Law And Policy

This post comprises summaries of –

1. H. R. Saviprasad, “Pre-incorporation Contracts: A Comparative Analysis Of Indian And English Laws” Journal of the Indian Law Institute , January-March 2002, Vol. 44, No. 1 (January-March 2002), pp. 117-131
2. Lakshmi Dwivedi & Varun Byreddy” Pre-Incorporation Contracts: A Legal Puzzle in India” 5.1 NLIU LR (2016) 32

“Pre-Incorporation Contracts: A Comparative Analysis of Indian and English Laws” by H.R. Saviprasad

The article provides a detailed comparative analysis of pre-incorporation contracts—agreements entered into on behalf of a company before its legal incorporation—examining their validity, enforcement, and implications under Indian and English law. The author, H.R. Saviprasad, explores the historical evolution of the doctrine, judicial interpretations, statutory interventions, and the continuing ambiguities that affect promoters, companies, and third parties.

Introduction: Nature and Need for Pre-Incorporation Contracts

A company is recognized as a separate legal entity only upon incorporation, acquiring rights to own property, enter into contracts, and sue or be sued in its own name. However, during the formation stage, promoters often enter into contracts—such as for property purchase, employment of experts, or procurement of goods—on behalf of the company yet to be formed. These are known as pre-incorporation or preliminary contracts. The core legal issue is that such contracts involve a non-existent principal, raising questions about their enforceability and the liability of the promoters involved.

Common Law Position

Under English common law, a company cannot be bound by contracts made before its existence, nor can it ratify them after incorporation, as ratification presupposes an existing principal. The only remedy lies in entering a new contract (novation) once the company is formed.

In Kelner v. Baxter (1866), the court held that promoters who signed a contract for an unformed company were personally liable, as they had contracted on behalf of a non-existent principal. Conversely, in Newborne v. Sensolid (1953), the court held the contract void, since the promoter signed only as an agent for a company that did not exist. This contradictory reasoning created significant confusion in common law.

Phonogram Ltd. v. Lane (1981) later attempted to reconcile these inconsistencies. Oliver J. emphasized that courts should look to the intention of the parties—whether the promoter intended to be personally liable or to act solely for the company. However, the decision was grounded in the European Communities Act, 1972, which had already altered the legal framework by statutorily addressing promoter liability.

Statutory Development under English Law

To bring certainty, the European Communities Act, 1972 and later Section 36C of the Companies Act, 1985 codified the law on pre-incorporation contracts. The section provided that:

A contract made on behalf of a company before its formation shall have effect as a contract with the person purporting to act for the company, who is personally liable, unless otherwise agreed.

This provision shifted the focus from the technicality of nonexistence to protecting third parties by imposing personal liability on promoters. However, the law did not allow post-incorporation ratification by the company; instead, the company must enter into a fresh agreement to adopt the contract (novation).

While the statute enhanced commercial certainty, it also left gaps—particularly regarding the rights of promoters to enforce contracts. Courts have assumed mutuality, allowing promoters to sue, though the law remains silent.

Despite reforms, English law remains restrictive: the company cannot unilaterally adopt pre-incorporation contracts. Jurisdictions like Singapore, however, allow statutory ratification under Section 35(1) of its Companies Act (1967), as affirmed in Cosmic Insurance Corporation Ltd. v. Khoo Chiang Poh (1981), permitting companies to retrospectively adopt contracts as if they existed at the time of execution.

Indian Law: From Common Law to Statutory Clarity

India initially followed the common law rule, disallowing companies from ratifying pre-incorporation contracts. The Indian Contract Act, 1872, posed additional complications. Section 230 provides that an agent cannot be personally bound unless explicitly stated—making it difficult to hold promoters liable.

This confusion persisted until the enactment of the Specific Relief Act, 1963, which in Sections 15(h) and 19(e), statutorily recognized pre-incorporation contracts. These provisions permit:

• A company to enforce contracts made by promoters if the contracts were for the company’s purposes, warranted by its incorporation terms, and accepted and communicated after incorporation.
• Conversely, third parties may enforce such contracts against the company, provided similar conditions are satisfied.

This marked a departure from English law, allowing ratification rather than novation, provided the contract falls within the company’s object clause and is duly accepted.

In Weavers Mills v. Balkis Ammal (1969), the Madras High Court upheld a company’s right to claim property purchased by promoters for its benefit. In Vali Pattabhirama Rao v. Sri Ramaja Ginning and Rice Factory (1986), the Andhra Pradesh High Court reiterated that promoters’ contracts, once accepted by the company, became binding.

However, not all contracts qualify. In Imperial Ice Manufacturing Co. v. Mancheshaw (1886), the court held that contracts for personal benefits (like purchase of shares by promoters) do not fall within the “purposes of the company.”

Doctrinal and Practical Implications

The article emphasizes that promoters stand in a fiduciary (quasi-trustee) relationship with the company. Property acquired by promoters before incorporation is presumed to be held in trust for the company, allowing the company to claim title post-incorporation. Yet, promoters are entitled to compensation or reimbursement for expenses and efforts incurred.

While Indian law provides a mechanism for ratification, it lacks clarity on the liability of promoters when the company refuses to adopt the contract. The absence of a presumption of promoter liability (as in English law) leaves third parties vulnerable.

Comparative Evaluation and Reform

Saviprasad concludes that both systems are incomplete:

• English law protects third parties through promoter liability, but disallows ratification by companies.
• Indian law allows ratification, but does not adequately protect third parties if the company refuses adoption.

The author recommends a hybrid approach—combining the English statutory rule (holding promoters liable) with the Indian ratification mechanism. Additionally, promoters’ fiduciary status regarding pre-incorporation property should be codified, ensuring fair treatment of both promoters and companies.

Conclusion

Pre-incorporation contracts remain a delicate balance between commercial practicality and legal formality. The comparative analysis reveals that while both Indian and English laws have evolved, neither system provides complete justice. A reformed framework should ensure:

1. Automatic transfer of rights and liabilities upon incorporation.
2. Statutory recognition of promoters’ fiduciary duties and compensation rights.
3. Third-party protection through presumptive promoter liability.

Only through such synthesis, Saviprasad argues, can the law achieve the dual goals of commercial flexibility and legal certainty in the field of corporate formation.

“Pre-Incorporation Contracts: A Legal Puzzle in India” by Lakshmi Dwivedi & Varun Byreddy:

The article “Pre-Incorporation Contracts: A Legal Puzzle in India” examines the complex legal position of contracts entered into by promoters on behalf of companies before their incorporation. Such contracts, known as pre-incorporation contracts, raise fundamental questions about validity, liability, and enforceability, since they are made by or for an entity that does not legally exist at the time of contracting. The authors undertake a comparative and doctrinal analysis of the Indian position, drawing on English, American, South African, and German jurisprudence to address ambiguities in the Indian legal framework.

The Core Problem and Context

For a contract to be valid under the Indian Contract Act, 1872, it must be made between competent parties. A company becomes a legal person only after incorporation under Section 9 of the Companies Act, 2013, which gives it the power to contract, sue, and be sued. Before incorporation, any purported contract entered on its behalf is legally questionable since one of the parties—the company—is nonexistent. The issue, therefore, centers on whether promoters can validly bind a company prior to its creation and whether they can themselves be held liable or claim benefits under such contracts.

In India, this area of law remains underdeveloped. The Specific Relief Act, 1963, under Sections 15(h) and 19(e), provides limited guidance by allowing companies to enforce or be bound by pre-incorporation contracts if certain conditions are met. However, the rights and obligations of promoters, and their relationship with co-promoters and third parties, remain unclear.

The Role and Liability of Promoters

Promoters are the individuals who conceptualize, organize, and take steps to form a company. Common law defines them as persons who “set in motion the machinery” for incorporation. While they act for the company’s benefit, they are not its agents, since an agency relationship requires a principal in existence. The Companies Act, 2013, defines “promoter” in Section 2(69), but the definition primarily applies post-incorporation and does not clarify liability for pre-incorporation dealings.

Under common law, promoters are personally liable on such contracts unless expressly excluded. In Kelner v. Baxter (1866), the court held promoters personally liable since the company was nonexistent when the contract was made. Conversely, in Newborne v. Sensolid (1953), the court voided the contract altogether, since the promoter signed in the company’s name rather than his own. These decisions highlight technical distinctions and uncertainties, often turning on how the contract is worded.

To address these issues, English and European law later codified the rule that any person purporting to contract for a company before incorporation is personally liable unless the agreement expressly states otherwise. India, lacking such a provision, leaves the matter open to judicial interpretation.

Enforceability and Ratification under Indian Law

The Indian Specific Relief Act allows companies to enforce pre-incorporation contracts provided two conditions are met:

1. The contract was entered “for the purposes of the company,” and
2. It was “warranted by the terms of incorporation.”

This means that the contract must align with the company’s objects and be ratified after incorporation. Indian courts, however, have interpreted these provisions variably. In Weaver Mills v. Balkis Ammal (1969), the court recognized the company’s title to property under a pre-incorporation agreement once it accepted the benefits of the contract. The Supreme Court in Jai Narain Parasurampuria v. Pushpa Devi Saraf (2006) confirmed that as long as a contract is not ultra vires the company’s objects, it may be enforceable upon acceptance.

This approach resembles the American doctrine of adoption, where a company, by accepting the benefits of a contract, becomes bound by it—even without formal ratification. However, unlike American law, India has no statutory mechanism to ensure the promoter’s discharge from liability upon such adoption.

Promoter’s Personal Liability and Remedies

The absence of statutory clarity leaves promoters in a precarious position. If a company refuses to ratify, the promoter may still be personally liable. In contrast, South African law presumes promoter liability but allows recovery of expenses or damages if the company later declines to adopt the contract. American law follows a similar rule, treating the promoter as personally bound until the company adopts the contract through novation.

Indian commentators such as Ramaiya argue that under Section 230 of the Indian Contract Act, a promoter cannot be held liable as an agent of a nonexistent principal. However, this reasoning is weak, as promoters act independently and not as true agents. Without express protection, Indian promoters risk personal exposure.

The authors propose that India could adopt the German “Theory of Identity”—which treats the pre-incorporation association as continuous with the incorporated entity—thereby automatically transferring rights and obligations to the company upon incorporation. Alternatively, adopting Australia’s Section 131 of the Corporations Act (2001), which empowers courts to grant equitable remedies to promoters, could provide fairness and predictability.

Relationship with Co-Promoters and Companies

Indian law recognizes the fiduciary relationship between a promoter and the company, as affirmed in Weaver Mills. Promoters must act in the company’s best interest and may be reimbursed for legitimate pre-incorporation expenses if the company accepts the contract. However, liability among co-promoters arises only through explicit or implied agreements, as courts hesitate to imply partnership unless the group operated with a profit motive before incorporation.

Distinction from Defective Incorporation

The paper differentiates pre-incorporation contracts from defective incorporations, where parties mistakenly believe a company exists. The latter are governed by doctrines like corporation by estoppel or de facto corporation, which protect innocent parties. In pre-incorporation contracts, both sides are aware that the company is not yet formed, making these doctrines inapplicable.

Recommendations and Conclusion

The authors conclude that India’s legal uncertainty stems from inadequate statutory design. They recommend clearer drafting of pre-incorporation agreements, explicitly limiting promoter liability, providing indemnity clauses, and clarifying the company’s obligations upon adoption. Legislative reform should codify promoter rights and responsibilities, following models from Germany or Australia. Until such reform occurs, promoters must rely on precise contractual language and equitable principles to safeguard their interests.