An Insight on the Contractual Liability of the Indian State

An Insight on the Contractual Liability of the Indian State

Author: Darell Corrie,

3rd Year BA LLB (Hons),
School of Law, Christ University.

Abstract
As per the welfare concept, the State serves the role of not just the regulator but also the entrepreneur. Consequently, it produces and renders a large number of goods and services, some of which it has a monopoly over. In an economy growing at 7.4% and a population of 1.3 billion people,[1]this entrepreneurial role of the State assumes further importance. The State is under an obligation to take up large scale and diverse production and services. To fulfill this, the State has to contract with private individuals. But given the authority of the State, there may occur illegitimate use of power and unfairness. If the State were immune from contractual liability it would harm business interests, as this would discourage public-private partnerships. Therefore, in public interest, there arises a necessity to not only recognize State contractual liability but also develop procedures and principles to govern it. This paper primarily divulges into what entities, authorities, bodies constitute the term “State”. Secondly, the paper aims at defining government contracts vis-à-vis ordinary contracts. Thirdly, it traces the evolution of contractual liability of the State in the Pre-Independence era, with the objective to ascertain the “colonial continuity”. Fourthly, it will shed light upon the current position of government contracts with respect to their liability, nature, procedure, and enforceability from the standpoint of contractual, constitutional, and administrative law. Lastly, the paper explores the distinction between statutory and government contracts.

                       I.          Authorities constituting “State”

Article 12 of the Indian Constitution defines the authorities that constitute the State.[2]This list however is not exhaustive due to the term “other authorities”. To interpret the ambit of “other authorities”, the courts first applied the doctrine of “Ejusdem Generis” (of the same group) in the University of Madras v. Shanta Bai.[3] Any sovereign or allied function was sufficient to constitute an authority as a State, thus the test was ambiguous, incoherent and discretionary. Consequently, it was struck down by the apex court in the Electricity Board, Rajasthan, SEB v. Mohanlal.[4] The case held that only the authorities created by statutes, laws, and the constitution were interpreted as State, necessitating legislative sanction. However, authorities not created by statutes but performing essential government activity were excluded. To remedy this, a “six-parameter test” of “agent and instrumentality of the state” was established in Ajay Hasia v. Khalid Mujib.[5]These parameters are based on: share capital, financial assistance, monopoly, control, nature of functions, and transfer of departments. However, no relationship was established betwee
n individual parameters of this test.
In Pradeep Kumar Biswas v. Indian Institute of Chemical Biology,[6] it was held that for the parameters of the Ajay Hasia test to be satisfied will depend on their nature to establish “brooding” governing power. Further, even a company or society can be an instrumentality or agency of the state, if it satisfies the test. Similarly, a formerly independent legal body now alleged to be a State would be subject to the same test. However, the burden of proof would be on the claimer. Additionally, the Supreme Court held in Naresh Shridhar Mirajkar v. State of Maharashtra that judiciary would be termed a State only in so far as its administrative functions.[7]Thus, other authorities consist of bodies that are financial, functionally and administratively controlled by the government.

                     II.          Government Contracts

As per Section 2(e) of the Indian Contract Act (ICA), 1872, an agreement is “every promise and every set of promises, forming consideration for each other.” Additionally, Section 2(h) of the ICA defines contract as “an agreement enforceable by law”. Due to the legal sanction, a contract accords certain rights and imposes certain obligations on the parties against each other. While ordinary contracts are between private individuals, a “Government Contract” is one where one of the parties is the Central or State Government.

       a)     Evolution of Government Contracts

Historically, the sovereign power always had contractual liability, whether it was the East India Company (the Company) or the Secretary of State. In British India, the doctrine of “rex non potest peccare”(the king can do no wrong) was not recognized for contractual liability.[8]
The Company acted in a dual capacity, as a Commercial Corporation and a Sovereign delegate of the Crown. Since it did not enjoy crown immunity, it was liable for its sovereign functions, and its commercial activities, like any private individual. Its liability for sovereign functions arose from the view that “no subjects would acquire the sovereignty of any territory, for themselves, but only for the nation to which they belonged.”[9]Further, in Moodalay v. The East India Company it was held that the Company is liable for its contractual breaches, and was subject to the jurisdiction of domestic courts.[10]
Even after the powers of the Company were transferred to the Secretary of State through the Government of India Act, 1858, the contractual liability of the State is to be the same. However, it would be immune from any liability arising out of
its sovereign functions.[11] For administrative convenience, the Government of India Act, 1915 extended the authority to contract on behalf of the Secretary of State to the Governor General and Governor of provinces. The Government of India Act, 1935 provided clarity on the validity of a Government contract. It had to be expressed by, executed on behalf of, and by an agent authorized by the Governor General or Governor of Provinces. All contracts made under the executive authority of the Federation or Province were deemed to be expressed by the Governor-General or Governor of Province respectively.[12] Additionally, it provided that the Federal or Provincial government may sue or be sued in its own name, in the event of a contractual breach.[13]In the Dhyan Singh v. State of U.P, it was held that Government contracts would only be enforceable if they were written.[14]

                     III.          Current Position of State Contractual Liability

The current position with respect to contractual liability of the state has been influenced by its colonial past. Several provisions of the Government of India Acts on contractual liability have been incorporated into the Constitution of India. Article 298 of the Constitution empowers the Union and each state therein with the executive powers to conduct trade, business, exchange property, and make contracts for any purpose. Article 300 of the Constitution and Section 79 of the Code of Civil Procedure, 1908 states that a government may sue or be sued by its own name. Article 300 also provides for any suit pending against the Dominion to now lie against the Union. Under Article 299(1) of the Constitution, a Government contract has to be expressed by, executed on behalf of, and authorized by the President or Governor of each state. This authority to execute may be granted by rules, formal notifications, or special orders. There is no specific mode to confer authorization, and it may conferred on an ad-hoc basis too.[15] Thus, contracts concluded by someone other than the authorized person are unenforceable.[16] Further, Article 299(2) provides that the President, Governor or any person acting on their behalf cannot be personally liable for Government contracts. However, personal liability has been recognized in the event of “misfeasance in public office.”[17]

Government contracts are governed not only by the ICA but also the provisions of Article 299 of the Constitution.[18] The Constitutional terms are mandatory, not discretionary, thus any contract contrary to these provisions would be void.[19] Thus, the contracting parties would not be entitled to any damages.[20] Interpreting Article 299(1), the Supreme Court clarified that the words “expressed to be made” and “executed” in Article 299(1) envisaged only formal written contracts to be enforceable.[21] Thus, no implied contracts can be concluded with the government, for any person can evade or create liability by arguing the existence of a contract based on inference of facts and circumstances.[22] The policy objective of written Government contracts is to protect the general public from unauthorized contracts that officials have ineptly or ignorantly concluded.[23] Siever, it does not accord substantive rights to any contracting party. These substantive rights are covered under ordinary contract law, such as ICA. Thus, there is a rigid compliance procedure established under Article 299 on the authority and method to contract. No person other than the one authorized by President or Governor can conclude a contract.< span class="MsoFootnoteReference" style="font-family: "Times New Roman", serif; font-size: 12pt;">[24]Further, the contract has to be a written one. While there is consensus that government contracts must be written, it isn’t indisputably clear whether they must also be a formal and legal document. Thus, a valid government contract could also be concluded through correspondence, which lacks this formal and legal character. However, the rigid compliance of these procedures under Article 299 may be impractical or ignore certain genuine causes of citizens.[25]

Owing to vastness and diversity of government functions, departments and public officials frequently enter into numerous contracts, often of petty nature, with private parties. A lot of these contracts are concluded through correspondence, i.e. when parties do not officially meet.  The specificity of the procedure is communicated through government orders, rules, regulations etc. and in situations of correspondence the citizen may not be aware of these procedures. Especially for India where this is large information asymmetry between the law maker and the subject. Thus, changes in practices and protocols may not be communicated to the citizen either through the Gazette or a special government notice to the party. Thus, from an administrative and business standpoint, it would be extremely inconvenient if every contract had to be “a ponderous legal document couched in a particular form.”[26]

On the other hand, there is a need to safeguard the interest of unsuspecting and unwary citizens who enter into unauthorized contracts. That is, they do not fulfill the Constitutional obligations on contracts. In the event of a bonafide mistake by the citizen, their interests have to be protected, especially when they have started performing their part of the obligations.[27] Further, citizens might have already acted to their detriment based on a representation made by the government. As per the doctrine of promissory estoppel,[28] founded on justice and equity, the Government should be liable. [29] However, it is well-settled that this doctrine cannot be enforced for promises that are opposed to public policy,[30] against public interest,[31] and ultra vires administrative statutes.[32]

In this conflict, judiciary has intermittently oscillated between the liberal and rigid interpretation of Article 299, trying to balance these interests by invoking contractual and administrative doctrines. In its liberal interpretation, the judiciary has recognized “ratification” and “unjust enrichment” as valid grounds under contract law. The Supreme Court has held that a contract void by virtue of its non-compliance to Article 299 can be made enforceable if the government “ratifies” it.[33]In keeping with justice and equity, this would accord rights to the citizen and enforce obligations on the government. However, this “balancing of rights” approach has not been incontrovertibly and uniformly adopted by the judiciary. According to the contrarian view, a contract in contravention of Article 299 is not valid in the eyes of the law, thus it cannot be enforced by ratification.[34]

Since the substantive rights of Government contracts are
defined under the ICA, the Supreme Court has invoked Section 65 and 70 to impose quasi-contractual obligations on the government.[35]This is with the view to prevent their “unjustenrichment” at the expense of the contracting citizen. Through this, the Supreme Court has reduced the injustice caused by administrative faults and bonafide mistakes. Thus, if the performance by the citizen is for the government’s use and enjoyment or benefit, the citizen should be entitled to a compensation claim.[36] However, this is subject to that performance being legitimate and proper with regards to public policy. Indeed, alike ordinary citizens the government should be accrue the benefits to the provisions of Section 65 and 70. Consequently, if under a government contract not compliant with Article 299, a person has obtained any benefit, then the government too should have a compensation claim.[37] From the government’s standpoint, unjust enrichment at its expense might even hamper its functioning. Furthermore, a valid contract may result from correspondence if in the tender process, the acceptance is made by a duly authorized person, on behalf of the President.[38]

In its liberal interpretation, the judiciary has further employed administrative law doctrines such as “legitimate expectation” and “executive necessity”. Arising from the principles of natural justice and rule of law, the object of administrative law is to ensure that the government discretion is exercised as per the law of law, not arbitrarily, unreasonably, and unfairly.[39] These principles are also applicable to Government contracts, [40] and non-compliance would mean nullity of contract.[41] Further, the judiciary has been very liberal in interpreting government contracts under the doctrine of “legitimate expectation”. Thus, when a public authority promises to follow a certain procedure, it should act fairly in its implementation, so long as it does not interfere with its statutory duty.[42]Founded on the principles of reasonableness and natural justice, the doctrine focuses on predictability and certainty in contractual relationship with the government. Thus, it provides protection against change in Government practice, when the private party has legitimate expectation for the Government to continue with its previous practice.

Thus, there should be a thumb rule of considerations laid down to avoid ambiguity in exercise and review. Further, the restrictive nature of this doctrine has provided the State with opportunities to exercise unfettered power to evade contractual liability. However, in Food Corporation of India v. Kamdhenu Cattle Feed Industries, the court fettered such power by holding that the State has to negotiate and conclude contracts in consonance with Article 14 and public law.[43] This was with the special aim to protect individuals and small businesses against the arbitrary and unfair actions of the State. Thus, the doctrine of judicial review has been extended to government contracts, restricting the contractual discretion of the State.[44] Judicial review can be conducted on the broad grounds of illegality, irrationality, and procedural impropriety.[45] While the judiciary has recognized the freedom of the State to decide the contracting party, that freedom has now been subjected to a test of the principles established in Article 14 of the Constitution.[46] These principles require a fair, transparent, and equal procedure, such as an open tender.[47] Notably, the judiciary should be mindful of the boundaries of judicial review in assessing government contracts.[48]

In contrast, the essence of “executive necessity” is the inability of the executive to restrict the future legislative freedoms of the Parliament, especially on matters of State welfare.[49] Thus, government can evade contracts by citing the inability of contracts to bind their future conduct, especially when future policies are affected. However, the Government cannot rescind its promise upon which citizens have acted to their detriment.[50] While the government cannot solely rely on change in policy or over-riding public interest to rescind contracts, its claim of public interest must be tested for genuineness through judicial review.[51] Thus, the judiciary should ascertain the extent of individual obligations that can be abrogated to uphold public interest, and the government liability in those cases. Constructed on a thumb rule, this deviance must be due to strong reasons and assessed on a case-by-case basis. However, the judiciary should be mindful to not excessively restrict government freedom because this would hamper its functioning, undermining public interest.

On the question of challenging arbitrariness of government action through writ petition with regards to the maintainability of a writ petition, the Supreme Court had held that since the substantive matters
of the government contract are governed by the ICA and not the constitution, the dispute is not under the writ jurisdiction.[52]Further, the question of breach of contract would depend on facts and evidence that require robust investigation, and this can only be properly instituted civil suit rather than in a writ petition. Recently, it has held that a writ, under Article 32 and 226 of the Constitution, cannot lie against a government contract, unless it can be proved that a “public duty element” is involved.[53]The grounds of the duty has to be statutorily and constitutionally established, it cannot be commercial difficulty, hardship in performance of the conditions or inconvenience. Thus, the maintainability of a writ petition against a government contract is contingent on the public and private law distinction.

                     IV.          Distinction between Statutory and Government Contracts

In statutory contracts, the power to contract has been conferred expressly or impliedly by a statute for the purpose of discharging a function envisaged by that statute.[54] The mere fact that a contract was awarded by a statutory body or concluded for the construction of public utilities does not make it statutory. [55] However, a contract merely concluded in exercise of a statutory power is not itself adequate to constitute a statutory contract. Only when the terms and conditions prescribed under the contract are a must under the parent statute, can the contract be deemed as statutory.[56] Likewise, a contract containing only some statutory terms and conditions, is statutory only to the extent of those terms and conditions.[57] Even if one of the party’s is a statutory body, disputes arising out of the non-statutory terms of such are settled by the ordinary principles of law of contract.[58]

Unlike government contracts, statutory contracts are not governed by Article 299(1), but by their parent act. Also, government contracts are discharged under executive powers and statutory contracts are discharged under ordinary statutory powers. Statutory contracts have been largely created to exercise a public duty, thus they are subject to the provisions of both judicial review under Article 14 of the Constitution, and the writ jurisdiction under Article 32 and 226 of the constitution.[59] When the contracting party has performed the contract due to a promise made by a statutory authority, it can file a writ of mandamus to enforce performance from the authority if it rescinds its promise. Since statutory contracts are not governed by Article 299(1), the doctrine of estoppel applies in all cases of statutory contracts.[60] Essentially, in statutory contracts the level of scrutiny by the judiciary is higher, and the contractual freedom of the statutory authority is lower.

                     V.          Conclusion

Therefore, through the course of this paper we see that government contracts are treated different to ordinary contracts, but with good reason. Further, the current position on contractual liability of the State is heavily borrowed from the legislations and customs of the colonial era. In the modern day, there exist a plethora of government contracts owing to the diverse functions performed by the State and the welfare obligation entrusted to it. This has created ambiguity over the formal nature of these contracts which still needs further contemplation by the Judiciary. While administrative law doctrines have facilitated access to justice, there is a requirement to develop clarity in these doctrines to allow transparency and efficiency in discharge of state functions.

[1] Gireesh Chandra Prasad, ‘RBI agrees with govt on growth, differs on inflation’ (Live Mint, 1 August 2018) < https://www.livemint.com/Politics/ZgPbHcntXM954i45VmtRVP/RBI-agrees-with-govt-on-GDP-growth-differs-on-inflation.html> accessed 1 December 2018.


[2] Article 12, the Constitution of India, 1949.

[3] AIR 1954 Mad 67.

[4] AIR [1967] 1857.

[5] AIR [1981] 487.

[6] [2002] 5 SCC 111.

[7] [1966] 1 SCR 744.

[8] Superintendent and Remembrance of Legal affairs W.B v. Corp. Of Calcutta (Corporation of Calcutta II) AIR [1967] 997.

[9] K.C. Joshi, ‘Government Liability: An Avoidable Confusion’ (Vol. 15, 3rd edn, The Indian Law Institute 1973) 432.

[10] [1785] 28 E.R. 1245.

[11] Peninsular and Oriental Steam Navigation Company v. Secretary of State [1861] 5 Bom HCR App 1; Nobin Chunder Dey v. Secretary of State [1876] ILR 1 Cal 12.

[12] Section 175(3), Government of India Act, 1935.

[13] Section 176, Government of India Act, 1935.

[14] [2004] 3 AWC 2559.

[15] State of Bihar v. Karam Chand Thapur AIR [1962] SC 110.

[16] Union of India v. N.K. Pvt. Ltd [1972] SCR (3) 437.

[17] Arvind Dattatraya Dhande v. State of Maharashtra [1997] 6 SCC 169.

[18] State of Bihar v. Abdul Majeed [1954] SCR 786.

[19] Bhikaraj Jaipuria v. Union of India AIR [1962] SC 113.

[20] State of Uttar Pradesh v. Kishori Lal, AIR [1980] SC 680.

[21] Bhikaraj Jaipuria v. Union of India AIR [1962] SC 113.

[22] K.P.Chowdhary v.State of Madhya Pradesh [1966] SCR (3) 919.

[23] State Of Haryana v. Mahabir Vegetable Oils Pvt. Ltd. [2011] 3 SCC 778.

[24] State of Punjab v. Om Prakash [1962] 2 SCR 254.

[25] Citizen can be an individual(s) or company.

[26] Thakur Dan Singh Bisht v. State Of Uttar Pradesh AIR [1964] All 128.

[27] Chatturbhuj Vithaldas v. Moreshwar Parashram [1954] SCR 817.

[28] Section 115, Indian Evidence Act, 1872.

[29] Motilal Padampat Sugar Mills v. State of U.P AIR [1979] 61.

[30] Kaniska Trading Co. v. Union of India AIR [1995] 87.

[31] Shrijee Sales Corpn. V. Union of India [1997] 3 SCC 398.

[32] Excise Commissioner v. Ram Kumar AIR [1976] 2237.

[33] Chatturbhuj Vithaldas v. Moreshwar Parashram [1954] SCR 817.

[34] Mulamchand v. State of M.P AIR [1968] SC 1218.

[35] The difference between Section 65 and 70 is that the former is for benefits/unjust enrichment under a void contract while the latter is for a valid one.

[36] State of West Bengal v. B.K. Mondal AIR [1962] SC 152.

[37] State of Orissa v. Rajballav AIR [1976] Ori 79; Pannalal v. Deputy Commissioner AIR [1973] SC 1174.

[38] Union of India vs Rallia Ram, AIR [1963] SC 1685.

[39] Ramana Dayaram Shetty v. International Airport Authority of India [1979] 3 SCC 489.

[40] Y. Konda Reddy v. State of A.P. AIR [1997] AP 121.

[41] M/Section Pyrites, Phosphates & Chemicals Ltd. v. Bihar Electricity Board AIR [1996] Pat 1.

[42] Attorney General of Hong Kong v. Ng Yuen Shiu [1983] 2 A.C. 629.

[43] AIR [1993] SC 1601.

[44] Ramana Dayaram Shetty v. International Airport Authority [1979] 3 SCR 1014.

[45] Tata Cellular v. Union of India [1994] 6 SCC 651.

[46] Ibid.

[47] Nagar Nigam, Meerut v. Al Faheem Meat Exports (P) Ltd. and others [2006] 13 SCC 382.

[48] Sterling Computers Ltd. v. M&N Publications Ltd. & Ors [1993] 1 SCR 81.

[49] Ibid.

[50] Union of India v. M/s Indo-Afghan Agencies Ltd
. [1968] 2 SCR 366.

[51] LIC v. Consumer Education and Research Centre [1995] 5 SCC 482.

[52] Shrilekha Vidyarthi vs State of Uttar Pradesh AIR [1991] 537.

[53] Joshi Technologies International Inc v. UOI [2015] 7 SCC 728.

[54] India Thermal Power Ltd v. State of Madhya Pradesh & Ors. [2000] 3 SCC 379.

[55] Kerala SEB v. Kurien E. Kalathil & Ors [2000] 6 SCC 293.

[56] Ibid.

[57] India Thermal Power Ltd v. State of Madhya Pradesh & Ors. [2000] 3 SCC 379.

[58] Ibid.

[59] Kerala SEB v. Kurien E. Kalathil & Ors [2000] 6 SCC 293.

[60] Gujarat State Financial Corporation v. Lotus Hotels Pvt. Ltd AIR 1983 SC 848.
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