Pre-incorporation contracts and the

promoter
In order to get the benefits of a ‘corporate personality’ [1] , it is very necessary for ‘an
association of persons’ to become incorporated under the Companies Act, 1956.
After the incorporation of association of persons the company comes in existence,
and it can start its business operations as company only after that [2] . The simple
reason behind it is that before incorporation company do no has any legal existence
before incorporation [3] , and if the ‘association of persons’ enters into an agreement
in the name of company before incorporation; the agreement would be void ab
initio [4] .

It would be a matter of inconvenience that ‘an association of persons’ cannot

perform any official business operation in the name of company before its
incorporation or the issue of certificate of commencement of business; they may
have to make arrangement for office, place of work, worker, etc. In order to do away
with these inconveniences, the promoter [5] can enter into the agreements in the
benefit of ‘association of persons’ or prospective company; these agreements are
known as pre-incorporation contract.

Under the strict principles of contract law, the promoter is solely liable for the breach
of contract. The reason behind is that the promoter is party who enters into the
contract, and not the company. The rule of privity of contract keeps away the
company from pre-incorporation contract. But recent development in corporate law
and contract law makes the company liable for pre-incorporation contract.

Research Question
Whether the promoter is liable for pre-incorporation contract or not? If he is liable,
under what circumstances he can be held liable?

Whether there is any difference among Indian Law, American Law and English Law
concerning the liability of promoter in relation to pre-incorporation contract?

Chapter I: Meaning of Promoter and Nature of Pre-

incorporation Contract

Promoter
The Company Act, 1956, does not provide a common definition of Promoter.
Although few section like 62, 69, 76, 478, 519 of Company Act and SEBI Guidelines
2000 Chapter VI Explanation I to III to clause 6.4.2(k) does discuss about promoter,
but definition provided under those section would be restricted to the area of those
section. Resent Company Bill does have the definition of Promoter in the definition
clause under section 2(zzq), it says that “promoter means a person who has (a) been
named as such in a prospectus; or (b) control over the affairs of the company, directly
or indirectly whether as a shareholder, director". But this Bill is not in force till now, so
the old Act of 1956 would be applicable in present day, which does not has the
common definition clause of promoter. Even the English law does not provide the
definition [6] . Joseph H. Gross in his celebrated article ‘Who is a Company
Promoter?’ found that it was rather intentional to not providing definition in English
Legislation, because if legislation try to define it then someone might escape from
the liability who enjoy the place of promoter but not come under the definition of
promoter [7] . In this situation, where the legislature if silent about the definition, it is
necessary to see the judicial interpretation.

According to Bowen J., the ‘Promoter’ is not the term of law but it is a term of
business [8] , who play main role in the setup of a company. Whereas Cockburn CJ in
Twycross v Grant observed that a promoter is ‘one who undertakes to form a
company with reference to a given project and to set it going and who takes the
necessary steps to accomplish that purpose’.

In conclusion, one can say that promoter connote any individual, syndicate,
association, partnership or a company, which takes all the necessary steps to create
company and mould a company and set it going [9] .

Pre-incorporation Contract
The promoter is obligated to bring the company in the legal existence and to ensure
its successful running,; and in order to accomplish his obligation he may enter into
some contract on behalf of prospective company. These types of contract are called
‘Pre-incorporation Contract’.

Nature of Pre-incorporation contract is slightly different to ordinary contract. Nature

of such contract is bilateral, be it has the features of tripartite contract. In this type of
contract, the promoter furnishes the contract with interested person; and it would be
bilateral contract between them. But the remarkable part of this contract is that, this
contract helps the perspective company, who is not a party to the contract.

One might question that ‘why is company not liable, even if it a beneficiary to
contact’ or one might also question that ‘doesn’t promoter work under Principal-
Agent relationship’.

Answer to all those question would be simple. The company does not in legal
existence at time of pre-incorporation contract. If someone is not in legal existence,
then he cannot be a party to contract, and ‘Privity to Contract’ doctrine excludes
company from the liability. In Kelner v Baxter, Phonogram Limited v Lane

In pure common law sense, Pre-incorporation contract does not bind the company.
But there are certain exceptions to this contract, and these exceptions were
developed in USA, India and later in England.

Chapter II: Liability of Promoter Concerning Pre-

incorporation Contract
Before the passing of the Specific Relief Act 1963, the position in India, regarding
pre-incorporation contract, was similar to the English Common Law. This was based
on the general rule of contract where two consenting parties are bound to contract
and third party is not connected with the enforcement and liability under the terms
of contract. And because company does not come in existence before its
incorporation, so the promoter signs contract on behalf of company with third party,
and that is why the promoter was solely liable for the pre-incorporation contract
under the established ruling of Kelner v Baxter.

Liability of Promoter
Promoters are generally held personally liable for pre-incorporation contract. If a
company does not ratify or adopt a pre-incorporation contract under the Specific
Relief Act, then the common law principle would be applicable and the promoter will
be liable for breach of contract.

Whether Promoter is personally Liable for Pre-

incorporation Contract?
In Kelner v Baxter, where the promoter in behalf of unformed company accepted an
offer of Mr. Kelner to sell wine, subsequently the company failed to pay Mr. Kelner,
and he brought the action against promoters. Erle CJ found that the principal-agent
relationship cannot be in existence before incorporation, and if the company was not
in existence, the principal of an agent cannot be in existence. He further explain that
the company cannot take the liability of pre-incorporation contract through adoption
or ratification; because a stranger cannot ratify or adopt the contract and company
was a stranger because it was not in existence at the time of formation of contract.
So he held that the promoters are personally liable for the pre-incorporation contract
because they are the consenting party to the contract.

In Newborne v Sensolid (Great Britain) Ltd, Court of Appeal interpreted the finding of
Kelner v Baxter in a different way and developed the principle further. In this case an
unformed company entered into a contract, the other contracting party refused to
perform his duty. Lord Goddard observed that before the incorporation the company
cannot be in existence, and if it is not in existence, then the contract which the
unformed company signed would also be not in existence. So company cannot bring
an action for pre-incorporation contract, and also the promoter cannot bring the suit
because they were not the party to contract.

This case created some amount of confusion that, if the contract was sign by the
agent or promoter, then he will be liable personally and he has the right to sue or to
be sued. But if a person representing him as director of unformed company enters
into the contact then the contact would be unenforceable. This distinction was found
objectionable by the Windeyer J in Black v Smallwood and this was also criticized by
Professor Treitel in the Law of Contract. Later in Phonogram Limited v Lane, Lord
Denning settled the position, he found that if an unformed company enters into the
contact, then it cannot bind the company, but the legal effect of contract does not
entirely lack. And even in that situation the promoter or representor are personally
liable for the pre-incorporation contract.

In Phonogram Limited v Lane, a person was attempting to from a company which

was going to run a pop artists group and that person arranged financial assistance
from a recording company. But this company never came in existence, and the
amount was due. The recording company brought an action against the person who
represented the unformed company. Lord Denning analyzed Kelner v Baxter,
Newborne v Sensolid, Black v Smallwood and the section 9(2) of the European
Communities Act, 1972 [10] , and found that the promoters are personally liable for
the pre-incorporation contract.

These principles were found applicable in Indian case. In Seth Sobhag Mal Lodha v
Edward Mill Co. Ltd., the High Court of Rajsthan followed the approach of Common
Law regarding liability of pre-incorporation contract. This case was criticised by A.
Ramaiya in Guide to Companies Act (Sixth Edition), he found that learned judges did
not noticed the Specific Relief Act [11] .

How can promoter shift his liability and right to

company
Although under common law promoter is personally liable for the pre-incorporation
contract, but there are some scope where the promoter can sift his liability to
company. He can shift to company his liability under the Specific Relief Act 1963 or
he can go for novation under contract law.

Under Specific Relief Act

Under the Specific Relief Act 1963, section 15(h) and 19(e) are the two important
sections for pre-incorporation contract. Section 15 is about stranger’s right to sue if
he entitled to a benefit or has any interest under the contract, although it has certain
limitation. Section 15(h) talks about the company, being a stranger to pre-
incorporation contract, has the right to sue to the other contracting party. But the
necessary condition is that the contract should be warranted by the terms of its
incorporation. This provision clearly negates the common law doctrine [12] which
says that the company cannot ratify or adopt the pre-incorporation contract [13] .
Under this provision promoter can give his right to sue to sue to the company. In Vali
Pattabhirama Roa v Sri Ramanuja Ginning and Rice Factory Pvt. Ltd.

On the other hand, section 19(e) states that the company can be sued by the other
party of pre-incorporation contract, if the terms of incorporation warrant and adopt
the contract. This provision reduces the promoter of liability of pre-incorporation
contract.

Under Novation of Contract

Novation of contract is defined in Scarf v Jardine [14] as, ‘being a contract in
existence, some new contract is substituted for it either between the same parties
(for that might be) or different parties, the consideration mutually being the
discharge of the old contract’ [15] .

Novation is different from the Ratification [16] ; because in Novation, a new contract
is made on the same terms but this time between the company and the third
party [17] , whereas in Ratification, dates back to the time of the act ratified, so that if
the company ratifying, who is not in existence, cannot itself have then performed the
act in question its subsequent ratification of it is ineffective [18] .

In the situation of Novation of Contract, the Company can replace the promoter from
the pre-incorporation contract. But one might say that such contract would not be
called pre-incorporation contract, but it should be called post-incorporation contract;
because novation of contract result into a new contract.

In Howard v Patent Ivory Manufacturing [19] ,

Doctrine of equity

Intension
Chapter III: Brief Comparison between Indian and other
countries Law regarding Promoter’s Liability for Prep-
incorporation Contract
Conclusion