Before a company commences business, it has to enter into several contracts and incur several initial expenses. Contracts which 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’.
1. Legal status of Pre-incorporation contract
The legal status of a pre-incorporation contract is not easy to define. Going by the definition of the contract, there have to be at least two parties/persons who enter into contract with each other. So, 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. Hence, the company can’t enter into a contract before it comes into existence, and it comes into existence only after its registration. It may be argued that, the pre-incorporation contract is entered into by the promoters on behalf of the company. But here also, is a tangle. The promoters, while entering into the contract, act as agents of the company. But when the principal, i.e. the company is itself not in existence, how can it appoint an agent to act for it? So, the promoters, themselves and not the company, become personally liable for all contracts entered into by them even though they claim to be acting for the prospective company.
But, u/s 230 of the Indian Contract Act, an agent cannot personally enforce contracts entered into by him on behalf of his principal, nor is he personally bound by them if he specifies clearly, at the time of making the contract, that he is only acting as an agent and he is not personally liable under the contract. So if this principle is applied, the contract becomes in fructuous as neither of the parties is liable under the contract.
However, u/s 15 (h) and u/s 19 (e) of the Specific Relief Act of 1963, lies the solution to our problem. These provisions, while deviating from the common law principles to some extent, make the pre-incorporation contracts valid. U/s 15 (h), Except as otherwise provided by this Chapter, the specific performance of a contract may be obtained by--
(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. U/s 19 (e), 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 [AIR 1969 Mad 462], 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 favour of the company after its incorporation, the company’s title over the property could not be set aside.
1. Conclusion
Pre-incorporation contracts, though at first, might appear to be with no legal status and value, but they are very much important and legally valid as well as enforceable. Pre-incorporation contracts may be undertaken by the company after its incorporation either by
(a) incorporating the contract in the terms of incorporation, or
(b) by entering into a fresh contract with the other party or with the promoters, or
(c) By accepting the benefits from the contract, either expressly or impliedly.
And hence, the pre-incorporation contract becomes legally enforceable against the company.
The author can be reached at: suryabhansingh@legalserviceindia.com
