Pre-incorporation contracts are those which are entered prior to the formation of the company. A promoter is a person who starts a company and has a fiduciary relationship with it. In nearly all cases, it is the promoter who on behalf of a company, enters a contract prior to its formation, and in many cases the court find it very difficult for people who appear on the legal horizon in the process of forming a company called a promoter.

It can be argued that the promoters are entering a pre-incorporation contract on behalf of the company. But here is a tangle, too. The promoters work as agents of the company when entering the contract. But if the principal, the company itself does not exist and cannot perform an act, how can an agent act on it? This issue questions the legitimacy of the promoter's legal status in the event of a pre-incorporation contract and the promoter's responsibility to the company and to the third party.

This article focuses to resolve the concerns that have evolved because of pre-incorporation contracts and analyze the law laid down in Indian, English, and Common law context. An attempt was made to look into the uncertainties due to contradictory judicial interpretations. This paper will also critically analyze the judgement delivered by the Madras High court in the case of Weavers Mills Ltd. vs Balkis Ammal And Ors.

The facts of this case are
The promoters entered an oral contract with the company- Weavers Mills to buy properties on behalf of the company before its incorporation. The second defendant was the managing director of the Weavers Mills. The first respondent issued a money decree against the second respondent and attached the suit property in execution of the decree. The second defendant claimed that the property belonged to Weavers Mills and he did not have the right to attach the property, but this claim got rejected.

After incorporation, the company took over the possession of the properties and started constructing building on it. Conveyance of properties was not held by the promoters. Despite this, the court held that company’s title over the properties cannot be set aside. The main argument in this case was that the promoters were in possession of the properties for a long period, and at the time of incorporation, no conveyance happened. There was no written agreement about the purchase of properties by the promoters. There was also a collusion between the two respondents and the plaintiff argued that they tried to conduct a fraud. He also said that the promoters did not tell the directors of the company about the situation and kept them in dark. [1]

This case held that the benefit of purchase would be passed to the company after its incorporation. In the case of Twycross v. Grant 1877, it was assumed by the Judges that a promoter in a company is the one takes necessary steps related to its formation of company and sets it going.[2]

In Whaley Bridge Printing Co. v. Green, 1880 the Judge saw that a promoter is the one who does business operations through which a company is brought into existence. According to Rule 405(a)Securities Exchange Commission (USA), a promoter is the one takes the initiative to set up a business and organize it. [3]
Now, we will emphasize on understanding the common law since it still has great significance in the Indian and the English context.

Common law
In common law, it was believed that the companies before incorporation had no existence and thus, cannot indulge in any contracts. Therefore, a promoter had two choices regarding pre incorporation contracts- They can enter using the company’s name, and they can enter contracts using their own name, and work as agents for the company. As the company does not has its separate existence, it cannot enter any contract.

Nor can anybody else contract as a company’s agent as the principal itself is not capable of doing the act. Also, after incorporation a company cannot even ratify the contract. But, to bring the pre-incorporation contract terms into effect, it can enter in a new contract by novation. It is a process by which the parties agree to replace a new contract for the current contract.

In the case of Kelner v. Baxter, the plaintiff entered a contract to sell wine to a company. As the company did not exist at that time, the plaintiff who was the director of the company took personal delivery of the goods. The defendant proposed to contract with the company. The court held that as they had contracted for the company and took personal delivery of goods, they must be liable to make the payment for it. The company cannot be sued on a pre-incorporation contract. [4]

The case of New Borne v. Sensolid created a sort of confusion about pre incorporation contracts. An agent of NewBorne Ltd. contracted with Sensolid to sell some stationaries in the name of the company. The market for the stationary items fell and Sensolid refused to take delivery for the goods. Sensolid said that they intended to contract with the company and not with NewBorne.

They court agreed to this argument. In this case, the court made an incorrect differentiation. Sensolid did not raise the argument of non-existence of the company earlier. NewBorne signed the contract with the official signature of the company. This made clear that it intended to contract in company’s name and used the goods of the company. The court held that this contract is null as the company was not in existence at that time. [5]

Now, when a person enters a contract on behalf of a company which is not yet formed, the contract will become void as it does not have the authority to do so. It does not have a separate existence and cannot perform those acts which the company itself cannot do. A promoter has the choice to impose the contract by declaring itself as a principal. In the case of Phonogram v. Lane, the court based its decision on Section 9(2) of the European Communities Act 1972. The court observed that agents act for the company and promoters should be declared as a party to the contract.[6]

Thus, the common law position is not clear as to what should be considered as both the above judgements created a conflicting situation. The solution for this can be that rather than looking at the person on whose behalf the contract has been made, we should look at the intent of the contract.

Now, we will analyze the English law on pre-incorporation contracts.

English Law
The English law lays a different view on pre-incorporation contracts, and it has gone through lots of changes throughout the years. Earlier, according to section 36 C of the Companies Act 1985, a person entering a contract on behalf of the company will be an agent working for the company and will be personally liable. This guarantees the third parties who are entering into the contract that they are protected. In common law, if a party enters a contract before the incorporation of the company, the contract would be considered null, and the third parties will be protected only to the extent of law of restitution. [7]

In Phonogram v. Lane, the defendant on behalf of the company F. Ltd. and a Music Group entered a contract by signing a copy of the letter. The contract was not completed, and the defendant said that he was personally not liable to repay the amount. The court held that the payment can be imposed under Section 9(2) of European Communities Ac, 1972. The law was not clear when it comes to section 36 of the companies act. It was not clear whether the promoters have the right to enforce a contractual obligation and a contract according to the statute.

Another issue was that this section has done nothing but provided a method for the companies to carry out duties of pre incorporation contracts easily. The rest was left on to the states. The condition was that after incorporation, a company cannot ratify a contract which was earlier made on its behalf by a promoter.

A new contract must be replaced with an old one. This section was re-enacted in 2006 and the present legislation in UK is Section 51 of the Companies Act 2006 which says that a promoter who enters a pre incorporation contract is personally liable for it. This section does not mention anything about ratification of a company.

It only focuses on the methods by which directors can absolve themselves if they fail to perform the pre-incorporation contract. It dissuades the promoters as they are held personally liable for all the contracts. It was a good move for preventing fiduciary transactions, but it does not include many issues about pre incorporation contracts.
Now, we will delve into the Indian law related to pre-incorporation contracts.

Indian law
In the Indian law, a promoter is said to be the one who controls the formulation of a company. Earlier, the position of pre incorporation contracts in India was the same as common law. Prior to 1963, the promoters did not feel safe in doing transactions for a company as they were held liable for it. They hesitated to provide any service as the contracts were not ratified. The law was that a company had no legal existence if it is not incorporated. It cannot be held liable if it did not exist at that time. The position of promoters in India has drastically changed after 1963. In the case of Kelner v. Baxter, it was held that a company cannot be constrained by a contract entered by the promoters as it did not exist at the time when it was made.

In the case of Seth Sobhagmal v. Edward Mills Co. Ltd., the court based its decision on the laws of England and held that the contracts before the incorporation of a company are invalid. Pre-incorporation contracts are not followed in English decisions as the promoters are personally liable for their actions. [8]

Section 230 of the Indian Contract Acts, 1872 says that a contract by an agent cannot personally bind him. A contract between a third party and an agent can exist where the name of the principal is not disclosed. It is under these situations that a promoter can be held personally liable after being bound by the pre-incorporation contract. This leads to a problem because if a contract is made on company’s name, then it will become void as the company does not exists.

And, if the contract is made on behalf of an agent, then the agent cannot be sued under section 230 unless there is a contract that provides for it. This means that the third party will only be protected when it is specifically mentioned that the promoter is an agent who works for the company and he will be liable for his actions.

Therefore, both English and Indian laws lay down opposite views. English law says that the promoter will be liable if there is no contract to the opposite. There is a need for a provision with the assumption that an agent will be liable if he is the promoter of a company which is not yet formed. This will help to protect the third-party interests. The promoter acts as a quasi- trustee for the company. Since the company is not in existence, the property cannot be constituted as a sale, or a lease.

Therefore, it does not come under section 548 of the Transfer of Property Act, 1882. Even if the argument is laid that the promoter is only a quasi-trustee, then also he will be told to convey the property under section 9 of the Transfer of Property Act, 1882.

In Weavers Mill case, the property was conveyed without proper sale deed. The logic which was followed was that the promoter is a quasi-trustee and can be obliged to transfer the property. Specific Relief Act which was passed in 1963 provided some relief to the Promoters. Section 15(h) of this act says that if a public company has made a contract with the promoters before incorporation, they can impose it. It says that the contracts entered by the promoters are for the benefit of the company. The company should accept the terms of the contract. Not only the companies can enforce pre incorporation contracts, but other parties can also enforce it on behalf of the company.

In the case of Vali Pattabhirama Rao v. Sri Ramaija Ginning and Rice Factory Pvt Ltd, it was held that if a person has an intention of promoting the company, obtained an interest in it, then the lessor will be bound to the company. Section 149 of Companies Act 1956 restricts the business of un-incorporated companies. This section is limited to the public companies. Section S.19 (e) of the Specific Relief Act also says that other parties can enforce the contracts against the company. [9]

Conclusion
Both the positions of India and England have now been examined and their flaws have been identified, it is also important to see what changes might be possible. Section 51 of the Companies Act 2006 (UK) is quite clear that a promoter has personal liability for pre-incorporation contracts. There is no ratification possible now in English law. A company can perform novation of contract. India permits for ratification of companies.

The decision by the court in the case of Phonogram cannot be depended as it is established on statutory law. India requires a statute by which the position of the promoter can be clarified. Benefits of the promoter should be passed on to the company. This does not mean that the interests of the promoters should be harmed.

The company should be responsible for paying the promoter consideration for taking the trouble of entering the contract. Pre-incorporation contracts are a must for every business. If the companies make the promoters do the ratification work, they should be allowed to get renumeration for it.

End-Notes:

1. https://indiankanoon.org/doc/42086/
2. https://swarb.co.uk/twycross-v-grant-ca-2-jun-1877/
3. https://drive.google.com/file/d/123sBcgm2r82uKUX7ZYV0a890KO7_KAjM/view
4. https://lawcasesummaries.com/knowledge-base/kelner-v-baxter-1866-lr-2-cp-174/
5. https://swarb.co.uk/newborne-v-sensolid-great-britain-ltd-1954/
6. https://swarb.co.uk/phonogram-ltd-v-lane-ca-1982/
7. https://www.lexology.com/library/detail.aspx?g=9d116abf-6ad8-4f68-ad6f-e727fc0b80a1#:~:text=Section%2036C%20of%20the%20Companies,purporting%20to%20act%20for%20the
8. https://indiankanoon.org/doc/1716446/
9. https://indiankanoon.org/doc/1299049/

Written By: Ishika Kamboj