Pre-incorporation Contracts

These contracts are also known as preliminary contracts. Pre-incorporation contracts are those
contracts purported to be made on behalf of the company which has not been yet incorporated. A
contract which is made for the sake of the company before its incorporation would be termed as
a preliminary contract. These contracts may be related to any property, any business which the
promoters want to acquire for that company. Whenever, the promoters want that a certain
business should be taken over by the company after its incorporation then promoters would make
certain arrangements for the sale and purchase of such business on behalf of the company but
before a company has been incorporated it has got no capacity to make contract. As company is
not in existence before its incorporation then no one can make contracts on its behalf. As far as
these contracts are concerned, they will be considered void as far as it is related to the company
because the promoter cannot be the agent of the company which is not yet incorporated. As
before incorporation a company has got no personality of its own. In such case, the company can
neither sue nor be sued on such contracts.

First of all, the first rule in relation to the pre-incorporation contract is that a company cannot
enter into contracts before its incorporation. So, a company has got no legal existence unless it is
incorporated after fulfilling the legal formalities. A company is also incapable of being a
principal before its incorporation. Whenever a person cannot act on his own, then he cannot be
represented as well. A company cannot act on its own before incorporation as it has got no legal
personality yet. Consequently, it is incapable of acting through an agent. Whenever a person
wants to make contract on behalf of a proposed company then such person would do this thing in
a way which will make this person liable over this contract. Although, in negotiations of such
contracts it is said that this contract will be taken over by a particular company after
incorporation but still the kinds of these contracts may give rise to certain problems. Certain
cases will be gone through in this regard.

The first case is Kelner v. Baxter 1866. In this case, Mr. Baxter and others were running
restaurant business but they wanted to make a company which will acquire this business. They
entered into contract with Kelner to supply certain things to the proposed company. The things
were supplied. Afterwards, the company was incorporated but before it can pay to Kelner for the
goods it failed. Consequently, Kelner went against the promoters who were Baxter and others for
the price of those goods. It was said by the judge that in this case the company when it was
incorporated was a new born person and it had got its right and liabilities after its birth. So if the
contract had been made after the incorporation of the company it means that the promoters will
not be personally liable because the contract would have been made on behalf of the company as
it has been incorporated. In this case, the contract was made before the incorporation. So, the
persons who made the contract were considered to be personally liable and they were asked to
pay the price of these goods.
Another case is Newborne v., Sensolid(Great Britain) Ltd. 1954. Sensolid agreed to buy certain
goods and a letter was sent to Sensolid Ltd. by Newborne which was titled as Leopold Newborne
London. In the end it was proposed to be signed on behalf of the company and Mr. Newborn
signed it on behalf of the proposed company. Afterwards, due to the market situations Sensolid
did not wanted to complete this contract and did not accept these goods. During the proceedings
it was said by Sensolid Ltd. that at the time of the contract the company Newborne (London)
Ltd. was not yet in existence and this contract was purported to be made by this company and not
by Mr. Newborn. Consequently, it was also upheld by the court that this contract was purported
to be made by a company which actually did not exist. This contract was not enforced and even
Mr. Newborn could not enforce the contract because he was not a party to the contract. The
company also could not enforce that contract because at the time of formation of contract the
company was not incorporated. The rule followed by this particular case is that a company
cannot make a contract before its existence.

The second rule in this behalf is that a company which wants to get benefit from such
preliminary contract must make a new contract. A company cannot ratify or adopt a pre-
incorporation contract. If a company wants to get the benefit of preliminary contract it cannot do
this thing by adoption or ratification. It should make a new contract and this can be done by
novation where by a contract is replaced by another contract generally with the similar terms or
by slight changes n the terms or the parties. In such cases, principle of novation may be exercised
whereby the previous contracts between the promoters and the third party can be replaced by a
new contract with same terms and conditions which will be between the company and that
particular third party but a company cannot ratify or adopt a preliminary contract because the
company was not in existence at the time of formation of that contract. This principle was
established in the case Natal Land Co. Ltd. Pauline Colliery Syndicate 1904. In this case, the
Pauline syndicate wanted to enforce a lease which was acquired for its sake by another person
before its incorporation. The appellant company Natal Land Co. Ltd. did not want to give this
lease to the respondent company. It was held that in this case although the respondent is being
benefitted by this contract but it cannot adopt or ratify the contract which was made before its
incorporation.

The third rule in this behalf is that a promoter is in fiduciary relationship with his company. A
promoter has fiduciary obligation towards a company on whose behalf he is going to act. A
contract which is made between a promoter and a company can be avoided by the company if he
has not disclosed all of the material facts related to the contract in front of an independent board.
The case in this behalf is Erlanger v. New Sombrero Phosphate Co.1878. In this case, Erlanger
got a lease. Afterwards, he sold that lease to a newly formed company. He disclosed this fact to
the board of directors but most of these directors were only puppets and acting on his directions.
Afterwards, the public subscribed to the shares of the company but the details of that transaction
were not disclosed to them initially. When these details were disclosed, the shareholders of this
company went against Mr. Erlanger to avoid that particular deal. Their claim was upheld by the
court because the reason here was that Mr. Erlanger did not complete his fiduciary obligations by
disclosing the necessary facts which were related to the contract made between him and the
company.

The fourth rule regarding the pre-incorporation contract is that a promoter cannot make secret
profits. While acting in the capacity of a promoter, a person cannot make secret profits. If a
promoter has received any secret profit then he will be made accountable for that profit and he
will be asked to account for the profit to the company. In this regard, the important case is
Gluckstein v Barnes 1900. Gluckstein and others bought an exhibition and sold it to the company
which was newly formed. They got certain profits on this sale and they also sold securities to the
company which they bought for very less price but they were selling it at the face price of those
securities and they were also making secret profits from these transactions. As they were the
promoters of the company and were making secret profits, it was held that they should have
disclosed these profits in front of an independent board of directors. As they did not have done
this thing they were made to handover those profits to the company.