COMPANY LAW

PROJECT ON

ROLE OF PROMOTER IN PRE INCORPORATION CONTRACT-

INDIAN CONTEXT

Submitted to: Prof. Anil R. Nair

Submitted by: Ancy Varghese (926)

On 06/09/2016
 INTRODUCTION
Common law rule states that, a company cannot enter in to a contract before its incorporation
because it does not yet exist as legal person. Nor, for the same reason, it is bound by the
contracts made by agents on its behalf before its incorporation. It is; however, open to the
company to enter into a fresh contract after its incorporation. Under the general principles, it
cannot even ratify such contracts made by the promoters before its incorporation.1 It makes no
difference that the contract delimits the funds out of which the other contracting party is to be
paid to the companys paid up capital.2 Nor does it make any difference if the contract were
expressly made conditional on the company being incorporated.

In India there is a marked deviation from the principles of the common law. Under the provisions
of S. 19 (e) of the Specific Relief Act, 1963, specific performance may be enforced against a
company where its promoters have, before its incorporation, entered into a contract for the
purpose of the company and such contract is warranted by the terms of incorporation of the
company, e.g., by inclusion in the Articles of Association. It is, however necessary that the
company in such a case must have accepted the contract after its incorporation and
communicated such acceptance to the other party to the contract. Section 15(h) of the same act,
which is identically worded, provides for obtaining of specific performance by a company. In
view of these two provisions the decisions of the English courts stating that a pre- incorporation
contract of a promoter on behalf of the company is nullity and cannot be enforced by or against
the company, must be considered in the light of Ss. 15 (h) and 19 (e) of the Specific Relief Act.

WHO IS A PROMOTER
A promoter may be an individual, syndicate, association, partner or company. The expression
promoter has been defined under Section 2(69) in the Companies Act, 2013 as: promoter
means a person

1
Kelner v. Baxter (1866) L. R. 2 CP 174; Newborne v. Sensolid (Great Britain) Ltd. (1953) 1 A11. ER. 708 : (1954) 24
Com. Case. 159
2
Scott v. Lord Eburry (1867) L.R. 2 CP 255
a) who has been named as such in a prospectus or is identified by the company in the annual
return referred to in section 92 or
b) who has control over the affairs of the company, directly or indirectly whether as a
shareholder, director or otherwise or
c) in accordance with whose advice, directions or instructions the Board of Directors of the
company is accustomed to act:
Provided that nothing in subclause
(c) shall apply to a person who is acting merely in a professional capacity The term is used
expressly in sections 35, 39, 300 and 317.3
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 Preincorporation 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. The company does not in legal existence at time of preincorporation
contract. If someone is not in legal existence then he cannot be a party to contract. Before the
passing of the Specific Relief Act 1963, the position in India, regarding preincorporation
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 preincorporation contract.
However, the provisions of the specific relief Act, 1963 makes the preincorporation contracts
valid. Section 15(h) and Section 19 (e) of the Specific Relief Act of 1963, deviate from the
common law principles to some extent.
SECTION 15 (H) OF THE SPECIFIC RELIEF ACT, 1963
Except as otherwise provided by this Chapter, the specific performance of a contract may be
obtained by,

3
Section 2(69) Companies act, Universal Publications
(a) Any party thereto
(b) The representative in interest or the principal, of any party thereto
Provided that where the learning, skill, solvency or any personal quality of such party is a
material ingredient in the contract, or where the contract provides that his interest shall not be
assigned, his representative in interest or his principal shall not be entitled to specific
performance his part of the contract, or the performance thereof by his representative in interest,
or his principal, has been accepted by the other party 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.
SECTION 19 (E) OF THE SPECIFIC RELIEF ACT, 1963

Except as otherwise provided by this Chapter, specific performance of a contract may be

enforced against the company, 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.
In Weavers Mills Ltd. v. Balkies Ammal 4, the Madras High Court extended the scope of this
principle through its decision. In this case, promoters had agreed to purchase some properties for
and on behalf of the company to be promoted. On incorporation, the company assumed
possession and constructed structures upon it. It was held that even in absence of conveyance of
property by the promoter in favor of the company after its incorporation, the companys title over
the property could not be set aside. Promoters are generally held personally liable for
preincorporation contract. If a company does not ratify or adopt a preincorporation contract
under the Specific Relief Act, then the common law principle would be applicable and the
promoter will be liable for breach of contract. 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.5 He further explain that the company cannot take the liability of
preincorporation 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 preincorporation
contract because they are the consenting party to the contract.

4
AIR 1969 Mad 462
5
Kelner v. Baxter
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 preincorporation 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. These principles were
found applicable in Indian case.
Although under common law promoter is personally liable for the preincorporation 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. In Howard v Patent Ivory Manufacturing, the English Court accepted the novation of
contract. In conclusion we can say that, a promoter is personally liable for the preincorporation
contract, because at the time of formation of preincorporation contract, the company does not
come in existence, so neither the principle agent relationship exist not the company become the
party.

WHAT IS PREINCORPORATION CONTRACT

Sometimes contracts are made on behalf of a company even before it is duly incorporated. But
no contract can bind a company before it becomes capable of contracting by incorporation. Two
consenting parties are necessary to a contract, whereas the company, before incorporation, is a
non entity.6 A company has no status prior to incorporation. It can have no income before
incorporation for tax purposes.7 Shares cannot be acquired in the name of a company before its
incorporation. A transfer form is liable to be rejected where the name of a proposed company is
entered in the column of transferee. Thus, for example, in English& Colonial Produce Co, re;

6
Erle CJ in Kelner v. Baxter, (1866) LR 2 CP 174; 15 LT 213; [1861-73] All er rep Ext 2009.
7
CIT v. City Mills Distributors (p) Ltd, (1996) 2 SCC 375
 A solicitor, on the instructions of certain gentlemen, prepared the necessary documents and
obtained the registration of a company. He paid the registration fee and incurred the incidental
expenses of registration
But the company was held not bound to pay for those services and expences. the company
could not be sued in law for those expenses, inasmuch as it was not in existence at the time
when the expenses were incurred. And ratification was impossible.
if is not desirable to saddle the corporation with burdens imposed upon it in advance by overly
optimistic promoters.8

Although a contract made before a companys incorporation cannot bind the company, it is not
wholly devoid of legal effect. It takes effect as a personal contract with the persons who purport
to contract on the companys behalf, and they are liable to pay damages for failure to perform the
promises made in the companys name, even though the contract expressly provided that only
the companys name paid up capital shall be answerable for performance.

It is open to doubt whether a person claiming to be an agent of a non- existed principal can be
rendered personally liable n the contracts made by him on behalf of such principle. Under the
terns of section 230 of the Indian Contract Act, in the absence of any contract to that effect, an
agent cannot personally enforce contracts entered into by him on behalf of principal nor is he
personally bound by them. Such contract is presumed to exist in the following cases, viz.

1. Where the contract is made by an agent for sale or purchase of goods for a merchant
resident aboard;
2. Where the agent does not disclose the name of his principal and where the principal
though disclosed cannot be sued.
An agent, therefore, is not personally liable, nor is he entitled to sue on a contract unless the
contract s expressly provides or it is on behalf of the foreign principal or where the principal is
disclosed but cannot be sued. The last branch of a rule cannot apply where there is no principal
in law. It is submitted, therefore, that under the scheme of Indian Contract Act where a
promoter of a company enters into a contract for and on behalf of the company to be

8
A Ramaiyas Guide to Companies Act, Lexis nexis, (18 th edn)
 incorporated and the company after its incorporation does not ratify the contract entered into on
its behalf by its promoter, the promoter cannot sue on such contract nor can he be sued on such
contract except on the principle of quantum meruit.
It may also be noted that any pre- incorporation share subscription, that is to say any agreement
by a person to take and pay for any share of a company to be formed, cannot be enforced and is
usually revocable unless accepted by the company after its formation.
As regards contracts made after the incorporation of the company and before it is entitled to
commence business.9

The true legal position in respect of preincorporation contracts may be discussed under the
following two heads:
Position before 1963(i.e., before passing of Specific Relief act, 1963), and
Position since 1963.
Position before 1963:
1. A preincorporation contract never binds a company since a person (legal or juristic cannot
contract before his or its existence and a company before incorporation has no legal existence.
Another reason is that promoters are proverbially profuse in their promises and if the corporation
were to be bound by them, it would be subject to many unknown, unjust and heavy
obligations).10
2. Even where there is a request purported to enforce such a contract, the company cannot be
found because ratification is not possible as the ostensible principal did not exist at the time the
contract was made.11 In re English and colonial Produce
Company case12, a solicitor was engaged to prepare the necessary documents and obtain the
registration of a company. He paid the registration fee and incurred the certain expenses
incidental to registration. It was held in this case that the company was not liable or bound to pay
for his services and expenses.

9
Section 149 ()4 Companies Act
10
Parker v. Modern Woodman 181 All. 214, 234., as quoted in Taxmanns Company Law,
p.7172
11
Kelner v. Baxter [1866] 15 LT 213.
12
[1906] 2Ch. 435 CA.
The company is also not entitled to sue on a preincorporation contract. As it was held in the case
of Natal land and colonisation company v. pauline colliery syndicate13 that the syndicate was not
entitled to its claim as it was not in existence when the contract was made and a company cannot
obtain the benefit of a preincorporation contract in the suit of specific performance. So, fact of
this case was that the a N company contracted with A, the nominee of the syndicate company
which was not even incorporated, to grant a lease of certain coal mining rights for three years.
After the syndicate was registered, it claimed the contracted lease which the company N
refused.
Position since 1963 (i.e., after passing of the specific relief Act, 1963):
Until the passing of the specific relief Act, 1963, in India the promoters found it very difficult to
carry out the work of incorporation. Since contracts prior to incorporation were void and also
could not be ratified, people hesitated to either supply any goods or services for the cause of
incorporation. Promoter also felt shy of accepting personal responsibility. The specific relief Act,
1963 came as a relief to the promoters.
The specific relief Act provides under the following sections:
Section 15(h) and 19(e) of the Specific Relief Act provides as follows:
1. The contract should have been entered into by the promoter for the purpose of the company.
2. The terms of incorporation should warrant should warrant such contract.
3. The company should accept the contract after incorporation.
4. Such acceptance should be communicated to the other party to the contract 14 . So, preliminary
contract enforced by the promoter at the prior to incorporation of the company will be treated as
contract between two individuals who are in existence. Thus, the company do have no inherent
right concerning ratification of those contract unless company acquiring the power as to the
ratification by its memorandum as the subjectmatter of contract is not contrary to the object of
the company. Hence, the third party cannot sue the company, if any breach of contract has been
taken place where such contract entered prior to the incorporation even they for the benefit of the
company.

13
[1904] AC 120.
14
K.S. Anantharaman, Lectures on Company Law & Competition Act (including
Secretarial Practice), Tenth ed., Nagpur, LexisNexis Butterworths Wadhwa 2005, p.49.
In Phonogram Limited v. Lane,15observed that although a contract made before a companys
incorporation cannot bind the company, it is not wholly devoid of legal effect, even if all the
persons who negotiated the contract are attempting to incorporate a Pop group had obtained
financial assistance from a recording company. He was held personally liable to refund the
amount on his project failing to materialise.
So, Promoters shall be liable to pay damages for failure to perform the promises made in the
name of company and this shall be so, even where the contract expressly provides that only the
companys paid up capital shall be answerable for performance as it was also held in the case of
Scot. v. Lord Ebury.16

LIABILITY OF PROMOTER REGARDING PRE INCORPORATION CONTRACT

Before the passing of the Specific Relief Act 1963, the position in India, regarding
preincorporation 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.
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 the case of Seth Sobhag Mal Lodha v. Edward Mills Co. Ltd. 17, the High Court of Rajasthan
followed the English decision in holding that a contract entered into on behalf of a company
before its incorporation is not binding on the company. Evidently the provisions of the Specific

15
[1982] QB 938.
16
[1867] LR 2CP255.
17
(1972) 42 Com. Cases 1 (D. B.) (Raj.)
Relief Act were not brought to the notice of the learned judges. There remains for consideration
a class of cases in which a promoter enters into a contract on behalf of a company to be
incorporated and the company does not ratify the contract. In such a case the question will arise
as to whether the promoter is personally liable to the other contracting parties on the footing that
he himself is the party to the contract.18

CONCLUSION

It may be said that the word Promoter is used in common parlance to denote any individual,
syndicate, association, partnership or a company which takes all the necessary steps to create and
set it going. The Promoter originated the scheme for the formation of the company gets together
the subscribers to the memorandum gets memorandum and prepared articles, executed and
registered finds the bankers, brokers and legal advisors located the first directors, settle the
terms of preliminary contracts with vender and agreement with underwriters and makes
arrangements for preparation, advertisement and circulation of the prospectus and arrangement
of the capital. So, Promoters act as a molding format for the company and gives it a shape which
can exist in the world although they cannot take anything in this regard.
The section enables pre incorporation contracts valid even though it is slightly contrary to the
common law principles to a certain extent. Going by the act specific performance of a contract is
enforceable against a company where its promoters or agents have entered into a valid contract
on behalf of the company before its incorporation. In such a situation a contract is acceptable by
the stipulations of the company's incorporation. The promoters of the company had consented to
buy for the company some properties on behalf of the company to be incorporated. After
incorporation structures were constructed on the property by the company after assuming
possession. The court took its view that even if the properties were not conveyed on to the
company at the time of making the contract by its promoters the company's title over the
property could not be set aside. Therefore, in India, despite the fact that pre incorporation
contracts are entered into by promoters or agents of the company before the company's existence

18
Pennigtons Company Law, 4th Edition p.90
they are legally enforceable and has contractual obligations that continue to exist under the
Specific Relief Act.