Pre-Incorporation Contracts

The promoter is the person who gives birth to the company, who brings the company into existence and holds a depositary relationship towards the corporation. In almost all type of cases, the promoter enters into a contract on behalf of the company before its incorporation. The major problem arising by these types of contracts is that of the legal consequences which should result when promoter deals with the other party on behalf of the company based on the future corporation. The position of the promoter is very vague, and most of the time, it is found that the company denied adopting the pre-incorporation contract.

Introduction

The primary characteristic of the company structure is separate legal identity, which allows the company to enter into a contract with other parties and own assets in its name. After the incorporation of the company and registration in India, the company obtains the legal identity. However, the promoters can enter into a contract with the third party even before registration of the company in India. These contracts are valid in the name of promoters; therefore, these contracts are known as promoter’s contract or pre-incorporation contract in legal terms.

What is a Pre-Incorporation Contract?

Promoters are the persons bound to promote a company to an operational level. They make sure that it is running successfully. Therefore, the promoters enter into many contracts which are necessary to promote the company. Pre- incorporation contracts also include those executed with the professionals for the company registration or those vital to float the company. Unless the registration process is completed, the company is only an artificial person that is unborn, and it cannot execute any agreement before incorporation. Therefore, the pre-incorporation contracts entered by the promoters are made in their liability. Thus these contracts are known as the pre-incorporation contracts, and they are incorporated before the incorporation of the concerned company. Such contracts are inescapable for company registration, and therefore they are also recognized by the Companies Act and even by the Special Relief Act. 

The Legal Status of Pre-Incorporation Contract

The legal status of the pre-incorporation contract is not easy to explain. According to the definition of the contract, there have to be at least two parties who enter into a contract with each other. So, the general principle says that no contract is valid if one of the parties to the contract is not in existence at the time of entering into the contract. Thus, the company cannot enter into a contract before its incorporation. Hence, the pre-incorporation contracts are always entered into by the promoters on behalf of the company. 

Here the promoters act as an agent of the company but here also is a tangle, if the principal, i.e. company is itself not in existence, how can it appoint an agent to act for it? So, the promoters are personally liable for all the contracts, and these contracts are not binding on the company unless it accepts the contracts. 

But, according to section 230 of the Indian Contract Act, neither an agent personally imposes contracts entered into by him on behalf of his principal, nor he is personally liable or bound by the contracts if he mentions, at the time of making the contract, that he is only functioning as an agent and he is not personally liable for that contract. 

However, section 15(h) and section 19(e) of the Special Relied Act, 1963 make the pre-incorporation contracts valid. 

Section 15(h): Thus section provides the specific performance of a contract which may be obtained by: 

  • Any party;
  • The representative in interest or the principal;

Provided that if the promoters of a company before its incorporation entered into a contract for the company and with the terms and conditions of the incorporation of the company, then the contracts as mentioned earlier are valid. 

Section 19(e): This section explains that the performance of a contract may be enforced against the company if the promoters of the company entered into a contract for the company and the terms and conditions must make this contract of the incorporation.

Weavers mills Ltd. v. Balkies Ammal (AIR 1969 Mad 462), in this case, the Madras High Court expanded the scope of this principle. In this case, the promoters had agreed to purchase some properties on behalf of the company. After that on incorporation, the company assumed possession and constructed structures upon it. In the above-mentioned case the court held that even in the absence of transfer of property by the promoter in courtesy of the company after its incorporation, the company’s title over the property could not be set aside.  

Whether Pre-Incorporation Contracts Entered by Promoters are Binding on the Company?

The promoters enter Pre-incorporation contracts on behalf of the company. However, the promoters act as agent of the company who represents the company’s interest while at the time of registration, and the principal is not in existence. At the time of execution of contracts, the company is not in existence; therefore, the contracts entered by the promoters are not bound by the company. Section 15 and 19 of the Special Relief Act, 1963 explain the validity and enforceability of the pre-incorporation contracts. 

Section 15(h) said that if the company has expressly shown the acceptance of the pre-incorporation contract after its incorporation and same communicated to the concerned third party. Only when the company can ask for specific performance from the third party, if the pre-incorporation contracts are entered by the promoters for the company and within terms and conditions of the incorporation of the company. 

Under the same circumstances, specific performance may be enforced by the third party to the contract on the liability of the company; it is said by section 19(e) of the Special Relief Act. Hence, for the enforcement of the contract by the company with the third party, the members must ratify the contract by the communication of acceptance to the other party. If the company has not accepted the contract, then the concerned contract is binding to the promoters, and the other party may demand specific performance against each other.

How to Ratify the Pre-Incorporation Contracts?

It is inescapable to ratify the pre-incorporation contracts for its enforcement by the company. Thus, for such acceptance or ratification, the promoters can follow either of the below-mentioned methods:

  • Accept the contract by passing a resolution for acceptance of contracts and act by the promoters for the incorporation of the company and associated matters.
  • Novation of contract: Novation of contracts simply means replace the existing contract with the new contract either between the same parties or distinct parties, but the prime consideration always is the discharge of the old contract. After completing the Novation of the contract, the new contract is binding on both the parties. In other words, Novation allows substituting the liability of the promoters with that of the company. The contract would be reconstituted in a manner that the contracting party was the company and no longer the promoters.

Such methods of acceptance are vital after the registration of the private company because it owns a separate legal identity to work in its name. Also, these actions are favorable to the promoters that they are not personally liable for these type of contracts in which they entered on behalf of the company.

What Happens When the Pre-Incorporation Contract is made in the Name of the Company?

A company comes into existence only after completion of the incorporation process. Before incorporation company is an artificial person. Before its incorporation, a company cannot execute any agreement or contract or be a part of any contract. Therefore, if the contracts entered in the name of the company, they are not valid due to its non-existence. Also, the enforceability of these contracts can be questionable and may also be denied. 

Thus, it is better to enter into a contract as a promoter of the company with the condition as to the incorporation of the company. The company can enforce these contracts if they are accepted. 

Conclusion 

Initially, the pre-incorporation contracts might appear to be with no legal status and value, but they are very much vital and legally valid as well as enforceable. Pre- incorporation contracts can be undertaken by the company after its incorporation either by:

  • entering into a newborn contract with the other party or with the promoters
  • Incorporating the contracts with the terms of incorporation
  • By accepting the benefits of the contract, either expressly or impliedly. 

Hence, the pre-incorporation contract becomes legally enforceable with the liability of the company.

FAQs

  1. Are the pre-incorporation contracts binding on the company?
  2. Are the promoters competent to enter into contracts without the existence of the company?
  3. What will happen if the pre-incorporation contract is made in the name of the company?
  4. How to ratify pre-incorporation contracts?

References  

  1. Majumdar, A.K., and G.K. Kapoor, 2009, Taxmann’s company law and practice, taxman pub Pvt ltd, 14th edition
  2. A Ramaiya, Guide to the companies act
  3. The Companies Act, 2013
  4. The Special Relief Act, 1963

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