Pre-Incorporation Contracts and Promoters

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Author: Aaratrika Roy Chowdhury, a 3rd-year B.A. LL.B. (Hons.) student at St. Xavier’s University, Kolkata

INTRODUCTION

The process of incorporation is a pivotal stage in the life of a company. Before a company comes into legal existence, various preparatory activities are undertaken to facilitate its future operations. These activities often require agreements with third parties, such as acquiring property, hiring staff, or arranging finance. However, as a company is not yet a legal entity before its incorporation, it cannot itself enter into contracts. Instead, such agreements are made by persons known as promoters, who act to bring the company into existence.

This scenario establishes that contracts entered into on behalf of a company before its incorporation have no binding effect on the company itself, since it lacks legal existence at that stage. The liability arising from such contracts therefore rests personally on the promoters who undertake themThe law in India, as in many common law jurisdictions, has developed nuanced rules to balance the interests of promoters, the company, and third parties.

This essay examines the legal consequences of pre-incorporation contracts and the liability of promoters, drawing upon statutory provisions, judicial interpretations, and doctrinal principles.

PRE-INCORPORATION CONTRACTS

Sometimes, contracts are entered into on behalf of a company even before its formal incorporation. However, such agreements cannot bind the company until it comes into legal existence and attains contractual capacity. As observed in Kelner v. Baxter , “two consenting parties are necessary to a contract, whereas the company before incorporation is a non-entity.” The legal treatment of pre-incorporation contracts may therefore be considered under two stages:

Position Prior to the Specific Relief Act, 1963

(a) Before 1963, a pre-incorporation contract had no binding effect on a company, as a legal or juristic person cannot contract before it exists. Since a company has no legal personality prior to incorporation, it could not be held liable for obligations entered into by its promoters. Another justification was that promoters often made excessive promises, and if companies were bound by them, they could face unforeseen and onerous liabilities (Parke v. Modern Woodman).

(b) Even where a promoter attempted to enforce such a contract, the company was not bound, because ratification was legally impossible. Ratification requires the principal to exist at the time of contracting, which is not the case for a pre-incorporation company (Kelner v. Baxter3, supra). For example, in In re English and Colonial Produce Company, a solicitor incurred expenses for drafting incorporation documents and registering the company, but the court held that the company was not liable to reimburse him.

(c) Similarly, a company could not itself enforce a pre-incorporation contract. In Natal Land and Colonisation Co. v. Pauline Colliery Syndicate, a syndicate (not yet incorporated) entered into a lease arrangement through a nominee. After incorporation, the syndicate sought to enforce the contract, but the court held that since it was not in existence when the agreement was made, it had no right to enforce the benefit of that contract.

Position Since the Specific Relief Act, 1963

The legal position changed with the enactment of the Specific Relief Act, 1963, which significantly eased the difficulties faced by promoters. Earlier, as pre-incorporation contracts were void and incapable of ratification, third parties were reluctant to provide goods or services, and promoters were hesitant to assume personal liability.

The 1963 Act provided statutory relief:

Section 15(h): If promoters enter into a contract for the purposes of a public company before its incorporation, and the contract is consistent with the company’s objects as stated in its memorandum, the company may adopt and enforce such a contract after incorporation. The phrase “warranted by the terms of incorporation” means that the contract must fall within the scope of the company’s objects clause. In Vali Pattabhirama Rao v. Sri Ramanuja Ginning and Rice Factory Pvt. Ltd.6, it was held that where a promoter acquired a lease with the intention of transferring it to a company, and the company later adopted it, the lessor was bound to recognize the company as the lessee.
Section 19(e): Not only can the company enforce such contracts, but the other contracting party may also enforce them against the company, provided two conditions are satisfied: (i) the company has adopted the contract after incorporation, and (ii) the contract is within the scope of its objects.

The Act thus envisages contracts such as drafting and printing of constitutional documents, remuneration of professionals engaged for incorporation, leasing office premises, or hiring preliminary staff. By validating such contracts, the law promotes commercial certainty and facilitates the process of company formation.

Under Section 15(h) of the Specific Relief Act, 1963, contracts entered into by promoters before incorporation, if made within the scope of the company’s objects, may be enforced by the company after incorporation, and the other party cannot object on grounds of lack of privity. This is complemented by Section 19(e), which allows the other contracting party to enforce such obligations against the company, provided the contracts are “warranted by the terms of incorporation.” Courts have emphasized that this phrase protects companies both by enabling enforcement of legitimate contracts aligned with their objects and by relieving them from liability where agreements are ultra vires the purposes of incorporation.7

LIABILITY OF PROMOTERS IN RELATION TO PRE INCORPORATION CONTRACTS

A crucial issue in company law concerns the position of promoters in respect of preliminary or pre-incorporation contracts. The question often arises: if, after incorporation, the company does not execute a fresh contract, or if the original contract is not one warranted for the company’s incorporation, what liability rests upon the promoter who facilitated such an agreement.

In Phonogram Ltd. v. Lanethe court clarified that while a pre-incorporation contract cannot bind the company, it is not entirely without legal effect, even if all parties are aware that the company has not yet been formed. In that case, an individual attempting to form a pop music group obtained financial backing from a recording company. When the project failed, he was held personally liable to repay the advance.

The principle is that a pre-incorporation contract operates as a personal contract of the promoter, i.e., the individual who purports to act on behalf of the company. This was established in Kelner v. Baxter (1866), where the promoters were held personally responsible for fulfilling obligations undertaken in the name of a company that did not yet exist. Promoters may therefore be liable to pay damages if they fail to carry out promises made in the name of the company. Importantly, this liability arises even where the contract expressly states that performance will be limited to the company’s paid-up capital (Scott v. Lord Ebury).

Furthermore, promoters are not merely liable for breach of an implied warranty of authority; rather, they are bound as actual parties to the contract. This distinction is significant in cases involving contracts that are specifically enforceable, such as agreements for the sale of land. In such situations, there is no reason why the vendor should not obtain an order for specific performance directly against the promoters, instead of being restricted to damages for breach.

Historically, however, where a person signed a contract in the name of a company prior to its incorporation—without expressly purporting to act on its behalf as agent or representative but merely described himself as an officer or in some other connection with the company, the legal consequences differed. In Newborne v. Sensolid (Great Britain) Ltd, such an agreement was held void both against the company and against the individual who had signed it.

This position has since evolved. Under Section 36(4) of the UK Companies Act, 1985, any contract purportedly made in the name of a company before its incorporation is deemed to take effect as a personal contract of the person making it. Crucially, this applies irrespective of whether that person knew or did not know that the company was not yet incorporated.

CONCLUSION

The law relating to pre-incorporation contracts and the liability of promoters highlights the tension between commercial necessity and strict legal principle. At common law, such contracts were unenforceable against or by the company, as the company lacked legal existence before incorporation. This often left third parties unprotected and placed undue risk on promoters. Judicial decisions, such as Kelner v. Baxter and Phonogram Ltd. v. Lane, reinforced that promoters are personally bound by contracts made on behalf of a non-existent company, unless the company, once incorporated, adopts the contract through novation.

The statutory intervention under the Specific Relief Act, 1963 in India provided a more balanced solution, allowing companies to adopt pre-incorporation contracts if they fall within the scope of their objects, and also enabling third parties to enforce such contracts against the company once adopted. This framework ensures fairness by safeguarding the legitimate expectations of those who deal with promoters, while at the same time clarifying promoters’ personal liability where contracts are not duly adopted.

Ultimately, the law places a fiduciary responsibility on promoters, requiring them to act transparently and cautiously in binding future companies. While the Specific Relief Act provides relief, promoters remain potentially liable until proper adoption occurs. The modern statutory approach, therefore, reconciles commercial practicality with legal certainty, ensuring that pre-incorporation transactions can proceed without undermining the foundational principle that a company acquires legal personality only upon incorporation.

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