Pre-incorporation and Provisional Contracts

We have mentioned earlier

that a company is an artificial person and is capable of entering into contracts. The promoters may enter into contracts with third parties on behalf of the proposed company before obtaining the certificate of incorporation or after obtaining the certificate of incorporation but before obtaining the certificate to commence business. Thus, in the case of a public company following are the three situations when contracts may be entered into: (i) contracts before incorporation, (ii) contracts after incorporation but before obtaining the certificate to commence business and (iii) contracts after obtaining the certificate to commence business.

However, in the case of a private company, as it is not required to obtain the certificate to commence business, there are only two situations, i.e., (i) contracts before incorporation; and (ii) contracts after incorporation.

Those contracts which are entered into by promoters for the intended company before registration of the company are known as pre-incorporation or preliminary contracts. Very often a company is formed to purchase an existing business or other property. In such circumstances, the promoters enter into contracts with the owners of the business or property to be acquired by the proposed company.

A pre-incorporation contract never binds a company since a person cannot contract before his (or its) existence and a company before incorporation has no legal existence. However, Ss.15(h) and 19 (e) of the Specific Relief Act, 1963 has provided some relief in this regard. It provides that when promoters of a company have, before its incorporation entered into a contract for the purpose of the company and such a contract is warranted by the terms of its incorporation, the contract may be specifically enforced by or against the company. It is, however, necessary that the company in such a case must have accepted the contract after its incorporation and communicated such acceptance to the other party to the contract. Contracts like preparation and printing of the Memorandum, Articles, etc., renting a premises, hiring secretarial staff are envisaged under the Act.

Liability of promoters vis-a-vis pre-incorporation contracts. An important question

that needs to be tackled is what is the position of a promoter vis-a-vis preliminary contracts? If the company does not execute a fresh contract after incorporation and the contract is not one warranted for the purpose of incorporation of the company, what will be the legal position of the promoter who brings about such a contract?

In Phonogram Ltd. v. Lane (1982) Q.B. 938, it was observed that although a contract made before a company's incorporation cannot bind the company, it is not wholly devoid of legal effect, even if all the persons who negotiated the contract are aware that the company has not yet been incorporated.

The contract takes effect as a personal contract with the persons who purport to contract on the company's behalf [Kelner v. Baxter (1866) LR 2 CP 174]. Promoters shall be liable to pay damages for failure to perform the promises made in the company's name. This shall be so even where the contract expressly provides that only the company's paid up capital shall be answerable for performance [Scot v. Lord Ebury (1867) LR 2 CP 255].

Provisional contracts. Those contracts which are entered into by a public company after obtaining the certificate of incorporation but before getting the certificate to commence business are known as provisional contracts [s.149(4)]. Such contracts are not binding on the company until the company is entitled to commence business and on that date they shall become binding, without any need for ratification.

If the company is unable to obtain the certificate to commence business, the provisional contracts will never become binding on it and no one can sue in respect of them.

As it shall be explained later, a company can do only such acts as by its memorandum it is expressly or impliedly authorised to do. Any transaction which is not so authorised is ultra vires (beyond the powers) and is null and void ab initio. Neither the company, nor the other party to the contract can enforce it.