DR.

RAM MANOHAR LOHIYA

NATIONAL LAW UNIVERSITY, LUCKNOW

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2019-2020
CORPORATE LAW
PROJECT

Legal Position of Pre-Incorporation Contracts: Comparative Analysis

of Indian Law & English Law
SUBMITTED FOR THE PROJECT WORK UNDERTAKEN IN THE PARTIAL FULFILMENT
OF B.A. L.L.B (HONS.) COURSE AT DR. RAM MANOHAR LOHIYA NATIONAL LAW
UNIVERSITY, LUCKNOW

SUBMITTED TO: SUBMITTED BY:

DR. VISALASKHI VEGESNA BISHWA BANDHU, CHAITANYA

ASSISTANT PROFESSOR (LAW) ENROLMENT NO. 046, 047 SECTION “A”

DR. RAM MANOHAR LOHIYA BA.LLB. (HONS.), 6TH SEMESTER

NATIONAL LAW UNIVERSITY, LUCKNOW.

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 ACKNOWLEDGEMENT

After researching for about a fortnight, I was able to collect sufficient matter to make this project of
‘Legal Position of Pre-Incorporation Contracts: Comparative Analysis of Indian Law &
English Law’. We are deeply indebted to Dr. VISALASKHI VEGESNA for their guidance and
support.

We would also like to acknowledge the invaluable support of my parents. The advice and
suggestions of all near and dear ones who have helped in shaping new developments in this project.

We would also like to extend my deep gratitude to the staff of Dr Madhu Limaye Library for
helping us with our research and project drafting. We sincerely thank all of you. We welcome any
criticism and suggestions by the people who go through it, for the improvement of our future
projects.

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 CONTENTS

INTRODUCTION 4
THE COMMON LAW POSITION 5
ENGLISH LAW POSITION 7
INDIAN POSITION OF PRE-INCORPORATION CONTRACTS 10
CONCLUSION 15

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 INTRODUCTION

The Company is a legal entity or device normally adopted to establish a business enterprise as an
independent legal entity capable of employing people and of buying and selling goods and services
in its own right capable in law of owning property, conducting business and entering into contracts
with other parties and capable of being bought and sold and inherited by successive owners. The
company is in fact a preferred choice of business structure mainly because it offers many distinct
advantages like limiting liability, independent corporate existence, opportunity to raise public funds,
perpetual succession, contractual powers etc. The company, which is of concern to us, now is what
is know as registered company this is because it is brought into existence by registration of
documents the most important of which is the memorandum of association and articles of
association and registration is to be done with the registrar of companies of state in which the
registered office of the company is to be situated.

It is very important that process of incorporation takes place before the company can be said to have
come into existence. Unless the process is complete, the independent legal entity does not come into
being. Only after incorporation does, the company attain its legal features; therefore the contractual
powers of the company can be exercise only after incorporation. However it may be necessary at
times for the people incorporating the company to enter into contracts purportedly on the behalf of
the yet to be formed company. Most of the times these contracts are entered into for purchase of
property or rights to be acquired or securing the service of some manger or expert. The persons
incorporating the company will want to offer the benefit of such agreements or contracts as an
inducement to the public to take shares hence it becomes necessary that these contracts be made
before the formation of company. These contracts are termed as pre-incorporation contracts. These
contracts are purported to be made on behalf of a company which is yet to come into existence i.e
before its incorporation. These contracts are also referred to as preliminary contract.

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 THE COMMON LAW POSITION

The common law position as regard as pre-incorporation contracts is the same, which was in
existence before the intervention of the legislature whether in European Union legislation or the
amendment of the Companies Act, 1985. In common law before its incorporation the company is
not in the existence therefore it has no capacity to contract. In a pre-incorporation contract the
promoter has two options; One is to enter into contract in the name of the company or secondly is to
enter contract in his own name as the agent of the company. In common law the company cannot
enter into the contract as it is not in existence and also nobody can contract for its as agent because
he cannot do an act, which cannot be done by the principal, through an agent, nor can company
ratify a pre-incorporation contract after its incorporation.1 There is however nothing to prevent the
company from entering into a new contract to put into effects the terms of the pre-incorporation
contract.2 The company entering into the new contract is an act of novation. Novation is when the
parties to the contract agree to substitute the existing contract with a new contract. Novation can be
of two types; novation involving change of parties and novation involving substitution of new
contract in the place of the old. As regard the principle of novation it must be kept in mind that the
mere acting after incorporation on the preliminary contract does itself constitute sufficient evidence
of creation of the new contract.3 It should be clearly establish that there came into existence a new
contract between the company and the third party.

The English court in Schmalz v Avery4 ruled that where a person purports to act as an agent he may
nevertheless disclose himself as being the principal and bring an action on his own. In the case of
Kelner v Baxter, the plaintiff intended to sell the wine to the company, which was to be formed, but
under the contract he agreed to sell the wine to the proposed director of the company and he
intended to buy the wine on the behalf of the company, but as it was not in existence at the time of
contract or when the good were delivered, they took personal delivery. The court held that as the
directors had contracted on the behalf of the principal who did not exist, they having received the
wine must pay for it.

1 Kelner v Baxter, (1867) LR-2 CP 174.

2 Touche v Metropolitan Railway Wearhousing Co. (1871) 6 Ch. App. 671.
3 Re Northumberland Avenue Hotel Co, (1886) 33 Ch. D. 16.
4 (1851) 16 QB 655.
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It was the case of New Borne v Sensolid5 that was the cause of much confusion in the common law
understanding of pre-incorporation contracts. While claiming that they were not deviating from the
earlier dictums, they did create some confusion by making a differentiation between the situations
where the promoter is acting as agent of unincorporated company i.e acting on behalf of the
company and where promoter is just authenticating the fact that the company is entering into
contract. In this one Newborne wanted to go into business and was on the point of registering his
company to be called Newborne (London) Limited. He also got got stationary printed in the name
of the company and started using the stationary even before the company came into existence. He
entered into contract with Sensolid and used the stationary of the company for the contract. The
contract was signed as Newborne (London) Limited and underneath was written a hieroglyphic that
was identified as the signature of the plaintiff. Subsequently the market for the goods went down
and Sensolid did not take delivery and wanted to avoid the contract. The defendant came to know
about the fact that company had not been incorporated and hence they pleaded that they had entered
into contract with the company and not with Newborne and so he could not recover. The judges said
that they were not departing from the earlier cases cited but held that in particular case the plaintiff
was not purporting to contract as agent or as the principal. They ruled that the plaintiff was making
the contract for the company and it was the company, which entered into the contract and the
signature of Newborne was to authenticate the contract. Newborne purported to sell the company’s
goods and not his goods. Since the company was not in existence when the contract was signed and
plaintiff cannot come forward to say, “it was my contract”. Therefore, the contract was nullity.

The differentiation made by the court was entirely incorrect. Now let us take the instance, where the
person acts as an agent of the company.6 In such an instance the principal is not in existence
therefore the agent has no authority and hence the contract fails to come into existence. This is
because agent has no independent existence separate from the principal. The agent cannot do
something that the principal could not have done. The principal could not have entered into these
contacts, as it was not in existence at that time. Alternatively the company enters into a contract that
the promoter authenticates.Such a contract is a nullity and therefore in both situations there is no
contract, which comes into existence. However in first instance the promoter has the option of
declaring himself be the principal and continue to be party to the contract and enforce it.

5 (1953) 1 All E R 708.

6 Agent acts ‘ for and on behalf’ of the company.
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 ENGLISH LAW POSITION

Section 36C of the Companies Act, 1985 states that “ A contract that purports to be made by or on
behalf of a company at a time when the company has not been formed has effect, subject to any
agreement to the contrary, as one made with the person purporting to act for the company or as
agent for it, and he is personally liable on the contract accordingly.

The aim of this provision is to increase security of transaction for third parties by avoiding the
consequences of the contract with the company being a nullity. Giving the third party an
enforceable contractual obligation, not against the subsequently formed company, but against the
promoter, provides the protection unless the third party agrees to forgo the protection. However the
courts have made it very clear that such consent couldn’t be deduced simply from the fact that the
promoter signed as the agent of the company; an express agreement presumably either in the
contract itself or subsequently, on the part of third party that the promoter should not be personally
liable was required.

If we draw the distinction between common law and section 36(c), In common law, if party intends
to contract with non-existent company, the result will be a nullity and the third party protected only
to the extent that the law of restitution provides protection. Under a statute, a contract, which
purports to be made with the company, will trigger the liability of the promoter, unless the third
party agrees to give up the protection. In other words, common law approaches the question of the
third party’s contractual rights against the promoter as a matter of the party’s intentions with no
presumption either way, whereas the statue creates a presumption in favour of the promoter being
contractually liable. The common law position is still important in those case that fall outside the
scope of the statue.

The most important case that dealt with the provision of the statue was Phonogram v Lane. The
facts of which were as follows, 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 held that payment can be enforce under the
section 9(2) of the European Communities Act, 1972, because agreement to repay was “a contract
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purporting to be made by the defendant as agent of the company at the time when the company had
not been formed and accordingly in the absence of anything to the contrary” the contract to repay
had effect under section 9(1) as a contract entered into by the defendant under which he was
personally liable.

Despite the statutory intervention through the introduction of section 36(c) in The Companies Act,
1955, there still persist considerable problems with its operation. The foremost among this is that
perhaps as a consequences if the legislature’s concern with the promotion of the third party, the
section does not make it clear whether the promoter acquire a right under the statue to enforce the
contract as well as contractual obligations. It is however submitted that if principles of contract are
applied, the concept of contactual mutuality will cover the issue and the effect will be that the
primer will also be able to enforce the contract.7

The second issue is that section 36(c) is only applicable when the contract “purports” to be made on
behalf of a company, which has not be formed. Both the parts of this provision must be satisfied, the
effect being that where the partied thought the company existed, though it has in fact been struck off
the register, the court of appeal8 held that the contract did not purport to be made on behalf of the
company of the same name which was hurriedly incorporated when the parties later discovered their
mistake. Since all were in blissful ignorance when the contract drawn up and signed, it could not be
said that the contract purported to be on behalf of the company, the need for whose existence was
not felt necessary at that time. That contract in truth that purported to be made on behalf of that
company which has been struck off, but that was not a company which could be said, it “ has not
been formed”. The plaintiff thus failed in his suit. The section thus has not been constructed as
protecting third parties in all situations.

However the most serious of the defects of the new rule is that it has done nothing to simplify the
procedure for the companies to “assume” the obligation of pre-incorporation agreement. The
European directive left it to the member states to act upon such a provision, however, the English
legislature has chosen not to do anything about it in England. The situation now is that a contract
purporting to be made on behalf of a company before it is incorporated cannot be adopted or ratified

7 Cotronic (U.K) Ltd v Dezonic, (1991) BCLC 721, Badgerhill Properties Ltd v Cottrell (1991) BCLC 805
8 Oshkas B’Gosh Inc v Dan Marbel, (1989) BCLC 507.
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by it after incorporation. It is necessary for a new contract to be made embodying the terms of the
old contract.

In the course of business, pre-incorporation transactions are inevitable features of every new
incorporation and we ought to make it as easy as possible to achieve what the parties intend so as to
encourage business. In this case if not generally, the legal technicality that ratification dates back to
the date of the transaction. So that it is not effective unless at that time, the ratifying person existed
and had capacity to enter into the transaction should not be applied. Companies should be allowed
to ratify the contracts. Where the company has taken benefit of promoter’s contract in such
instances the promoter should have the right to force the company to him consideration to the extent
of benefit enjoyed.

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 INDIAN POSITION OF PRE-INCORPORATION CONTRACTS

The expression promoter has not been defined in the Companies Act. The definition in sub section
(6) is meant for the purpose of the prospectus only. The term promoter actually is not a part of the
legal regime but one borrowed from the business world. The word promoter points to a person who
forms a company and gets it started. It indicates a person, who originates the scheme for the
formation of the company, has the memorandum and articles prepared, executed and registered, and
finds directors, settles the terms of the preliminary contracts and prospectus (if any) and makes
arrangement for advertising and articulating the prospectus and placing the capital.9 The promoter
controls the formation and future of the company.

The promoter as defined above may need to enter into contracts so as to incorporate the
company.These contracts entered into for the purposes of the company are what are referred to
as pre-incorporation contracts. In England there is one basic principle of law i.e., the legal
technicality that ratification dates back to the date of the transaction so that it is not effective unless
at that time, the ratifying person existed and had the capacity to enter into the transaction.

The position in India as regards this legal technicality is different. Section 182 of the Indian
Contract Act 1872 defines agent; and & principal;. If this is read with section 196 of the Act which
reads:
- Where acts are done by one person on behalf of another, but without his knowledge or authority,
he may elect to ratify or to disown such acts if he ratifies them, the same effects will follow as if
they had been performed by authority.

This ensures that it is possible for a subsequently incorporated company to ratify the transaction as
their own and claim the same. Therefore, in India the problem faced by ratification from general
principles of contract is not there. In India however there are different legal problems with regard
to pre-incorporation contracts. Before the coming into force of section 15(h) and section 19(e) of
the Specific Relief Act the position in India was the same as the common law position. However,
after the Act the position is drastically different.

9 A.Ramaya, Guide to Companies Act, Wadhwa and Company, Agra, Edn-14, 574(1998).
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 One of the important Indian cases as regards pre-incorporation contracts is Seth Sobhagmal
Lodha v. Edward Mills Co. Ltd.10 In this case the attention of the court was not drawn to the
provisions of the; Specific Relief Act and the court decided on the basis of common law decisions
of England and held that contract entered into on behalf of the company before its incorporation is
not binding on the company.

If the logic of the English decisions is followed then a pre- incorporation contract cannot bind the
company. It takes effect as a personal contract and the promoters themselves are personally liable.
However the problem is due to section 230 of the Indian Contract Act, 1872 that reads:
- In the absence of any contract to that effect an agent cannot personally enforce contracts entered
into by him on behalf of his principal, nor do they personally bind him.

Such a contract shall be presumed to exist in the following cases:

1. Where the contract is made by an agent for the sale or purchase of goods for a merchant
resident abroad.
2. Where the agent does not disclose the name of his principal.
3. Where the principal though disclosed cannot be used.
This would lead to a very big problem because under common law if the contract is entered into in
the name of the company, the contract is void because the company does not exist.

Entered into by the promoter as agent or on behalf of the company. Then due to the effect of section
230 of the Indian Contract Act, 1872 the agent cannot be sued unless there is a contract that
provides to the contract. The company under the common law cannot ratify the contract.Therefore
the situation was such that unless it was expressly provided that the promoter is the agent of the
company and he will be liable for the. contract only then will the third party be protected if the
company does not enter into a new contract with him. In present English law the presumption is that
promoter as agent is liable if there is no contract to the contrary.11 In the Indian position, the
presumption is just the opposite. Therefore what is needed is that a new clause should be added to
section 230 of the Indian Contract Act adding a presumption that agent will be liable if he is the
promoter of an unincorporated company. This can protect the interests of the third parties who
contract with the promoters and help in the formation of the company.

10 (1972) 42 Comp. Cas 1 (Raj).

11 S.36(c) The Companies Act, 1985 also The European Communities Act, 1972
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Claim for specific performance by the company against the promoter The promoter though he
fulfils some fiduciary duties12 cannot be described as a trustee as there is no beneficiary as defined
under section 3 of The Indian Trusts Act, 1882. He cannot also be strictly construed as agent since
there is no principal. -Hence the promoter occupies the peculiar position of quasi- trustee, The
important question, which arises now, is whether the declaration made by the promoter constitutes
transfer of property and whether the company can claim any interest in the property. The declaration
of the promoter that the property is held by him for the company to be formed does not constitute
either a sale, mortgage, lease, exchange or gift and the company before its incorporation is not a
living person and hence section 5 of the Transfer of Property Act, 1882 is not attracted. Such a
declaration also does not constitute a transfer to himself and the company has not come into force as
a beneficiary and hence it will not become a trust. Hence the transaction is outside the purview of
section 5 of the Transfer of Property Act and also Trust Act and it does constitute a conveyance as a
vesting instrument or other assurance of property and can be made orally under section 9 of the
Transfer of Property Act, 1882.

If the promoter purchases property from the third party, he will be acquiring the title though
apparently in his name for the benefit of the company yet to be formed. The property vests in him
for the benefit of the company though his assurance is sufficient to clothe the company after its
birth to claim full title. In Weavers Mills v. Balkis Ammal13 the judge held that the benefit of the
purchase made by the promoter passed to the company, on its incorporation, without any registered
deed. The reasoning is that the company can claim property acquired by the promoter after its
incorporation without any need for conveyance. Even if this reasoning is rejected just by the fact
that the promoter is a quasi- trustee he can be compelled to convey the property to the company and
if necessary on payment of consideration in view of the role of the promoter for obtaining the
benefit before its incorporation.14

Until the coming into force of the Specific Relief Act the promoters in India found it very difficult
to carry on the work of incorporation. Since contracts prior to the incorporation were void and also
could not be ratified, people hesitated to either supply goods or service for the cause of
incorporation. Promoters also felt shy of accepting personal responsibility.

12 Erlanger v. New Sombero Phosphate Co, (1818) L. R App Cas 1218.

13 AIR 1969 Mad 462, Also see Income Tax Officers v. Bijli Cotton Mills, (1953) 23 Com Cases 114.
14 Imperial Ice Manufacturing Co v. Mancheshaw, ILR 13 Bom 69
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The clauses of the Specific Relief Act came as a relief to the promoters. Section 15(h) of the
Specific Relief Act, 1963 provides that:
- Where 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 of the
company:
- Provided that the company has accepted the contract and has communicated such acceptance to
the other party to the contract.

The term “warranted by the terms of incorporation” means within the scope of the company’s object
as stated in the memorandum. Thus in Vali Pattabhirama Rao v. Sri Ramaija Ginning and Rice
Factory Pvt Ltd.15 it was held that where a person who intended to promote a company, acquired a
leasehold interest for it, held it for sometime for partnership firm, converted the firm into a
company which adopted the lease, the lessor was bound to the company under the lease. But it was
held in another case16 that in a contract by the promoters of a company for purchase of shares, when
it came into existence, is not a contract for the purposes of the company within the contemplation of
s.15 (h) of the Specific Relief Act. It should be clearly understood that the question whether a
particular contract is or not warranted by the terms of incorporation of a company can be answered
only by the facts and circumstances of each case.

The necessary conditions to enable the company to obtain specific performance of a contract made
by its promoters, before its incorporation is:
1. The promoters must have entered into the contract for the purposes of the company.
2. Such contracts must be warranted by the terms of incorporation of the company.
3. The company on coming into existence by incorporation must have accepted the contract.
4. The company must have communicated such acceptance to the other party to the contract either
expressly or impliedly.
5. Under s.149 of the Companies Act 1956 there are certain restrictions on the commencement of
business until certain conditions are fulfilled. These conditions are enumerated under s. 149 (1)
a, b, c, d and (2) a, b, c. Therefore, even after the company comes into existence, for the
company to commence business the company will have to follow these conditions. Therefore, it

15 [1986] 60 Comp. Cas. 568 A.P.

16 Imperial Ice Manufacturing Co v. Mancheshaw, ILR 13 Bom 69
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 is very obvious that an un-incorporated company cannot commence business through the
medium of pre- incorporation contracts. Therefore, the term “warranted by terms of
incorporation”; is limited by term not amounting to “commencement of business”. The logic
behind this is very simple, that the promoter acting for the company cannot do what the
company could itself not do. However the operation of s.149 is limited to only non-
private company that is public companies.

It is not only the company which is allowed under the Specific Relief Act to adopt and enforce
its pre-incorporation claims against third parties but s.19 (e) of the Specific Relief Act also allows
the other party to enforce the contract against the company - 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 incorporation of the company:
- Provided that the company has accepted the contract and communicated such acceptance to the
other party to the contract.

The liability declared in clause (e) was established in England in the58 course of the 19th century
by the decisions of the court of equity:
- Partly on the grounds of a distinct obligation having either been imposed on the company on its
original constitution or being assumed by it after its formation and partly on a ground
independent of contract and analogous to estoppel, namely that when a person has on certain
terms assisted or abstained from hindering the promoters of a company in obtaining the
constitution and the powers sought by them, the company when constituted must not exercise its
powers to the prejudice of that person and in violation of those terms.

This clause (e) now provides that the company has accepted the contract and communicated such
acceptance to the other party to the contract. This goes against the general rule for specific
performance of a contract of sale; a person who is not a party to the agreement is neither a
necessary nor a proper party. But it is acceptable as it is a rule provided by the legislature by way of
statute.

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 CONCLUSION

Now that both the Indian and English positions have been analysed and their faults identified it is
necessary to see what could be the possible reform. In England due to the intervention of the
European Communities Act, 1972 and subsequently the English Companies Act, 1985 the liability
of the promoter has been clearly and statutorily established and the agreements entered into by the
promoter purportedly for the company are now deemed to be the contracts of the promoter and he is
liable for them as if he were the principal. This is so unless there is a contract to the contrary. The
English statute stops here and no ratification of the contract by the company is possible. Therefore,
the possibility of the company taking over the contract from the promoter is completely ruled out.
The only way out for the company is the process of novation, i.e. the company enters into a new
contract with the other party to the same effect as the contract made on its behalf before
incorporation. However such a new contract will not be inferred if the acts of the company after
incorporation are due to the mistaken belief that it is bound by the contract made before
incorporation.

The only change that the English statute has brought about is the obliteration of the artificial
difference created by the decision in the case of Newborne v. Sensolid when it said that all
promoters who enter into the contract are liable. More or less the same effect was achieved by
Justice Oliver in Phonogram v. Lane but in that case it was still accepted that a contract with an
unincorporated company is void but the intention of the parties must be looked into rather than the
technicality as to the contract was signed.

India like other common law jurisdiction such as Singapore, allows for ratification by the company.
The main problem with Indian Law arises in the fact situation where there is no ratification by the
company. What this does is push the third party back into the quagmire of English common law,
which has arisen due to the decision of Newborne v. Sensolid. The decision of Phonogram cannot
be relied upon since it is based on statutory law. Also adding to the confusion of common law is s.
280 of the Indian Contract Act, which says that an agent cannot be made liable for the contract he
enters into on behalf of the principal. Therefore, both English and Indian law needs reform. Both
the laws cover complementary parts and what is needed is a combination of both the laws in each of
the two jurisdictions. In England they need to follow the recommendations of the Jenkins

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Committee Report and allow for ratification on the lines of the Indian legislation. India needs a
statute clarifying the position of the promoter and the third party when the company does not ratify
the pre-incorporation contract. India should move away from the common law position and adopt
the logic of the new s.36 C of the Companies Act, 1985. As regards the property held by the
promoter for the company a relationship of quasi-trusteeship should be declared as being
established. Hence the company should be entitled to take the property or benefits from the
promoter. However this does not mean that the promoters' interests should be harmed. The
company should be liable to pay the promoter consideration for taking the trouble of entering into
the contract for the company before its incorporation.

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