PRINCIPLES OF BUSINESS

SECTION 4- LEGAL ASPECTS OF A BUSINESS

NAME__________________________________________________________

GRADE_________________________________________________________

OBJECTIVE

i. explain the concept of contract

ii. identify the types of contracts

iii. describe the characteristics of a simple contract

iv. describe the characteristics of a specialty contract

v. explain the conditions under which offer and acceptance are communicated

vi. explain ways by which contracts may be terminated or discharged

vii. apply the principles of a simple contract to cases

viii. explain why documentation is necessary in business transactions

ix. *prepare business documents for various purposes

x. evaluate the principles upon which insurance is based

xi. explain the various types of insurance policies

xii. explain how insurance facilitates trade

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 LEGAL ASPECTS OF A BUSINESS

4.1 CONTRACT

▪ An agreement is an understanding or a mutual exchange of promises between two or

more persons.

▪ A contract is a specific legal binding agreement between two or more people in

which there is an agreement to do something in return for a benefit [consideration].

▪ A contract is enforceable by law, that is, if one person does not abide by the contract,
the other person may take legal actions.

Parties to a Contract

✔ Offeror- the person who made the offer

✔ Offeree- the person to whom the offer is made

4.2 TYPES OF CONTRACT

Two types of contracts include;

i. Simple contract
ii. Speciality contract

4.3. CHARACTERISTICS OF A SIMPLE CONTRACT

A Simple Contract

▪ A simple contract may be defined as written, oral or implied by conduct.

▪ Examples of a simple contract include; hiring a taxi, entering a store to purchase

items, and purchasing a life or general insurance policy [written contract].

▪ A simple contract is void or voidable [cannot be enforced by law] if one or more of

the following features are lacking:

a) offer and acceptance

b) consideration
c) legality
d) competence of the parties/capacity

(a) OFFER AND ACCEPTANCE

▪ A contract is formed when an offer has been unconditionally accepted. This

means that all the terms of the agreement must be accepted by both parties.

AN OFFER

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 ▪ This is an indication by one party to the other that they are willing to make a
proposal and to be legally bound by it.

Conditions under which an offer must be communicated

i. The offer must be communicated to either to a specific person or to the general public
⮚ E.g. - Golda offers to sell her bracelet to Tomora, this is an offer made to a specific
person.
⮚ E.g. - Golda advertises that the first person who comes to her house on a specific
date and time will be able to buy the bracelet, this is an example of an offer made
to the general public.

ii. An offer can be expressed in writing, oral or implied

⮚ Example of an implied offer - if you went to the dentist for some treatment, you
are agreeing in principle to pay for the treatment, if you are handed a bill and
refuse to pay, you would be in breach of a contract.

Invitation to Treat

▪ An invitation to treat is NOT an offer, it is an invitation to make an offer

▪ This is a situation where an offeror invites other parties to make him/her an offer

Examples of an Invitation to Treat

✔ An auctioneer’s request for a bid

✔ goods on display in a shop or store with a price tag

✔ property advertised for sale

✔ an advertisement in the newspaper

ACCEPTANCE

▪ Acceptance is when the offeree [the person to whom the offer was made]
agrees to the terms of the offer made by the offeror.

Conditions under which acceptance must be communicated

i. Acceptance must be communicated:

✔ written- that is effective from the time it is written

✔ verbal- that is when the offeree says ‘okay I accept your offer

✔ by conduct – for example when a cashier puts your clothes in your bag and
accepts your money

ii. Acceptance must be unconditional/unqualified.

▪ The offeree cannot introduce a new term to the contract. E.g. if a seller offers
a used car for sale, you cannot say ‘I accept your offer on the condition that all

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 tyres are replaced’, this is not acceptance, but you have created a counter
offer.

✔ NB: a counter offer is when the offeree changes the term of the
agreement and it is equal to the rejection of the original offer and is not
legal acceptance.

iii. Acceptance must be within an agreed time, however, if no time period is stated, it
must be done within a reasonable period.

iv. Acceptance made through the post is effective once the letter is posted.
E.g. an acceptance letter lost in the post and which never reaches the offeror is
still valid, since a contract existed from the time of posting by the offeree.

(b ) Consideration

▪ Consideration is the benefit received by both parties either in the form of cash, goods
or services.
▪ Consideration should be lawful since an unlawful act would be void [cannot be
enforced by law]
▪ E.g. Tom digs Jerry’s garden, in exchange, Jerry will repair his washing machine,
this is an example of a valid contract.

(c ) Competencies of Parties [ Capacity of Parties]

▪ Competencies of parties or capacity in law means that the persons entering a contract
are eligible to enter into a contract.

▪ The following groups of persons are not eligible to enter contracts: minors (persons
less than 18 years old), drunks, insane persons, and prisoners.

(d) Legality

▪ All forms of contract must conform to the laws of the land. E.g. if Joe pays Michael
$500, 000 to deliver a tonne of marijuana and Michael fails to carry out his side of the
contract, then Joe cannot get the courts to force Michael to carry out his side of the
agreement.

▪ Illegal contracts include: contracts to commit wrongs or crimes or contracts involving

sexual immorality.

4.4 SPECIALITY CONTRACTS

▪ Speciality contracts are also called a deed or contract under a seal

▪ Speciality contracts apart from being written must be :

✔ Signed – signed by both parties

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 ✔ Sealed – seal imprint is placed on the document

✔ Delivered – all the parties to the contract must have a copy of the document

▪ Examples: mortgage agreements, land or property sales, and hire purchase

agreements

4.5 CONDITIONS UNDER WHICH OFFER AND ACCEPTANCE ARE

COMMUNICATED (see objective 4.3)

4.6 WAYS IN WHICH A CONTRACTS MAY BE TERMINATED

▪ A contract may be discharged or terminated when one of the parties is released from
their contractual obligation.

Methods of Discharge

▪ By breach- one party breaks the contract by failing to carry out its side of the
agreement
▪ By agreement- both parties agree to cancel the contract before it is completed

▪ By performance- both parties carry out their side of the agreement

▪ By frustration- one or both parties being unable to meet their obligations because of
circumstances out of their control
▪ Lapse of time- failure of a party to carry out its side of the contract within a
reasonable time
▪ By renunciation – one party carries out a portion and fails to carry on any further

▪ By death – if one party dies, the contract is immediately terminated

▪ By bankruptcy – if one party becomes bankrupt, the contract comes to an end

Breach of Contract

▪ Breach of contract is a refusal of one party to fulfil the obligation of the contract

▪ When one party breaches a contract, the innocent party is entitled to some form of
compensation.
▪ Where there is a breach of contract the innocent party must be paid for damages, that
is, compensation must be given to the innocent person in the form of cash.

4.7 APPLY THE PRINCIPLES OF A SIMPLE CASE STUDY

Case Study #1

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 Daliah’s parents were present when her uncle promised to give her one of the most
up-to-date cell-phones on her18th birthday. On that day however, her uncle refused to
deliver the cell phone. Daliah was so disappointed that she threatened to sue her uncle for
breach of contract.

a) Define the term contract. (2 marks)

b) State three essential features of a valid contract (3 marks)
c) Explain the term breach of contract. (2 marks)
d) State whether Daliah would succeed if she sues her uncle. (1 mark)
e) Give a reason to justify your answer. (2 mark)

4.8 THE IMPORTANCE OF RECORD KEEPING

▪ Business documents are the official documents used in a business to help keep track of
all official and unofficial business transactions.

Business documents are important because:

▪ they make the communication process possible and are used for reference purposes e.g. if
a customer queries a bill the filed copy can be used in clarifying any queries
▪ governments require proper documentation for taxation and auditing purposes

▪ they provide a written record between a firm and its customers e.g. receipts, invoices

▪ it prevents business persons from forgetting important information to be used in the

performance of their various task
▪ it saves time since relevant information can be located easily and can be extracted if
needed

4.9 PREPARING COMMON BUSINESS DOCUMENTS

Pro-forma Invoice

▪ A pro-forma invoice is a bill sent to the buyer when the seller requires payment in
advance of delivery when the seller does not know the buyer well.

▪ Before despatching the goods, the seller will send the buyer a proforma invoice, when
payments have been made the seller will then despatch the goods.

Purchase Requisition Forms

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▪ This is a business document that is used within an organization when goods are
needed from the stock room.

▪ The purposes of the document are to help control the movement of stock and
to inform the firm on how stocks are used and by whom.

Statement of Account

▪ Is a summary of all transactions made between the buyer and the seller during the
month and it reminds the customer that payment is due.

▪ It contains: balance owing at the beginning of the month, the amount of invoice
issued, debit or credit notes issued, the net amount owing at the end of the month

Stock Card

▪ This is a document that keeps information about the stock e.g. records of stock
received and issued and the balance at any given time.

▪ It contains: minimum and maximum levels of stock, amount of stock received,

amount of stock issued, and re-order levels.

*The Invoice

▪ The invoice lists the goods purchased and informs the buyer of the amount owed to
the seller.
▪ It contains the: quantity supplied, price per unit, total amount owed, invoice number,
buyer’s order number, terms of sales, E & OE [errors and omissions expected] means
the supplier has the right to correct any errors at a later date

*Credit Note

▪ This is a document sent to a buyer if he has been overcharged due to: faulty or
damaged goods that have been returned or goods supplied in smaller quantities than
shown in the invoice.
▪ A credit note is sometimes printed in red to differentiate it from a debit note.

*Debit Note

▪ A document sent to the buyer if he/she is undercharged due to goods that were
delivered are not on the invoice, pricing errors made on the invoice or transport cost
omitted.

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* NB these documents are not required in the POB syllabus

4.10 INSURANCE

▪ Insurance is a promise for financial compensation for a risk that may or may not
occur such as accidents, theft, or fire. Unexpected events may occur at times when an
individual cannot afford to restore themselves.

▪ Insurance policies may be obtained through an agent working for a particular

company or through brokers selling insurance for a number of different companies.

POOLING OF RISK

▪ Many persons faced with a risk, usually pay the insurance company a small amount
of money called a premium to form a large pool of funds.
▪ When a contributor suffers a loss there is enough money in the pool of funds to
compensate (indemnify) them.
▪ E.g. if a home-owner loses his house due to the risk of fire, instead of one person
bearing the loss, it is shared by several persons of a large group.

THE PRINCIPLES OF INSURANCE

Indemnity

▪ This means to restore the insured to where he or she was before the loss or
damage occurred. This principle does not apply to life assurance since no money can
compensate death.

▪ The principle of indemnity is not to make a profit from a loss, but to receive a fair
compensation.

▪ E.g. Charlette premises were insured for $100 000, later they were completely
destroyed by fire. The cost of rebuilding was $80 000. How much would charlotte
receive from the insurance company?

Subrogation

▪ This is where the insurer after being compensated, surrenders the right of
ownership to the insurance company.

▪ E.g. if your car was completely wrecked in an accident, the insurance company would
compensate you, but they would take the wreck to ensure that you do not sell the
wreck and make a profit.

Contribution

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 ▪ This occurs when more than one insurance company is liable for the loss, the
amount of loss is shared in proportion by different insurance companies.

▪ E.g. If you have insured your car with two different insurance companies and your
car was stolen, the two insurance companies would contribute half the value of your
stolen car and buy you a new car, so you are fully compensated. You cannot get a
car from each insurance company.

Utmost Good Faith

▪ This principle states that the insured must give all relevant information about the
thing or person being insured, he/she must be truthful. Failure to give accurate
information may mean the insurance company may refuse to pay on the claim.

▪ Note: The insurance company must also give all relevant facts about the policy

Insurable Interest

▪ A person cannot take out an insurance policy to protect property in which they do
not have insurable interest.
▪ E.g. you cannot insure your neighbour’s house, it is not yours and you will lose
nothing.

Proximate Cause

▪ The insurance company can only pay out compensation if the loss suffered was
caused by the risk covered in the policy.

▪ E.g. if a person insures his house against fire but it was destroyed by flood, then he
cannot expect to get compensation from the insurance company.

4.11 TYPES OF INSURANCE POLICIES

(a) Life Assurance

(b) Non – life (Business Insurance)

(a) Life Assurance Policies

▪ Life assurance is a promise of financial compensation for events that must happen
such as death. Life assurance is the insurance of a person’s life or health. It is a form
of savings plan which benefits the dependants of the assured.

▪ The principle of indemnity cannot be applied under this coverage as no amount of

money can restore a person back to life.

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 ▪ Types of life assurance policies include; whole life, endowment policy and terms
policy.

(i) Whole Life Policy

▪ Provides payment after the death of the insured. The spouse or dependent
should benefit from this policy.

(ii) Endowment Policy

▪ Allows a sum of money to be paid, payable at a certain age or on death of
the policy holder, whichever comes first.
▪ Upon maturity, if the insured survives the period covered by the policy, then
he/she receives a lump sum of money.

(iii) Term Policy

▪ This is used by persons who need a mortgage on their home. In the event of
death, the policy is used to pay off the mortgage.

(b) Business Insurance Policies

(i) Fire Insurance

▪ Covers both domestic and business premises and their contents. It also includes
explosions, flood, burglary

▪ Premiums paid depend on the type of building, its layout and the nature of the
contents [e.g. flammable].

(ii) Liability Insurance

▪ Public Liability- provides coverage for firms which may have to pay claims for
injury to persons caused by their negligence.

▪ Employer’s Liability- provides coverage for employee’s having accidents on the

job.

▪ Fidelity Bond – provides compensation to a firm against theft by employees.

▪ Product liability- protects the business against claims by customers as a

result of unsafe/faulty goods being supplied by the business.

(iii) Motor Vehicle Insurance Policies

▪ Third Party policy- covers the cost of accidents with passenger and repairs to the
vehicle of other road users.

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 ▪ Comprehensive policy: covers repairs to your own vehicle and others. Most
persons have a comprehensive policy.

▪ NB: Most insurance companies offer a “no claim discount “ - this is a reduction
in premiums charged for not making a claim over a set period.

(iv) Consequential Loss

▪ Covers the loss of profit caused by being unable to use your business property
due to a business interruption such as fire, flood, theft, vandalism etc.

(v) Goods in transit or cash in transit

▪ Provides coverage for loss/theft of goods or cash being transported.

(vi) Personal accidents

▪ Covers injuries to a person that prevents them from working.

(vii) Marine insurance

▪ Covers the loss or damage to the ship, cargo and passengers or crew.

(viii) Aviation insurance

▪ Covers aircraft against loss or damage to the aircraft, cargo and passengers or
crew.

4.12 HOW INSURANCE FACILITATES TRADE

▪ Insurance encourages businesses to trade knowing that some of the risk involved are
taken care of. Insurance facilitates trade by ;

✔ providing financial protection and compensation if a risk occur e.g. fire

✔ promoting business confidence that is, entrepreneurs can claim compensation if

some unforeseen event occurs

✔ providing a source of investment to insurance companies. Insurance companies

invest the money they collect as premiums to provide compensation to meet
insurance claims.

Review Question #1

a) Distinguish between insurance and assurance. (4 marks)

b) State FOUR principles upon which insurance is based. (4marks)

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c) Identify THREE types of insurance risks that a business could insure against and state

how the business can benefit by insuring against those risks. (6 marks)

d) State the purpose of THREE business documents. (6marks)

[Total 20 marks]

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