Pre-Incorporation Contracts And The

Promoter
Introduction
In order to get the benefits of a ‘corporate personality', 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. The simple reason behind it is that
before incorporation company do no has any legal existence before incorporation, and if
the ‘association of persons' enters into an agreement in the name of company before
incorporation; the agreement would be void ab initio.
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
can enter into the agreements in the benefit of ‘association of persons' or prospective
company; these agreements are known as pre-incorporation contract.

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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?
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. 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. 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,
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.

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 this position was confirmed.
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.

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.

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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, 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.

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 shift 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 which says that the company cannot ratify or
adopt the pre-incorporation contract. 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 this position was accepted.

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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 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'.
Novation is different from the Ratification; because in Novation, a new contract is made
on the same terms but this time between the company and the third party, 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.
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,
the English Court accepted the novation of contract.

Doctrine Of Equity
In India under the doctrine of equity the company can be held liable. Weavers Mills Ltd
V. Balkies Ammal, company was held liable because it get the benefit of pre-
incorporation contract. But the position in English Common Law is deferent. According
to Chitty on Contract, even in equity the company cannot be held liable for pre-
incorporation contract.
Brief Comparison Between Indian And Other Countries Law
Regarding Promoter's Liability For Prep-Incorporation
Contract
Although under the English Common Law, the American law and the Indian Law
recognize the rule that promoter is personally liable for pre-incorporation contract,
American Laws and Indian laws are much more innovative and effective to solve the
problem of Pre-incorporation Contract. Whereas the English Courts still follow the
principle of Kelner v. Baxter. Although in UK, Contracts (Rights of Third Parties) Act
1999 brought some relief, but it is not as broad as the American and Indian Laws are.
Under English Common Law, the ratification or adoption, after the incorporation, did not
release the promoter from liability of pre-incorporation contract. Whereas in American
Court recognize that if the after the incorporation company can ratify or adopt the
contract, and this would bound the company and not the promoter. Indian Law the rule of
Kelner v Baxter is applicable but under the Specific Relief Act 1963, section 15(h) and
19(e) promoter can shift his right and responsibility to the company, if it is warranted by
the terms of incorporation.
The principle of novation of pre-incorporation contract is applicable in above three
counties, the reason behind is that, the novation replace the old contract with the new
contract, so there is not problem of non-existence of company.
Now after the Contracts (Rights of Third Parties) Act 1999, English laws may also allow
company to become the part of pre-incorporation contract, when it acquire its legal
existence.

Conclusion
This research paper finds that, promoter is personally liable for the pre-incorporation
contract, because at the time of formation of pre-incorporation contract, the company
does not come in existence, so neither the principle agent relationship exist not the
company become the party. Company is not liable for the pre-incorporation contract when
it come in existence, but under the arrangement of section 15(h) and 19(e) of the Specific
Relief Act 1963, company can take the rights and liability of promoter. It is also found
that promoter is personally liable for the pre-incorporation contract in American Law,
English Law and Indian Law.