RELEVANCE AND ENFORCEABILITY OF PRE-

INCORPORATION CONTRACTS OF A COMPANY

Ishan Shivakumar1

INTRODUCTION
According to Indian laws, “company” means a company incorporated
and registered in accordance with law. 1 In other words, it is only after a
company has been duly “registered” that it is recognized as a company in
India law. Therefore, prior to the formal incorporation of the company,
the “association of persons”2 is not considered to be a separate legal
entity. Prior to the incorporation of the company, there is a need to
promote the functioning of the company. Promoters will be obligated to
make adequate arrangements in order to ensure the smooth beginnings of
the company. Such tasks may include: renting of office space, procuring
raw materials, hiring workers, etc. Thus, agreements on behalf of a
prospective company or “association of persons” (preceding the formal
incorporation of the company) is known as a “pre-incorporation
contract”.

This paper seeks to explore the relevance and enforceability of pre-

incorporation contracts of a company under Indian law. Contractual law
is governed by the Indian Contract Act, 1872 along with the Specific
Relief Act, 1963. Company law is governed by the Companies Act, 2013
– which is an updated legislation based upon the Companies Act, 1956.

This first section of this paper deals with understanding fundamental

concepts including: what is a company, the need for pre-incorporation
contracts and the role of promoters of a company.The next section deals

1
B.A., LL.B. (Hons.) 5th Year, NUJS, The WB National University of Juridical
Sciences, Kolkata
with the liability of the promoter or company vis-à-vis the pre-
incorporation contract. This section sets out the conditions under which
the liability of either the promoter or the company is established insofar
as the obligations of the pre-incorporation contract are concerned.The
third and final section presents a comparative analysis of the
enforceability of pre-incorporation from other jurisdictions outside India.

WHO IS A “PROMOTER?”
Indian laws did not define a “promoter” until the enactment of the
Companies Act, 2013. According to the new Act “promoter” 3 means a
person, who has been named as such in a prospectus or is identified by
thecompany in the annual return referred to in section 92; or who has
control over the affairs of the company, directly or indirectlywhether as a
shareholder, director or otherwise; or in accordance with whose advice,
directions or instructions theBoard of Directors of the company is
accustomed to act:
Provided that nothing in sub-clause (c) shall apply to a person who is
actingmerely in a professional capacity.
Judicial pronouncements also clarify the functional meaning of a
promoter. The earliest definition of promoter is a person who as principal
procures or aids in procuring the incorporation of a company. 4 Justice
Cockburn said 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.”5 Later, Justice
Bowen held that “the term promoter is a term not of law, but of business,
usefully summing up in a single word a number of business operations
familiar to the commercial world by which a company is generally
brought into existence.”6

ACCORDING TO THE MADRAS HIGH COURT

“The promoters of the Company act before the incorporation of the legal
person. The promoter is a "midwife" of the business as coined by Henn
and Alexander in Law of Corporations. Nevertheless, before the legal
person has come into existence, it is the promoter who does the major
role for the purpose of bringing the corporate person into existence like
proposing the objects of the company to be incorporated, arranging
finance, formation of the original scheme, making arrangement to get
the company registered, preparing prospectus, Memorandum and
Articles of Association, etc., which are very crucial for the company to
come into existence.”7

PRE-INCORPORATION CONTRACTS
Promoters perform vital functions to bring out a corporate person (the
Company) into existence and are liable to the Company as well as the
third parties in respect of their conduct and contracts entered during the
pre-incorporation stage including the statement in prospectus, either
treating them as the agents or trustees of the Company to be
incorporated, but still they are not recognized in order to focus the legal
fiction of corporate personality. 8 Such agreements are called “Pre-
Incorporation Contracts”. Thus, all commercial transactions or promises
of commercial transactions which is intended for the benefit of the future
company fall within this category. The theoretical difference between an
ordinary contract and the “Pre-Incorporation contract” is the distinction
in terms of the beneficiary. Although the contracting parties are the
promoters and a third-party, the intended beneficiary is the prospective
company which is yet to be incorporated. As established in earlier
sections, it is not legally possible for an unincorporated company to enter
into contracts because its existence is not recognized in the eyes of the
law.

PRIVITY OF CONTRACT
It is pertinent to examine a fundamental principle of contract law –
privity of contract – in light of the abovementioned juridical discussion.
The doctrine of privity dictates that that only a party to a contract can
sue.9 No third party has the right to sue if they are not a party to the
contract.
In Kelner v Baxter,10 it was held that because the company was not in
existence at the time of the agreement, the contract would be wholly
inoperative unless it was held to be binding on the promoter-defendants
personally. There must be two parties to a contract; and the rights and
obligations which it creates cannot be transferred by one of them to a
third person who was not in a condition to be bound by it at the time it
was made. The same position was affirmed in Phonogram Ltd. v. Lane,11
where the promoters were held liable was the breach committed by the
company. Finally, Lord Goddard CJ held: “as the company was not in
existence when the contract was signed there never was a contract, and
MrNewborne cannot come forward and say: ‘Well, it was my contract.’
The fact is, he made a contract for a company which did not exist.”12
Thus, the Common Law position is that a company is not bound by
contracts entered into on its behalf by its promoters or other persons
before its incorporation. After incorporation, it cannot ratify or adopt any
such contract because there is no agency and the contract is that of the
parties making it.13

LIABILITY IN “PRE-INCORPORATION CONTRACTS”

It has been established in the above sections that the unincorporated
company shall not be liable for any obligations arising out of a pre-
incorporation contract. This view has been affirmed by the Rajasthan
High Court inSeth Sobhag Mal Lodha v. Edward Mills Co. Ltd. 14, where
the Court held that two mandatory conditions must be satisfied in order
to sue for breach of contract: “(1) that the firm must be a registered firm,
and (2) that the persons suing are or have been shown in the register of
firms as partners of the firm. Unless these two conditions are fulfilled,
there would be a fatal bar to the entire suit and it would be wholly
incompetent in a court of law.” The same position of law has been upheld
by the Supreme Court of India in CIT v. City Mills Distributors (P) Ltd. 15
where is was held where the assessee company did not exist when the
income concerned was earned, it is, therefore, not liable to pay tax on it.

However, this approach has been criticized 16and even overruled by

subsequent decisions. The key point of contention is the ignorance of the
provisions of the Specific Relief Act, 196317. Thus, the promoters are
entitled to preclude liability by using the provisions of the Specific Relief
Act, under novation of contract and use the doctrine of equity.
THE SPECIFIC RELIEF ACT
The relevant provisions of the Act are:
15. Who may obtain specific performance.—Except as otherwise
provided by this Chapter, the specific performance of a contract may be
obtained by—
(h) when the promoters of a company have, before its incorporation,
entered into a contract for the purposes of the company, and such
contract is warranted by the terms of the incorporation, the company:
Provided that the company has accepted the contract and has
communicated such acceptance to the other party to the contract.

19. Relief against parties and persons claiming under them by

subsequent title.—Except as otherwise provided by this Chapter, specific
performance of a contract may be enforced against—
(e) when the promoters of a company have, before its incorporation,
entered into a contract for the purpose of the company and such contract
is warranted by the terms of the incorporation, the company: Provided
that the company has accepted the contract and communicated such
acceptance to the other party to the contract.
These provisions have been discussed and interpreted in Vali
Pattabhirama Rao v. Sri Ramanuja Ginning, 18 where the Court held that
the promoter can give his right to sue to the company by incorporating
the same within the articles or terms of association. Thus, if the company
comes into existence by incorporation before the determined date, and
applies in any form, it may even be by a letter approbating and accepting
the acts of the promoter, which would make the application by the
company a perfectly valid one – the same could be justified, either on the
principle of adoption, or novation by a substituted application. 19

NOVATION OF CONTRACT
The classic definition of ‘novation’ was rendered by Lord Selborne LC in
Scarf v. Jardine20: “there being a contract in existence, some new
contract is substituted for it, either between the same parties (for that
might be) or between different parties; the consideration mutually is
being the discharge of the old contract”.

Therefore, the doctrine of novation gives the company an opportunity to

replace the liability of the promoter with its own. In other words, upon
incorporation, the pre-incorporation contract shall be reconstituted as if
the contracting party was the company; and no longer the promoter.
In Howard v. Patent Ivory Manufacturing Co.21, it was held that a
company cannot ratify a pre-incorporation contract, but it is open to it to
enter into a new contract after its incorporation to give effect to a
contract made before its formation. According to Palmer's Company
Law, 22nd edition, volume 1, at page 271, “there is nothing to prevent
the company, when incorporated, from entering into a new contract to
put into effect the terms of the pre-incorporation contract”. 22
In Weavers Mills Ltd. v. Balkies Ammal, 23 the Madras High Court
extended the ambit of this principle. In this case, the promoters had
purchased certain properties for the company. Subsequently, upon
incorporation, the company constructed structures on the said properties.
Applying the principle of equity, the Court held that even in absence of
conveyance of property by the promoter in favour of the company after
its incorporation, the company could be held liable because it is enjoying
benefits from the act of the promoters by using the properties.

CONCLUSION
Section 71 of the South African Companies Act, empowers the company
to ratify preliminary agreements made by promoters: “any contract made
in writing by a person professing to act as agent or trustee for a company
not yet formed, incorporated or registered shall be capable of being
ratified or adopted by or otherwise made binding upon and enforceable
by such company after it has been duly registered”. A reading of the
provision clearly provides all the requirements for "adoption" of a
preliminary contract (or pre-incorporation agreement) and it will be
legally sufficient to adhere to the terms of the said contract – nothing
more is required.24
The United Kingdom enacted the Contracts (Rights of Third Parties) Act
1999 which permits a company to become a party to the “pre-
incorporation contract”, upon acquiring its legal existence once duly
registered.
In light of the issues raised, arguments advanced and authorities cited,
the author believes that the correct position of law is that the promoters
should be held personally liable for “pre-incorporation contracts”. The
jurisprudential reasoning for this position is evident from the various
judgments discussed in this paper. The principle of privity of contract
clearly dictates that a valid contract is between contracting parties only.
Furthermore, how can something that does not exist have legal rights and
obligations? The Indian Company Laws specifically mandate that
companies by duly registered in accordance with law before being
recognized as legal entities.
The doctrine of novation as constructed by Indian Courts is based upon a
different principle of contract law. Upon incorporation, the company can
utilize the doctrine of novation in order to legitimize the agreement.
However, this can only be done after the acceptance by the third-party. In
other words, the third-party would only agree to the novation if the
company indemnifies it against all breach related losses.
Therefore, the legal position in India is clear and the law expounded in
Kelner v. Baxter is correct.

REFERENCES
1
Section 2(20) of Companies Act, 2013; and Section 3(1)(i) of the Companies Act, 1956
2
Borrowed from the definition of a “company” as rendered by Lord Justice Lindley: “an association of many persons who contribute
money or money's worth to a common stock and employed it in some trade or business and who share the profit or loss arising there from.
The common stock so contributed is denoted in money and is the capital of the company. The persons who contributed it or to whom it
belongs are members. The portion of capital to which each member is entitled is his share.The shares are always transferable although
the right to transfer them may be restricted.”
3
Section 2(69) of the Companies Act, 2013
4
Phosphate Sewage Co. v. Hartmount, (1877) 5 Ch D 394
5
Twycross v. Grant, (1877) 2 CPD 469
6
Whaley Bridge Calico Printing Co. v. Green, (1880) 5 QBD 109
7
Probir Kumar Misra v. RamaniRamaswamy and Ors., [2010] 154 CompCas 658 (Mad)
8
Ibid
9
Dunlop Pneumatic Tyre Co Ltd v. Selfridge & Co Ltd, [1915] UKHL 1
10
[1866] L.R.2 CP 174
11
[1982] QB 938
12
Newborne v. Sensolid (Great Britain) Ltd., [1954] 1 QB 45
13
Halsbury states in fourth edition at page 435, paragraph 727; as cited in ValiPattabhiramaRao v. Sri Ramanuja Ginning, (1986) 60
Comp Cas 568 AP
14
[1972] 42 CompCas 1 (Raj)
15
(1996) 219 ITR 1 (SC)
16
A. Ramaiya, Guide to Company Act, (Ed. 17th, 2010) pg. 689
17
Sections 15(h) and 19(e) of the Specific Relief Act, 1963
18
(1986) 60 CompCas 568 (AP)
19
G.K.Palaniswami v. Sri Nandhi Transports (P) Ltd., 1967 (3) Mad 80
20
(1882) 7 App Cas 345, pg. 351
21
(1888) 38 Ch D 156
22
As cited in ValiPattabhiramaRao v. Sri Ramanuja Ginning, (1986) 60 Comp Cas 568 AP
23
AIR 1969 Mad 462
24
G Ex parte Universal Property (Pty.) Ltd., 1947 (4) S.A. 12 (D)