Pre-Incorporation Contract: An Analysis
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This Blog is written by Jatin Pandey from Dharmashastra National Law University, Jabalpur. Edited by Ravikiran Shukre.
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ABSTRACT:
In India, most of the contracts are governed under Indian Contract Act, 1872. Section 11 of the Indian Contract Act talks about who is competent to enter into the contract. According to it, a person who attains the age of majority and is of sound mind and also not disqualified from entering into the contract by any law is competent to enter into the contract. There is certain exception to the above-mentioned conditions. One thing is clear from the above conditions that existence of the person or legal person is this world is necessary. But the situation in the pre incorporation contract is totally different. These contracts are entered on the behalf of the company which has no existence in the world and also not registered under the Companies Act. In this article, author will cover what is the legal status of such contract? And also, how these contracts are enforced.
INTRODUCTION:
Pre incorporation are preliminary contracts. These contracts are generally entered into with parties by promoters on the behalf of the company which has no legal existence in this world. The reason behind entering into the such contracts is swift and smooth beginning or start of the company. These contracts are generally for the work such as renting of office, hiring workers etc. According to the definition of a contract, at least two parties/persons must enter into a deal with one another. As a result, the general rule is that if one of the contracting parties does not exist at the time of making the contract, then there is no contract between the parties. As a result, the company cannot enter into a contract until it is registered.
It may be claimed that the promoters sign the pre-incorporation contract at the behest of the company. However, there is a complexity here as well. The promoters function as the company’s agents when they sign the contract. But how can the principle, i.e., the corporation or company appoint an agent to act on its behalf if it does not exist? As a result, even if they claim to have entered into contracts for the benefit of the company, the Promoters become individually responsible for any agreements entered into on behalf of the firm or company.
SIGNIFICANCE:
Promoters are liable to the Company as well as third parties for their conduct and contracts entered during the pre-incorporation stage, including the statement in prospectus, either treating them as the agents or trustees of the Company to be incorporated, and are liable to the Company as well as third parties in respect of their conduct and contracts entered during the pre-incorporation stage, including the statement in prospectus. As a result, this category includes all business transactions or promises of commercial transactions made for the benefit of a future corporation or company. The distinction in terms of the beneficiary is the theoretical difference between an ordinary contract and a “Pre-Incorporation contract.”
Although the promoters and a third-party are the contracting parties, the intended beneficiary is the yet to be incorporated. Thus, an unincorporated company’s existence is not recognized by the law, it is not legally possible for it to enter into contracts, as stated in previous sections.
IMPACT:
In light of the prior discussion, it is important to consider a key premise of contract law: privity of contract. Only a party to a contract can sue, according to the doctrine of privity. If a third party is not a party to the contract, they have no right to sue. The same conclusion was affirmed in Phonogram Ltd. v. Lane, where the promoters were found accountable for the company’s breach of contract. Finally, Lord Goddard CJ stated: “as the company was not in existence when the contract was signed there never was a contract, and Mr. Newborn cannot come forward and say: ‘Well, it was my contract.’ The fact is, he made a contract for a company which did not exist”. Thus, a company is not bound by contracts entered into on its behalf by its promoters or other persons prior to its incorporation, as per common law. It is critical that the incorporation procedure be completed before the company can be deemed to have come into existence and acquired its legal attributes; otherwise, the independent legal entity will not exist if the process is not completed.
The solution of the above problem is given in Sections 15 (h) and 19 (e) of the Specific Relief Act of 1963. These provisions made the pre-incorporation contracts lawful, with some deviations from common law standards.
LEGISLATIVE PROVISIONS:
Section 15 (H) Of The Specific Relief Act – Who May Obtain Specific Performance:
“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 the incorporation, the company:
Provided that the company has accepted the contract and has communicated such acceptance to the other party to the contract.”
Section 19 (E) Of The Specific Relief Act – Relief Against Parties and Persons Claiming Under Them by Subsequent Title:
“When the promoters of a company have, before its incorporation, entered into a contract for the purpose of the company and such contract is warranted by the terms of the incorporation, the company:
Provided that the company has accepted the contract and communicated such acceptance to the other party to the contract.”
CASE LAWS:
Vali Pattabhirama Rao v. Sri Ramanuja Ginning:
In this case the court held that the promoter can transfer his right to sue to the company by including it in the articles or terms of association, according to the Court. Thus, if the company is formed before the timeframe and applies in any form, including a letter endorsing and accepting the promoter’s actions, the firm is considered to be in good standing. On the basis of adoption or novation by a substituted application, the same could be justified.
Howard v. Patent Ivory Manufacturing Co:
In this case it was held that “A company cannot ratify a contract established before its creation, but it can enter into a new contract after its formation to give effect to a deal made before its formation.”
ANALYSIS:
Specific performance of a contract can be obtained by any party to the contract or a representative acting in the principal’s interest under Section 15(h) of the Specific Relief Act when the Promoters of a company enter into a contract before the company’s incorporation and the contract is warranted under the company’s incorporation terms. In the same way, relief against parties can be obtained under subsequent title under Section 19(e) of the Specific Relief Act provided the newly formed firm has accepted the pre-incorporation contract and conveyed its acceptance to the other party.
Pre-incorporation contracts can thus be enforced in India by including (a) the contract in the terms of incorporation, (b) entering into a new contract with the other party or the Promoter, or (c) recognizing the obligations of the pre-incorporation contract directly or impliedly.
After the business is formed, the parties can always request that the preliminary agreement be confirmed by the company or that novation be requested. The term “novation” refers to the act of entering into a new contract and replacing the prior agreement with new obligations or parties. The old contract (here, the pre-incorporation contract) and a new contract would be entered into by the parties under novation. Section 62 of the Contract Act also recognizes the notion of novation. As a result, it is usually preferable to enter into a formal agreement between parties before to the incorporation of a company to demarcate each party’s rights and duties and to establish a mechanism for damages in the event of a pre-incorporation agreement breach.
CONCLUSION:
Pre-Incorporation contracts are legally valuable and enforceable, despite the fact that they are regarded to have no legal position or worth. There were many problems in the law of pre-incorporation contracts in the past since no proper statement of law had been given in the Indian Companies Act addressing pre-incorporation contracts and the drafting problem. As a result, the judiciary is doubtful whether promoters can shift their liability or whether the firm is immune from liability. As we have seen, several adjustments have been made to the company act to address the problem of pre-incorporation contracts in order to make it easier for corporate companies to incorporate their businesses. The promoter is personally accountable for pre-incorporation contracts under American Law, and Indian Law. American Laws and Indian Laws are far more evolved and unique than English Common Laws and effective in overcoming the problem of pre-incorporation contract. English courts, on the other hand, continue to follow the basis and rule of law established in Kelner v Baxter.
REFERENCES:
(1) Probir Kumar Misra v. Ramani Ramaswamy and Ors., [(2010)154 CompCas 658 Mad]
(2) Newborne v. Sensolid (Great Britain) Ltd. [(1954) 1 QB 45]
(3) [(1986) 60 CompCas 568 (AP)]
(4) All Answers Ltd. (November 2018). Pre-incorporation Contracts and Promoters and Their Liability in India. Retrieved from https://ukdiss.com/examples/pre-incorporation-contracts-liability-india.php?vref=1
(5) http://www.legalservicesindia.com/article/134/Pre-incorporation-contracts.html
(6) https://ukdiss.com/examples/pre-incorporation-contracts-liability-india.php#citethis
(7) https://blog.ipleaders.in/tips-drafting-pre-incorporation-contracts/
(8) https://smallbusiness.chron.com/preincorporation-contract-11865.html