it A's duty to tell B if the horse is unsound. B says to A, "If you do not deny it, I shall assume that the horse is sound." A says nothing. Here A's silence is equivalent to speech. If the horse turns out to be vicious. A can be held liable for fraud. Note In the early 80 s the Federal Shariat Court decided that provision regarding position of silence in Contract Act is not in conformity with the teachings of Islam. Emile Woolf International 68 The Institute of Chartered Accountants of Pakistan

85 Section A: Mercantile Law - Chapter 6: Free consent 5 MISREPRESENTATION Section overview Definition of misrepresentation Essentials of misrepresentation Effects of misrepresentation 5.1 Definition of misrepresentation Definition: Misrepresentation [Section 18] Misrepresentation means and includes- Unwarranted statement When a person makes a positive statement that a fact is true when his information does not warrant it to be so, though he believes it to be true this amounts to misrepresentation. Breach of duty Any breach of duty which without an intent to deceive, gains an advantage to the person committing it, or anyone claiming under him, by misleading another to his prejudice or to the prejudice of anyone claiming under him. Inducing mistake about subject matter (Innocent misrepresentation) A party to an agreement induces (however innocently) the other party to make a mistake as to the nature or quality of the subject of the agreement. 5.2 Essentials of misrepresentation The essentials of misrepresentation are shown below: Emile Woolf International 69 The Institute of Chartered Accountants of Pakistan

86 These essentials are discussed below: Party to a contract The representation must be made by a party to a contract or by anyone with his connivance or by his agent. Thus, the representation by a stranger to the contract does not affect the validity of the contract. False representation There must be a false representation and it must be made without the knowledge of its falsehood i.e. the person making it must honestly believe it to be true. Representation as to fact A mere opinion does not amount to misrepresentation. A representation must relate to a fact if it amounts to misrepresentation. Object The objective is to induce the other party to enter into contract without the intention of deceiving the other party. Actually acted The other party must have acted on the faith of the representation. 5.3 Effects of misrepresentation The effects of representation are following [Section 19]: the contract becomes voidable at the option of the party whose consent was so caused. The party whose consent was so caused may insist on performance of the contract. Exceptions to rescind the contract A party cannot rescind the contract where: the party whose consent was caused by misrepresentation had the means of discovering the truth with ordinary diligence; the party gave the consent in ignorance of misrepresentation the party after becoming aware of the misrepresentation takes a benefit under the contract an innocent third party before the contract is rescinded acquires for consideration and in good faith some interest in the property passing under the contract, the parties cannot be restored to their original position. Emile Woolf International 70 The Institute of Chartered Accountants of Pakistan

87 Section A: Mercantile Law - Chapter 6: Free consent 6 MISTAKE Section overview Mistake Types of mistakes 6.1 Mistake Where both the parties to an agreement are under a mistake as to matters of facts essential to the agreement, the agreement is void [Section 20]. 6.2 Types of mistakes The types of mistakes are shown below: Types of mistakes Mistake of law Mistake of fact Pakistan law Foreign law Bilateral Unilateral Subject matter Possibility of performance Identity of person Nature of contract Mistake of Pakistan law A contract is not voidable because it was caused by a mistake as to any law in force in Pakistan. [Section 21] Mistake of foreign law A mistake as to the law not in force in Pakistan has the same effect as a mistake of fact i.e. void. [Section 21] Bilateral mistake Where both the parties to an agreement are under a mistake as to a matter of facts essential to the agreement, the agreement is void. An erroneous opinion as to the value of the thing which forms the subject matter of the agreement is not to be deemed a mistake as to a matter of facts. [Section 20] Example: Bilateral mistake A buys' a painting believing it to be worth Rs 100,000 while in fact it is worth only Rs 10,000. The contract is not void. A agrees to sell to B a specific cargo of goods supposed to be on its way from England to Karachi. It turns out that, before the date of the bargain, the ship conveying the cargo had been cast away and the goods lost. Neither party was aware of facts. The agreement is void. Emile Woolf International 71 The Institute of Chartered Accountants of Pakistan

88 Bilateral mistake as to the subject matter A bilateral mistake as to the subject matter includes the following mistakes as to the: existence of subject matter quantity of subject matter quality of subject matter price of subject matter identity of subject matter title of subject matter Example: Bilateral mistake as to the subject matter A agrees to buy from B a certain horse. It turns out that the horse was dead at the time of bargain though neither party was aware of the fact. The agreement is void because there is bilateral mistake as to the existence of subject matter. A agrees to buy from B all his horses believing that B has two horses but B actually has three horses. The agreement is void because there is bilateral mistake as to the quantity of subject matter A agrees to buy a particular horse from B. Both believe it to be a race horse but it turns to be a cart horse. The agreement is void because there is bilateral mistake as to the quality of the subject matter. A agrees to buy a particular horse from B who mentioned in his letter the price as Rs 1,150 instead of 5,150. The agreement is void because there is bilateral mistake as to the price of the subject matter. A agrees to buy from B a certain horse. B has one race horse and one cart horse. A thinks that he is buying race horse but B thinks that he is selling cart horse. The agreement is void because there is bilateral mistake as to the identity of subject matter. A agrees to buy a particular horse from B. That horse is already owned by A. The agreement is void because there is bilateral mistake as to the title of the subject matter. Bilateral mistake as to the possibility of performance Where the parties believe that an agreement is capable of performance and actually it is not then it is said to be a bilateral mistake as to the possibility of performance due to which agreement is void. Unilateral mistake A contract is not voidable merely because it was caused by one of the parties to it being under a mistake as to matter of facts. [Section 22] Example: Unilateral mistake A buys' a painting believing it to be worth Rs 100,000 while in fact it is worth only Rs 10,000. Exceptions Following are the exceptions where agreement is void on the basis of unilateral mistake: Mistake relating to the identity of the person Mistake relating to the nature of the contract Example: Mistake relating to the identity of the person A knew that on "account of his criticism of the plays in the past, he would not be allowed entry to the performance of a play at the theatre. The managing director of the theatre gave instructions that ticket should not be sold to A. A, however, obtained a ticket through one of his friends. On being refused admission to the theatre, he sued for damages for breach of contract. It was held that there was no contract between the theatre company and A as the theatre company never intended to contract with A. Emile Woolf International 72 The Institute of Chartered Accountants of Pakistan

89 Section A: Mercantile Law - Chapter 6: Free consent Example: Mistake relating to the nature of contract An old illiterate man was induced to sign a bill of exchange by means of a false representation that it was a mere guarantee. It was held that he was not liable for the bill of exchange because he never intended to sign a bill of exchange. Emile Woolf International 73 The Institute of Chartered Accountants of Pakistan

90 7 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Discuss the meaning of consent Explain when a consent is said to be free Understand the effects and meaning of coercion, undue influence, fraud and misrepresentation Discuss the laws relating to the effect of mistake on contracts Emile Woolf International 74 The Institute of Chartered Accountants of Pakistan

91 Certificate in Accounting and Finance C H A P T E R 7 Legality of object, consideration and agreements opposed to public policy Contents 1 Legality of object, consideration and agreements opposed to public policy 2 Chapter review Emile Woolf International 75 The Institute of Chartered Accountants of Pakistan

92 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Legality of object, consideration and agreements opposed to public policy LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to legality of object and agreements opposed to public policy. LO Identify circumstances where object or consideration is unlawful LO Identify agreements opposed to public policy. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 76 The Institute of Chartered Accountants of Pakistan

93 Section A: Mercantile Law - Chapter 7: Legality of object, consideration and agreements opposed to public policy 1 LEGALITY OF OBJECT, CONSIDERATION AND AGREEMENTS OPPOSED TO PUBLIC POLICY Section overview Circumstances where object or consideration is unlawful Agreement, the consideration or object of which is partly unlawful Agreements opposed to public policy 1.1 Circumstances where object or consideration is unlawful Definition: Legality of object and consideration [Section 23] The consideration or object of an agreement is lawful unless: It is forbidden by law Is of such a nature that if permitted would defeat the provisions of any law It is fraudulent It involves an in injury to the person or property of another The court regards it as immoral, or opposed to public policy The analysis of above definition is given below: Forbidden by law If the law of the state prohibits an object or the consideration of an agreement then such agreements are void. An act is forbidden by law when it is punishable by the law of the country. Example: Forbidden by law A promises B to drop a prosecution which he has instituted against B for robbery, and B promises to restore the value of the things taken. The agreement is void, as its object is unlawful. A promises to obtain for B an employment in the public service, and B promises to pay Rs.1,000/- to A. The agreement is void as the consideration for it is unlawful. The effects of such agreements are following: The collateral transactions to such an agreement also become tainted and hence cannot be enforced. No action can be taken for the recovery of money paid or property transferred under such an agreement and for the breach of any such agreement. In case of an agreement containing the promise, some part of which is legal and other part illegal, the legal position is as under: [Section 57 & 58] If the illegal part cannot be separated than the whole agreement is illegal. If the illegal part can be separated than court will enforce the legal part and will reject illegal party. Defeats the provisions of any law If the object or the consideration of an agreement is of such nature that, if permitted, it would defeat the provisions of any law, the agreement is void. Emile Woolf International 77 The Institute of Chartered Accountants of Pakistan

94 Example: Defeats the provisions of any law A's estate is sold for arrears of revenue under the provisions of an Act of the Legislature, by which a defaulter is prohibited from purchasing the estate. B, upon an understanding with A, becomes the purchaser, and agrees to convey the estate to A, upon receiving from him the price which B has paid. The agreement is void as the transaction, in fact, a purchase by the defaulter, and would so defeat the object of the law. Fraudulent Where the object of an agreement is fraudulent the agreement is void. Example: Fraudulent A, B and C enter into an agreement of the division among them of gains acquired, or be acquired, by them by fraud. The agreement is void, as its object is unlawful. A, being agent for a landed proprietor, agrees for money, without the knowledge of his principal, to obtain for B a lease of land belonging to his principal. The agreement between A and B is void, as it implies a fraud by concealment by A, on his principal. Involves or implies injury The object of an agreement will be unlawful if it tends to injure a person or the property of another. Property can either be movable or immovable. Example: Involves or implies injury A promised to pay Rs.100,000 to B on agreeing to publish a defamatory article against C. It was held that B could not recover the amount because the agreement was void as it involves injury to C. Court regards it as immoral or opposed to public policy Where the object or consideration of an agreement is such that the court regards it as immoral or opposed to the public policy then the agreement is void. Example: Court regards it as immoral or opposed to public policy A, who is B's mukhtar, promises to exercise his influence, as such, with B in favour of C, and C promises to pay Rs 1,000 to A. The agreement is void, because it is immoral. A agrees to let her daughter to hire to B for concubinage. The agreement is void because it is immoral, though the letting may not be punishable under the Pakistan Penal Code. 1.2 Agreement, the consideration or object of which is partly unlawful A contract may contain several distinct promises or a promise to do several distinct acts of which some are legal and others illegal, or a part of which is legal and a part of which is illegal. In case of an agreement containing the promise, some part of which is legal and other part(s) illegal, the legal position is as follows [Section 24]: If the illegal part cannot be separated than the whole agreement is illegal. If the illegal part can be separated than court will enforce the legal part and will reject illegal party. Promise to do legal and illegal things Where persons reciprocally promise, firstly, to do certain things which are legal, and secondly, under specified circumstances, to do certain other things which are illegal, the first set of promises is a contract, but the second is a void agreement. [Section 57] Emile Woolf International 78 The Institute of Chartered Accountants of Pakistan

95 Section A: Mercantile Law - Chapter 7: Legality of object, consideration and agreements opposed to public policy Example: Promise to do legal and illegal things A and B agree that A shall sell B a house for Rs.10,000,000 but that, if B uses it as a gambling house, he shall pay Rs.50,000,000 for it. The first set for reciprocal promises, namely to sell the house and to pay Rs.10,000,000 for it, is a contract. The second set is for an unlawful object, namely, that B may use the house as a gambling house and is a void agreement. Alternative promise being illegal In the case of an alternative promise, one branch of which is legal and the other illegal, the legal branch alone can be enforced. [Section 58] Example: Alternative promise being illegal A and B agree that A shall pay B Rs.1,000 for which B shall afterwards deliver to A either rice or smuggled opium. This is a valid contract to deliver rice, and a void agreement as to the opium. 1.3 Agreements opposed to public policy An agreement is said to be unlawful if the court regards it as opposed to public policy. Following are the agreements which are held to be opposed to public policy: Trading with enemy A person cannot enter into an agreement with an alien enemy during the period of war on the ground of public policy. This is because the further performance of the agreement involves commercial interaction with the enemy and the continued existence of agreement would confer upon the enemy an immediate or future benefit. Contracts entered before the declaration of war are either suspended or terminated during the period of war. Stifling prosecution Criminals should be prosecuted and punished; hence an agreement for stifling prosecution is illegal. It is in public interest that if a person has committed crime he must be prosecuted and punished. Example: Stifling prosecution A, who knows that B has stolen goods amounting to Rs.500,000, receives Rs.100,000 from B in consideration of not exposing A This agreement is illegal. Maintenance and champerty Maintenance is an agreement where a person promises to maintain a suit in which he has no interest. Example: Maintenance and champerty A promises to pay B Rs.100,000 if B files a suit against C. Champerty is an agreement whereby one party agrees to assist another in recovering property and in turn is to share in the proceeds of the action. In Pakistan, Maintenance and champerty are not absolutely void. They may be treated valid if they fulfil certain conditions if: (i) It is reasonable (ii) With bona fide intention If funds are supplied then maintenance and champerty both may be valid But if professional services have been provided then only maintenance may be valid and not champerty. Emile Woolf International 79 The Institute of Chartered Accountants of Pakistan

96 Sale of public offices The agreements of sale of public offices are illegal as such agreements, if enforced, would led to inefficiency and corruption on public life. Similarly, an agreement to pay money to a public servant to induce him to act corruptly or to retire and thus make way for the appointment of promisor are void on the ground of public policy. Restraint of parental rights An agreement which prevents a parent to exercise his right of guardianship is void. A father is entitled by law to the custody of his child. He cannot enter into an agreement which is inconsistent with his duties arising out of such custody. Restraint of personal liberty An agreement which unduly restricts the personal liberty of a person is void as law generally allows all persons freedom to enter into any contract they please. Agreement to create monopoly An agreement to create monopoly is void as this will impair consumer sovereignty and result in high prices for law quality of goods and services. Marriage brokerage agreement An agreement in which a person promises for reward to procure marriage for another is void being opposed to public policy. Emile Woolf International 80 The Institute of Chartered Accountants of Pakistan

97 Section A: Mercantile Law - Chapter 7: Legality of object, consideration and agreements opposed to public policy 2 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Explain the cases where the object or consideration of an agreement are said to be unlawful Name various types of agreements which are considered to be opposed to public policy Emile Woolf International 81 The Institute of Chartered Accountants of Pakistan

98 Emile Woolf International 82 The Institute of Chartered Accountants of Pakistan

99 Certificate in Accounting and Finance C H A P T E R 8 Void agreements Contents 1 Void agreements 2 Agreements in restraint of trade 3 Wagering agreements 4 Other void agreements 5 Chapter review Emile Woolf International 83 The Institute of Chartered Accountants of Pakistan

100 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Void agreements LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to void agreements. LO Be aware of circumstances or conditions when an agreement is considered as void LO Identify different types of void agreements. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 84 The Institute of Chartered Accountants of Pakistan

101 Section A: Mercantile Law - Chapter 8: Void agreements 1 VOID AGREEMENTS Section overview Meaning of void agreements Void agreements 1.1 Meaning of void agreements An agreement not enforceable by law is said to be void. All agreements may not be enforceable by law. The agreements which are not enforceable by law right from the time when they are made are called void-ab-initio. [Section 2(g)] Effect on agreement collateral to void agreement When an agreement is void, other agreement which is collateral to it is also void and is not enforceable by law if the other party has knowledge about it 1.2 Void agreements Contract Act declares certain agreements to be void. Such agreements are listed below: 1. Agreements by or with persons incompetent to contract [Section 11] 2. Agreements made under mutual mistake of fact [Section 20] 3. Agreements made under mutual mistake of foreign law [Section 21] 4. Agreement, the object or consideration of which is unlawful [Section 23] 5. Agreement, the consideration or object of which is partly unlawful [Section 24] 6. Agreement made without consideration [Section 25] 7. Agreements in restraint of trade [Section 27] 8. Wagering agreement [Section 30] 9. Agreements in restraint of legal proceedings [Section 28] 10. Agreements in restraint of marriage [Section 26] 11. Uncertain agreements [Section 29] 12. Agreements contingent on impossible events [Section 32] 13. Agreements to do impossible acts [Section 56] Note 14. Agreement to enter into an agreement in future Agreements from 1 to 6 have been discussed in earlier chapters. From 5 to 11 are those agreements which are specifically or expressly declared as void under the Contract Act. Emile Woolf International 85 The Institute of Chartered Accountants of Pakistan

102 2 AGREEMENTS IN RESTRAINT OF TRADE Section overview Meaning of agreements in restraint of trade Exceptions of agreements in restraint of trade 2.1 Meaning of agreements in restraint of trade Every agreement by which anyone is restricted from exercising a lawful profession, trade or business of any kind, is to that extent void. [Section 27] Example: Agreements in restraint of trade A and B carried on business in a certain locality in Karachi. A promised to stop business in that locality if B paid him Rs. 1,000. A stopped his business but B did not pay him the promised money. It was held that A could not recover anything from B because the agreement was in restraint of trade and was thus void. 2.2 Exceptions of agreements in restraint of trade Following are the exceptions where agreements in restraint of trade are not considered as void: Sale of goodwill One who sells the goodwill of a business may agree with the buyer to refrain from carrying on a similar business within specified local limits, so long as the buyer, or any person deriving title to the goodwill from him, carries on a like business therein, provided that such limits are reasonable. [Section 27] Partner s agreements The Partnership Act allows following agreements as an exception to the agreement in restraint of trade: Existing partner Subject to contract between partners, a partner may not carry on any business competing with that of the firm while he is a partner. [Section 1] Outgoing partner An outgoing partner may agree with his partners that he will not carry on any business similar to that of the firm for a specified period and for specified local limits. [Section 36] Dissolution of the firm Partners may, upon or in anticipation of the dissolution of the firm, make an agreement that some or all of them will not carry on a business similar to that of the firm for a specified period and for specified local limits. [Section 54] Sale of goodwill Partner(s) may upon the sale of the goodwill of a firm, make an agreement that partner(s) will not carry on any business similar to that of the firm for a specified period and for specified local limits. [Section 55] Trade combinations An agreement between different firms in the nature of a trade combination in order to maintain a price level and avoid under selling is not void. Example: Trade Combinations An agreement by two persons to avoid competition is void because it tends to create monopoly. An agreement among some manufacturing companies not to sell goods below a minimum price and to divide the profits in a certain proportion is not void because such agreement was made to regulate the business and not to restrain it. Emile Woolf International 86 The Institute of Chartered Accountants of Pakistan

103 Section A: Mercantile Law - Chapter 8: Void agreements Service Agreements During the employment, agreement of services often contains a clause by which an employee is prohibited from working anywhere else. Such a clause in service agreement by which an employer restricts the employee not to compete with the employer or accepting any other employment is not restraint of trade. Further, where legitimate interest or goodwill or trade secret of employer is involved an employer may restrict his employee even after the end of employment but such restriction should be just and reasonable. Example: Service Agreements An employee who possesses certain trade secrets, agreed not to carry on the similar business during 5 years after the termination of service. It is a valid agreement because restraint is intended to protect an employer against an employee making use of trade secrets learned by him in the course of his employment. An agreement to restrain a servant from competing for 5 years after the period of service. It is void because restraint is intended to avoid competition. Emile Woolf International 87 The Institute of Chartered Accountants of Pakistan

104 3 WAGERING AGREEMENTS Section overview Meaning of wagering agreement Effects of wagering agreement 3.1 Meaning of wagering agreement An agreement between two persons under which money or money s worth is payable, by one person to another on the happening or non-happening of a future uncertain event is called a wagering event. An agreement by way of wager is void. [Section 30] Example: Wagering agreement A promises to pay Rs. 10,000 to B if it rained today, and B promises to pay Rs. 1,000 to A if it did not. Example: Transactions which are not held wagers: Prize competitions which are games of skill, e.g. picture puzzles, athletic competitions. For example, an agreement to enter into a wrestling event in which winner was to be rewarded by the entire sale proceeds of tickets is not a wagering contract. An agreement to contribute to a plate or prize of the value of Rs. 500 and above to be awarded to the winner of a horse race. Stock market transaction in which the delivery of shares is intended to be given. Contracts of insurance. 3.2 Effects of Wagering Agreement The effects of wagering agreements are following: Such agreements are void No suit can be filed to recover the amount won on any wager. Transactions which are collateral to wagering agreements may also be void. Emile Woolf International 88 The Institute of Chartered Accountants of Pakistan

105 Section A: Mercantile Law - Chapter 8: Void agreements 4 OTHER VOID AGREEMENTS Section overview Agreements in restraint of legal proceedings Agreements in restraint of marriage Uncertain agreements Agreements contingent on impossible events Agreements to do impossible acts Agreements to enter into an agreement in the future 4.1 Agreements in restraint of legal proceedings Every agreement by which any party is restricted from enforcing his right under a contract by the usual legal proceedings or which limits the time within which he may enforce his right is void. [Section 28] Exceptions Exception An agreement between two or more persons who agree that any dispute which may arise between them shall be referred to arbitration, is valid. An agreement whereby parties agree not to file an appeal in upper court lf law, is valid. Parties making extract to select one court of law between two courts equally competent. An agreement restraining the marriage/to hear case, is valid of a minor is valid. 4.2 Agreements in restraint of marriage Every agreement in restraint of the marriage of any person other than a minor is void. This is because the law regards marriage and married status as the right of every individual. [Section 26] Example: Agreements in restraint of marriage A promises with B for good consideration that she will not marry C. It is a void agreement Uncertain agreements An agreement the meaning of which is not certain or capable of being made certain are void. [Section 29] Example: Uncertain agreements A agrees to sell to B "a hundred ton of oil." There is nothing whatever to show what kind of oil was intended. The agreement is void for uncertainty. A, who is a dealer in coconut oil, agrees to sell to B "one hundred ton of oil." The nature of A's trade affords an indication of the meaning of the words, and has entered into a contract for the sale of one hundred tons of coconut oil. A agrees to sell to B "all the grain in my granary at Peshawar." There is no uncertainty here to make the agreement void. A agrees to sell to B "one thousand mounds of rice at a price to be fixed by c." As the price is capable of being made certain, there is no uncertainty here to make the agreement void. A agrees to sell to B "my white horse for Rupees five hundred or Rupees one thousand." There is nothing to show which of the two prices are to be given. The agreement is void. Emile Woolf International 89 The Institute of Chartered Accountants of Pakistan

106 4.4 Agreements contingent on impossible events Contingent agreements to do or not to do anything, if an impossible event happens are void whether the impossibility of the event is known or not to the parties to the agreement at the time when it is made. [Section 32] Example: Agreements contingent on impossible events A agrees to pay Rs. 1,000 if B marries C (a Hindu) who is already married to D. This agreement is void. 4.5 Agreements to do impossible acts An agreement to do an impossible act is void. [Section 56] Example: Agreements to do impossible acts A agrees with B to discover treasure by magic. The agreement is void. 4.6 Agreements to enter into an agreement in the future An agreement to enter into an agreement in the future is void. Emile Woolf International 90 The Institute of Chartered Accountants of Pakistan

107 Section A: Mercantile Law - Chapter 8: Void agreements 5 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Discuss briefly expressly declared void agreements Discuss the exceptions to such void agreements Explain wagering agreement Emile Woolf International 91 The Institute of Chartered Accountants of Pakistan

108 Emile Woolf International 92 The Institute of Chartered Accountants of Pakistan

109 Certificate in Accounting and Finance C H A P T E R 9 Contingent contracts Contents 1 Contingent contracts 2 Chapter review Emile Woolf International 93 The Institute of Chartered Accountants of Pakistan

110 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Contingent contracts LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to contingent contracts. LO Define contingent contract LO Identify characteristics of contingent contract LO Understand rules regarding contingent contract LO Understand the difference between contingent contact and wagering agreement. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 94 The Institute of Chartered Accountants of Pakistan

111 Section A: Mercantile Law - Chapter 9: Contingent contracts 1 CONTINGENT CONTRACT Section overview Definition of contingent contract Characteristics of contingent contracts Rules regarding contingent contracts Difference between contingent contract and wagering agreement 1.1 Definition of contingent contract Definition: Contingent contract [Section 31] A contingent contract is a contract. to do or not to do something if some event, collateral to such contract does or does not happen. Insurance contracts and contracts of indemnity and guarantee provide the best example of contingent contracts. Example: Definition of contingent contract A contracts to pay B Rs.10,000 if B s house is burnt. This is a contingent contract. 1.2 Characteristics of contingent contracts The following are the characteristics of contingent contracts: the performance of a contingent contract depends upon the happening or non-happening of some future event. the event must be collateral to the contract the event must be uncertain 1.3 Rules regarding contingent contracts The rules regarding the enforcement of contingent contract are given below: Contracts contingent upon the happening of an uncertain future event A contract, the performance of which is contingent on the happening of an uncertain future event, cannot be enforced by law unless and until that event has happened. If the event becomes impossible, such contracts become void. [Section 32] Example: Contracts contingent upon the happening of an uncertain future event A makes a contract with B to buy B's horse if A survives C. This contract cannot be enforced by law unless and until C dies in A's life time. A makes a contract with B to sell a horse to B at a specified price if C to whom the horse has been offered, refuses to buy him. The contract cannot be enforced by law unless and until C refuses to buy the horse. A contract to pay B a sum of money when B marries C. C dies without being married to B. The contract becomes void. Emile Woolf International 95 The Institute of Chartered Accountants of Pakistan

112 Contracts contingent upon the non-happening of a certain future event A contract the performance of which is contingent on the non-happening of a certain future event can be enforced when the happening of that event becomes impossible and not before. [Section 33] Example: Contracts contingent upon the happening of a certain future event A agrees to pay B a sum of money if a certain ship does not return. This ship is sunk. The contract can be enforced when the ship sink. Contracts contingent upon the future conduct of a living person If the future event on which a contract is contingent is the way in which a person will act at an unspecified time, the event shall be considered to become impossible when such person does anything which renders it impossible that he should so act within any definite time or otherwise than under further contingencies. [Section 34] Example: Contracts contingent upon the future conduct of a living person A agrees to pay B a sum of money if B marries C. C marries D. the marriage of B to C must now be considered impossible, although it is possible that D may die, and that C may afterwards marry B. Contracts contingent upon the happening of an uncertain specified event within a fixed time Contingent contracts to do or not to do anything if a specified uncertain event happens within a fixed time become void if at the expiration of the time fixed such event has not happened or if before the time fixed such event becomes impossible. [Section 35] Example: Contracts contingent upon the happening of an uncertain specified event within a fixed time A promises to pay B a sum of money if a certain ship returns within a year. The contract may be enforced if the ship returns within the year, and becomes void if the ship is burnt within the year. Contracts contingent upon the non-happening, of an uncertain specified event within a fixed time A contract of performance of which is contingent on the non-happening of a specified uncertain event within a fixed time may be enforced by law: When the time fixed has expired and such event has not happened or If (before the expiry of the time fixed) it becomes certain that such event will not happen. [Section 35] Example: Contracts contingent upon the non-happening of an uncertain specified event within a fixed time A promises to pay B a sum of money if a certain ship does not return within a year. The contract may be enforced if the ship does not return within the year, or is burnt within the year. Agreements contingent upon impossible events Contingent agreements to do or not to do anything, if an impossible event happens, are void, whether the impossibility of the event is known or not to the parties to the agreement at the time when it is made. [Section 36] Example: Agreements contingent upon impossible events A agrees to pay B Rs. 1,000 if two straight lines should enclose a space. The agreement is void. A agrees to pay B, Rs. 1,000 if B will marry A's daughter C. C was 'dead at the time of the agreement. The agreement is void. Emile Woolf International 96 The Institute of Chartered Accountants of Pakistan

113 Section A: Mercantile Law - Chapter 9: Contingent contracts 1.4 Difference between contingent contract and wagering agreement Following are the few differences between contingent and wagering agreement: Validity It is a valid contract. Contingent contract Interest of parties In a contingent contract parties have real interest in the occurrence or non-occurrence of the event e.g. insurable interest in the property insured. Uncertain event The future uncertain event is merely collateral. Reciprocal promises It consists of reciprocal promises. It is void and illegal. Wagering agreement Parties are not interested in the occurrence or non-occurrence of the event except for the winning or losing the amount. The uncertain event is the sole determining factor of the agreement. It may or may not consist of reciprocal promises. Emile Woolf International 97 The Institute of Chartered Accountants of Pakistan

114 2 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Define the term contingent contracts Discuss the rules relating to the performance of contingent contracts Explain the extent of impossibility of the contingency affects the performance of the contract Differentiate between contingent contract and wagering agreement Emile Woolf International 98 The Institute of Chartered Accountants of Pakistan

115 Certificate in Accounting and Finance C H A P T E R 10 Quasi contracts Contents 1 Quasi contracts 2 Chapter review Emile Woolf International 99 The Institute of Chartered Accountants of Pakistan

116 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Quasi contracts LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to Quasi contracts. LO Know meaning of quasi contract LO Understand and apply rules regarding quasi contract LO Be aware of different kinds of quasi contract. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 100 The Institute of Chartered Accountants of Pakistan

117 Section A: Mercantile Law - Chapter 10: Quasi contracts 1 QUASI CONTRACTS Section overview Meaning of Quasi contract Types of Quasi contracts Application of Quantum Meruit 1.1 Meaning of Quasi contract A Quasi contract is an obligation imposed by law in absence of any agreement between the parties. A quasi-contract is not an actual contract, but is a legal substitute formed to impose equity between two parties. The concept of a quasi-contract is that of a contract that should have been formed, even though in actuality it was not. The other name for Quasi contracts is constructive contracts. 1.2 Types of Quasi contracts The types of Quasi contracts are listed below: Supply of necessaries Payment by interested person Person enjoying benefit of non-gratuitous act / goods Finder of goods Payment by mistake or under coercion These Quasi contracts are discussed below: Supply of necessaries If a person incapable to enter into contract or his dependent is supplied by another person necessaries suited to his conditions in life the person supplying such necessaries is entitled to be reimbursed his price from the property of such incompetent person. [Section 68] This has been discussed in detail in chapter 4. Example: Supply of necessaries A supplies B, a lunatic, with necessaries suitable to his condition in life. A is entitled to be reimbursed from B's property. A supplies the wife and children of B, a lunatic, with necessaries suitable to their condition in life. A is entitled to be reimbursed from B's property. Payment by interested person A person, who is interested in the payment of money which another is bound by law to pay, and who therefore pays it, is entitled to be reimbursed by the other. [Section 69]. Thus the essential requirement of this section is: The payment made should be bona fide for the protection of one s interest The payment should not be a voluntary one The payment must be such as the other party was bound by law to pay Example: Payment by interested person B holds land in Sindh, on a lease granted by A, a Zamindar. The revenue payable by A to the Government being in arrears, his land is advertised for sale by the Government. Under the revenue law, the consequence of such sale will be the annulment of B's lease. B, to prevent the sale and the consequent annulment of his own lease, pays the Government the sum due from A. A is bound to make good to B the amount so paid. Emile Woolf International 101 The Institute of Chartered Accountants of Pakistan

118 Person enjoying benefit of non-gratuitous act / goods Where a person lawfully does anything for another person, or delivers anything to him, not intending to do so gratuitously and such other person enjoys the benefit thereof, the latter is bound to make compensation to the former in respect of, or to restore, the thing so done or delivered. [Section 70] Following conditions must be satisfied before any right of action arises under this section: The thing must have been done lawfully The person doing the act should not have intended to do it gratuitously The person for whom the act is done must have enjoyed the benefit of the act. Example: Person enjoying benefit of non-gratuitous act / goods A, a tradesman, leaves goods at B's house by mistake. B treats the goods as his own. He is bound to pay A for them. A saves B's property from fire. A is not entitled to compensation from B, if the circumstances show that he intended to act gratuitously. Finder of goods A person who finds goods belonging to another, and takes them into his custody, is subject to the same responsibility as a bailee. He is bound to take as much care of the goods as a man of ordinary prudence would, under similar circumstances, take of his own goods. He must also take reasonable steps to trace its owner - if he does not, he will be guilty of wrongful conversion of the property. [Section 71] This has been discussed in detail in chapter 15. Example: Finder of goods A found a diamond rings at a wedding reception of B. A told B and other guests about it with an intention to find the true owner. If he is not able to find the owner he can retain the ring as bailee. Payment by mistake or under coercion A person to whom money has been paid, or anything delivered by mistake or under coercion, must repay or return it. [Section 72] Example: Payment by mistake or under coercion A and B jointly owe Rs. 100 to C. A alone pays the amount to C, and B, not knowing this fact, pays Rs. 100 over again to C. C is bound to repay the amount to B. A railway company refuses to deliver up certain goods to the consignee, except upon the payment of an undue charge for carriage. The consignee pays the sum charged in order to obtain the goods. He is entitled to recover so much of the charge as was excessive. Quantum meruit The term Quantum Meruit means as much as earned or deserved. In case of breach of contract the application or non-application of the term quantum meruit varies depending upon the terms of the contract. Further, the divisibility or indivisibility of performance of the contract may also be taken into account. The aim of such an award is based on an implied agreement to pay for what has been done. Quantum Meruit is likely to be sought where one party has already performed part of his obligations and the other party then repudiates the contract. Provided the injured elects to treat the contract as terminated, he may claim a reasonable amount for the work done. Emile Woolf International 102 The Institute of Chartered Accountants of Pakistan

119 Section A: Mercantile Law - Chapter 10: Quasi contracts 1.3 Application of Quantum Meruit Quantum meruit applies in the following cases: Void agreement or a contract that becomes void Person enjoying benefit of non-gratuitous act / goods Act preventing the completion of contract Divisible contract Indivisible contract performed completely but badly Express or implied contract to render services but no remuneration is pre-settled Void agreement or contract that becomes void When an agreement is discovered to be void, or when a contract becomes void, any person who has received any advantage under such agreement or contract is bound to restore it, or to make compensation for it to the person from whom he received it. [Section 65] Example: Void agreement or contract that becomes void A, pays B Rs. 1,000 in consideration of B s promising to marry C, A s daughter. C is dead at the time of the promise. The agreement is void, but B must repay A Rs. 1,000. A contracts with B to deliver to him 250 kg of rice before May. A delivers 130 kg only before the agreed time, and none after. B retains the 130 kg. He is bound to pay A for them. A, a singer contracts with B, the manager of a theatre, to sing at his theatre for two nights in every week during the next two months, and B engages to pay her Rs. 50,000 for each night's performance. On the sixth night, A wilfully absents herself from the theatre, and B, in consequence rescinds the contract. B must pay A for the five nights on which she has sung. A contracts to sing for B for Rs. 100,000 which are paid in advance. A is too ill to sing. A is not bound to make compensation to B for the loss of the profits which B would have made if A had been able to sing, but must refund to B Rs. 100,000 paid in advance. Person enjoying benefit of non-gratuitous act / goods Where a person lawfully does anything for another person, or delivers anything to him, not intending to do so gratuitously and such other person enjoys the benefit thereof, the latter is bound to make compensation to the former in respect of, or to restore, the thing so done or delivered. [Section 70] Example: Person enjoying benefit of non-gratuitous act / goods A, a tradesman, leaves goods at B's house by mistake. B treats the goods as his own. He is bound to pay A for them. A saves B's property from fire. A is not entitled to compensation from B, if the circumstances show that he intended to act gratuitously. Act preventing completion of performance If a party does not complete the contract or prevents the other party from completing it, the aggrieved party can sue on quantum meruit. Example: Act preventing completion of performance C, an owner of a magazine engaged P to write a book to be published by instalments in his magazine. After a few instalments were published, the publication of the magazine was stopped. It was held that P could claim payment for the part already published. Emile Woolf International 103 The Institute of Chartered Accountants of Pakistan

120 Divisible contract The party at default may sue on a quantum meruit if the contract is divisible and the party not at default has enjoyed benefits of the part performance. Example: Divisible contract A hired B to construct a house for Rs. 1 million but B abandoned this contract after having done the work worth Rs. 0.5 million. Afterwards, A got the work completed. B could not recover anything for the work done because he was entitled to the payment only on the completion of the work. Indivisible contract performed completely but badly If it is an indivisible contract which has been completely performed but with faults than the party at default may claim the amount agreed after deducting any amount which the other party has paid to remove faults. Example: Indivisible contract performed completely but badly A agreed to decorate B's flat for a lump sum of Rs. 200,000. A did the complete work but B complained of faulty workmanship. It costs B another Rs. 30,000 to remedy the defect. It was held that A could recover only Rs. 170,000 from B. Express or implied contract to render services but no remuneration is pre-settled When there is an express or implied contract to render services but no remuneration is presettled in such a case reasonable remuneration is payable. Emile Woolf International 104 The Institute of Chartered Accountants of Pakistan

121 Section A: Mercantile Law - Chapter 10: Quasi contracts 2 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Explain Quasi contracts Discuss the kinds of Quasi contracts Emile Woolf International 105 The Institute of Chartered Accountants of Pakistan

122 Emile Woolf International 106 The Institute of Chartered Accountants of Pakistan

123 Certificate in Accounting and Finance C H A P T E R 11 Performance of a contract Contents 1 Performance of a contract 2 Reciprocal promises 3 Appropriation of payment 4 Assignment of contracts 5 Chapter review Emile Woolf International 107 The Institute of Chartered Accountants of Pakistan

124 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Performance of a contract LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to performance of a contract. LO Explain performance and its types i.e. actual and attempted LO Understand rules relating to joint and reciprocal contracts and appropriation of payment LO Identify essentials of a valid tender LO Define tender and explain its types and effects. Describe the essentials of a valid tender LO Identify factors which may affect the performance of a contract LO Understand and apply rules relating to joint and reciprocal promises LO Understand the meaning of appropriation of payment and rules regarding appropriation of payment LO Explain the assignment of contracts. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 108 The Institute of Chartered Accountants of Pakistan

125 Section A: Mercantile Law - Chapter 11: Performance of a contract 1 PERFORMANCE OF A CONTRACT Section overview Meaning of performance Types of performance Types of tender Essentials of a valid tender Effect of refusal to perform Persons who can perform and demand performance Rules regarding the performance of joint promise Time and place of performance Time as essence of contract 1.1 Meaning of performance A contract creates an obligation, which continues till the contract has been discharged by actual performance. Performance of the contract is one of the vital modes of discharge of the contract. A contract is said to have been performed when the parties to a contract either perform or offer to perform their respective promises. Obligations of parties to contracts The parties to a contract must either perform, or offer to perform their respective promises, unless such performance is dispensed with or excused under the provisions of this Act, or of any other law. 1.2 Types of performance There are two types of performance as follows: Actual performance When the promisor has made the performance in accordance with the terms of the contract and is accepted by the promisee it is called an actual performance. [Section 37] Example: Actual performance A contracted to deliver to B at his warehouse on 1st November, 500 bales of cotton of a particular quality. A brought the cotton of requisite quality to the appointed place on the appointed day during the business hours, and B took the delivery of goods. This is an actual performance. Attempted performance Although, the promisor has made an offer of performance but the offer of performance of promisor is not accepted by the promisee it is called an attempted performance. Attempted performance is also known as tender. [Section 38] Example: Attempted performance A contracted to deliver to B at his warehouse on 1st November, 500 bales of cotton of a particular quality. B refused to take the delivery of goods; it is a case of attempted performance because A has done what he was required to do under the contract. Emile Woolf International 109 The Institute of Chartered Accountants of Pakistan

126 1.3 Types of tender There can be two types of tender as follows: Tender of goods or services Where the promisor offers to deliver the goods or services but the promisee refuses to accept. Effects Goods or services need not be offered again. Promisor may sue the promisee for non-performance and claim damages. Promisor is discharged from his liability i.e. he is not liable for non-performance. Tender of money Where the promisor offers to pay the amount but the promisee refuses to accept the same. Effects Promisor is not discharged from his liability to pay the amount Promisor will not be liable for interest from the date of a valid tender 1.4 Essentials of a valid tender The essentials of a valid tender are shown below: Unconditional Tender is said to be unconditional when it is made in accordance with the terms of the contract. Proper Time Tender must be made at the stipulated time or during business hours. Tender of goods or money before the due date is also not a valid tender. Emile Woolf International 110 The Institute of Chartered Accountants of Pakistan

127 Section A: Mercantile Law - Chapter 11: Performance of a contract Proper Place Tender must be made at the stipulated place or att business place. Proper Person It must be made to the promisee or his duly authorized agent. In case of several joint promisees, a tender made to one of them has the same legal consequences as tender to all of them. Reasonable Opportunity Promisee must have reasonable opportunity for examining e that the goods offered are the same as per the terms of the contract. Whole Obligation A valid tender is for the whole obligation. However, a minor deviation from the terms of the contract may not render the tender invalid. Fixed amount and legal tender In case of tender of money the amount must be fixed and in legal tender. 1.5 Effect of refusal to t perform When a party to a contract has refused to perform or o disabled himself from performing his promise in its entirety, the promisee may put an end to the contract, unless he has signified, by words or conduct, his willingness in its continuance. [Section 39] Example: Effect of refusal to perform A, a singer enters into a contract with B, the manager of a theatre, to sing at his theatre two nights in every week during the next two months, and B engages to pay her Rs.100 for each night's performance. On the sixth night, A wilfully absents herself from the theatre. B is at liberty to put an a end to thee contract. A, a singer enters into a contract with B, the manager of a theatre, to sing at his theatre two nights every week during the next two monthss and B engages to pay her at the rate of Rs.100 for each night. On the sixth night, A wilfully absents herself. With the assent of B, A sings on the seventh night. B has signified his acquiescence in the continuance of the contract, and cannott now put ann end to it, but is entitled to compensation for damage sustained by him through A's failure to sing on the sixth night. 1.6 Persons who can perform and demandd performance Personss who can perform and demand performance aree shown below [Section 40 to 42]: Persons who can perform Promisorr Promisor's agent Legal representativee Third party Joint promisor Persons who can demand performance Promiseee Promisee's agent Legal representativee Third party Joint promisees Emile Woolf International 111 The Institute off Chartered Accountants of Pakistan

128 Persons who can perform Promisor If a contract is of personal nature or it was agreed that promise will be performed by the promisor himself than such promise must be performed by the promisor. Example: Promisor A promises to marry B, A must perform this promise personally. A promises to paint a picture for B, A must perform the promise personally. Promisor s agent If the intention of parties is that the promise can either be performed by the promisor himself or any person employed by him than such contracts can be performed by the promisor himself or an agent employed by him. Example: Promisor s agent A promises to pay B a sum of money. A may perform this promise either by personally paying the money to B, or by causing it to be paid B by another, and if A dies before the time appointed for payment, his representatives must perform the promise, or employ some proper person to do so. Legal representatives Unless a contrary intention appears or the contract is of personal nature on death of promisor, his legal representative can perform the contract. Example: Legal representatives A promises to marry B, A dies. A s legal representatives cannot perform this promises. Third party With the consent of the promisee a contract can be performed by a third party. When a promisee accepts performance of the promise from a third person, he cannot afterwards enforce it against the promisor. Joint promisor Unless a contrary intention appears, in case of several promisor the following persons must perform the promise: All the promisors jointly in case of all the promisors are alive Representatives of the deceased promisor jointly with the surviving promisor(s) in case of death of any of the joint promisors Representatives of all of them jointly in case of death of all joint promisors Example: Joint promisor A and B jointly promise to repay a loan of Rs.10,000 on a specified day. A dies before that specified day. A's representative jointly with B must perform the promise on the specified day. Persons who can demand performance Promisee Under a contract only a promisee can demand the performance of the promise. Example: Promisee A promises B to pay Rs.10,000 to C. It is only B who can demand performance and not C. Emile Woolf International 112 The Institute of Chartered Accountants of Pakistan

129 Section A: Mercantile Law - Chapter 11: Performance of a contract Promisee s agent: If the intention of parties is that performance can be demanded from any person authorised by the promisee then performance can be demanded by promisee s agent. Legal representative Unless a contrary intention appears from the contract or the contract is of a personal nature on death of the promisee, his legal representative can demand performance. Example: Legal representative A promise to marry to B on the specified day. B dies before the specified day. The legal representatives of B cannot demand performance of the promise from A because the contract is of personal nature. Third party A third party can also demand the performance of the contract in some exceptional cases like beneficiary in case of trust or the person for whose benefit the provision is made in family arrangements. Joint promisees In case of several promisees, unless a contrary intention appears, the performance can be demanded by the following persons: All the promises jointly in case all the promisees are alive Representatives of deceased promisee jointly with the surviving promisees in case of death of any of joint promisees Representatives of all of them jointly in case of death of all joint promisees Example: Joint promisees A promises B and C jointly to repay loan of Rs.10,000 on a specified day. B dies before that specified day. B's representative jointly with C can demand the performance from Aon specified day. If B and C die before that specified day, the representatives of B and C jointly can demand the performance from A on the specified day. 1.7 Rules regarding the performance of joint promise The rules regarding the performance of joint promises are as follows [Section 43 to 44]: Joint and several liability of joint promisors When two or more persons make a joint promise, the promisee may, in the absence of express agreement to the contrary, compel anyone or more of such joint promisors to perform the whole of the promise. Example: Joint and several liability of joint promisors A, B and C jointly promise to pay DRs.3,000. D may compel either A or B or C to pay him Rs.3,000. Right to claim contribution Each of two or more joint promisors may compel every other joint promisor to contribute equally with himself to the performance of the promise, unless a contrary intention appears from the contract. Example: Right to claim contribution A, B and C jointly promise to pay D a sum of Rs.3,000. C is compelled to pay the whole. A is insolvent, but his assets are sufficient to pay one-half of his debts. C is entitled to receive Rs.500 from A's estate and Rs.1,250 from B. Emile Woolf International 113 The Institute of Chartered Accountants of Pakistan

130 Sharing of loss in contribution If anyone of two or more joint promisors makes default in such contribution, the remaining joint promisors must bear the loss arising from such default in equal shares. Example: Sharing of loss in contribution A, B and C are under a joint promise to pay D Rs.3,000. C is unable to pay anything and A is compelled to pay the whole. A is entitled to receive Rs.1,500 from B. Release of one joint promisor Where two or more persons have made a joint promise, a release of one of such joint promisors by the promisee, does not discharge the other joint promisor or joint promisors; neither does it free the joint promisor so released from responsibility to the other joint promisor or joint promisors. Example: Release of one joint promisor A, B and C jointly promise to pay D Rs.3,000. D releases A from his liability and sues B and C for payment, Here, neither B and C are released from their liability to D nor is A released from his liability to B and C for contribution. Devolution of joint rights When a person has made a promise to two or more persons jointly, then, unless a contrary intention appears from the contract, the right to claim performance rests, as between him and them, with them during their joint lives, and, after the death of any of them, with the representative of such deceased person jointly, with the survivor or survivors and after the death of the last survivor, with the representatives of all jointly. [Section 45] Example: Devolution of joint rights A, in consideration of Rs.5,000 lent to him by B and C, promises B and C jointly to repay them that sum with interest on a day specified. B dies. The right to claim performance rests with B's representative jointly with C during C's life, and, after the death of C, with the representatives of B and C jointly. 1.8 Time and place of performance The various rules regarding the time and place of performance are given below: Time for performance is not specified Where the time for performance is not specified in a contract and the promisor has undertaken to perform without application by the promisee then the contract must be performed within a reasonable time. The question 'What is reasonable time' is a question of fact. [Section 46] Time for performance is specified Where the time for performance is specified in a contract and the promisor has undertaken to perform it without application by the promisee then the promisor must perform his promise on that particular day during the usual hours of business and at a place where the promise ought to be performed. [Section 47] Place for performance is specified Where the time for performance is specified in a contract and the promisor has not undertaken to perform it without application by the promisee than the promisee must apply for performance at a proper place and within usual hours of business. [Section 48] Emile Woolf International 114 The Institute of Chartered Accountants of Pakistan

131 Section A: Mercantile Law - Chapter 11: Performance of a contract Place for performance is not specified Where the place for performance is not specified in a contract and the promise is to be performed without application by the promisee than the promisor must apply to the promisee to appoint a reasonable place for the performance and to perform the promise at such place. [Section 49] Promisee prescribes the manner or time Where the promisee prescribes the manner or time for performance then the promise must be performed in the manner and at the time prescribed by the promise. [Section 50] Example: Time and place of performance B owes A Rs.2,000. A desires B to pay the amount to A's account with C, a banker. B who also banks with C, orders the amount to be transferred from his account to A's credit, and this is done by C. Afterwards, and before A knows of the transfer, C fails. There has been a good payment by B. A and B are mutually indebted. A and B settle an account by setting off one item against another, and B pays A the balance found to be due from him upon such settlement. This amounts to payment by A and B, respectively, of the sums which they owed to each other. A owes B Rs.2,000. B accepts some of A's goods in reduction of the debt. The delivery of the goods operates as a part payment. A desires B, who owes him Rs.100, to send him a note for Rs.100 by post. The debt is discharged as soon as B posts a letter containing the note duly addressed to A. 1.9 Time as essence of contract Time is essence of a contract means that it is necessary for the parties to a contract to perform their respective promises within the specified time. But if the promisor fails to do so, can the promisee rescind the contract? This question can be answered by deciding whether in such a case time was or was not the essence of the contract. [Section 55] Cases where time is essence In the following cases, time is usually considered to be the essence of contract: Where the parties have expressly agreed to treat the time as the essence of the contract. Where the non-performance at the specified time operates as an injury to the party. Where the nature and necessity of the contract requires the performance of the contract within the specified time. Consequences where time is essence In case the performance is not made where time is essence the breach will have following consequences: Voidable at the option of promisee. Promisee is entitled to claim compensation for any loss arising to him due to nonperformance of the promise at agreed time where performance beyond the stipulated time is not accepted. Promisee is not entitled to claim compensation for any loss arising to him due to nonperformance of the promise at agreed time where performance beyond the stipulated time is accepted, unless the promisee gives notice to the promisor of his intention to claim compensation. Consequences where time is not essence In case the performance is not made where time is not essence the breach will have the following consequences: Emile Woolf International 115 The Institute of Chartered Accountants of Pakistan

132 Not voidable at the option of promisee. Promisee is entitled to claim compensation for any loss arising to him due to nonperformance of the promise at agreed time where performance beyond the stipulated time is not accepted. Promisee is not entitled to claim compensation for any loss arising to him due to nonperformance of the promise at agreed time where performance beyond the stipulated time is accepted, unless the promisee gives notice to the promisor of his intention to do so. Example: Consequences where time is not essence A, a singer, enters into a contract with B, the manager of a theatre, to sing at his theatre two nights in every week for the next two months. B agrees to pay her Rs 100 for each performance. On the sixth night, A willfully absents herself from the Theatre. In this case, B has the following two options: B may rescind the contract and claim compensation for the loss occasioned to him by A's failure to sing on the sixth night. B may permit A to sing on the seventh night and claim compensation for loss from A by giving a notice to A of his intention to do so. Emile Woolf International 116 The Institute of Chartered Accountants of Pakistan

133 Section A: Mercantile Law - Chapter 11: Performance of a contract 2 RECIPROCAL PROMISES Section overview Meaning of reciprocal promises Types of reciprocal promises Rules regarding performance of reciprocal promises 2.1 Meaning of reciprocal promises Promises which form the consideration or part of the consideration for each other are called 'reciprocal promises'. [Section 2(f)] Example: Meaning of reciprocal promises In a contract for sale, A promises to deliver the goods to B at a fixed price and B promises to give promise for the payment of the price. Such promises are called reciprocal promises. 2.2 Types of reciprocal promises The reciprocal promises have following types: Mutual and independent When the promises are to be performed by each party independently, without waiting for the other party to perform is called Mutual and independent. Mutual and dependent When the performance of one party depends on the prior performance of the other party it is called Mutual and dependent. Mutual and concurrent When the promises are to be performed simultaneously i.e. at the same time it is called Mutual and concurrent. 2.3 Rules regarding performance of reciprocal promises The rules regarding the performance of reciprocal promises are as follows: Simultaneous performance When a contract consists of reciprocal promises to be simultaneously performed, the promisor need not perform his promise unless the promisee is ready and willing to perform his reciprocal promise. [Section 51] Example: Simultaneous performance A and B contract that A shall deliver goods to B to be paid for by B on delivery A need not deliver the goods unless B is ready and willing to pay for the goods on delivery B need not pay for the goods, unless A is ready and willing to deliver them on payment. A and B contract that A shall deliver goods to B at a price to be paid in instalments, the first instalment to be paid on delivery. A need not deliver unless B is ready and willing to pay the first instalment on delivery. B need not pay the first instalment, unless A is ready and willing to deliver the goods on payment of the first instalment. Order of performance Where the order in which reciprocal promises are to be performed is expressly fixed by the contract, they must be performed in that order, and where the order is not expressly fixed by the contract, they must be performed in the order which the nature of the transaction requires. [Section 52] Emile Woolf International 117 The Institute of Chartered Accountants of Pakistan

134 Example: Order of performance A and B contract that A shall build a house for B at a fixed price. A's promise to build the house must be performed before B's promise to pay for it. A and B contract that A shall make delivery of his stock-in-trade to B at a fixed price, and B promises to give security for the payment of the money. A's promise need not be performed until the security is given, because the nature of the transaction requires that A should have security before he delivers up his stock. Preventing the performance When a contract contains reciprocal promises, and one party to the contract prevents the other from performing his promise, the contract becomes voidable at the option of the party so prevented; and he is entitled to compensation from the other party for any loss which he may sustain in consequence of the non-performance of the contract. [Section 53] Example: Preventing the performance A and B contract that B shall execute certain work for A, for Rs.1,000. B is ready and willing to execute the work accordingly, but A prevents him from doing so. The contract is voidable at the option of B; and, if he elects to rescind it, he is entitled to recover from A compensation for any loss which he has incurred by its non-performance. Non-performance in case of mutual and dependent reciprocal promises Where the performance of one party depends on the prior performance of the other party and the party who is liable to perform first, fails to perform it, then such party cannot claim the performance from the other party and must make compensation to the other party for any loss which the other party may sustain by the non-performance of the contract. [Section 54] Example: Non-performance in case of mutual and dependent reciprocal promises A contracts with B to execute certain builder's work for a fixed price, B supplying the timber necessary for the work. B refuses to furnish any timber. A need not execute the work, and B is bound to make compensation to A for any loss caused to him by the non-performance of the contract. A contracts with B to deliver to him, at a specified price, certain merchandise on board of a ship which cannot arrive for a month, and B engages to pay for the merchandise within a week from the date of the contract. B does not pay within the week. A's promise to deliver need not be performed, and B must make compensation. A promises B to sell him 1000 bales of merchandise to be delivered next day, and B promises A to pay them within a month. A does not deliver according to his promise. B's promise to pay need not be performed, and A must make compensation. Promise to do legal and illegal things Where persons reciprocally promise, firstly, to do certain things which are legal, and secondly, under specified circumstances, to do certain other things which are illegal, the first set of promises is a contract, but the second is a void agreement. [Section 57] Example: Promise to do legal and illegal things A and B agree that A shall sell B a house for Rs.10,000 but that, if B uses it as a gambling house, he shall pay Rs.50,000 for it. The first set for reciprocal promises, namely to sell the house and to pay Rs.10,000 for it, is a contract. The second set is for an unlawful object, namely, that B may use the house as a gambling house and is a void agreement. Emile Woolf International 118 The Institute of Chartered Accountants of Pakistan

135 Section A: Mercantile Law - Chapter 11: Performance of a contract Alternative promise being illegal In the case of an alternative promise, one branch of which is legal and the other illegal, the legal branch alone can be enforced. [Section 58] Example: Alternative promise being illegal A and B agree that A shall pay B Rs.1,000 for which B shall afterwards deliver to A either rice or smuggled opium. This is a valid contract to deliver rice, and a void agreement as to the opium. Emile Woolf International 119 The Institute of Chartered Accountants of Pakistan

136 3 APPROPRIATION OF PAYMENT Section overview Meaning of appropriation of payment Rules regarding appropriation of payment 3.1 Meaning of appropriation of payment Appropriation of payment means allocation of payment to a particular debt. 3.2 Rules regarding appropriation of payment The various rules regarding appropriation of payments are given below: Debt to be discharged is indicated The payment, if accepted must be applied accordingly. [Section 59] Example: Debt to be discharged is indicated A owes B, among other debts, Rs.1,000 upon a promissory note, which falls due on the first June. He owes B one other debt of that amount. On the first June, A pays to B Rs.1,000. The payment is to be applied to the discharge of the promissory note. A owes to B, among other debts; the sum of Rs.567. B writes to A and demands payment of this sum. A sends to BRs.567. This payment is to be applied to the discharge of the debt of which B had demanded payment. Debt to be discharged is not indicated The creditor has option to apply the payment to any lawful debt due from the debtor even if it is a time barred debt but he cannot apply to a disputed debt. [Section 60] Neither party makes an appropriation The payment shall be applied in discharge of the debts in order of time whether or not they are time barred. In other words, all payments shall be applied towards the payment of first debt till it gets extinguished. Similarly, all subsequent payments applied towards second debt till it gets fully paid and so on and so forth. If the debts are of equal standing, the payment shall be applied in discharge of each, proportionately. [Section 61] If principal amount and markup both are due, then mark-up is settled first and then principal amount is settled. Emile Woolf International 120 The Institute of Chartered Accountants of Pakistan

137 Section A: Mercantile Law - Chapter 11: Performance of a contract 4 ASSIGNMENT OF CONTRACTS Section overview Meaning of assignment of contracts Modes of assignment of contracts 4.1 Meaning of assignment of contracts Assignment of a contract means transfer of contractual rights and liabilities to a third party. 4.2 Modes of assignment of contracts Assignment of a contract may take place in the following ways: Assignment by act of parties Assignment by operation of law Assignment by act of parties Assignment by act of parties takes place when the parties to a contract themselves make the assignment. Such an assignment is subject to the following rules: If it is a contractual obligation/right involving personal skill or ability than it cannot be assigned. If the contract expressly or impliedly provides that the contract shall be performed by the promisor only then such obligation cannot be assigned If the contract does not expressly or impliedly provides that the contract shall be performed by the promisor only then the promisor or his representative my employ a competent person to perform such obligation but even than the promisor remains liable to the promisee for proper performance. By Novation the promisor may transfer his liability to a third party with the consent of the promisee and the transferee. Actionable claims i.e. claim to any debt or to any beneficial interest in movable property can always be assigned by an instrument in writing. Notice of such assignment is also required to be given by the debtor. Assignment by operation of law Assignment by operation of law takes place when the law intervenes. Such assignment takes place in the following cases: In case of death of any party the rights and obligation (other than those of personal nature) of the deceased party pass on to his legal representatives. In case of insolvency of any party the rights and obligations (other than those of personal nature) of the insolvent party pass on to the Official Receiver or Assignee. Example: Assignment A promises to marry B. Here, neither A can assign their obligation nor B can assign their right because the contract is of personal nature. A owes B Rs.100,000 and C owes A Rs.100,000. Here A cannot compel B to recover the amount from C. However, he can transfer his liability to C with the consent of B and C. B can also transfer his right to a third party to recover the amount from A. Emile Woolf International 121 The Institute of Chartered Accountants of Pakistan

138 5 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Understand the meaning of performance of a contract Explain the term tender and effect of refusal to accept a tender State who can perform and demand performance State briefly provisions of act relating to the time and place of performance Explain reciprocal promises and rules regarding their performance Summarize the rules laid down in the act as to the appropriation of payments Understand the meaning and modes of assignment of contract Emile Woolf International 122 The Institute of Chartered Accountants of Pakistan

139 Certificate in Accounting and Finance C H A P T E R 12 Discharge of a contract Contents 1 Discharge of a contract 2 Discharge by performance 3 Discharge by agreement or by consent 4 Discharge by operation of law 5 Discharge by impossibility of performance 6 Discharge by lapse of time 7 Discharge by breach 8 Chapter review Emile Woolf International 123 The Institute of Chartered Accountants of Pakistan

140 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Discharge of a contract LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to discharge of a contract. LO Understand the meaning of discharge of contract LO Identify modes of discharge of a contract: discharge by performance, by consent, operation of law, impossibility of performance, lapse of time and breach (actual and anticipatory) LO Understand rules relating to discharge of a contract. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 124 The Institute of Chartered Accountants of Pakistan

141 Section A: Mercantile Law - Chapter 12: Discharge of a contract 1 DISCHARGE OF A CONTRACT Section overview Meaning of discharge Modes of discharge of a contract 1.1 Meaning of discharge A contract is said to be discharged when contractual relations between the parties to a contract are terminated or comes to an end. In other words, when the parties to a contract have either performed or are freed from the task of performing their respective obligations as arising from the contract. 1.2 Modes of discharge of a contract The chart below shows the various ways in which a contract is said to be discharged: Emile Woolf International 125 The Institute of Chartered Accountants of Pakistan

142 2 DISCHARGE BY PERFORMANCE Section overview Actual performance Attempted performance Performance of a contract is one of the most common ways of discharging a contract. A contract can be discharged by performance in any of the following ways: 2.1 Actual performance If the parties to the contract perform their respective promises in accordance with the terms of the contract then it is said to be discharged by actual performance. [Section 37] Example: Actual performance A contracted to deliver to B at his warehouse on 1st November, 500 bales of cotton of a particular quality. A brought the cotton of requisite quality to the appointed place on the appointed day during the business hours, and B took the delivery of goods. This is an actual performance. 2.2 Attempted performance If the promisor has made an offer of performance as per the terms of the contract and the promisee refuses to accept the offer of performance then the promisor is said to be discharged by attempted performance. It is also known as tender. It is equivalent to actual performance. In this performance, the promisor offers to perform his obligation, but the promisee refuses to accept his performance. [Section 38] Effect of tender is that the contract is deemed to be performed. Promisee is discharged from his liability of non-performance. His rights against the promise are unaffected. Example: Attempted performance A contracted to deliver to B at his warehouse on 1st November, 500 bales of cotton of a particular quality. B refused to take the delivery of goods; it is a case of attempted performance because A has done what he was required to do under the contract. Emile Woolf International 126 The Institute of Chartered Accountants of Pakistan

143 Section A: Mercantile Law - Chapter 12: Discharge of a contract 3 DISCHARGE BY AGREEMENT OR BY CONSENT Section overview Novation Rescission Alteration Remission Waiver Promisee s refusal / neglect The rights and obligations created by an agreement can be discharged without being performed through formation of another agreement between the parties due to which the rights and obligations in the original agreement comes to an end. A contract can be discharged by mutual agreement in any of the following ways: 3.1 Novation Novation means the substitution of a new contract for an old one. The new agreement extinguishes the rights and obligations that were in effect under the old agreement. A novation ordinarily arises when a new individual assumes an obligation to pay that was incurred by the original party to the contract. In the case of a novation, the original debtor is totally released from the obligation, which is transferred to someone else. The nature of the transaction is dependent upon the agreement between the parties. A novation also takes place when the original parties continue their obligation to one another, but a new agreement is substituted for the old one. [Section 62] Example: Novation 3.2 Rescission A owes money to B under a contract. It is agreed between A, B and C that B shall now accept C as his debtor; instead of A. The old debt of A to B no longer exists and a new debt from C to B has been contracted. A owes B Rs.10,000. A enters into an agreement with B, and gives B a mortgage of his (A's) estate for Rs.5,000 in place of the debt of Rs.10,000. This is a new contract and extinguishes the old. Rescission is the cancellation of a contract by mutual agreement of parties. [Section 62] Example: Rescission A promises B to sell and deliver 500 Bales of cotton on 1st November at his godown and B promises to pay for goods on 1st December. A does not supply the goods. B may rescind the contract. 3.3 Alteration Alteration means a variation made in the language or terms of a contract with mutual agreement. When this occurs the original contract is discharged and a new contract is created. The parties in alteration remain same. [Section 62] Example: Alteration X promise to sell and deliver 500 bales of cotton, on 1st November and Y promises to pay for goods on 1st December. Afterwards, X and Y mutually decide that the goods shall be delivered in five equal instalments at Z's godown. Here, original contract has been discharged and a new contract has come into effect. Emile Woolf International 127 The Institute of Chartered Accountants of Pakistan

144 3.4 Remission Remission means accepting a less amount than the initial amount agreed. [Section 63] Example: Remission A promises to paint a picture for B. B afterwards requested A not to do so. A, if agreed is no longer bound to perform the promise. A owes B Rs.5,000. C pays to B Rs.1,000, and B accepts them in satisfaction of his claim on A. This payment is a discharge of the whole claim. 3.5 Waiver Waiver is a unilateral act of one person that results in the surrender of a legal right. Thus, it amounts to releasing a person of certain legal obligation under a contract. 3.6 Promisee s refusal / neglect If any promisee neglects or refuses to afford the promisor reasonable facilities for the performance of his promise, the promisor is excused by such neglect or refusal as to any nonperformance caused. [Section 67] Emile Woolf International 128 The Institute of Chartered Accountants of Pakistan

145 Section A: Mercantile Law - Chapter 12: Discharge of a contract 4 DISCHARGE BY OPERATION OF LAW Section overview Death Insolvency Material alteration Same identity A contract may be discharged by operation of law in any of the following cases: 4.1 Death On the death of the promisor a contract involving the personal skill or ability is discharged. In other contracts, the rights and liabilities of the deceased person pass on to his legal representatives. Example: Death A (an artist) promises to paint a picture for B by June 22, 2013 for Rs. 100,000. A dies before completing the picture. Here it is a contract involving personal skill and on death of A the contract will be discharged. 4.2 Insolvency When a person s debts exceeds his assets, he is adjudged insolvent and his property stands vested in the Official Receiver or Official Assignee appointed by the court. Such person cannot: Enter into contracts relating to his property Sue Sued Therefore, on declaration of a person as an insolvent person is discharged from his liabilities incurred prior to his adjudication. Example: Insolvency A took a loan from B amounting to Rs. 1 million payable in June On March 2013 A was declared as insolvent by relevant court. After the order adjudication he is discharged from his liabilities as the amount will be paid by the Official Assignee / Official Receiver. 4.3 Material alteration A contract is discharged if the terms of the contract are materially altered without getting prior consent of parties. A material alteration is one which changes following in a significant manner: Legal identity of the contract; or Character of the contract; or Rights and liabilities of the parties to the contract An alteration which is not material or which is made after getting prior consent does not affect the validity of the contract. Example: Material alteration A gives a promissory note amounting to Rs. 50,000 to B payable on August 16, B subsequently, endorses the same note in favour of C after altering the date from August 16, 2013 to August 23, Emile Woolf International 129 The Institute of Chartered Accountants of Pakistan

146 Example: Material alteration (continued) Here, change of date is a material alteration and has discharged A from the instrument because it was made without his consent. 4.4 Same identity When the promisor becomes the promisee, the other parties are discharged e.g. negotiation back in case of negotiable instrument i.e. creditor to himself becomes a debtor of the same loan. Example: Same identity A gives a promissory note to B. B endorses the note in favour of C who in turn endorses in favour of A. Here, A is both the promisor and the promisee and hence the other parties are discharged. Emile Woolf International 130 The Institute of Chartered Accountants of Pakistan

147 Section A: Mercantile Law - Chapter 12: Discharge of a contract 5 DISCHARGE BY IMPOSSIBILITY OF PERFORMANCE Section overview Supervening impossibility Grounds of supervening impossibility Not an excuse of supervening impossibility Supervening illegality 5.1 Supervening impossibility When a contract is valid at the time of formation and becomes impossible to perform subsequently it is called effected by supervening impossibility. Effects of supervening impossibility The effects of supervening impossibility are as follows: [Section 56] A contract becomes void when an act becomes impossible after the formation of the contract. A contract becomes void when an act becomes unlawful by reason of some event beyond the control of promisor. A promisor is liable to compensate the promisee for any loss which arose due to nonperformance of promisor when the promisor hides the impossibility of performance. A person is bound to restore any benefit received or compensated under a contract when such agreement or contract becomes void. Example: Effects of supervening impossibility A contracts to sing for B at a concert for Rs.10,000 which is paid in advance. A is too ill to sing. A must refund Rs.10,000 to B. 5.2 Grounds of supervening impossibility A contract is discharged by supervening impossibility in the following cases: Destruction of subject matter If the subject matter of the contract is destroyed after the formation of the contract without any fault of either party then a contract is said to be discharged. Example: Destruction of subject matter A music hall was rented out for a series of concerts. The hall caught fire before the date of first concert. It was held, the contract has become void on the ground of supervening impossibility. Death or personal incapacity (doctrine of frustration) If a contract is of personal nature then on the death / incapacity / illness of a person a contract is said to be discharged. Example: Death or personal incapacity (doctrine of frustration) A agreed to sing on a specified day. A fell seriously ill and could not perform on that day. The contract was discharged. Declaration of war At the time of declaration of war the contracts with alien enemies are either suspended or declared as void. Emile Woolf International 131 The Institute of Chartered Accountants of Pakistan

148 Example: Declaration of War X contracts to take in cargo for Y at a foreign port. X's government afterwards declares war against the country in which the port is situated. The contract becomes void when the war is declared. Particular state of things ceases to exist or occur The contract is discharged if that particular state of thing which forms the basis of a contract ceases to exist or occur. Example: P articular state of things cease to exist or occur A and B contract to marry each other. Before the time fixed for the marriage, A goes mad. The contract becomes void. 5.3 Not an excuse of supervening impossibility Impossibility of performance is, as a rule, not an excuse from performance. It means that a person should perform his promise if he has promised to do so unless the performance becomes absolutely impossible. A contract is not discharged by the supervening impossibility in the following cases: Difficulty of performance If the performance of a contract becomes difficult, more costly or less beneficial then that agreed at the time of its formation, a contract will not be discharged. Example: Difficulty of performance A agreed to supply gold within a specified time. He failed to supply in time because of government's restriction on the transport of gold from collieries. Here A will not be discharged because the gold was available in the open market from where A could have obtained it. Commercial impossibility When the contract becomes commercially unviable or non-profitable it is not said to be discharged. Example: Commercial impossibility A, a furniture retailer, agreed to supply certain furniture to B at an agreed rate. Afterwards, there was a sharp increase in the rates of the timber and rates of wages. Since, it was no longer profitable to supply at the agreed rate, A did not supply. A will not be discharged on the ground of supervening impossibility. Default of a third party On default of a third party, on whose work the promisor is relying, a contract is not said to be discharged. Example: Default of a third party A entered into a contract with B for the sale of goods to be manufactured by C, a manufacturer of those goods. C did not manufacture those goods. A will not be discharged and will be liable to B for damages. Strikes, lockouts and civil disturbances Unless otherwise agreed by the parties to the contract, a contract is not discharged on the grounds of strikes, lockouts and civil disturbances. Emile Woolf International 132 The Institute of Chartered Accountants of Pakistan

149 Section A: Mercantile Law - Chapter 12: Discharge of a contract Example: Strikes, lockouts and civil disturbances A agreed to supply to B certain goods to be imported from America. The goods could not be imported due to riots in that country. It was held that this was no, excuse for non-performance of the contract. Partial impossibility A contract is not discharged simply on the grounds of partial impossibility of some of the objects of the contract. 5.4 Supervening illegality If the performance of the contract becomes unlawful due to a change in the law after the formation of the contract then the contract is said to be discharged. Example: Change of law A agreed to sell his land to B after the formation of the contract, the Government issued a notification and acquired the land. The contract was discharged. Emile Woolf International 133 The Institute of Chartered Accountants of Pakistan

150 6 DISCHARGE BY LAPSE OF TIME Section overview Limitation period 6.1 Limitation period If a contract is not performed within the period of limitation then it is discharged as the parties cannot legally enforce their rights. After the expiry of the limitation period, the debt becomes time banned and hence cannot be recovered through court of law. Example: Limitation period A sold goods to B amounting to Rs. 10,000 on a credit of 1 year on January 1, On due date i.e. December 31, 2012 B defaulted in payment. In the given scenario A can file suit against B by December 31, Emile Woolf International 134 The Institute of Chartered Accountants of Pakistan

151 Section A: Mercantile Law - Chapter 12: Discharge of a contract 7 DISCHARGE BY BREACH Section overview Actual breach of contract Anticipatory breach of contract If a party refuses or fails to perform his part of the contract then the contract is said to be discharged due to breach. A breach of contract may occur in the following two ways: 7.1 Actual breach of contract Actual breach of contract occurs when a party to a contract refuses or fails to perform his part of the contract at the time fixed for performance. [Section 38] Actual breach of contract occurs in the following two ways: Due date of performance If any party to a contract refuses or fails to perform his part of the contract at the time fixed for performance, it is called an actual breach of contract on due date of performance. Example: Due date of performance A agreed to sell to B 10 tons of Rs.8,000 per ton to be delivered in two equal instalments on 20th November and on 21st November. On 20th November, A refused to deliver the goods. It is an actual breach of contract on due date of performance. Course of performance If any party has performed a part of the contract and then refuses or fails to perform the remaining part of the contract, it is called an actual breach of contract during the course of performance. Example: Course of performance A agreed to sell to B 10 tons of Rs.8,000 per ton to be delivered in two equal instalments on 20th November and 21st November. On 20th November, A delivered 5 tons and refused to deliver remaining 5 tons. It is an actual breach of contract during the course of performance. Consequences of actual breach The consequences of actual breach depend upon whether the time was the essence of the contract or not. The consequences in both the cases may be summarized as follows: Time is essence In case of actual breach where time is of the essence, the breach will have the following consequences: [Section 55] Voidable at the option of promisee Promisee is entitled to claim compensation for any loss arising to him due to nonperformance of the promise at agreed time where performance beyond the stipulated time is not accepted Promisee is not entitled to claim compensation for any loss arising to him due to nonperformance of the promise at agreed time where performance beyond the stipulated time is accepted, unless the promisee gives notice to the promisor of his intention to claim damages. Time is not essence In case of actual breach where time is not essence the breach will have the following consequences: [Section 55] Emile Woolf International 135 The Institute of Chartered Accountants of Pakistan

152 Not Voidable at the option of promisee Promisee is not entitled to claim compensation for any loss arising to him due to nonperformance of the promise at agreed time where performance beyond the stipulated time is accepted, unless the promisee gives notice to the promisor of his intention to claim damages. Example: Time is not essence A, a singer, enters into a contract with B, the manager of a theatre, to sing at his theatre two nights in every week for the next two months. B agrees to pay her Rs.100 for each performance. On the sixth night, A wilfully absents herself from the Theatre. In this case, B has the following two options: B may rescind the contract and claim compensation for the loss occasioned to him by A's failure to sing on the sixth night. B may permit A to sing on the seventh night and claim compensation for loss from A by giving a notice to A of his intention to do so. 7.2 Anticipatory breach of contract Anticipatory breach of contract occurs when before the performance is due the party acts in a way that the contract may not be performed. [Section 39] A party may be intended not to perform the contract in the following two ways: Refusal to perform promise When a party to a contract has refused to perform his promise Example: Refusal to perform promise A, a farmer agrees to sell to B his entire crop of 10 tons of Rs. 8,000 per ton to be delivered on 20 th November. On 1 st November, A informs B that he is not going to supply the goods. A has committed anticipatory breach of contract by express repudiation. Disabled to perform promise When a party to a contract has disabled himself from performing his promise in its entirety. Example: Disabled to perform promise A, a farmer agrees to sell to B his entire crop of 10 tons of Rs. 8,000 per ton to be delivered on 20 th November. On 1 st November, A contracted to sell his entire crop to Rs. 10,000 per ton. A has committed anticipatory breach of contract by implied repudiation. Options to the aggrieved party In case of anticipatory breach, the aggrieved party has the following two options: Options to the aggrieved party Rescind the contract and claim damages for breach of contract without waiting until the due date for performance or Treat the contract as operative and wait till the due date for performance and claim damages if the promise still remains unperformed Calculation of damages Damages will be equal to the difference between the price prevailing on the date of breach and the contract price. [Section 73] Damages will be equal to the difference between the price prevailing on the due date of performance and the contract price. Consequences of treating contract as operative If the aggrieved party treats the contract as operative and waits till the due date for performance, the consequences of anticipatory breach will be as follows: Emile Woolf International 136 The Institute of Chartered Accountants of Pakistan

153 Section A: Mercantile Law - Chapter 12: Discharge of a contract The promisor may perform his promise on or before the due date of performance and the promisee will be bound to accept the performance. The promisor may take advantage of the discharge by supervening impossibility arising between the date of breach and the due date of the performance and in such a case, the promisee shall lose his right to sue for damages. Example: Consequences of treating contract as operative A, a farmer agrees to sell to B his entire crop of 10 tons of Rs. 8,000 per ton to be delivered on 20 th November. On 1 st November, A informs B that he is not going to supply the goods. B decided not to rescind the contract on 1 st November and to wait till 20 th November. On 19 th November, the entire crop was destroyed by fire without the fault of either party. Since the contract becomes void on the ground of impossibility of performance, B had lost the right to sue A for damages. Emile Woolf International 137 The Institute of Chartered Accountants of Pakistan

154 8 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Explain the various modes in which a contract may be discharged Discuss the doctrine of supervening impossibility Explain types of breach and their consequences Emile Woolf International 138 The Institute of Chartered Accountants of Pakistan

155 Certificate in Accounting and Finance C H A P T E R 13 Remedies for breach of contract Contents 1 Remedies for breach of contract 2 Chapter review Emile Woolf International 139 The Institute of Chartered Accountants of Pakistan

156 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Remedies for breach of contract LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to remedies for breach of a contract. LO Explain the remedy LO Describe the various remedies available in case of breach of a contract LO Understand rules relating to amount of damages LO Identify different kinds of damages LO Understand the remoteness of damages. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 140 The Institute of Chartered Accountants of Pakistan

157 Section A: Mercantile Law - Chapter 13: Remedies for breach of contract 1 REMEDIES FOR BREACH OF CONTRACT Section overview Meaning of remedy Remedies for breach Kinds of damages Rules regarding amount of damages Remoteness of damages 1.1 Meaning of remedy A remedy can be defined as a manner in which a right is enforced or satisfied by a court when some harm or injury, recognized by society as a wrongful act, is inflicted upon an individual. Remedies can be categorized into the following types: Common law remedies Equitable remedies Quantum meruit claim Common law remedies Damages and action for the price are common law remedies and are more frequently sought when a remedy is needed for breach of contract, since they arise as of a right. The object of such a remedy is not to punish the party at fault but to compensate the aggrieved party (pecuniary loss) as far as money can do so. Equitable remedies Equitable remedies are the court ordered action that directs parties to do or not to do something. In other words, equitable remedies are only appropriate in specialised circumstances e.g. where monetary damages would be inadequate compensation for the breach of an agreement. Specific performance and injunction are equitable remedies. Quantum meruit claim Quantum meruit claim is categorized as a claim in quasi contract. The aim of such an award is based on an implied agreement to pay for what has been done. Quantum meruit is likely to be sought where one party has already performed part of his obligations and the other party then repudiates the contract. Provided the injured elects to treat the contract as terminated, he may claim a reasonable amount for the work done. 1.2 Remedies for breach Parties to a lawful contract are bound to perform their respective obligations. But when one of the parties refuses to perform his obligations he is said to have committed a breach of the contract. The various remedies available to an aggrieved party are as follows: 1. Rescission of contract 2. Restitution 3. Damages 4. Specific performance 5. Injunction 6. Quantum meruit Emile Woolf International 141 The Institute of Chartered Accountants of Pakistan

158 Rescission of contract Rescission is the putting an end to a contract. Rescission means a right not to perform your obligation. In case of breach of a contract, the promisee may put an end to the contract. In such a case, the aggrieved party is discharged from all the obligations under the contract and is entitled to claim compensation for the damage which he has sustained because of the non-performance of the contract. [Section 39 and 75] Example: Rescission of Contract A agrees to supply 10 tons of wheat to B on 20th November. B promises to pay for the goods on its receipt. A does not supply the goods on the due date. Here, B is discharged from the liability of paying the price. B is entitled to rescind the contract and to claim compensation for the damage which he has sustained because of non-supply of goods on the due date. When is rescission granted? The court may grant rescission in the following two cases: Where the contract is voidable at the option of the aggrieved party Where the contract is unlawful for causes not apparent on its face and defendant is more to blame than the plaintiff When is rescission not granted? The court may not grant rescission in the following cases: Where the aggrieved party has expressly or impliedly ratified the contract Where owing to the change of circumstances, the parties cannot be restored to their original positions Where the third party has acted in good faith and for consideration Where only part of a contract is sought to be rescinded and such part is not severable from the rest of the contract Restitution It means return of the benefit received by one party to the contract from the other under a void contract. When a contract becomes void it needs not to be performed by either party. Example: Restitution A pays B Rs. 1,000 in consideration of B s promising to marry C (A s daughter). C is dead at the time of promise. The agreement is void but B must repay A Rs.1,000. Damages Damages are monetary compensation allowed for loss suffered by the aggrieved party due to breach of a contract. The object of awarding damages is not to punish the party at fault but to compensate the aggrieved party (pecuniary loss) as far as money can do so. [Section 73] Specific performance Suit for specific performance is an equitable doctrine that compels a party to execute the agreement according to its terms where monetary damages would be inadequate compensation for the breach of an agreement. Specific performance is a discretionary remedy, which is allowed only in a limited number of cases some of them are listed below: Monetary compensation is not adequate Actual damage cannot be ascertain due to non-performance It is probable that compensation in money on non-performance cannot be obtained There is a contract for the sale of rare commodities There is a contract for the sale of land / building / apartment / houses Emile Woolf International 142 The Institute of Chartered Accountants of Pakistan

159 Section A: Mercantile Law - Chapter 13: Remedies for breach of contract Following are the cases where suit for specific performance is not maintainable where: Monetary compensation are considered as an adequate remedy Contract is of personal nature, e.g. contract of services Court cannot supervise the performance of the contract e.g. construction of building One of the parties is a minor Contract is inequitable to either party Example: Specific performance Injunction A agreed to sell an old painting to B for Rs. 500,000. Subsequently, A refused to sell the painting. Here, B may file suit against A for the specific performance of the contract. A agrees to sell two rare Pakistani Handmade carpets to B for Rs. 2 million. In case of breach by A, B may compel A to perform the contract specifically, because there is no standard for ascertaining the actual damages which would be caused by the nonperformance by A. Suit for injunction is also an equitable remedy demanding courts stay order. Injunction means an order of the court which abstains from wrong doing. Where a party to a contract does something which he promised not to do, the court may issue an order prohibiting him from doing so. Thus, injunction is a preventive relief. It is particularly appropriate in case of anticipatory breach of contract where damages would not be an adequate relief. Example: Injunction A agreed to play cricket for Apple Cricket Club during the contract period of 3 years. During the contract period, A made a contract with Orange Cricket Club and refused to play cricket for Apple Cricket Club. Here, A could be restrained by injunction from doing so. X, a film actress, agreed to act exclusively for Y for a year and for no one else. During the year she contracted to act for Z. Here, she could be restrained by injunction from doing so. Quantum meruit The term Quantum Meruit means as much as earned or deserved. In case of breach of contract the application or non-application of the term quantum meruit varies depending upon the terms of the contract. Further, the divisibility or indivisibility of performance of the contract may also be taken into account. The aim of such an award is based on an implied agreement to pay for what has been done. Quantum Meruit is likely to be sought where one party has already performed part of his obligations and the other party then repudiates the contract. Provided the injured elects to treat the contract as terminated, he may claim a reasonable amount for the work done. This has been discussed in detail in Chapter 10. Example: Quantum Meruit C as owner of a magazine engaged P to write a book to be published by instalments in his magazine. After a few instalments were published, the publication of the magazine was stopped. It was held that P could claim payment for the part already published. A, a singer contracts with B, the manager of a theatre, to sing at his theatre for two nights in every week during the next two months, and B engages to pay her Rs. 100 for each night's performance. On the sixth night, A wilfully absents herself from the theatre, and B, in consequence rescinds the contract. B must pay A for the five nights on which she had sung. Emile Woolf International 143 The Institute of Chartered Accountants of Pakistan

160 1.3 Kinds of damages Following are the different kinds of damages: Ordinary Damages Ordinary damages are those which arise naturally in the usual course of things from the breach itself. These damages can be recovered if the following two conditions are fulfilled: [Section 73] The aggrieved party must suffer by breach of contract, and The damage must be a direct consequence of the breach of contract Example: Ordinary Damages On 1st December; X contracted to sell and deliver 50 tons of Rs. 8,000 per ton to Y on 1st January. On 20th December y, afterwards, contracted to sell those goods to Z at Rs. 10,000 per ton. X failed to deliver goods on 1st January when the price of the wheat was Rs. 9,500 per ton. Y is entitled to recover Rs. 75,000 [i.e. (Rs. 9,500 Rs. 8,000) x50). Y is not entitled to recover Rs. 1,00,000 as profit which would have arisen to Y from the sale to Z because the profit is the indirect consequence of the breach of contract. Special damages Special damages can be recovered for the loss which the parties [Section 73] Knew about At the time they made the contract As likely to result from such breach of contract Special damages are due to special losses which are in the reasonable contemplation of the parties at the time of formation of contract. Example: Special Damages A, a builder; contracts to erect and finish a house by the first of January, in order that B may give possession of it at that time to C, to whom B has contracted to let it. A is informed of the contract between B and C. A builds the house so badly that, before the first of January it falls down, and has to be rebuilt by B, who, in consequence, loses the rent which he was to have received from C, and is obliged to make compensation to C for the breach of his contract. A must make compensation to B for the cost of rebuilding the house, for the rent lost, and for the compensation made to C. A delivers to B, a common carrier; a machine to be delivered without delay, to A's mill informing that his mill has stopped for want of the machine. B unreasonably delays the delivery of machine, and A, in consequence, loses a profitable contract with the Government. A is entitled to receive from B, by way of compensation, the average amount of profit, which would have been made by the working of the mill during the time that delivery of it was delayed, but not the loss sustained through the loss of the Government contract. Exemplary (vindictive) damages Exemplary (vindictive) damages are those which are awarded with a view to punish the wrong doer and not primarily with an idea of awarding compensation to the injured party. The court may award these damages in case of: a breach of promise to marry, where damages shall be calculated on the basis of mental injury sustained by the aggrieved party. wrongful dishonour of a cheque by a banker. In case of wrongful dishonour of a cheque, the rule is smaller the amount of the cheque, larger will be the amount of damages awarded. A trader may recover such damages as wrongful dishonour of cheque shall adversely affect his goodwill but a non-trader whose cheque is wrongfully dishonoured will have to prove the loss of goodwill before claiming such damages. Emile Woolf International 144 The Institute of Chartered Accountants of Pakistan

161 Section A: Mercantile Law - Chapter 13: Remedies for breach of contract Nominal damages Nominal damages are awarded where the injured party has sustained damage of a short but not of a substantial nature to be reckoned. Where the breach is technical and injured party has no intention of performing his part of the contract Where the injured party has not suffered any actual damage or fails to prove that he has Where damage is due to the fault of the injured party Damages for inconvenience and uneasiness If a party has suffered physical inconvenience and discomfort due to breach of contract, that party can recover the damages for such inconvenience and discomfort. Example: Damages for inconvenience and uneasiness H with his wife and children booked a ticket for a midnight train, to be transported to a particular place where he lived. They were, however, transported to a wrong place and they had to walk several miles on a drizzling night and as a result, his wife caught cold and he had to incur some medical expenses., It was held that he could recover compensation for inconvenience and not for medical expenses for the sickness of his wife because it was very remote consequence. Liquidated damages When the parties to a contract at the time of formation of contract, specify a sum which will become payable by the party responsible for breach, such specified sum is called Liquidated Damages. This amount represents a genuine attempt to work out what the loss would be in the event of such a breach. [Section 74] Penalty If a contract states that a particular sum is to be paid on breach of the contract and [Section 74] that sum is not the genuine pre-estimate of the loss that would be suffered in the event of breach or that the sum is disproportionate to the actual loss likely to result due to breach this is penalty clause. the court can decrease but not increase the penalty stipulation. Stipulation for Interest Two parties may agree to give a specific rate of interest in case of breach of contract. [Section 74] Forfeiture of Security Deposit (or Earnest Money) A clause in a contract which provides for forfeiture of security deposit in the event of failure to perform is in the nature of a penalty. In such cases, the court may award reasonable compensation only but in case where contract is made with the government, in case of breach the government can forfeit the whole amount of the deposit as security. [Section 74] 1.4 Rules regarding amount of damages The object of awarding damages is not to punish the party at fault The injured party is to be placed in the same position as money can do if the contract had been performed The aggrieved party can recover actual loss suffered by him arising naturally. The fact that damages are difficult to assess does not prevent the injured party from recovering. Where no real loss arises nominal damages are awarded. Emile Woolf International 145 The Institute of Chartered Accountants of Pakistan

162 If the parties fix any amount as damages in case of breach of contract then the court will allow only reasonable amount. It is the duty of the injured party to minimise the damage suffered. 1.5 Remoteness of damages There are some losses which clearly result from the defendant s breach of contract but are considered too remote from the breach for it to be fair to expect the defendant to compensate the claimant for them. Example: Remoteness of damages A taxi driver is booked to take a passenger to the airport in time for a certain flight to Karachi where the passenger expects to complete a deal worth Rs. 1 million. If the tax driver breaches the contract by arriving late, the taxi firm may be liable for expenses such as any extra cost for getting the next flight but is unlikely to be expected to compensate the passenger for the loss of Rs. 1 million. Emile Woolf International 146 The Institute of Chartered Accountants of Pakistan

163 Section A: Mercantile Law - Chapter 13: Remedies for breach of contract 2 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Discuss the various remedies available to a party in case of breach of a contract Explain the circumstances when rescission is granted by court Explain the circumstances when specific performance is granted by court Understand the different kinds of damages Emile Woolf International 147 The Institute of Chartered Accountants of Pakistan

164 Emile Woolf International 148 The Institute of Chartered Accountants of Pakistan

165 Certificate in Accounting and Finance C H A P T E R 14 Indemnity and guarantee Contents 1 Contract of indemnity 2 Contract of guarantee 3 Chapter review Emile Woolf International 149 The Institute of Chartered Accountants of Pakistan

166 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Indemnity and guarantee LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to indemnity and guarantee. LO Define contract of indemnity and contract of guarantee. Differentiate between contract of guarantee and indemnity LO Identify parties in a contract of indemnity and contract of guarantee LO Differentiate between contract of guarantee and indemnity LO Describe the rights of indemnity holder LO Identify the essentials of the contract of guarantee LO Understand the kinds of guarantees i.e. specific and continuing, and revocation of continuing guarantee LO Describe rights and responsibilities of surety LO Explain how surety is discharged LO Understand rules relating to indemnity, guarantee and surety. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 150 The Institute of Chartered Accountants of Pakistan

167 Section A: Mercantile Law - Chapter 14: Indemnity and guarantee 1 CONTRACT OF INDEMNITY Section overview Definition of contract of indemnity Parties in a contract of indemnity Rights of indemnity holder Time of commencement of the indemnifier s liability 1.1 Definition of contract of indemnity Definition: Contract of indemnity [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. 1.2 Parties in a contract of indemnity Indemnifier (Promisor) The indemnifier (or promisor) is the person who promises to make good the loss. Indemnified / Indemnity holder (Promisee) The indemnified (also referred to as the indemnity holder or promisee) is the person whose loss is to be made good. Example: Indemnified / Indemnity holder (Promisee) A contracts to indemnify B against the consequences of any proceedings which C may take against B in respect of a certain sum of Rs. 200/-. This is a contract of Indemnity. In the above example A is the indemnifier and B is the indemnity holder. 1.3 Rights of indemnity holder According to Section 125 of Contract Act, a promisee is entitled to recover the following amounts from the promisor provided that he acts within the scope of his authority: All damages which he may be compelled to pay in any suit in respect of any matter to which the promise to indemnify applies; All costs which he may be compelled to pay in bringing or defending such suits. But the indemnified should not acted against the order of the promisor and acted as any prudent man would act under similar circumstances in his own case, or with the authority of the indemnifier and All sums which he may have paid under the terms of any compromise of any such suit. The compromise should not be contrary to the orders of the indemnifier and should be a prudent one or authorized by the indemnifier. 1.4 Time of commencement of the indemnifier s liability The Contract Act is silent on the time of commencement of the indemnifier s liability under the contract of indemnity. On the basis of judicial pronouncement of courts, it can be said that the liability of an indemnifier commences as soon as the liability of the indemnity holder becomes absolute and certain. In other words, if the indemnity holder has incurred an absolute liability even though he has himself paid nothing, he is entitled to ask the indemnifier to indemnify him. Emile Woolf International 151 The Institute of Chartered Accountants of Pakistan

168 Example: Time of commencement of the indemnifier s liability A promises to compensate B for any loss that he may suffer by filing a suit against C. The court orders B to pay C damages of Rs. 50,000. As the loss has become certain, B may claim the amount of loss from A and give it to C. Emile Woolf International 152 The Institute of Chartered Accountants of Pakistan

169 Section A: Mercantile Law - Chapter 14: Indemnity and guarantee 2 CONTRACT OF GUARANTEE Section overview Definition of contract of guarantee Parties in a contract of guarantee Essentials of a contract of guarantee Kinds of guarantee Revocation of a continuing guarantee Nature of surety s liability Rights of surety Discharge of surety Circumstances where surety is not discharged Difference between contract of indemnity and contract of guarantee 2.1 Definition of contract of guarantee Definition: Contract of guarantee [Section 126] A contract of guarantee is a contract to perform the promise or discharge the liability of a third person in case of his default. Consideration received by the principal debtor is sufficient for the surety and it is not necessary to result in some benefit to the surety himself. [Section 127] Example: Contract of guarantee 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 A s promise to deliver the goods. This is sufficient consideration for C s promise. 2.2 Parties in a contract of guarantee Principal debtor The person in respect of whose default the guarantee is given. [Section 126] Creditor The person to whom guarantee is given. [Section 126] Surety The person who gives guarantee. [Section 126] Example: Contract of guarantee A and his friend B enter a shop and A says to Z Supply the goods required by B and if he does not pay you, I will. It is a contract of guarantee. Emile Woolf International 153 The Institute of Chartered Accountants of Pakistan

170 2.3 Essentials of a contract of guarantee The essentials of a contract of guarantee are shown below: These essentials are discussed below: Tripartite agreement A contract of guarantee is a tripartite agreement between the principal debtor, creditor and surety. There are three contracts in contract of guarantee: Contract between creditor and the principal debtor Contract between surety and the principal debtor Contract between surety and creditor Consent of parties Consent is an essential for all the contracts similarly all three must have consented in a contract of guarantee. Existence of a debt A contract of guarantee requires an existing debt or a promise whose performance is guaranteed which is enforceable at law. If no such liability exists then there cannot be a contract of guarantee. The principal debtor can be a minor; in this case surety will be liable personally. Essentials of a contract All the essentials required in a contract must exist in a contract of guarantee. Examples: Essentials of a contract 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 A s promise to deliver the goods. This is a sufficient consideration for C s promise. A sells and delivers goods to B. C afterwards requests A to forbear to sue B for the debt for a year and promises that if he does so, C will pay for them in default of payment by B. A agrees to forbear as requested. This is a sufficient consideration for C s 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. Emile Woolf International 154 The Institute of Chartered Accountants of Pakistan

171 Section A: Mercantile Law - Chapter 14: Indemnity and guarantee Misrepresentation According to Section 142 of Contract Act, a guarantee must not be obtained by misrepresentation. Fraud According to Section 143 of Contract Act, a guarantee must not be obtained by fraud. 2.4 Kinds of guarantee Guarantee may be classified under the following two categories: 1. Specific guarantee 2. Continuing guarantee Specific guarantee When a guarantee extends to a single transaction or debt, it is called a specific or simple guarantee. The liability of the surety comes to an end when the guaranteed debt is duly discharged or the promise is duly performed. Examples: Specific guarantee A guarantees payment to B of the price of the five bags of flour to be delivered by B to C and to be paid for in 3 months. B delivers five bags to C, C pays for them. This is a contract of specific guarantee. Continuing guarantee According to Section 129 of Contract Act, when a guarantee extends to a series of transactions, it is called a continuing guarantee. A surety s liability continues until the revocation of the guarantee. Examples: Continuing guarantee A, in consideration that B will employ C in collecting the rent of B s zamindari 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. 2.5 Revocation of a continuing guarantee A continuing guarantee can be revoked in the following ways: Notice A continuing guarantee may at any time be revoked by the surety as to future transactions, by notice to the creditor. [Section 130] Examples: Notice A, in consideration of B s discounting, at A s request, bills of exchange for C, guarantees to B, for 12 months, the due payment of all such bills to the extent of Rs. 5,000. B discounts bills for C to the extent of Rs. 2,000. Afterwards at the end of three months. A revokes the guarantee. This revocation discharges A from all the liability to B for any subsequent discount. But A is liable to B for Rs. 2,000 on default of C. A guarantees to B to the extent of Rs. 10,000, that C shall pay all the bills that B shall draw upon him. B draws upon C, C accepts the bill. A gives notice of revocation, C dishonours the bill at maturity. A is liable upon his guarantee. Death of surety The death of the surety operates, in the absence of any contract to the contrary, as a revocation of a continuing guarantee regarding future transactions. [Section 131] Emile Woolf International 155 The Institute of Chartered Accountants of Pakistan

172 Other modes of revocation of continuing guarantee A continuing guarantee is also revoked in following ways: novation [Section 62] alteration [Section 133] release or discharge of the principal debtor by creditor [Section 134] compounding of creditor with the principal debtor [Section 135] creditor s act or omission impairing surety eventual remedy [Section 139] loss of security [Section 141] 2.6 Nature of surety s liability Nature of surety s liability - it is co-extensive The liability of a surety is equal to that of the principal debtor unless otherwise agreed. [Section 128] Examples: Nature of surety s liability it is co-extensive A guarantees to B the payment of a bill of exchange by C, the acceptor. The bill is dishonoured by C, A is liable not only for the amount of the bill, but also for any interest and charges which may have become due on it. Limitation of surety s liability The liability of surety may be made less than that of the principal debtor by an express contract to that effect. Initiation surety s liability The liability of the surety arises immediately at the time of default by the principal debtor. The creditor can sue the surety without suing the principal debtor. Condition precedent to surety s liability Where a person gives a guarantee upon a contract that a creditor shall not act upon it until another person has joined in it as co-surety, the guarantee is not valid if that person does not join. 2.7 Rights of surety The rights of surety are shown below: Rights of surety Against / towards principal debtor Against / towards creditor Against / towards co-sureties Right to subrogation Right to indemnity Right to securities Right to claim set off Rigth to claim contribution Emile Woolf International 156 The Institute of Chartered Accountants of Pakistan

173 Section A: Mercantile Law - Chapter 14: Indemnity and guarantee Rights against / towards principal debtor Right to subrogation After making a payment and discharging the liability of the principal debtor, the surety is clothed with all the rights of the creditor, which he can himself exercise against the principal debtor. [Section 140] Right to indemnity 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 all payments properly made under the guarantee. After the surety makes payment, he is entitled to recover from the principal debtor whatever amount he has paid rightfully including the amount of interest. [Section 145] Examples: Right to indemnity B is indebted to C, and A is surety for the debt. C demands payment from A and, on his refusal, sues him for the amount. A 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 B the amount paid by him for costs, as well as the principal debt. C lends B a sum of money, and A at the requests of B accepts a bill of exchange drawn by B upon A to acute the amount. C the holder of the bill demands payment of it from A, and on A s refusal to pay sues him upon the bill. A, not having reasonable grounds for so doing, defends the suit, and has to pay the amount of the bill and costs. He can recover from B the amount of bill, but not the sum paid for costs, as there was no real ground for defending the action. Rights against / towards creditor Rights to securities A surety is entitled to the benefit of every security which the creditor has against the principal debtor at the time when the contract of suretyship is entered into, whether the surety knows of the existence of such security or not and if the creditor loses or without the consent of the surety parts with such security, the surety is discharged to the extent of the value of the security. [Section 141] Examples: Right to securities C advances to B, his tenant, Rs. 2,000 on the guarantee of A. C has also a further security for Rs.2,000 by a pledge of B s furniture. C cancels the pledge. B becomes insolvent, and C sues A on his guarantee. A is discharged from liability to the amount of the value of the furniture. C, a creditor, whose advance to B is secured by a decree, receives also a guarantee for that advance from A. C afterwards takes B s goods in execution under the decree, and then without the knowledge of A, withdraws the execution. A is discharged. A, as surety of B makes a bond jointly with B to C to secure a loan from C to B. Afterwards, C obtains from B a further security for the same debt subsequently C gives up the further security. A is not discharged. Right to claim set off The surety has a right to claim set off if any which the principal debtor had against the creditor. Rights against co-sureties Right to claim contribution When a debt is guaranteed by two or more sureties, they are called co-sureties. The co-sureties are liable to contribute, as agreed, towards the payment of the guaranteed debt. When one of the co-sureties makes payment to the creditor, he has a right to claim contribution from the other cosurety or co-sureties. Following are the rules of contribution between co-sureties: [Section 146 & 147] Emile Woolf International 157 The Institute of Chartered Accountants of Pakistan

174 In the absence of any contract, all co-sureties are liable to contribute equally in case of default by principal debtor. Examples: Right to claim contribution A, B and C are sureties to D for a sum of Rs.3,000 lend to E. E makes default in payment. A, B and C are liable, as between themselves to pay Rs.1,000 each. A, B and C are sureties to D for a sum of Rs.1,000 lent to E, and there is a contract between A, Band C that A is to be responsible to the extent of one-quarter, B to the extent of one quarter, and C to the extent of one half. E makes default in payment. As between the sureties, A is liable to pay Rs.250, B Rs.250 and C Rs.500. If co-sureties have agreed to guarantee different sums than co-sureties are liable to contribute equally, subject to the maximum amount guaranteed by each one. Examples: Guarantee of different sums A, B and C as sureties for D, enter into three separate bonds, of different amounts - A for Rs.10,000, B for Rs.20,000 and C for Rs.40,000, conditional for D s duly accounting to E. D makes default to the extent of Rs. 30,000 than A, B and C are each liable to pay Rs. 10,000. D makes a default to the extent of Rs. 40,000 than A is liable to pay Rs. 10,000 and B and C are liable to pay Rs. 15,000 each. D makes a default to the extent of Rs. 70,000 than A, B and C are liable to pay full penalty of his bond. Where there are co-sureties, a release by the creditor of one of them does not discharge the others, neither does it free the surety so released from his responsibility to the other sureties. [Section 138] 2.8 Discharge of surety The ways in which a surety is discharged are shown below: These modes are discussed below. Emile Woolf International 158 The Institute of Chartered Accountants of Pakistan

175 Section A: Mercantile Law - Chapter 14: Indemnity and guarantee Discharge of surety by revocation Notice A surety can be discharged by giving notice to the creditor in case of continuing guarantee, as to future transactions, by notice to the creditor. [Section 130] Death of surety The deceased surety s estate will not be liable for any transactions entered into between the creditor and the principal debtor after the death of the surety, even if the creditor has no notice of the death. [Section 131] Novation Novation means the substitution of a new contract of guarantee for an old one. The new contract extinguishes the rights and obligations that were in effect under the old contract. [Section 62] Discharge of surety by the conduct of the creditor Alteration If an alteration is made without the consent of the surety then the surety is discharged as to the transactions, subsequent to the alteration. [Section 133] Examples: Alteration A becomes surety to C for B's conduct as a manager in C's bank. Afterwards, B and C contract, without A's consent, that B's salary shall be raised, and that he shall become liable for one-fourth of the losses on overdrafts. B allows a customer to overdraw, and the bank loses a sum of money. A is discharged from his surety ship by the variance made without his consent, and is not liable to make good this loss. C agrees to appoint B as his clerk to sell goods at a yearly salary, upon A's becoming surety to C for B's duly accounting for money received by him as such clerk. Afterwards, without A's knowledge or consent, C and B agree that B should be paid by a commission on the goods sold by him and not by a fixed salary. A is not liable for subsequent misconduct of B. C contracts to lend B Rs. 5,000 on the first March. A guarantees repayment. C pays Rs. 5,000 to B on the first January. A is discharged from his liability as the contract has been varied in as much as C might sue B for the money before the first of March. Release of principal debtor The surety is discharged by any contract between the creditor and the principal debtor, by which the principal debtor is released. [Section 134] Examples: Release of principal debtor A gives guarantee to C for goods to be supplied by C to B. C supplies goods to B, and afterwards B becomes embarrassed and contracts with his creditors (including C's) to assign to them his property in consideration of their releasing him from their demands. Here, B is released from his debt by the contract with C, and A is discharged from his surety ship. A contracts with B to grow a crop of wheat on A's land and to deliver it to B at a fixed rate, and C guarantees A's performance of this contract. B diverts a stream of water which is necessary for irrigation of A's land, and thereby prevents him from raising the wheat. C is no longer liable for his guarantee. A contracts with B for a fixed price to build a house for A within a stipulated time, B supplying the necessary timber. C guarantees A's performance of the contract. B omits to supply the timber. C is discharged from his surety ship. Arrangement A contract between the creditor and the principal debtor, by which the creditor makes a competition with, or promises to give time to, or not to sue, the principal debtor, discharges the surety, unless the surety assents to such contract. [Section 135] Emile Woolf International 159 The Institute of Chartered Accountants of Pakistan

176 Discharge of surety by invalidation of contract Misrepresentation/ Fraud Any guarantee which has been obtained by means of misrepresentation made by the creditor or keeping silence as to material circumstances, or with his knowledge and assent, concerning a material part of the transaction, is invalid. [Section 142 & 143] Examples: Fraud A engages B as a clerk to collect money for him. B fails to account for some of his receipts and A, in consequence calls upon C to furnish security for his duly accounting. C gives guarantee for B's duly account. A does not inform C about B s previous conduct. B, afterwards, makes default. C is not liable because the guarantee was obtained by concealment of facts. Act or omission If the creditor does any act which is inconsistent with the rights of the surety, or omits to do any act which his duty to the surety requires him to do, and the eventual remedy of the surety himself against the principal debtor is impaired, the surety is discharged. [Section 139] Examples: Act or omission B contracts to build a ship for C for a given sum, to be paid by instalments as the work reaches certain stage. A becomes surety to C for B's due performance of the contract. C, without the knowledge of A, pre-pays to B the last two instalments. A is discharged by this prepayment. C lends money to B on the security of a joint and several promissory note, made in C's favour by B, and by A as surety for B, together with a bill of sale of B's furniture, which gives power to C to sell the furniture, and apply the proceeds in discharge of the note. Subsequently, C sells the furniture, but, owing to his misconduct and wilful negligence, only a small price is realized. A is discharged from liability on the note. Failure of co-surety to join surety Where a person gives a guarantee upon a contract that a creditor shall not act upon it until another person has joined in it as co-surety, the guarantee is not valid if that other person does not join. [Section 144] 2.9 Circumstances where surety is not discharged Where a contract to give time to the principal debtor is made by the creditor with a third person, and not with the principal debtor, the surety is not discharged. Patience on the part of the creditor to sue the principal debtor or to enforce any other remedy against him, does not, in the absence of any provision, in the guarantee to the contrary, discharge the surety. Where there are co-sureties, the release by the creditor of one of them does not discharge the other nor does it free the surety so released from his responsibility to the other sureties. [Section 138] 2.10 Difference between contract of indemnity and contract of guarantee The following table summarises the key differences between the contract of indemnity and contract of guarantee as explored above. S.no Contract of indemnity Contract of guarantee 1 Number of parties There are two parties indemnifier and indemnity holder. There are three parties principal debtor, creditor and surety. Emile Woolf International 160 The Institute of Chartered Accountants of Pakistan

177 Section A: Mercantile Law - Chapter 14: Indemnity and guarantee S.no Contract of indemnity Contract of guarantee 2 Number of contracts There is only one contract. 3 Object The indemnifier undertakes to save the indemnity holder from any loss. 4 Nature of liability The liability of indemnifier is primary and unconditional. 5 Commencement of liability The liability arises only on the happening of a contingency. 6 Right to sue The indemnifier cannot sue a third party in his own name because of absence of privity of contract between him and third party. There are three contracts. The surety undertakes for the payment of debts of principal debtor in case of his default. The liability of surety is secondary and conditional and co-extensive. The liability arises only on the nonperformance of an existing promise or non-payment of an existing debt. A surety, on discharging the debt of principal debtor, can sue the principal debtor in his own name. Emile Woolf International 161 The Institute of Chartered Accountants of Pakistan

178 3 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Define a contract of indemnity Discuss the rights of indemnity holder Define contract of guarantee and its types Discuss the nature and extent of surety s liability Understand the rights of surety Explain the various ways in which the surety is discharged Emile Woolf International 162 The Institute of Chartered Accountants of Pakistan

179 Certificate in Accounting and Finance C H A P T E R 15 Bailment and pledge Contents 1 Nature of bailment 2 Duties and rights of bailor and bailee 3 Termination 4 Finder of goods 5 Pledge 6 Chapter review Emile Woolf International 163 The Institute of Chartered Accountants of Pakistan

180 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Bailment and pledge LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to contract of bailment and pledge. LO Define bailment and identify the essentials of the contract of bailment LO Explain the types of bailment LO Identify duties and rights of the bailor and bailee LO Explain how contract of bailment is terminated LO Identify rights and duties of finder of goods LO Explain pledge (pawn), pledgor (pawnor) and pledgee (pawnee) LO Explain rights of pledgor and pledgee LO Understand the rules of pledge by non-owners LO Differentiate between bailment and pledge. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 164 The Institute of Chartered Accountants of Pakistan

181 Section A: Mercantile Law - Chapter 15: Bailment and pledge 1 NATURE OF BAILMENT Section overview Meaning of bailment Essential elements of bailment Types of bailment 1.1 Meaning of bailment The 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. [Section 148] The word Bailment is derived from a French word Baillier which means to deliver. The analysis of the above law also reveals that if a person already having had possession of the goods of another, contracts to hold them as a bailee, he thereby becomes the bailee, and the owner becomes the bailor of such goods, although they may not have been delivered by way of bailment. Example: bailment X delivers a piece of cloth to Y, a tailor, to be stitched into a suit. There is a contract of bailment between X and Y. A lends a laptop to B to be returned after the examination. There is a contract of bailment between A and B. An insurance company places a damaged insured car of X in possession of Y, a repairer. X is the bailor, the insurance company is the bailee, and Y is the sub-bailee. 1.2 Essential elements of bailment The essential elements of bailment are shown below: Emile Woolf International 165 The Institute of Chartered Accountants of Pakistan

182 Agreement A bailment is usually created by agreement between the bailor and the bailee. It may be gratuitous i.e. without consideration or non-gratuitous i.e. with consideration. The agreement may be express or implied. In case of finder of goods the bailment is implied by law. Delivery of goods A bailment involves delivery of goods by bailor to bailee. In this connection, the following points may be noted: The delivery must be voluntary e.g. the delivery of jewellery by its owner to a thief who shows a revolver does not create a bailment because the delivery is not voluntary. Delivery may be actual or constructive Actual delivery is when goods are physically transferred by one person to another e.g. delivery of a car to mechanic for the purpose of repair. Constructive or symbolic delivery may be made by doing something which has the effect of putting the goods in the possession of the intended bailee or any person authorized to hold them on his behalf. This means possession is transferred to the bailee without actually handing over the goods physically e.g. the delivery of a railway receipt amounts to delivery of the goods. Purpose The delivery of goods from bailor to bailee must be for some purpose such as personal service, safe custody, some work to be done upon or transportation. Return of specific goods In contract of bailment the goods are either returned or disposed of as per the instructions of bailor after the purpose is achieved. 1.3 Types of bailment The various types of bailment are shown below: Types of bailment On the basis of reward On the basis of benefit Gratuitous Bailment Non-gratuitous Bailment Bailment for the exclusive benefit of bailor Bailment for the exclusive benefit of bailee Bailment for the mutual benefit of bailor and bailee Bailment on the basis of reward Type Gratuitous bailment Non-gratuitous bailment Meaning It is a contract of bailment where no consideration passes between the bailor and the bailee. It is a contract of bailment where some consideration passes between the bailor and the bailee. Emile Woolf International 166 The Institute of Chartered Accountants of Pakistan

183 Section A: Mercantile Law - Chapter 15: Bailment and pledge Example: Gratuitous bailment Zaheer lends an IPAD to Imran for his work without any charge. Example: Non-gratuitous bailment A hires a car from B. Bailment on the basis of benefit Type Bailment for the exclusive benefit of bailor Bailment for the exclusive benefit of bailee Bailment for the mutual benefit of bailor & bailee Meaning A contract of bailment which is executed only for the benefit of the bailor. A contract of bailment which is executed only for the benefit of the bailee. A contract of bailment which is executed for the mutual benefit of the bailor and the bailee. Example: Bailment for the exclusive benefit of bailor X who is going out of station to attend a conference delivers his tablet to Y for proper care. Example: Bailment for the exclusive benefit of bailee Zaheer lends an iphone to Imran for a day without any charge. Example: Bailment for the mutual benefit of bailor & bailee A hires a car from B. There can be two more types of bailment: Sub-bailment A sub-bailee is a person to whom the actual possession of goods is transferred by someone who himself is not the owner of goods but has a present right to possession of them as bailee of the owner. Where the bailee sub-bails the goods with the authority of the owner, the relationship between the owner and the sub-bailee is that of bailor and bailee. Example: Sub-Bailment 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. Pledge/Pawn Term Pledge Pawnor Pawnee Meaning The bailment of goods as security for payment of a debt or performance of a promise is called pledge or pawn The bailor in this case is called the pawnor / pedgor The bailee in this case is called the pawnee / pledgee Emile Woolf International 167 The Institute of Chartered Accountants of Pakistan

184 2 DUTIES AND RIGHTS OF BAILOR AND BAILEE Section overview Duties of bailor Duties of bailee Rights of bailor Rights of bailee The table below shows the duties and rights of bailor and bailee: These are explained below: 2.1 Duties of bailor Duty to disclose faults According to Section 151 of Contract Act: Gratuitous Bailment The bailor is bound to disclose to the bailee faults in the goods bailed: Of which the bailor is aware and Which materially interfere with the use of them or expose the bailee to extraordinary risks If the bailor does not disclose such faults and the bailee undergoes some loss due to such faults, the bailor is liable to bailee for such loss. Non-gratuitous Bailment If the bailee suffers any loss due to any fault in the goods, the bailor is liable to bailee for such loss whether he knows those faults or not. Emile Woolf International 168 The Institute of Chartered Accountants of Pakistan

185 Section A: Mercantile Law - Chapter 15: Bailment and pledge Example: Gratuitous bailment A lends a horse, which he knows to be vicious, to B. He does not disclose that the horse is vicious. The horse runs away and B is thrown and injured. A is responsible to B for damage sustained. Example: Non-gratuitous bailment A hires a car of B. The car is unsafe, though B is not aware of it, and is injured. B is responsible to A for the injury. Duty to bear expenses According to Section 158 of Contract Act: Gratuitous bailment In case of gratuitous bailment it is the duty of the bailor to indemnify bailee for all the necessary expenses which the bailee has incurred for the purpose of bailment. Non-gratuitous bailment In non-gratuitous bailment it is the duty of the bailor to indemnify bailee for all the extra ordinary expenses which the bailee has incurred for the purpose of bailment. Example: Gratuitous Bailment A leaves his car with B, a friend, for safe custody for six months. B has to pay Rs. 1,000 per month to the night watchman for keeping a watch over the car. It is the duty of A to pay B the necessary expenses incurred by B. Example: Non-gratuitous Bailment A lends his horse to B, a friend, for two days. The feeding charges are to be paid by B. But if the horse meets with an accident A will have to repay B medical expenses incurred by B Duty to indemnify bailee for loss in case of early termination of gratuitous bailment In case of gratuitous bailment the bailor can terminate bailment even if it is made for a fixed time or purpose. In such case bailor is liable to compensate bailee for any loss in excess of benefit due to early termination. [Section 159] Example: Duty to indemnify bailee for loss in case of early termination of gratuitous bailment A lends an old discharged IPhone to B gratuitously for three months. B incurs Rs.12,000 on its repairs. If A asks for the return of the IPhone after one month, he will have to compensate B for expenses incurred by B in excess of the benefit derived by him. Duty to receive back the goods Bailor is bound to receive back the goods when the purpose is completed or on expiry of period. In case the bailor refuses to accept the goods then he is liable to pay the charges incurred by bailee for the safe custody of goods. [Section 164] Example: Duty to receive back the goods A lent an X-box to B for five days. On the expiry of five days, A refused to receive back the x-box but two days thereafter, he agreed to receive back the X-box. During these two days, B incurred Rs. 1,000 as software update charges. A must repay Rs. 1,000 to B. Duty to indemnify the bailee The bailor is liable to indemnify bailee for any loss arising due to defective title of bailor. [Section 164] Emile Woolf International 169 The Institute of Chartered Accountants of Pakistan

186 Example: Duty to indemnify the bailee B asks A, his friend to give him car for one hour. A, instead of his own car delivers Z s car to B. While B was riding, Z catches B and hands him over to the police custody. B is entitled to recover from A all costs which he had to incur in getting out of this situation. Duty to bear the risk of loss If the bailee has taken reasonable steps to protect the goods then the bailor is bound to bear the risk of loss of goods bailed. [Section 152] 2.2 Duties of bailee Duty to take care of the goods bailed In all cases of bailment, the bailee is bound to take as much care of the goods bailed to him as a man of ordinary prudence would, under similar circumstances, take of his own goods of the same bulk, quality and value as the goods bailed. [Section 151 & 152] Example: Duty to take care of the goods bailed Imran entered a restaurant for dining. His coat was taken by a waiter who hung it on a hook behind Imran. When Imran rose to leave, the coat was gone. The proprietor of the restaurant will be liable for the loss. Duty not to make any unauthorized use of goods If the bailee uses the goods bailed in a manner which is not according to the terms of the contract, he shall be liable to compensate bailor for any loss arising due to inconsistent use of goods bailed. [Section 154] Example: Duty not to make any unauthorized use of goods A lends a laptop to B for his use only. B allows C, a member of his family, to use the laptop. C uses with care, but the laptop accidently falls and its LCD braked. B is liable to make compensation to A for the injury caused to the laptop. Duty not to mix the goods bailed with his own goods A bailee is bound to keep the goods bailed separately. He must take prior consent from bailor to mix with his own goods. [Section 155 to 157] Mixture without bailor s consent Goods being separable If the bailee so mixes without the consent of the bailor and the goods can be separated or divided, the bailee is liable for the: Expenses of separation or division Any damage arising from the mixture. Goods being inseparable If the bailee so mixes without the consent of the bailor and the goods cannot be separated then the bailee is liable to the bailee for the loss of the goods. Example: Mixture without bailor s consent Goods being separable A bails 100 bales of cotton marked with a particular mark to B. B, without A s consent, mixes the 100 bales with other bales of his own, bearing a different mark. A is entitled to have his 100 bales returned and B is bound to bear all the expenses incurred in the separation of the bales, and any other incidental charges. Goods being inseparable A bails a bag of farm wheat worth Rs. 550 to B. B without A s consent, mixes the wheat with imported wheat of his own, worth only Rs. 250 a bag. B must compensate A for the loss of his wheat. Emile Woolf International 170 The Institute of Chartered Accountants of Pakistan

187 Section A: Mercantile Law - Chapter 15: Bailment and pledge If the goods of the bailor get mixed up with the like goods of the bailee, by inadvertence of the bailee or accident or by the act of an unauthorized third party, the mixture belongs to the bailor and the bailee in proportion to their shares. Duty not to set up an adverse title The bailee is not the legal owner of the goods bailed but holds the goods on behalf of the bailor. He cannot deny the right of the bailor to bail the goods and receive them back. He may however refuse to deliver goods back to the bailor if there is an effective pressure such as a court order, not to return goods to the bailor. Duty to return the goods It is the duty of the bailee to return the goods bailed without demand as soon as the: Time for which they were bailed has expired or Purpose for which they were bailed has been accomplished unless otherwise agreed upon. If the bailee fails to do so, he is responsible for any loss, destruction or deterioration of the goods from that time. [Section 160 & 161] Example: Duty to return the goods A delivered some CDs to B for watching. He pressed for their return, but B neglected to return them although more than reasonable time had elapsed. A fire accidently broke out on B, premises and the CDs were burnt. B was liable for the loss although he was not negligent, because of his failure to deliver the CDs within a reasonable time. Duty to return increase In the absence of any contract, it is the duty of the bailee to return to the bailor any: increase or profit if the goods are bailed. [Section 163] Example: Duty to return increase A leaves a cow in the custody of B to be taken care of. The cow has a calf. B is bound to deliver the calf as well to A. 2.3 Rights of bailor Right to claim damages in case of negligence A bailor is entitled to claim damages if bailee has not taken reasonable care of the goods bailed. [Section 152] Right to terminate the contract in case of unauthorized use A bailor is entitled to terminate the contract if the bailee without the consent of bailor uses the goods for other purposes. [Section 153] Right to claim compensation in case of unauthorized use A bailor is entitled to claim compensation if the bailee without the consent of bailor uses the goods for other purposes and any damage arise. [Section 154] Right to claim separation of goods in case of unauthorized mixture A bailor has a right to claim separation of goods bailed (if separable) if bailee mixes the goods with his own goods without prior consent. [Section 156] Right to claim compensation in case of unauthorized mixture of goods A bailor has a right to claim compensation from bailee for any loss to the goods bailed if bailee mixes the goods with his own goods without prior consent. [Section 157] Emile Woolf International 171 The Institute of Chartered Accountants of Pakistan

188 Right to demand return of goods A bailor has a right to demand return of goods after the fulfilment of the purpose or after the expiry period of bailment. [Section 160] Right to claim compensation in case of unauthorized retention of goods If the bailee does not return or deliver the goods according to the bailor s direction after the fulfilment of purpose or after the expiry of period of bailment, the bailor has a right to claim compensation for any loss, destruction or deterioration of the goods. [Section 161] Right to demand increase In the absence of any contract, the bailor has a right to demand any increase or profit which may have accrued from the goods bailed. [Section 163] 2.4 Rights of bailee Right to claim damages According to Section 150 of Contract Act: Gratuitous bailment If the bailor does not disclose the fault in the goods of which he is aware and the bailee suffers some loss due to such faults, the bailee has a right to claim damages. Non-gratuitous bailment If the bailee undergoes any loss due to any fault in the goods, the bailee has a right to claim damages. Right to claim reimbursement of expenses According to Section 158 of Contract Act: Gratuitous bailment In case of gratuitous bailment the bailee has a right to claim indemnification of all the necessary expenses which he has already incurred for the purpose of bailment. Non-gratuitous bailment In case of non-gratuitous bailment the bailee has a right to claim indemnification of all the extra ordinary expenses which the bailee has already incurred for the purpose of bailment. Right to be indemnified in case of early termination of gratuitous bailment In case of gratuitous bailment the bailee has a right to claim indemnification if the bailor terminates the contract of bailment before the expiry of fixed period or completion of purpose. In such case bailee has a right to claim compensation for any loss in excess of benefit due to early termination. [Section 159] Right to recover loss in case of bailor s defective title The bailee has a right to be indemnified for any loss arising due to defective title of bailor. [Section 164] Right to recover loss in case of bailor s refusal to take the goods back If the bailor refuses to take back the goods then bailee has a right to be indemnified in case he suffers any loss. [Section 164] Right to deliver goods in case of several joint owner In absence of any contract to the contrary, the bailee has a right to deliver back the goods in accordance with the instructions of one joint owner without the consent of or other of the joint owners. [Section 165] Bailee not responsible on re-delivery to bailor without title 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. [Section 166] Emile Woolf International 172 The Institute of Chartered Accountants of Pakistan

189 Section A: Mercantile Law - Chapter 15: Bailment and pledge Rights of bailor and bailee against wrong-doer If a third person wrongfully deprive the bailee of the use or possession of the goods bailed then the bailee may use such remedies as the owner might have used and either the bailor or the bailee may bring a suit against the third person for such deprivation or injury. Whatever is obtained by way of relief or compensation is any such suit in the above case, shall as between the bailor and the bailee, be dealt with according to their respective interests. [Section 180 & 181] Example: Rights of bailor and bailee against wrong doer X delivered a TV to Y for repairs. Z forcefully takes possession of TV from Y s shop. In this case, either X or Y may sue Z, if Y files the suit, he shall hand over the amount received after deducting his repair charges to X. Right of particular lien Where the lawful charges of the bailee in respect of the goods bailed are not paid, he may retain the goods until he receives due remuneration for the services he has rendered in respect to them. This right of the bailee to retain the goods is known as particular lien. A particular lien is available to a bailee only against those goods on which some skill and labour have been expended by him. But if the bailee does not complete the work within the agreed time, or a reasonable time, he cannot exercise his right of lien. Also, if he voluntarily permits the bailor to regain possession of the goods without payment of the charges, he cannot exercise the right of lien. [Section 170] Example: Right of particular lien A delivers a rough diamond to B, a jeweller to be cut and polished which is accordingly done. B is entitled to retain the stone till he is paid for the services he has rendered. A gives a piece of cloth to B, a tailor, to sew it into a coat. B promises A to deliver the coat as soon as it is finished, and to give A three months credit for the price. B is not entitled to retain the coat. Emile Woolf International 173 The Institute of Chartered Accountants of Pakistan

190 3 TERMINATION Section overview Termination of all contract of bailment Termination of gratuitous bailment 3.1 Termination of all contract of bailment All contract of bailment are terminated in the following cases: Automatic termination A bailment of goods is automatically terminated on: Expiry of the time for which goods were bailed Completion of purpose for which they are bailed. Inconsistent use of goods When the bailment is for a specific purpose and goods bailed are used inconsistent of the purpose for which they are bailed. Destruction of the subject-matter A bailment is terminated when the subject-matter of the bailment is destroyed, or by reason of a change if its nature becomes incapable of use for the purpose of the bailment. 3.2 Termination of gratuitous bailment Death of the bailor or bailee On death of the bailor or bailee the gratuitous bailment is terminated. Before the expiry of the fixed period In case of gratuitous bailment the bailor can terminate the contract of bailment before the expiry of fixed term or completion of purpose. In such a case, the bailor is liable to indemnify the bailee in case the loss exceeding the benefit derived due to early termination. Emile Woolf International 174 The Institute of Chartered Accountants of Pakistan

191 Section A: Mercantile Law - Chapter 15: Bailment and pledge 4 FINDER OF GOODS Section overview Rights of finder of goods Duties of finder of goods Finder of goods is the person who finds some goods which do not belong to him. If he takes them into his custody, he becomes a bailee. 4.1 Rights of finder of goods Right to lien The finder of goods has a right of lien over the goods found until he receives the compensation for expense incurred by him to preserve the goods and to find the owner but he has no right to sue the owner for any such compensation incurred by him voluntarily. [Section 168] Right to sue for reward The finder can sue for any specific reward which the owner has offered for the return of the goods. He may also retain the goods until he receives the reward. [Section 168] Right of sale A finder of goods may sell the goods found if [Section 169]: The owner cannot with reasonable diligence be found, or If found, he refuses to take the goods or Goods will perish or lose the greater part of their value, or The lawful charges of the finder, in respect of the goods found, amount to two third of their value. 4.2 Duties of finder of goods The finder of goods is subject to same responsibility as a bailee. The duties are given below: Duty to take care The finder of goods must take reasonable care of the goods found like a person of ordinary prudence. Duty not to use for personal purpose The goods found must not be used for personal purpose. Duty not to mix with its own goods The goods found must not be mix with his own goods. Duty to find the owner Subject to lien, the finder of goods must return the goods to the true owner if found. Emile Woolf International 175 The Institute of Chartered Accountants of Pakistan

192 5 PLEDGE Section overview Definition Rights of pawnee Rights of pawnor Pledge by non-owners Difference between pledge and bailment 5.1 Definition Definition: Pledge [Section 172 The bailment of goods as security for payment of a debt or performance of a promise is called a pledge. The person who delivers the goods as security for payment of a debt or performance of a promise is called pawnor or pledgor. The person to whom the goods are delivered as security for payment of a debt or performance of a promise is called pawnee or pledgee. Any kind of movable property, i.e., goods, documents, or valuables may be pledged. But delivery is necessary to complete a pledge. The delivery may be actual or constructive. Example: Pledge If A borrows Rs. 200,000 from B and keeps his Rolex watch as security for payment of the debt, the bailment of watch is a pledge. 5.2 Rights of pawnee Right of retainer The pawnee may retain the goods pledged for [Section 173]: Payment of the debt or the performance of the promise For the interest of the debt and All necessary expenses incurred by him in respect of the possession or for the preservation of the goods pledged. Example: Right of retainer A borrows Rs. 100,000 for a period of 1 month on an interest of 1% per month (Rs 1,000 ) from ABC Bank and kept his laptop as security. ABC Bank has a right to keep laptop of A in its custody until the loan amount i.e. Rs. 100,000 and mark up i.e. Rs. 1,000 is paid in full. Right of retainer for other advances It is the presumption that when the pawnee lends money to the same pawnor after the date of the pledge the right of the retainer over the pledged goods extends to subsequent advances also unless otherwise agreed upon. If the goods are separately secured then such presumption will not prevail. [Section 174] Right to extraordinary expenses The pawnee is entitled to receive from the pawnor extraordinary expenses incurred by him for the preservation of the goods pledged. [Section 175] Emile Woolf International 176 The Institute of Chartered Accountants of Pakistan

193 Section A: Mercantile Law - Chapter 15: Bailment and pledge Example: Right to extra ordinary expenses A pledged gold with B against a loan of Rs. 100,000 at a mark-up of 15% per annum. Being concerned with the growing incidences of burglary in the city, B insured the gold. At the time of repayment, B claimed the cost of insurance cover in addition to the principal sum due and interest. Here, the claim of B is valid as the expenses were made for the preservation of the goods pledged. Right against true owner, when the pawnor s title is defective When the pawnor has obtained possession of the goods pledged by him under a voidable contract but the contract has not been rescinded at the time of the pledge, the pawnee acquires a good title to the goods, provided he acts in good faith and without notice of the pawnor s defect of title. Rights where pawnor makes default If the person makes default in payment of the debt or performance of the promise then the pawnee can exercise the following rights: [Section 176] Right to sue The pawnee may file a suit against the pawnor upon the debt or promise and may retain the goods pledged as a collateral security. Right to sell The pawnee may sell the goods pledged after giving pawnor a reasonable notice of the sale. He can recover from the pawnor any deficiency arising on the sale of the goods by him. However, he shall have to hand over the surplus to the pawnor, if any, realized on the sale of the goods Example: Rights where pawnor makes default ABC Bank granted a loan of Rs. 10 million to XYZ Limited against the pledge of shares of a listed company. XYZ Limited defaulted on repayment of the loan. The market value of the shares at the time of default was Rs. 9 million. Here, ABC Bank can file a suit for the recovery of the defaulted amount and retain the pledged shares or after giving reasonable notice to XYZ Limited may sell the shares of the listed company to recover the defaulted amount and sue XYZ Limited for the remaining amount. 5.3 Rights of pawnor Right to get back goods On the performance of promise, or repayment of loan and interest, if any, the pawnor is entitled to get back the goods pledged. [Section 177] Right to redeem debt If the pawnor makes default in payment of the debt or performance of the promise at the stipulated time, he may still redeem the goods pledged at any subsequent time before the actual sale of them. In this case he must pay, in addition, any expenses which have arisen from his default. [Section 177] Right to see The pawnor has a right to see that the pawnee preserves the goods pledged and properly maintains them. Emile Woolf International 177 The Institute of Chartered Accountants of Pakistan

194 Note Other duties of pawnee and pawnor are same as duties of bailor and bailee 5.4 Pledge by non-owners The general rule is that it is the owner who can ordinarily create a valid pledge. But in the following cases even a non-owner can create a valid pledge. Pledge by mercantile agent The pawnee of goods from a mercantile agent, who has no authority from the principal to pledge, gets a good title to the goods if: [Section 178] The agent is in possession of the goods or documents of title to the goods with the consent of the owner The agent pledges the goods while acting in the ordinary course of business of a mercantile agent The pawnee acts in good faith and The pawnee has not at the time of the pledge, notice that the agent has no authority to pledge. Pledge by person in possession under voidable contract When a person has obtained possession of the goods under a voidable contract and he pledges those goods before the contract has been rescinded, the pawnee of such goods acquired a goods title to them provided the pawnee acts in good faith and without notice of the pawnor s defect of title. [Section 178A] Example: Pledge by person in possession under voidable contract A purchases a piano from B by fraud. A has a voidable title to the goods. Before B rescinds the contract, A pledges the piano to C, who acted in good faith and is ignorance of the fraud. It is a valid pledge. Pledge by seller in possession after sale Where a seller having sold goods, continues to be in possession of the goods or of the documents of title to the goods and pledges them either himself or through a mercantile agent to a person who pledges them in good faith and without notice of the sale, it will be a valid pledge. [Section 30 of the Sales of Goods Act] Example: Pledge by seller in possession after sale A sells certain goods to B and promises to deliver the goods the next day. Before delivery A pledges the goods with C who acts in good faith and without notice of the prior sale to B. It will be a valid pledge. Pledge by buyer in possession before sale Where a person having bought or agreed to buy goods obtains with the consent of the seller, possession of the goods or documents of title to the goods and pledges them either himself or through an agent, the pawnee who acts in good faith and without notice of any right of the original owner is respect of the goods. The pledge of goods will be valid. [Section 30 of the Sales of Goods Act] Pledge by co-owner in possession One of the several co-owners of goods in possession thereof with the assent of the other coowners may create a valid pledge of the goods if the pawnee acts in good faith and without notice about the co-owners. Emile Woolf International 178 The Institute of Chartered Accountants of Pakistan

195 Section A: Mercantile Law - Chapter 15: Bailment and pledge 5.5 Difference between pledge and bailment Following are the few differences between pledge and bailment: Pledge Nature of contract The bailment of goods as security for payment of a debt or performance of a promise is called pledge. Name of parties pawnor and pawnee Purpose The purpose of pledge is security for the performance of a specific promise, i.e. the payment of a debt or performance of a promise Right to use Pawnee has no right to use the goods pledged. Right to sell Pawnee can sell the goods pledged after giving notice to the pawnor in case of default by the pawnor. Bailment The 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. Bailor and bailee Bailment is for safe custody, transportation etc. Bailee can use if terms of bailment so provide. Bailee can either retain the goods or sue the bailor for his dues. Emile Woolf International 179 The Institute of Chartered Accountants of Pakistan

196 6 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Define bailment and its characteristics State the rights and duties of bailor and bailee Describe briefly the various ways by which an bailment may be terminated Explain the rights and obligations of a finder of goods Define pledge and discuss the circumstances where pledge can be made by non-owners Differentiate between pledge and bailment Emile Woolf International 180 The Institute of Chartered Accountants of Pakistan

197 Certificate in Accounting and Finance C H A P T E R 16 Agency Contents 1 Role of an agent 2 Rights and duties of the agent and principal 3 Irrevocable agency 4 Termination of agency 5 Undisclosed agency 6 Personal liability of an agent 7 Chapter review Emile Woolf International 181 The Institute of Chartered Accountants of Pakistan

198 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Contract of Agency LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to contract of agency. LO Define agency, agent and principal and explain types of agents LO Identify rights and duties of the agent and principal LO Understand rules relating to agency LO Differentiate between sub agent and co-agent LO Explain how an agency can be created LO Understand the circumstances when an agent is personally liable LO Identify irrevocable agency LO Explain how an agency can be terminated LO Understand the meaning of undisclosed agency, position of agent, principal and third party. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 182 The Institute of Chartered Accountants of Pakistan

199 Section A: Mercantile Law - Chapter 16: Agency 1 ROLE OF AN AGENT Section overview Definition of an agent: the principal-agent relationship Types of agent Difference between Sub-agent and Co-agent Legal problems with agency relationships Creation of agency Authority of an agent 1.1 Definition of an agent: the principal-agent relationship Definition: Agent [Section 182] An agent is a person employed to do any (lawful) act for another or to represent another in dealing with a third person. The person for whom such act is done or who is so represented is called the principal. All types of business may use agents. An agent is a person who acts on behalf of someone else (a principal ) to arrange a transaction with a third party. The transaction creates a legal contract, and the contract is between the principal and the third party. There is a legal relationship between the agent and the principal. The nature of this relationship is explained later. The agent acts on behalf of the principal, by negotiating with a third party. Under normal circumstances, there is no legal agreement between the agent and the third party. However, the agent may negotiate the terms of a contract between the principal and the third party. When the contract is made, it is between the principal and the third party. Any person who is of the age of majority and who is of sound mind may employ an agent. As between the principal and third persons any person may become an agent. Thus even a minor or a person of unsound mind can be appointed as agent. It is so because the act of the agent is the act of the principal and therefore the principal is liable to third parties for the acts of a minor agent. No consideration is necessary to create an agency. An agent may act for a principal in arranging just one transaction. However, it is common in business for an agent to act regularly on behalf of a principal, arranging large numbers of different business transactions and contracts. However, it might be useful to have a simple example of an agent-principal relationship in mind. One example is using an agent appointed for the sale of goods. The agent will act on behalf of the owner (the principal) and try to find a buyer (a third party). If the agent is successful and the goods are sold, the contract for the sale and purchase of the goods is between the seller and the buyer. The agent does not enter into a contract with the buyer (the third party) although he has an agreement with the principal (from which he will earn a fee). Emile Woolf International 183 The Institute of Chartered Accountants of Pakistan

200 1.2 Types of agent Following are the different types of agent: Commercial agent or mercantile agent Broker Auctioneer Del credere agent Company directors and managers Partners in a business partnership Sub-agent [Section 191 to 193] An agent who regularly buys or sells goods on behalf of a principal. For example, a company in Karachi might have an agent in Lahore, who arranges the sale of the company s goods with buyers in Lahore. A broker is an intermediary who arranges trades or transactions on behalf of clients (principals). An example is a stock broker, who arranges the purchase or sale of stock market investments on behalf of a client. An auctioneer is an agent who is authorised to sell property of a principal at auction. 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 obligation. He occupies the position of both a guarantor and an agent. It is important to be aware that company directors act as agents for their company; therefore the rules of agency law apply to the actions carried out by directors on behalf of the company. Employees, particularly senior managers, might also act as agents for their employer. It is also important to be aware that business partners act as agents for their partnership business. The rules of agency law therefore apply to the powers conferred on a partner to bind the partnership to contractual agreements and obligations. A sub-agent is the person employed by the original agent to act under his control in the business of agency. The general rule is that an agent is not entitled to delegate his authority to another person without the consent of his principal. This is because when the principal, appoints a particular agent to act on his behalf, he relies upon the agent's skill, integrity and competence. However, an agent may appoint a sub-agent and delegate the work to him if: The principal has expressly permitted delegation of such power. The ordinary custom of trade a sub-agent may be employed. Thus stock exchange member brokers generally appoint clerks to transact business on behalf of their clients. Or: The nature of work is such that a sub-agent is necessary e.g. a manager of a shop may employ sales assistant. The acts to be done are purely immaterial. Unforeseen emergencies arise rendering appointment of the sub-agent necessary. Where a sub-agent is properly appointed In such a case: The principal is bound by the acts of the sub-agent as if the subagent was an agent originally appointed by the principal. The agent is responsible to the principal for the acts of the subagent. The sub-agent is responsible for his acts to the agent, but not to the principal, except in case of fraud or wilful wrong. Emile Woolf International 184 The Institute of Chartered Accountants of Pakistan

201 Section A: Mercantile Law - Chapter 16: Agency Where a sub-agent is not properly appointed Where the appointment of a sub-agent is made without authority and without any justification the following consequence arises: The agent stands as a principal towards such a sub-agent The principal is not represented by such sub-agent and hence he is not liable for the acts of the sub-agent. The agent is responsible for the acts of the sub-agent to the principal as well as to the third parties. The sub-agent is not responsible to the principal at all. He cannot be held liable by the principal even for fraud or wilful wrong. He is responsible for his acts only to the agent. Co-agent or substituted agent [Section 194] A co-agent or a substituted agent is a person who is named by the agent, on an express or implied authority from the principal, to act for the principal. He is not a sub-agent but an agent of the principal for such act of the business of the agency as to be entrusted to him. He is the agent of the principal, though he is named, at the request of the principal, by the agent. In selecting a co-agent for his principal an agent is bound to exercise the same amount of discretion as a man of ordinary prudence would exercise in his own case and if he does this then he is not responsible to the principal for the acts or negligence of his co-agent. 1.3 Difference between Sub-agent and Co-agent S.no Sub-agent Co-agent / substituted agent 1 Control A sub-agent works under the control of the agent. A co-agent works under the instructions of the principal. 2 Contract There is no contract between sub-agent and the principal. There is a contract between co-agent and the principal. 3 Responsibility The agent is responsible to the principal for the act of the sub-agent. The agent is not responsible to the principal for the act of the substituted agent if the agent while selecting the substituted agent exercised the same amount of discretion as a man of ordinary prudence would exercise in his own case 4 Termination A sub-agent is automatically terminated if the authority of the agent is revoked by the principal. Co-agent is not affected by the termination of the original agency. 5 Remuneration Remuneration to sub-agent is paid by the agent. Remuneration to co-agent is paid by the principal. Emile Woolf International 185 The Institute of Chartered Accountants of Pakistan

202 1.4 Legal problems with agency relationships There are several possible legal problems with agency arrangements. In particular, there may be some doubt about the validity of a contract that an agent makes with a third party on behalf of a principal. For example: A person might claim to act on behalf of a principal P, and a third party might enter into an agreement believing the contract to be with P. However, P might deny that the person is in fact his agent. A person might be the agent of P with authority to make certain agreements on behalf of P. However, the agent might make an agreement with a third party and in doing so go beyond the limits of his authority as agent. The principal P might then refuse to accept the agreement as legally binding. An example of this is where a manager makes an agreement on behalf of the company he works for, and the company refuses to honour the agreement on the grounds that the manager did not have the authority to make the agreement. 1.5 Creation of agency An agency relationship does not have to be a written agreement between the principal and the agent, although it will certainly help to remove much of the uncertainty if there is a written agency agreement. There are four ways in which an agency relationship, recognised in law, can be established: by express appointment (by agreement) by ratification by estoppel by necessity. Agency by express appointment (by agreement) The most common method of creating an agency relationship is by agreement and mutual consent. The principal appoints an agent (to carry out a particular task or to undertake a particular function) and the agent agrees to act for the principal. [Section 186] In many cases, the relationship is established formally, in writing. This written agreement would be a contractual agreement between principal and agent. An agency agreement may also be established by verbal agreement (although both parties may need to provide proof of a verbal agreement in the event that one party subsequently denies that the agreement ever took place). The principal may wish to give the agent the power to execute deeds. (A deed is a form of written legal document, and it is executed by signature.) In these cases, the agent must be appointed by a deed. When an agent is appointed by deed, he is given a power of attorney to act for the principal. When an agency is created by agreement, the agreement will usually specify the ways in which the agent has authority to act on behalf of the principal. The agreement should therefore make it clear, between the principal and the agent, what the agent is allowed to do on behalf of the agent (and so what he is not allowed to do). Agency by ratification An agency relationship may be created retrospectively, by ratification. This may happen when a person who does not actually have actual authority as an agent negotiates with a third party, claiming to be an agent of a named principal. The agent may negotiate a transaction between the third party and the so-called principal. At this stage, there is no agency relationship. However, the person who has been named as principal might then choose to accept the contract with the third party. This gives validity in retrospect to the actions of the person claiming to act as agent of the named principal, and an agency relationship is created by ratification. ( Ratification means giving approval to or giving validity to something.) [Section 196] Emile Woolf International 186 The Institute of Chartered Accountants of Pakistan

203 Section A: Mercantile Law - Chapter 16: Agency If the actions of a person claiming to be an agent are not ratified by the person named as principal, and there is no proof that an agency arrangement exists by agreement, the contract is between the agent personally and the other party. If the other party suffers a loss due to breach of contract by the so-called agent, he would have to take action against the so-called agent to recover any losses suffered, because the so-called agent is actually the other party to the contract. Effect of ratification Ratification is established from the time of formation of contract between the ratifier of the act and the person who did of the act. A contractual relationship is established between the ratifier and the third party. Requisites of valid ratification Following are the requisites for a valid ratification: [Section 198 to 200] An act to get ratified should be done on behalf of the person who wants to ratify it. Since ratification has a retrospective application it is necessary that the ratifier must be in existence at the time when the contract is entered into and also at the time of ratification. Since ratification has a retrospective application it is necessary that the ratifier must be competent to contract at the time when the contract is entered into and also at the time of ratification. Only lawful acts can be ratified. There cannot be ratification of partial transaction, for a ratification to be effective whole transaction must be ratified. The person ratifying the transaction must have complete knowledge of the transaction in question else ratification will not be valid. No act can be ratified which result in third party to damages. Ratification must be made within a reasonable time, what is the reasonable time is a question of facts. Agency by estoppel Estoppel is a word used in law to mean stop or prevent. An agency relationship may be created when someone has led others to believe that a person has the authority to act on his behalf. An express agency agreement does not in fact exist, but it may seem to other people that it does. If a third party then agrees a transaction with the person who appears to be an agent, the principal can be prevented ( estopped ) from denying that an agency agreement does not exists. In other words, the principal cannot reject the agreement by saying that the person who was apparently acting as an agent was not in fact an agent. In this situation, the agent has ostensible authority or apparent authority, even though he does not have actual authority to act as an agent. [Section 237] For a third party to rely on the existence of an agency by estoppel, the following conditions must apply. A person (the principal) must give a clear representation to others that someone has the authority to act as his agent. The representation must be made by the principal. If a person claims to be an agent but the principal has given no representation to others that this person is an agent, an agency by estoppel cannot exist. This representation must have been made to the third party who then relies on the existence of the agency relationship. The third party who then negotiates the transaction with the agent must have relied on the existence of the agency relationship in reaching a decision about the transaction. If these circumstances apply, a third party who suffers losses resulting from the situation can hold the principal as liable, and take legal action against the principal. Emile Woolf International 187 The Institute of Chartered Accountants of Pakistan

204 In a simple situation, suppose that a father regularly pays the debts of his daughter to a particular shop. He may be denied (estopped) from denying that she acts as his agent, so that if he decides that he will not pay a particular bill to the shop for his daughter, he may nevertheless be legally obliged to do so. Agency by necessity Agency by necessity occurs in circumstances where there is no agreement between the parties, but an emergency requires that one party (the agent) has to take action to protect the interests of the other party (the principal). A typical situation that might create agency by necessity happens when one person (the agent) is in possession of property belonging to another person (the principal), and as a result of an unexpected emergency, the agent takes action to protect or safeguard the property of the principal. Unless the agent takes action, the principal will lose the property, or the property will suffer significant damage. For agency by necessity to exist, the following conditions must apply. There must be a real emergency. It must be impossible for the person acting as the agent to contact the owner of the property and obtain instructions. The person acting as agent by necessity must act as far as possible, in the best interests of the principal. In most cases involving agency by necessity, the person acting as agent by necessity is in charge of goods or other assets owned by the principal, and there is an emergency in relation to those assets or goods. Agency by operation of law Sometimes an agency arises by operation of law. When a company is formed its first directors are its agents by operation of law. A partner is agent of the firm for the purposes of the business of the firm. 1.6 Authority of an agent Agent s authority and the power to bind the principal A principal does not give an agent unlimited authority to enter into any contract on behalf of the principal. There are limits on the authority of an agent that restrict the type of agreement that the agent can enter into, and the principal is only bound to honour agreements that the agent makes within the limits of his authority. When a third party deals with an agent who does not have the authority to make the transaction, the principal may or may not be bound by such transaction as it depends upon the knowledge of a third party regarding the authority of an agent. [Section 188] Example: Agent s authority and the power to bind the principal An agent A is acting on behalf of a principal P. He enters into a contract with another party T, stating that he is acting as agent for P. However, A has actually acted outside his authority. P refuses to carry out the terms of the contract. In this situation, the agent A would be liable to both the third party T and to the principal for breach of warranty of authority. However, there might be problems in identifying the authority of a particular agent. These arise mainly when an agent makes an agreement with another party, and the other party genuinely believes that the agent has the necessary authority, but in fact the principal has not given the agent that authority. The authority of an agent to act on behalf of the principal may be any of the following types of authority: Express authority Implied authority Ostensible authority (apparent authority) Emile Woolf International 188 The Institute of Chartered Accountants of Pakistan

205 Section A: Mercantile Law - Chapter 16: Agency Express authority An agreement is express if both parties by words spoken or written agree to create an agency relationship. A written agency agreement may give the agent express authority. [Section 186] Express authority is not unlimited power to do anything on behalf of the principal. The principal should specify what task or tasks the agent is required to perform, and what power and authority the agent can exercise. If the agent subsequently acts outside the limits of his express authority, this will affect the contractual relationship between the principal and the third party. In such a situation, express authority does not exist, but there may be implied authority or ostensible authority. The legal consequences will depend on whether the third party knew that the agent was acting outside the limit of his authority. Implied authority Implied authority is authority of an agent in excess of his express authority i.e. which is inferred from the circumstances of the case. The scope of an agent s authority may be increased by implied authority. Unless the third party has knowledge to the contrary, he is entitled to assume that an agent holding a particular position has all the powers that are normally given to a person in such a position. [Section 187] Example: Implied authority The purchasing director of a company may order a quantity of goods from a supplier. In doing so, the director might exceed the scope of his express authority, because the company policy might be that purchases above a certain value must be made by the managing director. Unless the supplier has knowledge that the purchasing director has exceeded the limits of his authority, he is entitled to assume that the director does have the authority to purchase the goods. The company must accept that in the circumstances the purchasing director had implied authority. Ostensible authority (apparent authority) Ostensible authority, also called apparent authority, is an aspect of agency by estoppel. Ostensible authority arises in two ways. Where a person makes a representation to third parties that another person has the authority to act as his agent, even though he has not actually been appointed as agent. Where a person has previously represented to a third party that another person has the authority to act as his agent and: the authority was subsequently taken away/ended, but the third parties who previously dealt with the agent have not been informed of this fact. A person who is agent by estoppel has the ostensible authority that would be assumed for any such agent. The existence of ostensible authority is therefore found in cases of agency by estoppel. [Section 188] Emile Woolf International 189 The Institute of Chartered Accountants of Pakistan

206 2 RIGHTS AND DUTIES OF THE AGENT AND PRINCIPAL Section overview Duties of agent Rights of agent Duties of principal Rights of principal In a normal agency agreement, the principal appoints an agent to perform a task (or several tasks, or a particular function) on his behalf, and the agent agrees to carry out the task or the function. The agreement between the principal and agent is a contractual agreement that should give both parties certain rights and duties. (The duties of an agent are rights of the principal, and rights of the agent are duties of the principal.) An agency relationship also gives the agent certain authority and powers. 2.1 Duties of agent The duties of an agent are as follows: Duty to carry out mandate Every agent should perform the work for which he has been appointed to do. Duty to follow instructions It is the duty of the agent to follow all the lawful instructions of his principal. If the agent deviates from the instructions of the principal then any loss arising will be compensated by the agent. [Section 211] Duty to reasonable carefulness and proficiency An agent should conduct the business of agency with reasonable carefulness and proficiency. [Section 212] Duty to maintain and render accounts An agent should render true accounts to the principal when demanded. [Section 213] Duty to communicate An agent should communicate to the principal in cases requiring principal s instructions / directions. [Section 214] Duty not to deal personally An agent must not deal in his own account in the course of agency without getting prior approval from principal. [Section 215 & 216] Duty to pay sums received An agent is bound to pay all sums received to the principal after deducting amounts due to him in the course of the business of agency. [Section 218] Duty in case of principal s death or insanity When an agency is terminated by the principal death or unsoundness, the agent is bound to take on behalf of the representatives of his late principal, all reasonable steps for the protection and preservation of the interests entrusted to him. [Section 209] Duty not to use critical information An agent is bound to keep the information of principal secret not only during the course of agency but also after its termination. Emile Woolf International 190 The Institute of Chartered Accountants of Pakistan

207 Section A: Mercantile Law - Chapter 16: Agency Duty not to make secret profit An agent must not secure secret profit from agency without getting prior consent from principal. [Section 217 & 218] Duty not to delegate authority An agent is not entitled to delegate his authority to another person without the consent of his principal or unless under certain circumstances. [Section 190] Duty in selecting sub-agent and substituted agent An agent is bound to exercise the same amount of discretion as a man of ordinary prudence would exercise in his own case while selecting a sub-agent or substituted agent. [Section 195] Duty in case of emergency An agent has authority in emergency to do all such acts for the purpose of protecting his principal from loss as would be done by a person of ordinary prudence in his own case under similar circumstances. [Section 189] 2.2 Rights of agent An agent has the following rights against the principal: Right to receive remuneration The agent is entitled to his agreed remuneration or if there is no agreement to a reasonable remuneration unless he agrees to act without it. If a transaction for which the agent claims remuneration is the direct or indirect result of his services or efforts he is entitled to remuneration. [Section 219 & 220] Example: Right to receive remuneration Right of lien A has employed an agent to sell a property on the terms that he would be paid commission on the completion of sale. He produced a person ready and willing to buy but the owners refused to sell. Held, the agent was not entitled to commission as sale had not been completed. An agent was appointed to introduce a customer to purchase the principal's property. He did introduce one customer the amount was fixed and earnest money paid. The sale fell because of the customer's inability to find money. Held, the agent was entitled to his agreed commission. Subject to contract to contract an agent has a lien on goods, papers and other properties of the principal received by him, until the amount due to himself for commission, disbursements and services in respect of the same has been paid or accounted for, to him. [Section 221] Right of retainer An agent has a right to retain his principal s money in his hands for all money due to himself in respect of: Remuneration as may be payable to him for acting as agent Advances made or Expenses properly incurred by him in conducting the business of agency. [Section 217] Right of indemnify for lawful acts The agent has a right to be indemnified against the consequences of all lawful acts done by him in exercise of the authority conferred upon him. [Section 222] Emile Woolf International 191 The Institute of Chartered Accountants of Pakistan

208 Example: Right of indemnify for lawful acts A, an agent refused to deliver goods of T a third party, at the instructions of B (Principal). T sued A for the goods to which A incurred expenses in defending the suit. A is entitled to be indemnified from his principal. Right of compensation The agent has a right to be compensated for injuries caused by neglect or want of skill of the principal. [Section 225] Right of stoppage in transit An agent has a right to stop the goods in transit to the principal just like an unpaid seller if: he has bought goods for his principal by incurring personal liability for the price and the principal has become insolvent. 2.3 Duties of principal The duties of a principal towards his agent are the rights of the agent against the principal. The rights of an agent have already been discussed. The principal owes the following duties to an agent: Duty to indemnify for lawful acts The principal has a duty to indemnify the agent against the consequences of all lawful acts done by his agent in exercise of the authority conferred upon him. [Section 222] Duty to indemnify against consequences of acts done in good faith Where the principal employs an agent to do an act, and the agent does the act in good faith, the principal has a duty to indemnify the agent against the consequences of that act, even though it causes an injury to the rights of a third person. [Section 223] Duty to compensate The principal has a duty to compensate the agent for injuries sustained by him by neglect or want of skill on the part of the principal. [Section 225] Duty to pay It is the duty of the principal to pay to agent the agreed remuneration or if there is no agreement to a reasonable remuneration, unless he agrees to act without it. [Section 219 & 220] 2.4 Rights of principal The principal can enforce all the duties of the agent which are indirectly the rights of the principal. The principal has the following rights against the agent: Right to revoke The principal can revoke the authority given to his agent except in case of irrevocable agency or where authority has been exercised. [Section 203] Right in case of departure from direction Where an agent conducts the business of agency otherwise than the instructions of the principal than the principal: [Section 211] must be compensated by the agent for any loss sustained is entitled to profit (if any) that accrues from the transaction. Emile Woolf International 192 The Institute of Chartered Accountants of Pakistan

209 Section A: Mercantile Law - Chapter 16: Agency Right in case of misconduct The principal is entitled to compensation for any loss which is the direct consequence of agent s [Section 212] neglect want of skill or misconduct. Right to accounts It is the right of the principal that proper accounts are provided to him by the agent when he demands. [Section 213] Right to repudiate If an agent deals on his own account in the business of agency without first getting prior consent of his principal, it is the right of the principal to repudiate the transaction. [Section 215] Right to claim benefit If an agent secured secret profit during the course of agency without getting prior consent from the principal then the principal is entitled to claim all the benefits resulting from the transaction. [Section 216] Right to refuse remuneration If an agent has committed misconduct in the business of agency then the principal can refuse to pay remuneration, or for that part which has been misconducting. [Section 220] Emile Woolf International 193 The Institute of Chartered Accountants of Pakistan

210 3 IRREVOCABLE AGENCY Section overview Agency coupled with interest Revocation would cause the agent personal loss Authority partly exercised When an agency cannot be terminated or put an end to by the principal, it said to be an irrevocable agency. 3.1 Agency coupled with interest Where the agent has himself an interest in the subject-matter of agency, the agency is said to be coupled with interest. Such an agency is created with the object of protecting or securing any interest of the agent. Such agency cannot be terminated by the Death or Unsoundness of mind or Insolvency of the principal. However, it may be revoked by the principal for the agent s misconduct in the performance of duties. Such agency may be revoked only if the contract of agency contains an express provision for the revocation of agency. [Section 202] Example: Agency is coupled with interest A gives authority to B to sell A's car 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. 3.2 Revocation would cause the agent personal loss Where an agent, while acting in the course of business of agency, carries a transaction in his own name he is personally liable to the third party, unless and until the adventure is completed. Example: Revocation would cause the agent personal loss A authorize B to buy 10,000 bales of cotton on account of A, and to pay for it out of A's money remaining in B's hands. B buys 10,000 bales of cotton in his own name so as to make himself personally liable for the price. A cannot revoke B's authority so far as regards payment for the cotton. 3.3 Authority partly exercised If an agent has exercised his authority partly then the authority of the agent to the extent of acts and obligations arising from acts already done cannot be revoked. [Section 204] Example: Authority partly exercised A authorizes B to buy 10,000 bales of cotton on account of A, and to pay for it out of A's money remaining in B's hands. B buys 10,000 bales of cotton in A's name and so as not to render himself personally liable for the price. A cannot revoke B's authority so far as regards buying the cotton but can revoke B's authority to pay for the cotton. Emile Woolf International 194 The Institute of Chartered Accountants of Pakistan

211 Section A: Mercantile Law - Chapter 16: Agency 4 TERMINATION OF AGENCY Section overview Termination by acts of parties Termination by operation of law Agency can be terminated in the following ways: 4.1 Termination by act of parties Mutual agreement A contract of agency can be terminated at any time by mutual agreement of principal and agent. Revocation by the principal Unless the agency is irrevocable, the principal may revoke the authority of the agent at any time before the agent has exercised his authority so as to bind the principal. [Section 205 to 207] Compensation Where there is an express or implied contract that the agency should be continued for any period of time the principal must make compensation to the agent for revocation of the agency without sufficient cause. Reasonable notice Reasonable notice must be given of revocation of agency where agency is for a fixed period of time otherwise the damage thereby resulting to the agent must be compensated by the principal to the agent. Express or implied Revocation may be expressed or may be implied by the conduct of the principal. Termination The termination of the authority of an agent takes effect: As regards to the agent from the time when it becomes known to him As regards third persons from the time it becomes known to them Even when the agency is terminated on the death of the principal the termination is effective when it comes to the knowledge of the third party. Effect of termination The agent would be entitled to indemnity for acts done and to receive remuneration for the period before termination. Renunciation by the agent An agent may renounce the business of agency at any time and in the same manner in which the principal has the right of revocation. [Section 205 to 207] Compensation Where there is an express or implied contract that the agency should be continued for any period of time the agent must make compensation to the principal for renunciation of the agency without sufficient cause. Reasonable notice Reasonable notice must be given of renunciation of agency where agency is for a fixed period of time otherwise the damage thereby resulting to the principal must be compensated by the agent to the principal. Express or implied Renunciation may be expressed or may be implied by the conduct of the agent. Emile Woolf International 195 The Institute of Chartered Accountants of Pakistan

212 4.2 Termination by operation of law Completion of business An agency is automatically terminated when its business is completed. [Section 201] Expiry of time When the agent is appointed for a fixed period of time the agency comes to an end after the expiry of that time. Death of the principal or agent Unless the agency is irrevocable, a contract of agency is terminated on the death of the principal or agent. [Section 201] Insanity of the principal or agent Unless the agency is irrevocable, a contract of agency is terminated on the insanity of the principal or agent. [Section 201] Insolvency of the principal An agency is also terminated by the insolvency of the principal. [Section 201] Destruction of subject matter An agency is terminated automatically due to destruction of the subject-matter for which it was created. On winding up of company An agency is automatically terminated when the principal or agent is a company and the company is wound up. Principal or agent becoming an alien enemy When the agent or principal becomes an alien enemy the contract of agency is terminated. [Section 208] Emile Woolf International 196 The Institute of Chartered Accountants of Pakistan

213 Section A: Mercantile Law - Chapter 16: Agency 5 UNDISCLOSED AGENCY Section overview Meaning of undisclosed agency Position of agent Position of third party Position of principal 5.1 Meaning of undisclosed agency Where an agent while acting in the course of business of agency does not disclose at the time of formation of contract the existence of his principal or representative character and enters into the contract with third party in his own name this is called undisclosed agency. [Section 231] 5.2 Position of agent As the agent has entered into a contract in his own name his position is exactly as that of a contracting party. The agent is bound by the contract. He may be sued on it and he has the right to sue the third party. 5.3 Position of third party The position of third party is exactly that of a contracting party. On discovering about the existence of agency, the third party contracting with the agent may seek his remedy against either: the agent or the principal or both of them. Example: Position of third party A enters into contract with B to sell him 100 cars and afterwards discovers that B was acting as an agent for C. A may sue either B or C, or both for the price of the cars. 5.4 Position of principal As the agent was acting in the course of business of agency the principal may be allowed to intervene in the contract provided the following requirements are fulfilled: Consent of third party If the principal discloses himself before the contract is completed: the other contracting party may refuse to fulfil the contract if he can show that he would not have entered into the contract if he had known who was the principal in the contract or that the agent was not principal. Emile Woolf International 197 The Institute of Chartered Accountants of Pakistan

214 Example: Consent of third party A employed B to bring a theatre ticket for him. A was banned in entering the theatre and if A would have collected the ticket himself the management would have refused to give the ticket. In such a case the theatre management may subsequently refuse A to enter the theatre. Terms unchanged The terms of the contract between the agent and the other contracting party will remain unchanged if the principal is allowed to intervene in the contract. Emile Woolf International 198 The Institute of Chartered Accountants of Pakistan

215 Section A: Mercantile Law - Chapter 16: Agency 6 PERSONAL LIABILITY OF AN AGENT Section overview Circumstances where agent is personally liable 6.1 Circumstances where agent is personally liable It s a general rule that an agent is not liable if he acts on behalf of the principal. However, in certain circumstances agent is personally liable which are discussed below: Foreign principal When an agent contracts for a principal resident abroad he is presumed to be personally liable. [Section 230] Unnamed principal If an agent declines to disclose the identity of his principal then he is personally liable to the third party. Principal cannot be sued An agent is also presumed to incur personal liability where he contracts on behalf of a principal who though disclosed cannot be sued. E.g. where promoters contract for a projected company, they are held liable personally as the company being non-existent at the time of the contract but cannot be sued. [Section 230] Undisclosed Principal Where an agent acts for an undisclosed principal and contracts in his own name then he is personally liable to the third parties. [Section 231] Agency coupled with interest In case of agency coupled with interest, since the agent has himself an interest in the property which forms the subject matter of the agency therefore the agent is personally liable to the extent of his interest. [Section 202] Custom An agent is personally liable on a contract if there is any usage or custom of a market or trade to that effect. e.g. stock brokerage business. Agent exceeding his authority Where an agent while acting in the course of business of agency exceeds his authority, he is personally liable for the excess part if it is a separable transaction otherwise for the entire transaction. [Section 227 & 228] Improperly appointed sub-agent An agent is personally liable to third parties for the acts of an improperly appointed sub-agent. [Section 193] Agent incurring personal liability Where an agent, while acting in the course of business of agency incurs personal liability he is personally liable on the contract. Criminal act Where an agent has been employed to do a criminal act, the agent is not entitled to indemnify himself against the consequences of that act and is personally liable for it. Special contract If an agent, while acting in the course of business of agency enters into a special contract with the third party that he will be personally liable on the contract then the agent is personally liable. Emile Woolf International 199 The Institute of Chartered Accountants of Pakistan

216 7 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Define the terms agent and principal Discuss the general rules of agency Explain the various modes by which an agency may be created Define the different types of authorities and explain the extent Discuss the extent of principal s liability and cases where agent is personally liable Briefly explain the rights and duties of agent and principal Describe briefly the various modes by which an agency may be terminated Emile Woolf International 200 The Institute of Chartered Accountants of Pakistan

217 Certificate in Accounting and Finance C H A P T E R 17 Partnership Act Contents 1 The nature of partnership 2 Relations of partners to one another 3 Relations of partners to third parties 4 Chapter Review Emile Woolf International 201 The Institute of Chartered Accountants of Pakistan

218 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Partnership Act 1932 LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to partnership LO3.1.1 Define the terms. LO3.2.1 Understand and describe the partnership relationship, its creation and identify and explain the types of partnership and the mode of determining existence of a partnership. LO3.3.1: Determine and explain the rights and duties of partners of the firm under various circumstances LO3.3.2: Explain the provisions of the law relating to conduct of the business, property of the firm and personal profits earned by partners. LO3.4.1: Describe the relationship of partners with third parties LO3.4.2: Identify and explain the concepts of implied authority of the partner in relation to third parties, partner s authority in an emergency, mode of doing act to bind the firm, effect of admissions by a partner, effect of notice to acting partner, liability of a partner for acts of the firm and liability of the firm for wrongful acts of a partner or misapplication by partners, principle of holding out in given situations LO3.4.3: Identify and explain the rights of transferee of a partner s interest and the rights and liabilities of a minor admitted to the benefits of partnership. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 202 The Institute of Chartered Accountants of Pakistan

219 Section A: Mercantile Law - Chapter 17: Partnership Act 1 THE NATURE OF PARTNERSHIP Section overview Definitions Essential elements of a partnership Test of partnership Types of partnership Types of partners Difference between a partnership firm and a joint stock company Difference between a partnership firm and co-ownership 1.1 Definitions Definition: Partnership [Section 4] Partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Definition: Firm and partners [Section 4] Persons who have entered into partnership with one another are called individually partners and collectively a firm and the name under which their business is carried on is called the firm name. Definition: Act of firm [Section 2(a)] An act of firm means any act or omission by all the partners, or by any partner or agent of the firm which gives rise to a right enforceable by or against the firm. Definition: Third party [Section 2(d)] Third party used in relation to form or to a partner therein means any person who is not a partner in the firm. 1.2 Essential elements of a partnership The definition of partnership indicates the following essential elements in a partnership: [Section 6] Association of two or more persons Mutual agency Agreement Essential elements of partnership Business Sharing of profit Emile Woolf International 203 The Institute of Chartered Accountants of Pakistan

220 Association of two or more persons The partnership is an association between two or more persons and all persons must be competent to contract. Thus, there can be no partnership consisting of a single individual. If the number gets reduced to one, for any reason, it ceases to be a partnership. The partnership Act does not say anything about the maximum number of partners. But Companies Ordinance fixes the following maximum numbers: 1. In case of a partnership firm carrying on banking business maximum number is In case of a partnership firm carrying on any other business maximum number is In case of a partnership firm of professional persons maximum number may exceed 20. If the number of partners exceeds in 1 & 2 then the partnership firm becomes an illegal association. Agreement A partnership is a contractual agreement between the partners. This agreement may be express (whether written or oral) or implied. The written agreement is known as partnership deed. In Pakistan partnership arises from contract and not from status such as, (Joint Family Business) operation of law inheritance, or succession. A partnership deed usually sets out the following: Firm name Place or principal place of business of the firm Names of any other places where the firm carries on business The date when each partner joined the firm Number of partners Names in full and permanent addresses of partners Duration of partnership (if any) Purpose of the partnership Rights and duties of the partners. Amount of capital that each partner should put into the business, and keep in the business until the partner retires or the partnership is dissolved In Pakistan, if the partnership agreement does not specify what the rights or duties of the partners should be in particular circumstances, the rules set out in the Partnership Act 1932 are assumed to apply. These are the default rules in the absence of anything else. This means that if a partnership exists but does not have a written agreement, it will be assumed (unless there is evidence to suggest otherwise) that the rules of the partnership agreement are those contained in the Partnership Act. Carrying on business To constitute a partnership, the parties must have agreed to carry on a business. Where there is no business to be done, there can be no question of partnership. Business here includes any lawful trade, occupation and profession. An agreement to carry on business at a future time does not result in partnership unless that time arrives and the business is commenced. If the purpose is to carry on some charitable work it will not be a partnership. Example: Carrying on business Ghaffar and Jabbar purchased a shop, incurred additional expenses to renovate it contributing in the ratio of 50:50 and then leased out the shop on rent which was shared equally by them. It won t be a partnership as they are co-owners and never carried out any business. Sharing of profits The next essential element of partnership is that there must be an objective to make profit. The partners may agree to share profits in any manner they like. The sharing of profits is a prima Emile Woolf International 204 The Institute of Chartered Accountants of Pakistan

221 Section A: Mercantile Law - Chapter 17: Partnership Act facie evidence and not a conclusive evidence of partnership. Partners may share it equally or in any other proportion. Further, it is not necessary that the partners should agree to share losses. It must be noted that even though a partner may not share in the losses of the business, yet his liability towards outsiders shall be unlimited. A person receiving profits is not necessarily a partner, such as: Lender of money to persons engaged or about to engage in any business Servant or agent as remuneration Widow or child of a deceased partner as annuity A transferee of a partner s interest A minor who is admitted to the benefits of an existing partnership Previous owner or part owner as consideration for the sale of goodwill or share of it. Mutual agency There must exist a mutual agency relationship among partners. Mutual Agency relationship means that each partner is both an agent and a principal. Each partner is an agent in the sense that he has the capacity to bind other partners by his acts done. Each partner is principal in the sense that he is bound by the acts of other partners. Example: Mutual agency A, B and C are partners in a business. D an outsider deals with the firm through A. As between A and D, A is the principal. But as between A, B and C, A is also the agent of B and D. As such A, B and C can all sue D. D can also sue A, B and C. Furthermore A is accountable to B and C because he is an agent of B and C. Mutual agency relationship in case of a firm of A, B and C When A does an act When B does an act When C does an act Who is an agent A B C Who are principals B and C A and C A and B Note Following two important features of the partnership need to be understood. A partnership does not have a legal personality. Unlike a company, it is not a legal person. A third party entering into business transaction with a partnership does not have a contractual agreement with the partnership; the contractual agreement is between the third party and all the partners as individuals. Partners in a partnership do not have limited liability, and are personally liable for any liabilities of the partnership business that the partnership cannot pay. 1.3 Test of partnership In determining whether a group of persons is or is not a firm or whether a person is or is not a partner in a firm regard shall be given to the real relationship between the parties as shown by ALL RELEVANT FACTS TAKEN TOGETHER i.e. [Section 6] 1. Association of two or more persons 2. Agreement 3. Carrying on business 4. Sharing of profits 5. Mutual agency Emile Woolf International 205 The Institute of Chartered Accountants of Pakistan

222 1.4 Types of partnership Partnership-at-will Where no provision is made between the partners for the duration of their partnership, or for the determination of their partnership, the partnership is called partnership at will. In such partnership there is no provision as to when the partnership will come to an end. Any partner is free to dissolve the partnership by giving a notice in writing to all other partners of his intention to dissolve the firm. The firm is dissolved as from the date mentioned in the notice as the date of dissolution or if no date is mentioned as from the date of the communication of the notice. [Section 7 and 43] If freedom to dissolve the firm at will is curtailed by agreement, like if the agreement provides that the partnership can be dissolved by mutual consent of all the partners, only then will it not constitute a partnership at will. Particular partnership Where a partnership is created for any particular adventure or undertaking or for a specific time period it is called a particular partnership. Such partnership comes to an end on the completion of venture or on the expiry of the period. If the partners decide to continue such a partnership even after the expiry of the specific period or completion of specific venture then it becomes partnership at will. [Section 8] 1.5 Types of partners Actual or ostensible partner A partner who is actively engaged in the conduct of a business is called actual or ostensible partner. Such a partner is an agent of all other partners for the purposes of the business of the firm. He can bind himself and other partners for the acts done in the ordinary course of the business. Sleeping or dormant partner A sleeping partner is not known as such as a partner to third parties dealing with the firm. He may or may not take active part in the conduct of the business of the firm. He, like other partners, invests capital and shares in the profits of the business. He is equally liable along with other partners for all the debts of the firm, even though his existence is kept a secret from the outsiders dealing with the firm. Note A sleeping partner is not required to give public notice of his retirement and he is not liable for any act done by the firm after his retirement. Nominal partner A partner who does not contribute any capital or share in profits, but lends his name to the firm is called a nominal partner. He along with other partners is liable to the outsiders for all the debts of the firm. Partner in profits only A partner may agree that a partner shall get a share of the profits only and that he shall not be liable to contribute towards the losses. But for third parties he is liable for all the debts of the firm. Sub-partner When a partner agrees to share his profits derived from the firm with a stranger, that stranger is known as a sub-partner. A sub-partner is in no way connected with the firm and cannot represent himself as a partner of the firm. He has no rights against the firm nor is he liable for the acts of the firm. Silent partner Those who by agreement with other partners have no voice in the management of the partnership business. They share profit and losses, are fully liable for the debts of the firm and may take active part in the conduct of the business. Emile Woolf International 206 The Institute of Chartered Accountants of Pakistan

223 Section A: Mercantile Law - Chapter 17: Partnership Act Partner by estoppel or holding out Where a person Holds himself out as a partner or Allows other to do it they are then stopped from denying the character he has assumed and upon the faith of which creditors may be presumed to have acted. [Section 28(1)] The holding concept is discussed in 3 section of this chapter in detail. 1.6 Difference between a partnership firm and a joint stock company S.no Partnership firm Joint stock company 1 Formation It is created by an agreement alone. 2 Registration Registration is optional. 3 Legal entity It is not a separate legal entity. 4 Nature of liability Partners have joint and seversal liability i.e. unlimited liability. 5 Perpetual sucession A firm is dissolved on the death or insolvency of a partner. It has no perpetual succession. 6 Agency A partner is an agent of the firm for the purpose of business of the firm. 7 Transfer of interest A partner cannot transfer his interest without getting consent from other partners. 8 Number of persons Minimum two competent to contract persons are required and a maximum of 20 persons can carry partnership other than banking business. 9 Management All partners can take part in the management. It is created by law. Registration is compulsory. It is a separate entity or an artifical person distinct from it members. It has limited liability i.e. liability is restricted to the amount of capital A joint stock company continues to exist irrespective of death or insolvency of its members or directors. Directors are agent of the company. Shareholders are not agents. There is no such restriction for transfer of shares. Minimun one person can carry single member company and and no limit on shareholders for a public company. All shareholders cannot take part in the management. Emile Woolf International 207 The Institute of Chartered Accountants of Pakistan

224 1.7 Difference between a partnership firm and co-ownership S.no Partnership firm Co-ownership 1 Formation It is created by an agreement alone. 2 Business In partnership carry on business in an essential. If there will be end of business it will ultimately result in end of partnership firm. 3 Number of persons Minimum two competent to contract persons are required and a maximum of 20 persons can carry partnership other than banking business. 4 Sharing of profit Sharing of profit is one of the essential elements. Co-ownership is not necessarily a result of an agreement. Co-ownership does not necessarily involve the carrying on of a busines. No limit on maximum number of coowners. It does not involve sharing of profit. 5 Agency A partner is an agent of the firm for the purpose of business of the firm. 6 Transfer of interest A partner cannot transfer his interest without getting consent from other partners. Co-owners are not agents to one another. Co-owner can transfer his interest without getting consent from other coowner(s). Emile Woolf International 208 The Institute of Chartered Accountants of Pakistan

225 Section A: Mercantile Law - Chapter 17: Partnership Act 2 RELATIONS OF PARTNERS TO ONE ANOTHER Section overview General duties of partner Qualified duties of partner Rights of partner Mutual rights and liabilities Partnership property The duties, rights and liabilities of the partners are shown below: The liabilities are discussed in section 3.3 of this chapter. Emile Woolf International 209 The Institute of Chartered Accountants of Pakistan

226 2.1 General duties of partner These are mandatory duties of a partner that cannot be changed by an agreement amongst the partners. These are: Duty to be just and faithful An ideal partnership is one where there is mutual trust and confidence, and spirit of helpfulness among partners. As such every partner must be just and faithful to his co-partners. He must observe utmost good faith and fairness towards other partners of the firm. [Section 9] Duty to carry on business to the greatest common advantage Every partner is bound to carry on the business of the firm to the greatest common advantage. It implies that every partner must use his knowledge and skill for the benefit of the firm and not for his personal gain. He must conduct the business with the best of his ability and secure maximum benefits of the firm. [Section 9] Duty to render true accounts Every partner must render true and proper accounts to his co-partners. It implies that each partner must be ready to explain the accounts of the firm and produce vouchers in support of the entries. No partner should think of making a secret profit at the expense of the firm. [Section 9] Duty to provide full information A partner must give full information to the other partners, in relation to everything affecting the partnership. [Section 9] Duty to indemnify for loss caused by fraud Every partner shall indemnify means (compensate) the firm for any loss caused to it by his fraud in the conduct of the business of the firm. [Section 10] Duty to be liable jointly and severally unlimited liability Every partner is liable jointly with all the other partners and also severally means separately, to third parties for all acts of the firm done while he is a partner. The third party may take legal action for non-payment of a debt or losses incurred as a result of a breach of contract against: all the partners jointly, or any individual partner. The liability of all the partners is not only joint and several but is also unlimited. [Section 25] Example: Joint and several liability B, C and D are in partnership. Partner B purchases equipment for the partnership business. The equipment itself cost Rs. 20,000 and the installation costs were Rs.15,000. There is a dispute with the supplier, and the firm refuses to pay the installation costs. The supplier decides to sue for the unpaid Rs.15,000. If the supplier succeeds in his action, all the partners will be liable jointly for the Rs.15,000 liability. If the dispute goes to court, the supplier can either: sue all three partners jointly, or he can sue any individual partner, B, C or D. If he chooses to sue B personally, and succeeds with his claim, B will be required to pay the supplier. It will then be for B to obtain from his partners C and D their share of the liability that they now owe. Duty to act within authority Every partner is bound to act within the scope of his actual or apparent authority. Where he exceeds the authority conferred on him and the firm suffers a loss he shall have to compensate the firm for any such loss, unless the other partners ratify i.e. accept such acts. [Section 19] Emile Woolf International 210 The Institute of Chartered Accountants of Pakistan

227 Section A: Mercantile Law - Chapter 17: Partnership Act Duty in case of emergency It is the duty of the partner to do all such acts for the purpose of protecting the firm from loss as would be done by a person of ordinary care, in his own case acting under similar circumstances. He can even exceed his authority in order to save the firm from any loss. [Section 21] Example: Duty in case of emergency A, a partner receives goods at Karachi for being sent to a purchaser at Lahore. A may sell the goods at Karachi, if the goods will not bear the journey to Lahore without spoiling. X, Y and Z are partner in a firm. By an agreement, they decided that no partner would have authority to sell goods of the firm above the value of Rs.50,000/- without the consent of other partners. Owing to a sudden slump in the market, the prices crashed. One partner, in order to save the firm from loss, sold all the stock worth Rs. 5,000,000 without consulting any other partner. Such an act would bind the firm. 2.2 Qualified duties of partner The qualified duties of a partner can be changed by an agreement amongst the partners. Unless, otherwise agreed by the partners, every partner has the following duties: Duty to attend diligently to his duties Every partner is bound to attend diligently to his duties in the conduct of the business. A partner is not entitled to receive remuneration for taking part in the conduct of the business. [Section 12] Duty to contribute to the losses The partners are bound to contribute to the losses sustained by the firm. An agreement to share profits may imply an agreement to share losses also. [Section 13] Duty to indemnify for wilful neglect Every partner is under a duty to indemnify the firm for any loss caused to it by his wilful neglect (i.e. failure to perform a duty or to do something which the partner should have done) in the conduct of the business of the firm. [Section 13] Duty to use firm s property exclusively for the firm It is the duty of every partner to use the property of the firm exclusively for the purposes of the business. No partner should use partnership property for his personal benefit. [Section 15] Duty to account for personal profits derived A partner must account to the firm for any benefit obtained, without the consent of the other partners, from any transaction involving the partnership, the partnership property, the partnership name or the partnership s business connection. In other words, if a partner uses the partnership property, name or business connections to make a secret profit (a personal profit that the other partners do not know about), the other partners can claim those profits for the partnership. [Section 16(a)] Example: Duty to account for personal profits derived Tom and Jerry are in partnership. The partnership purchased an item of equipment costing Rs.30,000. It was discovered later that the equipment had actually been purchased by Tom for Rs.18,000, and Tom had re-sold it to the partnership without revealing that he was the owner of the property. In this case, since the other partner did not know that Tom had made a personal profit from the transaction with the partnership, he can claim successfully that Tom should hand over to the partnership the Rs.12,000 profit that he made. If Tom had informed Jerry in advance that he was the owner of the equipment and intended to keep the profit himself, and if Jerry agreed to this, Tom would have been able to keep all the profit for himself. Emile Woolf International 211 The Institute of Chartered Accountants of Pakistan

228 Duty not to compete with the business of the firm Similarly, if a partner competes in business (as in the case of personal profit) with the partnership, without the consent of the other partners, he is liable to account to the partnership for all the profits that he earns from the competing business. [Section 16(b)] Example: Duty not to compete with the business of the firm A, B, C and D are in partnership. Without informing the other partners, D sets up a sole trader s business in competition with the partnership, and makes a profit of Rs. 50,000 by either, using firm name or property or connections of the firm. When the other partners find out what D has been doing, they can require D to account to the partnership for the profits he has made while operating in competition (and hand over the Rs. 50,000 to the partnership). Duty not to assign his interest No partner can assign or transfer his partnership interest to any other person so as to make him a partner in the business without the consent of all other partners. He can, however, assign his share of the profit and his share in the assets of the firm but the transferee shall not have any right to interfere in the conduct of the business during the continuance of the firm. [Section 29] 2.3 Rights of partner Right to take part in the conduct of the business Every partner irrespective of the amount of capital contribution has an inherent right to take part in the conduct of the business of the firm. Although one may agree not to participate but right of participation should be available to each partner. [Section 12] Right to be consulted Every partner has the right to be consulted before any matter is decided. Any difference arising as to ordinary matters connected with the business may be decided by a majority of the partners in good faith but no change may be made in the nature of the business without the consent of all the partners. [Section 12] Right to have access to the books Every partner has a right to have access to and to inspect and copy any of the books of the firm. [Section 12] Right to share the profits In the absence of a contract to the contrary every partner has a right to share profits equally earned by the firm. [Section 13] Right to interest on capital No partner is allowed to receive any interest on capital as a general rule because a partner is not a creditor of the firm. Interest on capital is allowed only when agreed among the partners. Where a partner is entitled to interest on the capital subscribed investment by him such interest will be payable out of the profits, earned by the firm. [Section 13] Right to interest on advances Where a partner makes for the purpose of the business, any payment or advance beyond the amount of capital he has agreed to subscribe, he is entitled to interest on it at the rate of 6% per annum or as agreed upon. [Section 13] Right to indemnity Every partner has a right to claim indemnity from the firm in respect of payments made or liabilities incurred by him: In the ordinary and proper conduct of the business and In doing such act, in an emergency, for the purpose of protecting the firm from loss, as would be done by a person of ordinary prudence, in his own case, under similar circumstances. [Section 13] Emile Woolf International 212 The Institute of Chartered Accountants of Pakistan

229 Section A: Mercantile Law - Chapter 17: Partnership Act Right to retire A partner has a right to retire. With the consent of all the partners or In accordance with an express agreement between the parties or Where the partnership is at will, by giving notice in writing to all the other partners of his intention to retire. [Section 32] Right of outgoing partner to share in the subsequent profits Where a partner has died or has ceased to be a partner by retirement, expulsion, insolvency or any other cause, the surviving or continuing partners may carry on the business with the property of the firm without any final settlement of accounts as between them and the outgoing partner. In such a case in the absence of a contract to the contrary, legal representative of the deceased partner or the outgoing partner, is entitled at his option to: Such share of the profits as in proportionate to his share in the property of the firm or Interest at the rate of 6% on the amount of his share in the property of the firm. [Section 37] Rights after reconstitution of firm Where a change occurs in the constitution of a firm or a firm constituted for a fixed term continues to carry on business after the expiry of that term, the mutual rights and duties of the partners in the reconstituted firm remain the same as far as may be possible, as they were immediately before the change 2.4 Mutual Rights and Liabilities Partners have the following mutual rights and liabilities which are subject to contract between them: 1. Duty to work without remuneration 2. Rights to share profits and losses equally 3. Right to interest on capital 4. Rights to interest on subsequent advance 5. Right to indemnity 6. Duty to indemnify for wilful neglect These have been discussed earlier. [Section 13] 2.5 Partnership property Subject to contract between the partners, the property of the firm includes: [Section 14] All property originally brought into the common stock of the firm Note All rights or interest in the property originally so brought All property acquired, by purchase or otherwise, by or for the firm and all rights and interest in any property so acquired and Goodwill of the business of the firm Unless, any contrary intention appears any property purchased with partnership money without other partners consent will be deemed to be partnership property. Example: Partnership property A, B and C are partners in a business. They buy a property in the name of fictitious person with the money of the partnership. The property is a partnership property. Emile Woolf International 213 The Institute of Chartered Accountants of Pakistan

230 Example: Partnership property (continued) A, a partner in a firm, buys shares of a company in his own name, without the authority of the other partners, but with the money and on account of the firm. The shares may deemed to be partnership property. Goodwill Goodwill is an accounting concept meaning the value of an intangible asset which has a quantifiable value in a business. An example would be the reputation the firm enjoys with its customers. This reputation enables the firm to earn more than the normal profits earned by the business as a whole. Goodwill can be thought of as the value of the business as a whole (i.e. what Emile Woolf International 214 The Institute of Chartered Accountants of Pakistan

231 Section A: Mercantile Law - Chapter 17: Partnership Act 3 RELATIONS OF PARTNERS TO THIRD PARTIES Section overview Agent of the firm Authority of partners Liabilities of partner and firm Holding out Rights of transferee of a partner s interest Minor s admission to the benefits of partnership 3.1 Agent of the firm A partner is the agent of the firm for the purpose of the business of the firm. [Section 18] 3.2 Authority of partners The authority of a partner means the capacity of a partner to bind the firm by his act. Since the partnership is not a legal person, a partner acts as an agent for the other partners. The authority of a partner may be actual or implied. Actual authority The authority of each partner to take decisions for the business, and enter into transactions with other parties, may be specified in the partnership agreement. Since the partnership agreement is a contract, its terms are the terms of a contractual agreement between the partners. Implied authority The act of a partner done by him: [Section 19] as an agent of the firm in the course of business of the firm in the name of the firm, or in any other manner expressing an intention to bind the firm. An authority to bind the firm is known as implied authority of a partner. In a trading partnership, all the partners have the implied authority to borrow money on the credit of the partnership, and a lender is under no particular obligation to investigate the purpose of the loan. This means that unless a lender has knowledge that a partner does not have the actual authority to borrow on behalf of the partnership, he can rely on the partner s implied authority. Every partner within the scope of his implied authority may bind the firm by the following acts: Buying and selling good, on behalf of the firm and giving valid receipts for them Receiving payments of the debts due to the firm and giving valid receipts or discharge for them Contracting debts and paying debts on behalf of the firm Settling accounts with persons dealing with the firm Employing servants for the partnership of the firm Drawing cheques, accepting or endorsing bills of exchange and promissory notes in the name of the firm Pledging movable property of the firm Suing on behalf of the firm and defending suits in the name of the firm Emile Woolf International 215 The Institute of Chartered Accountants of Pakistan

232 Example: Implied Authority A and B are partners. A with the intention to bind the firm, goes to a shop and purchases certain articles on behalf of the firm which are generally used in the partnership business. Here firm will be liable for the price of the goods because A acted within his authority. A, a partner in the firm of chartered accountants, borrows money and executes a promissory note in the name of the firm. The other partners won t be liable on the note because it is not part of the ordinary business of chartered accountants to draw, accept or indorse a promissory note. Restrictions on the implied authority of a partner Following acts are not included in the implied authority of a partner unless there is any usage or custom of trade: [Section 19(2)] Arbitration Submit a dispute relating to the business of the firm to arbitration Bank account Open a banking account on behalf of the firm in his own name Compromise Compromise or relinquish any claim or portion of a claim by the firm Withdrawal of suit Withdraw a suit or proceeding filed on behalf of the firm Acceptance of liability Admit any liability in a suit or proceeding against the firm Acquisition Acquire immovable property on behalf of the firm Transfer Transfer immovable property belonging to the firm Partnership Enter into partnership on behalf of the firm. Statutory restrictions The restrictions imposed by law are statutory restrictions and is applicable against the whole world whether a particular person dealing with the firm has knowledge of it or not e.g. about the name of the firm, etc. Restrictions by partnership deed A restriction which is specifically written in partnership deed is effective only against the person dealing with the firm having knowledge of it. [Section 20] Example: Restrictions by partnership deed The partnership deed of a trading firm placed a restriction on the authority of the partners to sell the goods. One of the partners sells the good. If the third party did not know of the restriction the firm is liable toward such third party and if the third party know of the restriction the firm will not be liable. Ratification of actions taken by a partner outside his actual authority When a partner exceeds his authority, that is act outside his actual authority, the other partners may approve such unauthorized act with retrospective effect. This is known as ratification. Emile Woolf International 216 The Institute of Chartered Accountants of Pakistan

233 Section A: Mercantile Law - Chapter 17: Partnership Act By giving their retrospective approval to the contract made by another partner, even though it was outside the partner s actual authority at the time, the partners can remove any questions about whether implied authority existed or whether the other party knew that the partner did not have the actual authority to make the contract. 3.3 Liabilities of partner and firm Liability of a partner for acts of a firm In order to make a partner liable for any act of the firm, the same must have been done while he was a partner. The liability of the partner is both joint and several, so that the creditor may compel any one or more of the partners to discharge the whole of the debts of the firm. [Section 25] Example: liability of a partner for acts of a firm B, C and D are in partnership. Partner B purchases equipment for the partnership business. The equipment itself cost Rs. 20,000 and the installation costs were Rs. 15,000. There is a dispute with the supplier, and the firm refuses to pay the installation costs. The supplier decides to sue for the unpaid Rs. 15,000. If the supplier succeeds in his action, all the partners will be liable jointly for the Rs. 15,000 liability. If the dispute goes to court, the supplier can either: sue all three partners jointly, or he can sue any individual partner, B, C or D. If he chooses to sue B personally, and succeeds with his claim, B will be required to pay the supplier. It will then be for B to obtain from his partners C and D their share of the liability that they now owe. Liability of the firm for wrongful acts of a partner Where by the wrongful act or omission of a partner acting in the ordinary course of the business of a firm, loss or injury is caused to any third party or any penalty is incurred the firm is liable to the same extent as the partner. In case of fraud, although the firm is liable to the third party for loss caused to the third party by fraud committed by a partner but as between partners same must be borne by the partner committing the fraud and cannot be shared among all the partners. [Section 26] Example: Liability of the firm for wrongful acts of a partner One of the partners who was an active partner in the firm, knowing that the goods were stolen, purchased and sold them in the name of the firm. The other partner knew nothing about this theft. In this case all the partners will be liable. Liability for misapplication by partners A partner acting within his apparent authority receives money or property from a third party and misapplies it or A firm in the course of its business receives money or property from a third party, and the same is misapplied by any of the partners while it is in the custody of the firm, the firm is liable to make good the loss. [Section 27] Example: Liability for misapplication by partners A, B and C are partners in an instalment sales business. A asked one of the customer to deposit a security worth Rs. 100,000 in order to purchase goods on instalments. Subsequently, A misappropriated the security and absconded. The other partners will be liable for the misappropriation as security was given to A while he was acting within his scope of his apparent authority. Emile Woolf International 217 The Institute of Chartered Accountants of Pakistan

234 Liability to indemnify for wilful neglect Every partner is under a liability to indemnify the firm for any loss caused to it by his wilful neglect (i.e. failure to perform a duty or to do something which the partner should have done) in the conduct of the business of the firm. [Section 13] Liability to share losses The partners are bound to contribute to the losses sustained by the firm. An agreement to share profits may imply an agreement to share losses also. [Section 13] Liability to account for personal profits A partner must account to the firm for any benefit obtained, without the consent of the other partners, from any transaction involving the partnership, the partnership property, the partnership name or the partnership s business connection. In other words, if a partner uses the partnership property, name or business connections to make a secret profit (a personal profit that the other partners do not know about), the other partners can claim those profits for the partnership. [Section 16(a)] Liability to account for profit of competing business If a partner competes in business (as in the case of personal profit) with the partnership, without the consent of the other partners, he is liable to account to the partnership for all the profits that he earns from the competing business. [Section 16(b)] Effect of admissions by a partner Any admission or representation made by a partner is evidence against the firm if the following two conditions are fulfilled: Such admission or representation must relate to the affairs of the firm and Such admission or representation must be made in the ordinary course of business. [Section 23] Effect of notice to an active partner Any notice to a partner operates as a notice to the firm if the following conditions are fulfilled: Such notice must relate to the affairs of the firm Such notice must be given to a working partner and not to a sleeping partner There must not be any fraud committed by the partner receiving the notice. [Section 24] 3.4 Holding out Where a person Represents himself or Allows partners to do it, he is then estopped from denying the character he has assumed and Upon the faith of which creditors may have acted. [Section 28] Requirement In order to render a person liable as a partner on the ground of estoppel or holding out: Direct Representation He must have by words spoken or written or by his conduct represented himself to be a partner Indirect Representation He must have knowingly permitted himself to be represented as a partner to the other person. Knowledge of the third party The other person must have acted on the faith of such representation and gives credit to the firm. It does not matter whether the person representing himself or represented to be a partner does or does not know that the representation has reached the other person giving credit. Emile Woolf International 218 The Institute of Chartered Accountants of Pakistan

235 Section A: Mercantile Law - Chapter 17: Partnership Act Example: Knowledge of the third party A tells B (supplier) within the hearing of C (partner) that he (A) is a partner in partnership firm of C. C does not object to this statement of A. Later B supplies certain goods to A who pretends to act as partner with C. C will be liable to pay the price. C by keeping quiet had led B to believe that A is a partner. Examples of applications of holding out partner Retiring partner Where a retiring partner does not give a public notice of his retirement and the continuing partners still use his name as a partner he will be personally liable on the ground of holding out to third parties. [Section 35] A Minor on attaining majority If a minor (who was admitted to the benefits of an existing partnership) after attaining majority act as a partner without giving public notice, he will be liable as a partner by estoppel. [Section 34] Exceptions of holding out Deceased partner After a partner s death if the business of the firm is continued in the old firm s name the continued use of that name or of the deceased partner s will not itself makes his legal representatives liable for any act of the firm done after his death. Insolvent partner Where a partner is adjudicated as insolvent he ceases to be partner on the date on which the order of adjudication is made whether or not the firm is dissolved. The estate of the insolvent partner is not liable for any act of the firm and the firm is not liable for any act of the insolvent. 3.5 Rights of transferee of a partner s interest A partner may transfer his interest in the firm by sale, mortgage or charge fully or partially. [Section 29] Rights of Transferee He is entitled to receive the share of the profits of the transferring partner. On the dissolution of the firm or on retirement of the transferring partner he is entitled to receive: the share of the assets of the firm to which the transferring partner is entitled. an account from the date of the dissolution for the purpose of ascertaining the share. Disabilities of Transferee No status of a partner. Disability to interfere in the conduct of the business during the continuance of the firm Disability to require accounts. Disability to inspect the books of the firm. Disability to challenge the accounts of profits agreed to by the partners. Disability to sue for dissolution of the firm. 3.6 Minor s admission to the benefits of partnership Since a minor is not capable of entering into a contract, a contract by or with a minor is void abinitio i.e. from the beginning. Since partnership is formed by a contract, a minor cannot enter into a partnership agreement but with the consent of all the partners for the time being a minor may be admitted to the benefits of partnership. [Section 30] Emile Woolf International 219 The Institute of Chartered Accountants of Pakistan

236 An analysis of the above provision highlights the following three conditions: Before admission of a minor there must be an existence of partnership There must be mutual consent of all the partners A minor can be admitted only to the benefits of partnership Benefits of partnership include benefits, which the minor would enjoy if he was a major. Position of a minor before attaining majority Rights Right to share property and profits of the firm as agreed by the partners Liabilities: Disabilities: Right to have access to accounts of the firm ONLY and not to the secret books Right not to be adjudged insolvent Personally not liable i.e. limited liability. His share is liable for the acts of the firm. No status of a partner. No suit against partners for profit and property except after disconnecting his relation with the firm. Not entitled to have access to books other than accounts. Position of a minor on attaining majority On attaining majority the minor partner has to decide within six months whether he shall continue in the firm or leave it. These six months run from the date: of his attaining majority or when he first comes to know that he had been admitted to the benefits of partnership, whichever is later. Within this period he should give a public notice of his choice: to become or not to become a partner in the firm. If he fails to give a public notice, he is deemed to have become a partner in the firm on the expiry of the six months after obtaining majority. Where such person elects to become a partner The following holds; Personal liability since the date of admission to the benefits of the firm Same share in the profits and property of the firm to which he was entitled as a minor. Where such person elects not to become a partner The following holds: The status of a minor up to the date of public notice His share not liable for any act of the firm after the date of public notice Right to sue partners for share of the property and profits Emile Woolf International 220 The Institute of Chartered Accountants of Pakistan

237 Section A: Mercantile Law - Chapter 17: Partnership Act 4 CHAPTER REVIEW Chapter review Before moving on to the next chapter check that you now know how to: Understand the concept of partnership and determine whether a group of persons has constituted a partnership Explain the different types of partnerships and partners Explain role and relationship of partner among themselves and with outsiders Summarise the authority of the partner Describe the liabilities for acts of the firm Understand the status of a minor in a partnership and rules governing his rights and liabilities Emile Woolf International 221 The Institute of Chartered Accountants of Pakistan

238 Emile Woolf International 222 The Institute of Chartered Accountants of Pakistan

239 Certificate in Accounting and Finance C H A P T E R 18 Negotiable Instruments Act Contents 1 Meaning and characteristics of negotiable instruments 2 Promissory Note 3 Bill of Exchange 4 Cheque 5 Discharge of liability 6 Chapter review Emile Woolf International 223 The Institute of Chartered Accountants of Pakistan

240 INTRODUCTION Learning outcomes The overall objective of the syllabus is to give students an understanding of the legal system and commercial laws; and build a knowledge base of corporate laws. Negotiable instruments Act LO On the successful completion of this paper, candidates will be able to demonstrate knowledge of laws relating to Negotiable Instruments. LO4.1.1 Define and explain terms LO4.1.2 Explain provisions relating to types of negotiable instruments and their maturity. LO4.2.1 Identify and explain how the maker of a negotiable instrument is discharged from his liability under given scenarios. LO4.3.1 Describe provisions relating to crossing of cheques LO4.3.2 Briefly describe and differentiate between a cheque crossed generally and a cheque crossed specially and their payment modes. References to Legal Acts Section number references embedded in the learning materials refer to the following legal acts unless otherwise stated: Act Chapters Contract Act Partnership Act Negotiable Instrument Act Companies Act, Securities Act Emile Woolf International 224 The Institute of Chartered Accountants of Pakistan

241 Section A: Mercantile Law - Chapter 18: Negotiable instruments act 1 MEANING AND CHARACTERISTICS OF NEGOTIABLE INSTRUMENTS Section overview Definition of negotiable instrument Characteristics of negotiable instrument Parties to negotiable instrument Types of instrument Amount on negotiable instrument Endorsement Negotiation Material alteration Payment in due course 1.1 Definition of negotiable instrument Definition: Negotiable instruments [Section 13] A negotiable instrument means a: Promissory note Bill of exchange or Cheque payable either to order or to bearer. In simple terms, negotiable means transferable by delivery and instrument means a written document by which a right is created in favour of some person. Thus negotiable instrument may mean a written document transferable by delivery. Thus, from the above definition it reveals that promissory note, bill of exchange and cheque can be termed as negotiable instruments. 1.2 Characteristics of negotiable instrument The essential characteristics of a negotiable instrument are shown below: These essential characteristics are discussed below: Emile Woolf International 225 The Institute of Chartered Accountants of Pakistan

242 Payable to order or bearer Payable to order A promissory note, bill of exchange or cheque is payable to order which is expressed to be so payable or which is expressed to be payable to a particular person, and does not contain words prohibiting transfer or indicating an intention that it shall not be transferable is called payable to order. e.g. Pay A, Pay A or order and Pay A or B. However, there is an exception in favour of cheque. A crossed cheque "Account Payee only" can still be negotiated further. Payable to bearer A promissory note, bill of exchange or cheque is payable to bearer which is expressed to be so payable or on which the only or last endorsement is an endorsement in blank. If an instrument is payable to any person whosoever bears it than it is called payable to bearer. Thus a note, bill or cheque in the form Pay to A or bearer or pay bearer is payable to bearer. Example: Payable to bearer A cheque is payable to A. A endorses it merely by putting his signature on the back and delivers it to B with the intention of negotiating it (without making it payable to B or B s order). In the hands of B the cheque is a bearer instrument. Easy transferability They are transferable from one person to another by mere delivery if payable to bearer and by endorsement and delivery if payable to order. Transferee can sue in his own name A bill, note or a cheque represents a debt and implies the right of the creditor to recover something from his debtor. The creditor can either recover this amount himself or can transfer his right to another person. In case he transfers his right, the transferee of a negotiable instrument is entitled to sue on the instrument in his own name in case of dishonour, without giving notice to the debtor of the fact that he has become holder. Example: Transferee can sue in his own name A B To pay To receive A gave a cheque to B who transfers it to C. If the cheque dishonours C can sue A in his own name without giving notice to A that he has become the holder. Title of holder in due course It means that once an instrument is received in the hands of holder in due course it becomes free from all defects. Example: Title of holder in due course A gives a promissory note to B. B lost the instrument and it was found by C. C cannot recover the amount on the negotiable instrument as he is not the holder in due course but if C transfer the instrument to D and D becomes holder in due course he can recover the amount on the instrument from A or all prior parties. Presumptions Following presumptions in respect of negotiable instruments, unless the contrary is proved; [Section 118] Consideration Every negotiable instrument was made, drawn, accepted, endorsed or transferred for consideration. Date Emile Woolf International 226 The Institute of Chartered Accountants of Pakistan

243 Section A: Mercantile Law - Chapter 18: Negotiable instruments act Every negotiable instrument bearing a date was made or drawn on such date. Time of acceptance Every bill of exchange was accepted within a reasonable time after its date and before its maturity. Time of transfer Every transfer of a negotiable instrument was made before its maturity. Order of endorsements The endorsements appearing upon a negotiable instrument were made in the order in which they appear. Stamp A lost negotiable instrument was duly stamped. Holder in due course A holder of negotiable instrument is a holder in due course but this presumption would not arise where it is proved that the holder has obtained the instrument from its lawful owner, or from any person in lawful custody thereof, by means of an offence, fraud or for unlawful consideration and in such a case the holder has to prove that he is a holder in due course. 1.3 Parties to negotiable instrument Drawee in case of need The person whose name is given in addition to the drawee to be referred in case of need. [Section 7 & 115] By whom the name is given By the drawer while drawing the bill By the endorser while indorsing the bill. When dishonoured Such a bill is not dishonoured until it has been dishonoured by such a drawee in case of need. Acceptor for honour When a bill of exchange has been noted or protested for non-acceptance or for better security and any person accepts it supra protest or honour of the drawer or of any one of the endorsers, such person is called an acceptor for honour. [Section 7, 108 to 112] The conditions for a valid acceptance for honour are as follows: The bill must have been noted or protested for non-acceptance or for better security. The acceptance for honour must be made with the consent of the holder. It must be written on the bill and it must indicate that it is an acceptance for honour of a party who is already liable on the bill. It must be signed by the acceptor for honour who must not already be liable on the bill. Where the acceptance does not specify to whose honour it is made it shall be deemed to be made for the honour of the drawer. Rights and liabilities of acceptor for honour On acceptance the acceptor for honour takes exactly the same position as the party for whose honour he accepts. His rights and liabilities are the same with the only difference that his liability is conditional and arises only after: The bill is once more presented to the drawee for payment at maturity and has been dishonoured. Noting or protesting has been done for such dishonour by non-payment. Emile Woolf International 227 The Institute of Chartered Accountants of Pakistan

244 The bill should be presented or forwarded to the acceptor for honour not later than the next day after the date of its maturity. If the acceptor for honour makes payment without the fulfilment of the above conditions none will be liable to him not even the original drawer. Right of acceptor for honour On paying the bill, the acceptor for honour can sue the party for whose honour the bill is accepted. Payment for honour The following conditions are essential for the payment for honour: [Section 113 & 114] Bill must have been dishonoured for non- payment Bill must have been noted or protested for non-payment. Person paying or his agent must declare before the notary public, the party for whose honour he accepts otherwise it is deemed to be accepted for drawer. Such declaration must have been recorded by the notary public. Payment for honour must be made for the honour of any party liable to pay the bill. Right of payer for honour Any person making payment for honour is entitled to all the rights, in respect of the bill, of the holder at the time of such payment. He may recover from the party for whose honour he pays all sums so paid with interest thereon and all expenses properly incurred in making such payment. A drawee in case of need may, however, accept and pay the bill of exchange without previous protest. Holder A person is called holder of a negotiable instrument if he satisfies the following two conditions: He must be entitled to the possession of the instrument in his own name and He must be entitled to receive / recover the amount due on the instrument from the parties liable under the instrument Thus a holder means the bearer of the bearer instrument and the endorsee or payee of the order instrument. When the note, bill or cheque is lost and not found or is destroyed, the person in possession of it or the bearer at the time of loss or destruction shall deemed to continue to be its holder. [Section 8] Holder in due course A person becomes holder in due course when he fulfils the following conditions: [Section 9] Conditions to be holder in due course Holder He must be a holder i.e. He fulfils the essentials of a holder. Holder for valuable consideration There must be a lawful and adequate consideration. Before maturity A person should receive the instrument before its maturity. In case of instrument payable on demand, he must have taken the instrument within a reasonable time of its issue. Complete and regular It is the duty of every person who takes a negotiable instrument to examine its form and contents thoroughly, for if it contains any material alteration which has not been confirmed by the drawer through his signature or it is incomplete like drawer name is missing or not properly stamped. Holder in good faith Emile Woolf International 228 The Institute of Chartered Accountants of Pakistan

245 Section A: Mercantile Law - Chapter 18: Negotiable instruments act A person should take the instrument without any negligence on his part and in good faith without having any reason to believe that any defect existed in the title of the transferor. If there is any suspicion and he takes the instrument without making proper inquiries he cannot be said to be acting in good faith. 1.4 Types of instrument Order instrument A promissory note, bill of exchange or cheque is payable to order if either of the following two conditions is fulfilled: Which is expressed to be so payable or Which is expressed to be payable to a particular person and does not contain words: which prohibit transfer or indicate an intention that it shall not be transferable. [Section 13] Note: An order instrument can be transferred by an endorsement on it and then its delivery. Bearer instrument A promissory note of bill of exchange or cheque is payable to bearer if either of the following two conditions if fulfilled: expressed to be so payable, or last endorsement must be an endorsement in blank. [Section 13] Note: A promissory note cannot be made payable to the bearer. A bill of exchange cannot be made payable to bearer on demand. Demand instrument Instruments payable on demand means the instrument in which no time for payment is mentioned. A cheque is always payable on demand. A promissory note or bill of exchange is payable on demand where: It is expressed to be so or It is expressed to be payable at sight or presentment ; or on demand No time for payment is specified; or The bill or note accepted or endorsed after it is overdue, as regards to person accepting or indorsing it. [Section 19 & 21] Notes 'At sight' and presentment means on demand. An instrument on demand is payable immediately. Time instrument An instrument payable after a fixed time or on a specified date is called Time Instrument. A promissory note or bill of exchange is a time instrument when it is expressed to be payable. After a specified period On a specific day Certain date after sight On the happening of event which is certain to happen e.g. death. Emile Woolf International 229 The Institute of Chartered Accountants of Pakistan

246 Note There can be a time bill, time note but not a time cheque because the cheque cannot be expressed to be payable otherwise than on demand. Maturity of negotiable instrument Maturity means the date on which the payment of an instrument falls due. The question of maturity arises only in the case of a promissory note or a bill of exchange which is expressed to be payable otherwise than on demand. An instrument payable on demand or at sight such as a cheque becomes payable immediately on the date of issue. [Section 22 to 25] Every Promissory note or Bill of Exchange expressed to be payable: On a specified day, or At a certain period after date, or At a certain period after happening of a certain event Matures on third day after the day on which it is expressed to be payable. i.e. a grace period of three days is allowed. Example: A bill of exchange is payable on 1 St January, will have maturity on 4 th January. Rules for calculating maturity If it is made payable a stated number of months after date or after sight, or after a certain event, it matures three days after the corresponding date of the month after the stated number of months. Example: Payable stated number of months A negotiable instrument dated 30 Th August 2013 is made payable three months after date. The instrument is at maturity on the 3 rd December, If the month in which the period would terminate has no corresponding date, the period shall be held to terminate on the last day of such month. Example: Payable stated number of months A negotiable instrument dated 30 January, 2013 is made payable at one month after date. The instrument is at maturity on the third day after the 28 th February, If it is made payable a certain number of days after date or after sight, or after a certain event, the maturity is calculated by excluding the day on which the instrument is drawn or presented for acceptance or sight or on which the event happens. Note that only one day is to be excluded. Example: Payable after certain number of days A bill of exchange dated 1 st March is made payable 20 days after date. The period of 20 days will be counted from 2 nd March and the bill will be at maturity on 24 th March. If the date on which a bill or note is at maturity is a public holiday, the instrument shall be deemed due on the next preceding day. Thus, if the maturity of an instrument falls on Sunday, it shall be deemed to be due on Saturday. If the maturity falls on an emergency holiday, the instrument shall be deemed to be due on the next succeeding business day. If an instrument is payable by instalments, three days of grace are to be allowed on each instalment. Emile Woolf International 230 The Institute of Chartered Accountants of Pakistan

247 Section A: Mercantile Law - Chapter 18: Negotiable instruments act Inland instrument A promissory note, bill of exchange or cheque which is: Made or drawn in Pakistan and also made payable in Pakistan, or Made or drawn in Pakistan upon any person resident in Pakistan, although it may be payable in a foreign country. is called an inland instrument. [Section 11] Example: Inland instrument Note: A promissory note made in Multan and payable in Peshawar. A bill of exchange drawn in Sukkur on a person resident in Toba Tek Singh although it may be payable in Afghanistan. An inland instrument remains inland even if it has been endorsed in a foreign country. Foreign instrument An instrument, which is not an inland instrument, is deemed to be a foreign instrument. [Section 12] Example: Foreign instrument Promissory note made in Pakistan but payable in Myanmar. A bill of exchange drawn in Pakistan on a person residing outside Pakistan, and made payable outside Pakistan. Inchoate instrument An incomplete or blank negotiable instrument is one which is properly stamped and signed but where the name or amount is missing. [Section 20] The following points should be noted in connection with inchoate instrument. The liability of a person who signs and delivers an inchoate instrument arises only when the blanks are filled in and the instrument is completed. Note To make the signer liable on an inchoate instrument, it is necessary that the instrument should be delivered to the transferee. The instrument must be stamped and the stamp affixed must be sufficient to cover the amount filled in the instrument. If an inchoate instrument is completed and negotiated to a holder in due course, he can claim payment of full amount covered by the stamp. The provisions in this section cannot be applied to a cheque which is not required to be stamped. Example: Inchoate Stamped Instrument P owes Q some money on account of credit purchases made by him. P gives a promissory note, after affixing a stamp on which a person can claim up to Rs. 1,000 and signing, leaving the amount blank to Q authorising him to fill it up in accordance with the account. Q fills Rs. 1,000 while actual amount due is Rs. 500 only. Q cannot recover more than Rs But if Q transfers it to R, a holder in due course, R can recover Rs.1, 000, the full amount from P. If however the amount filled in by Q is Rs. 1,200 R cannot recover it as the amount is not covered by the stamp. Emile Woolf International 231 The Institute of Chartered Accountants of Pakistan

248 Example: Inchoate Stamped Instrument (continued) Holder A holder can recover only the amount receivable from the signer. Holder in due course A holder in due course can recover the whole amount made payable by the instrument provided that It is covered by the stamp Even though the amount authorized was the smaller. Ambiguous instrument An instrument which may be interpreted as either promissory note or bill of exchange is called an ambiguous instrument. Its holder must elect once for all whether he wants to treat it as a promissory note or bill of exchange. [Section 17] Example: Ambiguous instrument A bill of exchange where the drawer and the drawee are the same person Where the drawee is a fictitious person Bills drawn by an agent on his principal 1.5 Amount on negotiable instrument If the amount stated in figures and words is different the amount stated in words shall be the amount undertaken or ordered to be paid. Provided that if the words are ambiguous, the amount may be ascertained by referring to the figures. [Section 18] 1.6 Endorsement Definition: Endorsement [Section 15] When the maker or holder of a negotiable instrument signs the same, otherwise than as such maker, for the purpose of negotiation on the back or face or on a slip of paper annexed to it thereto, or so signs for the same purpose a stamped paper intended to be completed as negotiable instrument he is said to endorse the same and is called the endorser. The term endorsement may be defined as signing one s name on the negotiable instrument for the purpose of transferring it to another person. Essentials of valid endorsement It must be on instrument itself, if no space is left on the back of the endorsement, further endorsements are signed on a slip of paper attached to the instrument called allonge. It must be signed by the endorser for the purpose of negotiation. Signature of the endorser on the instrument without any additional words is sufficient. No particular form of words is necessary for an endorsement It must be completed by the delivery of the instrument. The delivery of the instrument with the intention of passing the property in it. Negotiation by endorsement must be of the entire instrument. Endorsement for part of the amount or to two or more endorsee severally is invalid. Emile Woolf International 232 The Institute of Chartered Accountants of Pakistan

249 Section A: Mercantile Law - Chapter 18: Negotiable instruments act Kinds of endorsements Blank or general endorsement If the endorser signs his name only and does not specify the name of the endorsee, the endorsement is said to be blank. The effect of a blank endorsement is to convert the order instrument into bearer instrument which may be transferred by delivery. [Section 16 & 54] Example: Blank or general endorsement A bill is payable to the order of Imran. Imran signs on the back of the bill and does not specify the name of the endorsee; this is an endorsement in blank by Imran. Endorsement in full or special endorsement If the endorser, in addition to his signature, also 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 full. [Section 16 & 54] Example: Endorsement in full or special endorsement A holder of a bill of exchange wants to make an endorsement in full to B he would write Pay to B or order. After such an endorsement it is only the endorsee i.e. B who is entitled to receive the payment of the instrument and to further negotiate the instrument by his endorsement. A blank instrument can easily be converted into an endorsement in full. The holder of a negotiable instrument endorsed in blank may without signing his own name by writing above the endorser s signature a direction to pay to any other person as endorsee, convert the endorsement in blank into an endorsement in full, and since such holder does not sign himself on the instrument he does not thereby incur the responsibility of an endorser. Example: Endorsement in full or special endorsement A is the holder of a bill endorsed by B in blank. A writes over B s signature the word Pay to C or order. A is not liable as an endorser but the writing operates as an endorsement in full form B to C. 1.7 Negotiation Definition: Negotiation [Section 14] "When a promissory note, bill of exchange or cheque is transferred free from defects to any person, so as to constitute that person the holder of it, the instrument is said to be negotiated. The analysis of the definition reveals that negotiation takes place when the negotiable instrument is transferred from one person to another and the transfer is made in such a manner so as to make the transferee the holder of the negotiable instrument and it must be transferred free from defects. Modes of negotiation Negotiation by mere delivery A negotiable instrument payable to bearer is negotiable by delivery (voluntary delivery with the intention of transferring the ownership) It does not require signature of the transferor i.e. endorsement and the transferee becomes the holder by mere possession. The transferor of a bearer instrument is not liable on its dishonour because by not signing as endorser he has not added his credit to the instrument. [Section 47] Negotiation by endorsement and delivery A negotiable instrument payable to order is negotiable by the holder by endorsement and delivery. Emile Woolf International 233 The Institute of Chartered Accountants of Pakistan

250 The negotiation of an order instrument requires two formalities The holder should endorse it and Then deliver to his endorsee (voluntary delivery with the intention of transferring the ownership) [Section 48] 1.8 Material alteration An alteration is material which: Alters the character or identity of the instrument or which shakes the very foundation of the instrument or Changes the rights and liabilities of the parties or Alters the operation of the instrument. The following alterations are material: Date Sum payable, Time of payment, Place of payment, Addition of place of payment, Rate of interest. In the following cases the alteration of a negotiable instrument is not material: A material alteration made before the instrument is issued. An alteration made for the purpose of correcting a mistake. e.g. The correction of mistake in a bill dated 2031 instead of An alteration made to carry out the common intention of the original parties. An alteration made with the consent of the parties. An alteration which is not material. Alterations permitted by the Act The following alterations are permitted by the Act, and do not invalidate the instruments. Filling blanks of inchoate instruments. [Section 20] Conversion of a blank endorsement into an endorsement in full. [Section 49] Crossing the cheques [Section 125] Effect of material alteration: Any material alteration renders the instrument void. But if an alteration is made in order to carry out the common intention of the original parties, it does not render the instrument void. [Section 87 & 88] 1.9 Payment in due course Means payment in accordance with the apparent tenure of the instrument in good faith and without negligence to any person in possession of it. Apparent tenure means the period of time as expressed in the instrument, after which it is payable. [Section 10] Payment in due course, which results in discharge of a negotiable instrument, must fulfil the following conditions. The payment must be in accordance with the apparent tenure of the instrument. It should be made at or after maturity. A payment before maturity is not a payment in due course so as to discharge the instrument. Emile Woolf International 234 The Institute of Chartered Accountants of Pakistan

251 Section A: Mercantile Law - Chapter 18: Negotiable instruments act Example: Payment in accordance with apparent tenure If a banker makes payment of a post-dated cheque before the date mentioned on the cheque, he acts against the apparent tenor of the instrument. Hence the payment will not be treated as payment in due course. The payment must be made in good faith and without negligence. It must be honestly in the bonafide belief that the person demanding the payment is legally entitled to it. The payer must not be guilty of any negligence in making the payment. Example: Payment in good faith Bill of Exchange is paid without enquiry as to the payee or cheque with forged signature of the drawer is paid will amount to negligence on the party of the payer and the payment will not be treated as payment in due course. The payment must be made to a person in possession of the instrument under circumstances which do not arouse the suspicion about his title to possess the instrument and to receive payment of the amount therein mentioned. The payment must be made in money only, unless the holder agrees to accept payment in any other medium i.e. by cheque or draft. Emile Woolf International 235 The Institute of Chartered Accountants of Pakistan

252 2 PROMISSORY NOTE Section overview Definition of promissory note Parties to a promissory note Specimen of a promissory note Essential elements of a promissory note 2.1 Definition of promissory note Definition: Promissory note [Section 4] A promissory note is an instrument in writing (not being a bank note or currency note) containing an unconditional undertaking, signed by the maker, to pay on demand or at a fixed or determinable future time a certain sum of money only, or to the order of a certain person, or to the bearer of the instrument. The analysis of the definition shows that, a promissory note is a written and signed promise to pay a certain sum of money to a specified person or his order. 2.2 Parties to a promissory note Following are the two main parties in a promissory note: Maker It is a person who makes the promissory note and promises to pay the money stated in it. Payee It is a person to whom the amount of promissory note is payable i.e. to whom the promise to pay is made. Emile Woolf International 236 The Institute of Chartered Accountants of Pakistan

253 Section A: Mercantile Law - Chapter 18: Negotiable instruments act 2.3 Specimen of a promissory note Rs. 10,000/- only Date: September 15, 2013 Three months after date I promise to pay ABC or to his order the sum of Rupees Ten Thousand, for value received To ABC Jail Road Karachi Sign: XYZ Saddar Karachi In the specimen XYZ is the maker and ABC is the payee. 2.4 Essential elements of a promissory note The essential elements of a promissory note are shown below: These essential characteristics are discussed below: In writing A promissory note has to be in writing. An oral promise to pay does not become a promissory note. The writing may be on any paper, on any book. The words used must impart a clear undertaking to pay, but it is not necessary that the word promise should be used. Emile Woolf International 237 The Institute of Chartered Accountants of Pakistan

254 Example: It must be in writing A signs the instruments in the following terms a) I promise to pay B or order Rs.500. b) I acknowledge myself to be indebted to B in Rs.1,000 to be paid on demand, for value received. c) A promise to pay B a sum of Rs. 500 on telephone. This promise will not make a promissory note because it is not in writing. In the above example (a) and (b) are promissory notes while (c) is not a promissory note. Promise to pay There must be a promise or a clear undertaking to pay. A mere acknowledgement of indebtedness is not a promissory note, although it is valid as an agreement and may be sued upon as such. Example: Promise to pay A signs the instruments in the following terms: a) Mr. B I owe you Rs. 1,000 b) I am liable to pay to B Rs. 500 c) I have taken from B Rs.2,000 and I am accountable to him for the same with interest. The above instruments are not promissory notes as there is no clear undertaking or promise to pay. There is only an acknowledgement of indebtedness. Where A signs instrument in the following terms: I acknowledge myself to be in debited to B in Rs.1,000 to be paid on demand for value received. There is a valid promissory note Definite and unconditional The promise must not depend upon the happening of some uncertain event. i.e. a contingency or the fulfilment of a condition. If an instrument contains a conditional promise to pay, it is not a valid promissory note and will not become valid and negotiable even after happening of the condition. Example: Definite and Unconditional A signs the instrument in the following terms: a) I promise to pay B Rs.500 seven days after my marriage with C. b) I promise to pay B Rs. 500 on D s death, provided D leaves me enough to pay the sum. c) I promise to pay B Rs. 500 as soon as I can. The above instruments are not valid as the payment is made dependent upon the happening of an uncertain event which may never happen and as a result the sum may never become payable. Exception But a promise to pay is not conditional if the amount is made payable at a particular place or after a specified time or on the happening of an event which must happen, although the time of its happening may be uncertain. Emile Woolf International 238 The Institute of Chartered Accountants of Pakistan

255 Section A: Mercantile Law - Chapter 18: Negotiable instruments act Example: Exception If A signs an instrument stating I promise to Pay B Rs.500 seven days after C s death, the promissory note is valid because it is not considered to be conditional, for it is certain that C will die one day. Signed by maker It is imperative that the promissory note should be duly authenticated by the signature of the maker. If the maker is illiterate he may place his thumb mark. Certain parties The instrument point out with certainty as to who is the maker and who is the payee. Where the maker and the payee cannot be identified with certainty, the instrument even if it contains an unconditional promise to pay is not a promissory note. A promissory note cannot be made payable to the maker himself. But if it is endorsed by the maker to some other person or endorse in blank it will become valid. Sum payable must be certain It is essential that sum of money promised to be payable must be certain and definite. The amount payable must not be capable of contingent addition or subtraction. Example: Sum payable must be certain A signs instrument in the following term a) I promise to pay B Rs.500 and all other sums which shall be due to him b) I promise to pay B Rs.500 and all fines according to rules. The above instruments are invalid as promissory notes because the exact amount is not certain. Sum payable must be legal tender A promise to pay a certain amount of foreign or to deliver a certain quantity of goods is not a promissory note. Thus, an instrument signed by A, I promised to pay B Rs.500 and to deliver him my black horse is not a valid promissory note. Emile Woolf International 239 The Institute of Chartered Accountants of Pakistan

256 3 BILL OF EXCHANGE Section overview Definition of bill of exchange Parties to a bill of exchange Specimen of a bill of exchange Essential elements of a bill of exchange 3.1 Definition of bill of exchange Definition: Bill of exchange [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 on demand or at a fixed or determinable future time a certain sum of money only, to or to the order of, a certain person, or to the bearer of the instrument. The analysis of the definition shows that, a bill of exchange is a written and signed order directing a person to pay a certain sum of money to the bear or of the instrument or to a specified person or his order. Generally, a bill of exchange is drawn by a creditor, who directs his debtor to pay the money to the person specified in the instrument. 3.2 Parties to a bill of exchange Following are the three main parties in a bill of exchange: Drawer It is a person who draws a bill of exchange. Drawee It is a person who is ordered to pay the amount of the bill of exchange (on whom the bill is drawn). When drawee accepts the bill of exchange (when he gives consent to make the payment) he is called the acceptor. Payee It is a person to whom the amount of bill of exchange is payable. Emile Woolf International 240 The Institute of Chartered Accountants of Pakistan

257 Section A: Mercantile Law - Chapter 18: Negotiable instruments act 3.3 Specimen of a bill of exchange Rs. 10,000/- only Date: September 15, 2013 Three months after date pay to XYZ or to his order the sum of Rupees Ten Thousand, for value received. Accepted ABC To ABC Jail Road Karachi Sign: MNO Saddar Karachi In the specimen MNO is the drawer, ABC is the drawee and XYZ is the payee. 3.4 Essential elements of a bill of exchange The essential elements of a bill of exchange are shown below: These essential characteristics are discussed below: In writing A bill of exchange is required to be in writing. Like promissory note, a bill of exchange also cannot be oral. Order to pay A bill of exchange contains an order to pay instead of a promise to pay like in promissory note. This feature distinguishes it from promissory note. Further, a request to pay money is not considered to be a bill of exchange. Emile Woolf International 241 The Institute of Chartered Accountants of Pakistan

258 Example: Order to pay The following instruments signed by A are valid bills of exchange as they contain an order to pay, though the language used is very polite: a) B, please pay Rs. 500 to C or order. b) B will much oblige me by paying to C Rs The following instruments signed by A are not valid bills of exchange as they contain only a request to pay and no order to pay: a) B, please let C have Rs.500, and place it to my account and oblige, b) B, I shall be highly obliged if you make it convenient to pay Rs.1,000 to C. Definite and unconditional In other words, the order to pay should not depend upon a condition or upon the happening of an uncertain event. This point has already been discussed in detail in case of a promissory note. Signed by drawer and drawee The instrument must be signed by the drawer and drawee. Certain parties All the parties must be certain i.e. indicated in a bill of exchange with reasonable certainty. Sum payable must be legal tender If the instrument contains an order to pay something other than money or something in addition to money, it will not be valid bill of exchange. Sum Payable must be certain It is essential that sum of money ordered to be payable must be certain and definite. The amount payable must not be capable of contingent addition or subtraction. Emile Woolf International 242 The Institute of Chartered Accountants of Pakistan

259 Section A: Mercantile Law - Chapter 18: Negotiable instruments act 4 CHEQUE Section overview Definition of cheque Parties to a cheque Specimen of a cheque Essential elements of a cheque Method of crossing Types of crossing Crossing of a cheque after issue Protection to the collecting banker Rights of holder against the banker Circumstances in which a banker must refuse to honour a cheque Circumstances in which a banker may refuse to honour a cheque 4.1 Definition of cheque Definition: Cheque [Section 6] Cheque is a bill of exchange drawn on a specified banker and not expressed to be payable otherwise than on demand. The analysis of the above definition reveals that a cheque is a bill of exchange but is different in following two characteristics: Drawee will always be a banker Always payable on demand 4.2 Parties to a cheque Emile Woolf International 243 The Institute of Chartered Accountants of Pakistan

260 Following are the three main parties in a cheque: Drawer It is a person who draws a cheque. Drawee It is a banker who is ordered to pay the amount of the cheque. Payee It is a person to whom the amount of cheque is payable. 4.3 Specimen of a cheque ABC Bank Limited Date: September 15, 2013 Main Branch, Karachi Cheque no: Pay OR BEARER Rupees Account no: Title of account Rs. Do not write below this line Signature 4.4 Essential elements of a cheque The essential elements of a cheque are shown below: These essential characteristics are mentioned below: Emile Woolf International 244 The Institute of Chartered Accountants of Pakistan

261 Section A: Mercantile Law - Chapter 18: Negotiable instruments act It must be in writing There must be an express order to pay and not a request to pay The order must be definite and unconditional It must be signed by the drawer The three parties (drawer, drawee and payee) must be certain. The order must be to pay a certain sum The order must be to pay money only It must always be drawn upon a specified banker It must always be payable on demand 4.5 Method of crossing A cheque is said to be crossed when it bears across its face two parallel transverse lines which are usually drawn on the left hand top corner of the cheque. It is an instance of an alteration which is authorised by the Act. A crossing is a direction to the director of the paying banker not to pay across the counter. Purpose of crossing The purpose of crossing is to direct the drawee (banker) to pay the amount of the cheque only to a banker so that the party who receives the payment can easily be traced. 4.6 Types of crossing General crossing A cheque is said to be crossed generally where it bears across its face an addition of: The words and company or any abbreviation of it between two parallel transverse lines. [Section 123 ] Effect of general crossing When a cheque is crossed generally the banker on whom it is drawn shall not pay it otherwise than to a banker. [Section 126] Example: General crossing Special crossing A cheque is said to be crossed especially where it bears across its face an addition of: Name of the banker Parallel lines are not necessary. [Section 124] Effect of special crossing When a cheque is crossed specifically the banker on whom it is drawn shall not pay it otherwise than to a banker to whom it is crossed or his agent for collection. [Section 126] Emile Woolf International 245 The Institute of Chartered Accountants of Pakistan

262 Example: Special crossing Restrictive crossing Restrictive crossing may be added with general crossing by adding the words A/c Payee or A/c Payee only. [Section 123A] Effect of restrictive crossing Strictly speaking, the amount collected on the cheque must be credited only to the account of payee. Example: Restrictive crossing Not negotiable crossing 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 transfer ability of the cheque. It only takes away the main feature of negotiability, which is transferability free from defects. Therefore, a holder with a defective title cannot give a good title to a subsequent holder. 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 for the cheque so crossed cashed, until it reaches its destination. [Section 131] Example: Not Negotiable Crossing 4.7 Crossing of a cheque after issue A cheque may be crossed after its issue in the following manner: [Section 125] Case Where a cheque is uncrossed Where a cheque is crossed generally Where a cheque is crossed generally or specially Where a cheque is crossed specially Right to cross The holder may cross it generally or specially. The holder may cross it specially by adding the name of the banker. The holder may add the word Not negotiable. The banker to whom it is crossed may again cross it especially to another banker (his agent) for collection. Emile Woolf International 246 The Institute of Chartered Accountants of Pakistan

263 Section A: Mercantile Law - Chapter 18: Negotiable instruments act 4.8 Protection to the collecting banker A collecting banker is one who receives the payment of a crossed cheque on behalf of his customer. If the collecting banker has collected a cheque on behalf of a person whose title to the cheque was defective, he would be protected and would not be held liable in conversion to the true owner, provided he proves that: He acted in good faith and without negligence The cheque was already crossed before it reached his hands and He received the payment on behalf of a customer and not on his own account i.e. he acted as an agent for collection and not in the capacity of holder for value. It may be noted that if the banker credits his customer s account with the amount of the cheque before receiving payment, he does not become a holder for value and the protection shall be available to such a collecting banker as well. This protection is not available where the banker allows the proceeds of an Account payee crossed cheque to be credited to any account other than the payee and the endorsement in favour of the last payee is proved forged. The protection afforded to the collecting banker is very valuable in view of the fact that when one person deals with the goods of another without his permission, he is liable to an action for conversion and in the absence of this protection the position of the banker would not be different from that of any other person. [Section 130] 4.9 Rights of holder against the banker The holder has no right of action against the banker for refusing to pay the cheque because there is no privity of contract between him and the banker. But the holder is entitled to enforce payment from the banker in the following two cases: Where the holder does not present the cheque within reasonable time of its issue and on account of the delay the drawer suffers actual damage by the failure of the bank and is therefore discharged to the extent of such damage. The holder in this case becomes the creditor of the banker. Where a banker pays a cheque crossed generally over the counter or a cheque crossed specially otherwise than to the banker to whom the same is crossed, he is liable to the true owner of the cheque for any loss he may sustain owing to the cheque having been so paid. The banker can recover from the wrong payee, if traceable Circumstances in which a banker must refuse to honour a cheque Where the customer has stopped the payment of the cheque. When a garnishee order or any other legal order of the court prohibits payment of cheque. When the banker receives notice of customers death. But a payment made before receiving the notice of death is valid. When an order of adjudication has been passed against the customer by the insolvency court. When the banker receives the notice of customers insanity. When the customer has given a notice to the banker for the assignment of the credit balance of his account. When the banker has reason to believe the holder title is defective. When the banker receives a notice of loss of cheque from his customer. When there has been material alteration in the cheque and such alteration has not been authenticated by his customer by putting his signature. When the signature of the drawer does not tally with the specimen signature kept by the bank. When the banker receives notice in respect of closure of account. Emile Woolf International 247 The Institute of Chartered Accountants of Pakistan

264 4.11 Circumstances in which a banker may refuse to honour a cheque When the balance in customers account is insufficient to meet the cheque. When the balance in the customer s account cannot be properly allocated to the payment of the cheque. When the cheque is presented at a branch other than the one where the customer has account. When the cheque is presented after banking hours. When the cheque has become stale. When the cheque is undated. When the cheque is post-dated. Emile Woolf International 248 The Institute of Chartered Accountants of Pakistan

265 Section A: Mercantile Law - Chapter 18: Negotiable instruments act 5 DISCHARGE OF LIABILITY Section overview Discharge of the negotiable instrument Discharge of party or parties Discharge of liability means that the party s liability, on instrument comes to an end. The term discharge in relation to negotiable instrument has the following two meanings: Discharge of the negotiable instrument Discharge of one or more parties from their liability The chart below shows the various ways in which an instrument and party may get discharged. 5.1 Discharge of the negotiable instrument A negotiable instrument is said to be discharged when the rights against all the parties to it comes to an end and the instrument ceases to be negotiable. No party even a holder in due course can claim the amount of the discharged instrument from any party. An instrument can be discharged in following ways: Payment in due course The instrument is discharge by payment made in due course by the party who is primary liable to pay. A payment by a party who is secondary liable does not discharge the instrument because in that case the payer holds it to enforce it against the prior endorsers and the principal debtor. [Section 82] Emile Woolf International 249 The Institute of Chartered Accountants of Pakistan