Contract Law and Freedom of Contract in India: Sanctity of Contract, Standard Form Agreements, Inequality of Bargaining Power and the Statutory Limits on Party Autonomy

Freedom of contract is the proposition that parties should be free to make what bargain they please and that courts should enforce it as made. The Indian Contract Act, 1872 was drafted in the period when that proposition was at its strongest, and much of the Act still assumes it. But the Act itself contains substantial limits on the freedom it presupposes, and over the last century those limits have been widened considerably by the courts, chiefly through the standard of public policy in Section 23 and through the application of constitutional norms to contracts made by the State. The subject is best understood as the interaction between a principle the Act endorses and the qualifications the same Act and the Constitution impose on it.

1. The Classical Principle

The doctrine rests on two propositions which are distinct and are often confused. The first is freedom of contract, which concerns the making of the bargain: a person is free to choose whether to contract, with whom, and on what terms. The second is sanctity of contract, which concerns its enforcement: once made, the bargain binds, and the courts will give effect to it without inquiring whether it was a good bargain. The Latin expression for the second is pacta sunt servanda.

The classical judicial statement is that of Sir George Jessel MR in Printing and Numerical Registering Co. v. Sampson, (1875) LR 19 Eq 462, who said that if there is one thing more than another which public policy requires, it is that persons of full age and competent understanding shall have the utmost liberty of contracting, and that their contracts, when entered into freely and voluntarily, shall be held sacred and enforced by courts of justice. The economic theory behind the statement was that of laissez-faire: parties are the best judges of their own interests, and a freely struck bargain is presumptively efficient.

1.1 Where the principle appears in the Act

• Section 10 makes free consent the condition of enforceability, and treats the parties' agreement as the source of the obligation.
• Explanation 2 to Section 25 provides that an agreement is not void merely because the consideration is inadequate. The court will not reprice the bargain, though inadequacy may be taken into account in deciding whether consent was free.
• Most of Chapter IV on performance consists of default rules which apply only in the absence of a contrary agreement. Sections 46 to 50 on time and place of performance and Sections 59 to 61 on appropriation of payments are examples.
• Section 73 measures damages by the parties' own contemplation at the time of contracting, not by an external standard of fairness.

2. The Limits Built Into the Act Itself

The 1872 Act was never a charter of unrestricted autonomy. Five groups of provisions restrict what parties may agree, and they restrict it in different ways.

Section 27 deserves particular notice because it is more restrictive than the English rule it replaced. English law asks whether a restraint of trade is reasonable as between the parties and in the public interest; Section 27 declares every agreement by which a person is restrained from exercising a lawful profession, trade or business void, subject only to the statutory exception for the sale of goodwill. The Supreme Court confirmed in Superintendence Company of India (P) Ltd. v. Krishan Murgai, (1981) 2 SCC 246 that the English test of reasonableness cannot be applied to a post-employment restraint in India. A restraint operating during the subsistence of the employment stands differently, as held in Niranjan Shankar Golikari v. Century Spinning and Manufacturing Co. Ltd., AIR 1967 SC 1098, because it does not restrain the person from exercising his trade at all.

3. The Decline of the Classical Principle

3.1 The standard form contract

The practical assumption behind freedom of contract is that terms are negotiated. In the modern economy most consumer and service contracts are not negotiated at all. Insurance policies, bank account terms, carriage documents, utility connections, employment terms in large organisations and software licences are offered on printed forms on a take-it-or-leave-it basis. The weaker party's freedom consists only in the choice whether to contract, and where the service is a necessity or the supplier holds a monopoly, that freedom is nominal. Such contracts are described as contracts of adhesion.

Indian courts have responded with a set of techniques which stop short of a general doctrine of unfairness. An exemption clause must be adequately brought to the notice of the other party before or at the time of contracting; ambiguity in such a clause is construed against the party who drafted it under the contra proferentem rule; and a clause will not be read as excluding liability for a fundamental breach unless the language is unmistakable. In Lily White v. R. Munuswami, AIR 1966 Mad 13, a dry cleaner's printed condition limiting liability to fifty per cent of the value of a lost garment was held unenforceable as opposed to public policy, the court observing that such a term would place the customer at the mercy of the trader.

3.2 Inequality of bargaining power

The most significant Indian development is the willingness of the Supreme Court to use Section 23 to refuse enforcement of a term imposed by a party in a dominant position.

The principle was carried further in Delhi Transport Corporation v. D.T.C. Mazdoor Congress, 1991 Supp (1) SCC 600, where a comparable power of termination was invalidated, and in Life Insurance Corporation of India v. Consumer Education and Research Centre, (1995) 5 SCC 482, where the Court held that where a policy term offered by an instrumentality of the State is arbitrary or discriminatory, it is open to challenge under Article 14 even though the relationship is contractual.

3.3 The expanding content of public policy

Because Section 23 does not define public policy, the courts have had to decide how freely they may develop it. Two decisions mark the boundaries of the debate.

4. Constitutional and Statutory Regulation

4.1 The constitutional dimension

The State does not contract as an ordinary person. Article 299 prescribes the form in which contracts of the Union and the States must be executed, and non-compliance is fatal. Article 14 requires that the State act fairly and without arbitrariness in entering into and performing contracts, and the decisions on award of tenders and on unconscionable service conditions proceed on that basis. Article 19(1)(g) guarantees the freedom to practise a profession or carry on trade, subject to reasonable restrictions under Article 19(6), and it supplies the constitutional background against which restraints of trade are assessed.

4.2 Statutory regulation of terms

• Consumer Protection Act, 2019. Section 2(46) defines an unfair contract, and the State and National Commissions are empowered to declare terms of a contract unfair and therefore void as against a consumer. The definition covers excessive security deposits, disproportionate penalties, unilateral termination without reasonable cause and refusal to accept early repayment.
• Specific Relief Act, 1963. Sections 19 to 21 permit rescission and refusal of specific performance where enforcement would be inequitable, and the 2018 amendment reduced judicial discretion by making specific performance the general rule.
• Arbitration and Conciliation Act, 1996. An award may be set aside if it conflicts with the public policy of India, a ground given a restricted meaning by later amendment.
• Sector-specific regulation. Insurance, banking, telecommunications, electricity and real estate are each governed by statutes and regulators that prescribe or prohibit particular contractual terms, and to that extent remove them from negotiation altogether.

4.3 Proposals for reform

The Law Commission of India recommended a general legislative control of unfair terms in its 103rd Report (1984), which proposed a new Section 67A empowering courts to refuse to enforce an unconscionable term, and again in its 199th Report (2006), which proposed separate legislation distinguishing procedural unfairness in the making of a contract from substantive unfairness in its content. Neither recommendation has been enacted. India therefore has no general statute on unfair contract terms comparable to the English legislation, and the work continues to be done by Section 23, by Section 16 and by the consumer legislation.

5. The Position Stated Shortly

1. Freedom of contract concerns the making of the bargain; sanctity of contract concerns its enforcement. The Act assumes both.
2. The classical statement is that of Jessel MR in Printing and Numerical Registering Co. v. Sampson (1875), resting on laissez-faire assumptions.
3. The Act itself restricts autonomy through capacity, free consent, lawful object and consideration, and the classes of agreement expressly declared void.
4. Section 27 is stricter than English law: every restraint of trade is void save for the goodwill exception, and reasonableness is not a saving test.
5. Standard form contracts undermine the factual premise of negotiated bargaining, and courts respond through notice requirements, contra proferentem construction and strict reading of exemption clauses.
6. Central Inland Water Transport (1986) permits an unconscionable term imposed through grossly unequal bargaining power to be struck down under Section 23 and, where the State is a party, under Article 14.
7. Gherulal Parakh counsels restraint in extending public policy; Rattan Chand Hira Chand confirms that the category is not closed.
8. There is no general Indian statute on unfair terms; the Consumer Protection Act, 2019 covers part of the ground for consumers, and successive Law Commission proposals remain unimplemented.

6. Related Topics and Provisions