NAME-AKASH KUMAR.

S
ROLL NO-5
SUBJECT-COMPANY LAW
TOPIC-PROMOTER AND PREINCORPORATION OF CONTRACT
CLASS- VIII SEM B. COM LLB
 CONTENTS

 Introduction
 Meaning Of Promoter And Nature Of Pre-
Incorporation Contract
 Pre-Incorporation Contract
 Liability Of Promoter
 Table of cases
 CONCLUSION
 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.

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.

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

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.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.

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.

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.
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.

The prime characteristic of the company structure is separate legal identity,

which allows it to enter into contract with parties and own assets in its own
name. A company obtains the legal identity after its incorporation and
registration in India. However, more often, it is observed that the promoters
enter into contract with third parties even before pvt ltd company
registration in India, whether for the registration purpose itself or otherwise.
Here, we are discussing whether these contracts made in name of promoters
are valid or not. These contracts are known as promoter’s contract or pre-
incorporation contract in legal terms.
While execution, the contracts are entered by the promoters on behalf of the
company. Although, the promoters act as agent of the company to represent
its interest, while registration, the principal is not in the existence.
Therefore, the contracts entered by the promoters do not bind the company
or the third party. The validity and enforceability of the pre-incorporation
contracts is always in question. However, the fix lies in Section 15 and 19 of
the Specific Relief Act, 1963.

Section 15(h) provides that the company may ask for specific performance
from the third party if the pre-incorporation contracts are entered by
promoters for the purpose of the company and subject to terms of
incorporation of company. This condition can only be applied if the company
has expressly shown the acceptance of such contracts after its
incorporation and communicated the same to concerned third party (i.e. the
other party). Under similar circumstances, specific performance may be
enforced against the company by the other party to the contract u/s 19(e) of
Specific Relief Act.

Hence, for enforcement of the contract by the company against the other
party to contract, the members must ratify the contract followed by
communication of acceptance to other party. Unless the contract is
accepted by the company, the company may not receive any benefit from
such contract and the promoters would be personally liable for the contracts.

In case, the said contract is not accepted by the company in its meeting,
such contract is binding to the promoters and the both, promoters and other
party may demand specific performance against each other.

While executing contract on behalf of company, some also mistake to

contract in name of company even before it is incorporated. Let us analyse
its validity too.

Company is artificial person which comes into existence after completion of

incorporation process. Unless a company is born, it cannot execute any
agreement or be a party of contract. Therefore, such contracts entered in
name of company are not valid due to its non-existence. Enforceability of
such contracts would be questionable and may also be denied. Hence, it is
preferable to enter into contract as promoter of the company with condition
as to incorporation of company. Such contracts can be enforced by the
company if it is accepted as discussed above.

Promoter’s contracts or pre-incorporation contracts are inevitable in most

cases. Process like private limited company registration in india would
always be allied with such contracts whether in form of contract with
professional or property owners or otherwise that would affect the company
operations in one or the other way. Hence, while such execution these
prospects must be known by the promoters. Also, it would be advisable to
ask the professionals while executing such contract that which aspects
must be kept in mind.

The end result envisaged is the exchange of something of value usually

money, at least in most instances. The same end result is worked towards in
a pre-incorporation contract; however the achievement of this result will not
be possible if the contract does not make provision for a special clause
dealing with the pre-incorporation aspect.

There is no correct way to phrase such a clause, but to ensure that the
contract will be legally enforceable the construction of the clause is
important.

The following aspects should be addressed in the clause dealing with the
incorporation of the company:

There must be an undertaking given by the agent acting on behalf of the

company to be form that the company will be incorporated within a specific
timeframe.

An undertaking that the company will be bound by the contract once

incorporated.
In the event of the company is incorporated but refuses to adopt and ratify
the agreement or rejects it conditionally, partially or completely who is to be
held liable?

Who will be liable as purchaser if any of the above conditions are not
fulfilled?

While the purpose of having such a clause in a contract is to protect the

seller, by ensuring that there is a legal subject (i.e. Company or Agent) that
will be had liable as purchaser. The true intention of the Section 21 of the
Companies Act 71 of 2008 is to provide a legal basis for companies that are
not yet incorporated to engage in business transaction before, it is legally in
existence.

Pre-Incorporation contracts thought to have no legal status and value, but

are legally valued and enforceable. In past, there are lot of flaws in the law of
pre-incorporation contract as there were no proper statement of law had
explained in the companies act of India regarding pre-incorporation contract
and the problem of drafting which leads to a uncertainty for the judiciary to
decide whether to promoters can shift their liability or company is safe from
being held liable. As we have seen a lot of changes made in the company act
to tackle the problem in the law of pre-incorporation contract to make it easy
for the corporate company at the time of incorporation of their company.
There are some problems regarding the ratification of the contracts made at
the time of incorporation to protect the company or their members from any
liabilities. As we are going to discuss in this research the liability of the
promoters after pre-incorporation contracts and the problem arises due to
pre-incorporation contracts.

As Per the companies act India 1956 pre-incorporation contracts are

contracts purported on behalf of an unformed company or in other words the
company which does not have any legal existence[1] (i.e. before its
incorporation). This is the fact that for new incorporation very often there is
a necessity of the pre-incorporation contracts.

It is very important that the process of incorporation must be done before the
company can be said to have come into existence to attain its legal features
otherwise, if the process is not complete the independent legal entity does
not come into existence. Most of the times the pre- incorporation contracts
can be done for purchase of property of rights or rights to be acquired or for
securing the services of some mangers and experts. The persons
incorporating the company[2] will want to offer as an inducement to the
public for benefits of such agreements and contracts to take shares hence it
become necessary that these contracts be made before the formation of the
company.
 CASES

Lindsay International Pvt. Ltd. & … vs Laxmi Niwas Mittal & Ors on 18
September, 2017

On such consideration, the suit was held to be barred by limitation and,

accordingly, dismissed under Order 7 Rule 11(d) of the Code of Civil
Procedure.

An agreement can be oral. An oral agreement can be enforced. It can be

proved by conduct and course of dealings between the parties.

It is for the plaintiff to prove at the trial the agreement pleaded in Paragraph
6 of the plaint.

Mr. Chidambaram has referred to Section 15(h) of the Specific Relief Act,
1963. The said section relates to pre-incorporation contracts. Where the
promoters of company, that is, the persons who were engaged in setting up
the company entered into contracts with parties would procure its formation
and such contracts are within the limits of the objects of the company, then
the company after its incorporation may sue to enforce the contracts and the
other contracting party cannot raise any objection on the ground of privity.
Conversely, the company if it ratifies such contract is bound by its obligation.
This clause is conversed to Clause € of Section 19 of the Specific Relief Act
on which Mr. Kapoor has relied on behalf of the plaintiffs. Mr. Kapoor has
emphasized on the expression “warranted by the terms of the incorporation”
appearing in the said section and has argued that continuous support by the
defendant No.1 prior and after incorporation of the plaintiff No.1 and its
assurance that all supplies for the AM Companies would be procured solely
through the plaintiff No.1 are now being breached by the defendant No.1. The
other way of looking at is that if a situation arises as to whether the
transactions made by the company are ultra vires for which the purposes for
which the company was incorporated the said phrase in Section 19€ comes
to the aid of the company to relieve the company from its liability. This
specific argument of Mr. Kapoor was that the record manifests that the
buying and selling was indeed warranted by the terms of incorporation of the
company. The said Section 19€ is conversed to Clause (h) of Section 15.
Vali Pattabhirama Rao And Anr. Vs Sri Ramanuja Ginning And Rice … on 26
December, 1983

“In order that the company may be bound by agreements entered into before
its incorporation, there must be a new contract to the effect of the previous
agreement.”

30. The editors of Palmer’s Company Law, in their 22 nd edition, volume 1, at

page 271, state regarding pre-incorporation contracts :

“In common law. Before its incorporation a company has no capacity to

contract. Consequently, in common law, nobody can contract for it as agent
because an act which cannot be done by the principal himself cannot be
done by him through an agent, nor can a pre-incorporation contract be
ratified by the company after its incorporation. There is, however, nothing to
prevent the company, when incorporated, from entering into a new contract
to put into effect the terms of the pre-incorporation contract. But the mere
acting after incorporation on the preliminary contract does not in itself
constitute sufficient evidence of the creation of a new contract.” Thus,
virtually a new contract has to be entered into in order to bind the company
in respect of contracts entered before its incorporation. But, in India, both
the Specific Relief Acts 1 of 1877 and 47 of 1963, made provisions making
the pre-incorporation contracts binding on the company. Section 21(f) of the
1877 Act which corresponds to section 14 of the 1963 Act did not retain in
the said provision as the said clause is covered by section 9. The present
section 15(h) corresponds to section 23(h) of the previous Act and section
19€ of the present Act corresponds to section 27€ of the previous Act.
Section 15(h) provides that the company can enforce pre-incorporation
contracts, if such contract is warranted by the terms of the incorporation and
the company has accepted the contract and has communicated such
acceptance to the other party. The converse position is covered by section
19€ where a third party can enforce the contract against the company if such
contract is warranted by the terms of the incorporation of the company and
the company has accepted the contract and communicates such acceptance
to the other party to the contract, and hence, the dicta in Natal Land and
Colonization Co. Ltd. V. Pauline Colliery Syndicate Ltd. [1904] AC 120, 126
(PC) of Lord Davey speaking for the Judicial Committee “that a company
could not by adoption or ratification obtain the benefit of a contract
purporting to have been made on its behalf before the company came into
existence”, cannot be invoked in our country. No doubt it is true that the
sections in the Specific Relief Act are concerned with the executory
contracts and cannot be applied to conveyances of immovable property and,
hence, we have to see whether the title has passed to the company and
whether the provisions of the Transfer of Property Act stand in the way.
 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€ 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.