Nature of Pre-Incorporation Contracts

Introduction:

A pre-incorporation contract is basically an agreement that is thru by an individual at the directive of a corporation that does not exist at the stint of signing such agreement. These agreements are entered into as there are primary contracts and expenses suffered before an association takes form. An example of a pre-incorporation contract is a co-founder’ agreement.  The main aim of the individual who is signing the agreement on behalf of the company is to bind the company to the agreement in forthcoming when the company is finally incorporated. 

The person who enters into a pre-incorporation agreement is usually termed as the Promoter.  According to the Indian Companies Act 2013 the Promoter is defined under section 2(69) of the Act.[1] Nonetheless, the definition of promoter mentioned under the Companies Act only outlines the Promoter once the company has been formed and not about pre-incorporation.[2]

As per the definition of the contract, there has to be a minimum of two parties/persons who enter into a contract with each other. As per the general principle, there will be no contract if one of the parties to the contract is not in being at the time of entering into the contract. Hence, the company can’t enter into a contract formerly it comes into existence, and it comes into existence only subsequently its registration. It may be contended that the pre-incorporation contract is entered into by the promoters on behalf of the company. But here also, is a mesh. The promoters, while entering into the contract, perform as agents of the company. But when the principal, i.e., the corporation is itself not in existence, how can it assign an agent to act for it? So, the promoters, themselves and not the corporation, become personally accountable for all contracts entered into by them even though they claim to be acting for the forthcoming corporation.

Types of Pre-Incorporation Contracts

There could be several types of pre-incorporation agreements.  This could array from a co-founder’ agreement wherein the founders of a company yet to be incorporated approve of their rights and responsibilities formerly incorporating the company.  It might also be an employment agreement with a manager or a corporation secretary whose assistances are vital for the corporation to be incorporated.  The manager or company secretary’s remuneration, obligations to the forthcoming company, etc. would be encompassed in this pre-incorporation employment agreement.[3]

Legal Status of Pre-Incorporation Contract

It is very difficult to define the legal status of a pre-incorporation contract. According to the Specific Relief Act under Section 15(h), the specific performance of a contract can be achieved by any party thereto or a representative in the favor of the principal, when the Promoters of a corporation have entered into a contract prior to the incorporation of a company and such a contract is acceptable under the company’s incorporation terms.  Likewise, under Section 19(e) of the Specific Relief Act if the recently incorporated corporation has recognized the pre-incorporation contract and has communicated its acceptance to the other party, relief counter to parties can be claimed under the consequent name.[4]

Liability of Promoter Relating to Pre-Incorporation Contract

Earlier the transient of the Specific Relief Act 1963, the concept of pre-incorporation in India was completely analogous to the English Common Law. This was constructed on the general rule of the contract where two consenting parties are confident to contract and the third party is not associated with the enforcement and liability underneath the terms of the contract. And as the corporation does not come into existence formerly its incorporation, so the promoter signs contract on behalf of the corporation with a third party, and that is why the promoter was exclusively liable for the pre-incorporation contract under the established ruling of Kelner v Baxter.[5]

Liability of Promoter

Generally, in pre-incorporation contracts, promoters are held liable. If a corporation does not sanction or approve a pre-incorporation contract under the Specific Relief Act, then the common law principle would be applicable and the promoter will be held accountable for a contract breach.[6]

Is Promoter Personally Held Liable for Pre-Incorporation?

In the case of Kelner v Baxter,[7]where the promoter on behalf of an indistinct corporation accepted an offer of Mr. Kelner to sell wine, subsequently, the corporation failed to reimburse Mr. Kelner, and finally, he brought the action against promoters. Erle CJ found that the principal-agent relationship cannot be in being before incorporation, and if the corporation was not in existence, that means the principal of an agent does not come into existence. He further explains that the corporation cannot take the liability of pre-incorporation contract through adoption or ratification; as a stranger cannot sanction or adopt the contract and the corporation was a stranger for the reason that it was not in existence at the time of formation of the contract. Consequently, he held that the promoters are personally liable for the pre-incorporation contract for the reason that they are the consenting party to the contract.

In the case of Newborne v Sensolid[8] (Great Britain) Ltd, the Court of Appeal construed the verdict of Kelner v Baxter in a diverse mode and developed the principle more. In this case an unformed corporation come into a contract, the other contracting party declined to perform his duty. Lord Goddard observed that formerly the incorporation of the company cannot be in existence, and if it is not into being, then there was no existence of the contract which the unformed corporation signed. So, the corporation cannot bring an action against the contract of pre-incorporation, and also the promoter cannot bring the suit for the reason that they were not the party to the contract.

This case created some amount of muddle that, if the contract was signed by the agent or promoter, then he will be liable personally and he has the right to sue or to be sued. But then again if an individual representing him as director of an unformed corporation enters into the contract, then the contract would be unenforceable. This dissimilarity was found objectionable by Windeyer J in Black v Smallwood[9] and this was also disparaged by Professor Treitel in the Law of Contract. Far along in the case of Phonogram Limited v Lane,[10] Lord Denning established the position, he found that if an unformed corporation enters into the contract, then it cannot bind the corporation, but the lawful effect of contract does not completely lack. In addition, even in that situation the promoter or representor are personally liable for the pre-incorporation contract.

In the famous case of Phonogram Limited v Lane, an individual was attempting to form a corporation that was going to run a group of pop artists and that individual arranged financial assistance from a recording company for the group of pop artists. Then this firm not ever came into existence, and the amount was due. The recording corporation took an action against the individual who represented the unformed company to them. In the cases of Kelner v Baxter, Newborne v Sensolid, Black v Smallwood and section 9(2) of the European Communities Act, 1972, Lord Denning analyzed and found out that the promoters are personally held responsible for the pre-incorporation contract.

These principles were found relevant in the Indian case. In the case of Seth Sobhag Mal Lodha v Edward Mill Co. Ltd[11]., the Rajasthan High Court followed the approach of Common Law regarding the liability of pre-incorporation contract. This case was criticized by A. Ramaiya and he concluded that learned judges did not note the Specific Relief Act.[12]

Doctrine of Equity

In India under the doctrine of equity, the corporation can be held accountable. In the famous case of Weavers Mills Ltd V. Balkies Ammal,[13] the corporation was held liable because it receives the advantage of a pre-incorporation contract. But the position in English Common Law is regardful. Conferring to Chitty on Contract, even in equity, the corporation cannot be held liable for a pre-incorporation contract.

Conclusion

The option of entering into a preliminary or pre-incorporation agreement all depends upon the parties involved in the incorporation and whether the Promoters believe that it would have an advantage for them and the forthcoming corporation.  Though, it is always a decent idea to enter into a written agreement with parties to clearly demarcate the rights and responsibilities of each side.  Moreover, it helps in resolving a lot of disputes that just an oral agreement could bring about. Though, it is always a decent idea to enter into a written agreement with parties to clearly demarcate the rights and responsibilities of each side.  Moreover, it helps in resolving a lot of disputes that just an oral agreement could bring about.

The Promoter is accountable, personally, for the contract of pre-incorporation, for the reason that at the period of establishment of a pre-incorporation contract, the corporation does not come into existence, therefore neither the principal-agent relationship exists nor does the company turn out to be the party. It is also found that the promoter is personally accountable for the pre-incorporation contract in the countries like America, English and India.

In the present COVID-19 pandemic time when even parties to written contracts, an unwritten pre-incorporation agreement would add to a misunderstanding between the parties and a dispute which could have been avoided had they entered into a written agreement. 

References:

• Section 2(69) of the Indian companies Act,2013; Last Visited- July 16, 2021.
• By Ayush Verma; Tips for drafting pre-incorporation contracts; https://blog.ipleaders.in/tips-drafting-pre-incorporation-contracts/; Published on- August 28, 2020; Last Visited- July 16, 2021
• By Diva Rai; Formation and Incorporation of a Company; https://blog.ipleaders.in/formation-and-incorporation-of-a-company/; Published on- February 22, 2020; Last Visited- July 16, 2021.
• By Suryabhan singh; Pre-incorporation contracts; http://www.legalservicesindia.com/article/134/Pre-incorporation-contracts.html; Last Visited- July 16, 2021
• Pre-Incorporation Contracts and the Promoter; https://www.lawteacher.net/free-law-essays/contract-law/pre-incorporation-contracts-and-the-promoter.php; Published on- 4th Nov 2020; Last Visited- July 16, 2021
• Sarkar, M.C., Sudipto Sarkar and K. Kanman, 2007, Sarkar’s Specific Relief Act, Wadhwa & Company, New Delhi & Nagpur, Sixteenth Edition; Last Visited- July 16, 2021
• Kelner v Baxter (1866) LR 2 CP 174; https://lawcasesummaries.com/knowledge-base/kelner-v-baxter-1866-lr-2-cp-174/; Last Visited- July 16, 2021  
• Seth Sobhag Mal Lodha and Ors. vs Edward Mills Co. Ltd. And Ors. on 19 December, 1969; https://indiankanoon.org/docfragment/1716446/?formInput=indian%20partnership%20act%20%20doctypes%3A%20highcourts; Last Visited- July 16, 2021.
• Anantharaman, K.S., 2005, Lecture on Company Law & Competition Act (Including Secretarial Practice), Wadhwa & Company, Nagpur & New Delhi, Ninth Edition; Last Visited- July 16, 2021
• Weavers Mills Ltd V. Balkies Ammal AIR 1969 Mad 462, (1969) 2 MLJ 509; https://indiankanoon.org/doc/42086/; Last Visited- July 16, 2021.
• Newborne v Sensolid (Great Britain) Ltd [1954] 1 QB 45; https://simplestudying.com/newborne-v-sensolid-great-britain-ltd-1954-1-qb-45/; Last Visited- July 16, 2021   
•   Black v Smallwood [1966] HCA 2; 117 CLR 52; [1966] ALR 744; https://jade.io/j/?a=outline&id=65900; Last Visited- July 16, 2021   
•   Phonogram Ltd v Lane: CA 1982; https://swarb.co.uk/phonogram-ltd-v-lane-ca-1982; Last Visited- July 16, 2021   

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Other Sources:

[1] Section 2(69) of the Indian companies Act,2013; Last Visited- July 16, 2021.

[2]By Ayush Verma; Tips for drafting pre-incorporation contracts; https://blog.ipleaders.in/tips-drafting-pre-incorporation-contracts/; Published on- August 28, 2020; Last Visited- July 16, 2021.

[3] By Diva Rai; Formation and Incorporation of a Company; https://blog.ipleaders.in/formation-and-incorporation-of-a-company/;  Published on- February 22, 2020; Last Visited- July 16, 2021.

[4] By Suryabhan singh; Pre-incorporation contracts; http://www.legalservicesindia.com/article/134/Pre-incorporation-contracts.html; Last Visited- July 16, 2021

[5] Pre-Incorporation Contracts and the Promoter; https://www.lawteacher.net/free-law-essays/contract-law/pre-incorporation-contracts-and-the-promoter.php; Published on- 4th Nov 2020; Last Visited- July 16, 2021

[6] Sarkar, M.C., Sudipto Sarkar and K. Kanman, 2007, Sarkar’s Specific Relief Act, Wadhwa & Company, New Delhi & Nagpur, Sixteenth Edition; Last Visited- July 16, 2021

[7]Kelner v Baxter (1866) LR 2 CP 174; https://lawcasesummaries.com/knowledge-base/kelner-v-baxter-1866-lr-2-cp-174/;  Last Visited- July 16, 2021

[8]Newborne v Sensolid (Great Britain) Ltd [1954] 1 QB 45; https://simplestudying.com/newborne-v-sensolid-great-britain-ltd-1954-1-qb-45/; Last Visited- July 16, 2021   

[9] Black v Smallwood [1966] HCA 2; 117 CLR 52; [1966] ALR 744; https://jade.io/j/?a=outline&id=65900; Last Visited- July 16, 2021   

[10] Phonogram Ltd v Lane: CA 1982; https://swarb.co.uk/phonogram-ltd-v-lane-ca-1982; Last Visited- July 16, 2021   

[11]Seth Sobhag Mal Lodha and Ors. vs Edward Mills Co. Ltd. And Ors. on 19 December, 1969; https://indiankanoon.org/docfragment/1716446/?formInput=indian%20partnership%20act%20%20doctypes%3A%20highcourts; Last Visited- July 16, 2021.

[12] Anantharaman, K.S., 2005, Lecture on Company Law & Competition Act (Including Secretarial Practice), Wadhwa & Company, Nagpur & New Delhi, Ninth Edition; Last Visited- July 16, 2021

[13] Weavers Mills Ltd V. Balkies Ammal AIR 1969 Mad 462, (1969) 2 MLJ 509; https://indiankanoon.org/doc/42086/; Last Visited- July 16, 2021