Law and You > Corporate Laws > Companies Act, 2013 > Pre-incorporation Contracts
Since the general principle goes that no contract is there if one of the parties to the contract is not in existence at the time of entering into the contract, before incorporation company do no has any legal existence, and if the ‘association of persons’ enters into an agreement in the name of company before incorporation; the agreement would be void ab initio. But before a company commences a business, it has to enter into several contracts and incur several initial expenses. Contracts that are entered into by promoters with parties to acquire some property or right for and on behalf of a company yet to be formed are called as ‘pre-incorporation contracts’ or ‘preliminary contracts’. Since the corporation has not been formed yet, it cannot be a party to the agreement. If the corporation is not formed or if it fails to adopt the agreement, the promoters can be held personally liable for any breach of the agreement.
Responsibility of A Company Towards Pre-incorporation Contracts:
- The company, when it comes into existence, is not bound by any contract made on its behalf before its incorporation. A solicitor or lawyer, or chartered accountant who on the request of promoters, prepared a company’s documents and spent time and money in getting it registered, could not recover his charges from the company.
- The other party to the contract is also not bound. The company cannot ratify a pre-incorporation contract and hold the other party liable.
- The agents who contract for a proposed company may sometimes incur personal liability.
In Kelner v Baxter (1866) LR 2 CP 174 case, where the promoter of a new hotel on behalf of the unformed company accepted an offer of Mr. Kelner to sell wine. He supplied wine to the company. But, subsequently the company failed to pay Mr. Kelner, and he brought the action against promoters. The Court held that 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. The company cannot take the liability of pre-incorporation contracts through adoption or ratification; because a stranger cannot ratify or adopt the contract and the company was a stranger because it was not in existence at the time of formation of the contract. So he held that the promoters are personally liable for the pre-incorporation contract because they are the consenting party to the contract.
In Newborne v Sensolid (Great Britain) Ltd [1954] 1 QB 45 case, an unformed company entered into a contract, the other contracting party refused to perform his duty. The Court held 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 the company cannot bring an action for pre-incorporation contracts, and also the promoter cannot bring the suit because they were not the party to the contract.
In Phonogram Limited v Lane [1982] 1 QB 938 case, a person was attempting to form a company that was going to run a pop artists group and that person arranged financial assistance from a recording company. But this company never incorporated, and the amount was due. The recording company brought an action against the person who represented the unformed company. The Court held that the promoters are personally liable for the pre-incorporation contracts.
In Weavers Mills Ltd. v. Balkies Ammal AIR 1969 Mad 462 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 favour of the company after its incorporation, the company’s title over the property could not be set aside.
In Natal Land & Colonisation Co. v. Pauline Colliery Syndicate, (1904) AC 120 case, an agent for a company not yet formed, entered into a contract with a mining company by which it was to grant a mining lease to the new company yet to be formed. When the company was formed, the mining company gave notice that it would not grant the lease. The newly formed company claimed that it was entitled to the lease. The Court held that although the company had the benefit of the contract it did not impose on it any liability to pay since the contract was made before the company was formed. A company, even after its incorporation, cannot expressly, or by conduct, retrospectively ratify or adopt a contract made in its name or on its behalf.
Thus the company formed is not bound by the pre-incorporation contracts. However, in India under Sections 15 and 19 of the Specific Relief Act, 1963, make a departure from the strict application of the rule relating to the enforceability of the pre-incorporation contract by and against the company. It provides that if such a contract was made by the promoters for the purposes of the company and if that contract is warranted by the terms of its incorporation, the company may adopt and enforce such a contract. Likewise, even the other party can enforce such a contract if the company has adopted it after incorporation.
In Imperial Tea Manufacturing Co. Ltd. v. Munchelshaw, 1889 13 Bom 415 case, Munchershaw promised the promoters to buy shares after incorporation but Munchershaw did not buy them. The Court held that Company cannot held Munchershaw liable.
In Jai Narayan Parasrampuria v. Pushpa Devi Saraf, (2006) 113 Co. Cases 794 case, the Court held that just because the transaction involved in a pre-incorporation contract is not reflected in the articles of the company, it cannot be said that the company has not adopted such a transaction. The very fact that the company files a suit for a declaration of the ownership of a property purchased for it before incorporation shows that the company had opted to adopt this transaction.