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5.1 NLIU LR (2016) 32

Pre-Incorporation Contracts: A Legal Puzzle in India

by
Lakshmi Dwivedi & Varun Byreddy*
This paper attempts to examine the validity of a pre-incorporation contract i.e. of a
contract entered into by a company before its incorporation. The problem arises
because at the time of contracting, the company is non existent and hence the
contract has been entered into with an incapable party. It is surprising that such a
contemporary aspect hasn't received much scrutiny in Indian legal literature. Even
though Specific Relief Act lays down the procedure for a contract to be enforceable
against the company, how must a lawyer advise the promoters of the company,
liability on whom can be cast by law, especially if the company refuses to accept the
contract? Proper drafting of the contract can eliminate the need for law to resolve the
dispute. However, due to inadequate drafting, when law does come into picture, how
is to one clarify the position of all the parties to the contract. The paper begins with
probing who can be considered as a promoter. By a comparative analysis, the paper
tries to trace the common law and provide answers. This paper attempts to examine
the law regarding the enforceability of the contract, against the company by
interpreting the section of the specific relief act. On the basis of common law, it
attempts the answer on the question of promoter's personal liability on a pre-
incorporation contract. It answers the question, if the promoter can recover any
reincorporation expenses from the company and from the co-promoters, if any.
Drawing a distinction between a pre-incorporation contract and a contract by a
company defectively incorporated, it concludes with some drafting suggestions for a
pre-incorporation contract.

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I. INTRODUCTION
For any contract to be a valid one, it needs to be executed between two competent
persons.1 Birth of a company's competency is marked by its incorporation.2 This gives
it a separate legal existence3 and the rights and obligations of the contract lie squarely
with the company and not personally with the director or the promoter or the promoter
group.4
Thus, as seen, there is always a group of people or persons who are working on
behalf of the corporation. However, what happens when someone purports to be
working on behalf of a company, which is technically not a company (due to the
absence of incorporation)? Can anyone contract for a non-existent person, and in this
case, an artificial person in the process of formation but which has not yet been
brought into existence? This is precisely termed as a pre-incorporation contract i.e. a
contract entered on behalf of a company prior to its incorporation.5
Usually, there are three stakeholders to this contract i.e. the promoter,6 the party
with which the promoter contracts with and the company (the company will be
considered as a party only after the
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incorporation is completed) on whose behalf the promoter has entered into a contract.
The legal status of this contract is extremely questionable. After all, how can any one
contract on behalf of a person who has not yet come into existence?7 This leads us to
the primary question ‘What is the legal status of such a contract?’

Along with the above question, another important question relating to the rights
and obligations of the stakeholders can also be raised in this context. It is pertinent to
mention that such a contract, especially in India stand on shaky grounds and might
not enjoy “the security of transaction”.8 Is the promoter to be held personally liable
(also entitled to rights) on the contract? Will he have any defenses? When can a
company be held liable and be entitled to the benefits from such a contract? Will
making the company liable relieve the promoter of all liabilities (subsequently, even
disentitling him from the rights under the contract)? Can the promoter recover his pre-
incorporation expenses, especially those arising under a pre-incorporation contract
from other promoters or even the company after it is incorporated?
If one attempts to search answers for these questions solely within the four corners
of the Indian legal framework, then they will notice that the picture regarding pre-
incorporation contracts in the Indian legal framework is, to an extent, blurry.9 There
are different permutations of situations that can exist and the validity and
enforcement of a pre-incorporation transaction in such different scenarios is
equivocal.10 The only guiding light is provided by the Specific Relief Act, which lays
down when can companies sue and be sued for a pre-incorporation contract.11
However, the rights and obligations of the company comprise only one aspect of the
transaction. There is more to it, as we have seen.

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Also, the Specific Relief Act can be enforced only in certain circumstances.12 Dearth of
case laws expounding on this concept has been a major hindrance in getting answers
to the numerous questions. The enforcement of contracts in India is considered to be a
cumbersome process,13 resulting in fewer case laws and limited evolution of law.14 The
paper will try to answer these questions by a critical and comparative analysis of
various jurisprudences, like English Law, American Law, and South African Law.

One can avoid this mess by simply entering into contracts after incorporation.15
Incorporation under the Indian Law might take around 15 days to one month16 and for
a foreign company, this might take around 1.5 months.17 It is always advised to wait
for incorporation and get the benefit of a secure transaction rather than enter into
legal conundrums of a pre-incorporation contract in India. However, as noticed in
England, companies hardly issue prospectus before entering into arrangements for
business and property18 and sometimes the promoters deem it necessary to enter into
legally binding arrangements19 to make sure that company reaps the benefits for
which it was formed.20 Apart from contracts for constructing the office, hiring lawyers
for the company etc. (few illustrations), they might enter into contracts related to the
specific business of the company to ‘lock-in’ the other party.21 However, there is a

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possibility that technicalities might render such attempts infructuous since it is a pre-
incorporation contract22 or there might be a scenario that the promoter has to
personally pay the fees of the lawyer or might have to pay the builders out of his own
pockets. As noted, the answer is blurry and equivocal.23

This paper will first address the theoretical framework of the pre-incorporation
contract, specifically the nexus between the promoter and the company. Out of such
impossible theoretical framework, some answers might be sought which will also try to
examine the contractual relationship between the three stakeholders, especially its
enforceability and if any defenses will be available to the parties. This will also address
relation between the promoter and co-promoters. Then, the paper will look into the
difference in the effect between defective incorporation and pre-incorporation
contracts. The paper will conclude with the examination of some legal and non-legal
solutions for securing the transaction.
II. PROMOTER AND THE ROLE OF PROMOTER
Common Law propounds that “the term promoter is a short and convenient way of
designating those who set in motion the machinery by which the Act enables them to
create an incorporated company”24 and promoter is one who “undertakes to form a
company with reference to a given project and to set it going, and who takes the
necessary steps to accomplish that purpose.”25
Promoter plays a very important role in a company. Formation of a company starts
with the promotion of a company. Usually the idea of the company will be of the
promoters, they have the idea of the business and its feasibility. After considering
many things and doing a basic research or

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assessment only promoters will decide to form a body to do business. The decision to
create what kind of body will also be decided by the promoters i.e. whether to form a
sole proprietorship or partnership or limited liability partnership or a company will be
also decided by the promoter.26 Promoters have various duties before the company is
formed and they take care of incorporation and they enter into pre-incorporation
contracts.

To understand the liability of the promoter regarding the pre-incorporation contracts

we have to understand the definition of the promoter and also have to see statutory
definitions of the this word. In India the definition of the word promoter is not clearly
defined. The Companies act, 1956 defined the word promoter with respect to
prospectus. Section 62 of the 1956 act defines promoter as “a promoter who was a
party to the preparation of the prospectus or of the portion thereof containing the
untrue statement, but does not include any person by reason of his acting in a
professional capacity for persons engaged in procuring the formation of the company”.
The relevance of this provision is only with respect to claims for compensation made
by shareholders in case if any misstatement or misrepresentation made in the
prospectus issued to raise capital. This definition is to be applied only under those
circumstances where compensation is claimed by a person who has purchased shares
and debentures on the faith of the content given in the prospectus. This definition
expressly prohibits professionals who act for the company.
The word ‘promoter’ has also been defined in the SEBI (Substantial Acquisition of
Shares and Takeovers) Regulations 199727 and also in the SEBI (Issue of Capital and
Disclosure Requirements) Regulations 2011.28 But none of these definitions help us to
understand the liability of the promoters for the pre-incorporation contracts. So there
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was a hope that the 2013 act will define this word in a proper manner and gives clarity
but it also disappointed by giving an inclusive definition29 and not giving a descriptive
definition. This definition only deals with the situations

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after incorporation but not pre-incorporation. So even the definition of the word
promoter is not clear in India.

III. ENFORCEMENT OF THE CONTRACT

The peculiarity of a pre-incorporation contract revolves around the fact that a
contract is entered on behalf of a non-existent company.30 The third party has been
left on shaky grounds in a number of jurisdictions with the contract being declared null
and void due to lack of competent persons entering into the contract.31 However, there
are various interesting ways in which these situations were dealt under the common
law where some protection to the third party was given.
The first question that needs to be dealt with is the relation between he promoter
and the company, prior to its incorporation. A number of positions have been espoused
in different jurisdictions to define this relation, which range from making them the
agents of the company, to the trustees of the unincorporated company.32
The usual argument that has been made and often selectively applied is to treat the
promoter as an agent of the unincorporated company.33 However, the promoter can't
bind the company as its agent since the principal is non-existent.34 Another
implication of this is manifested in the post-incorporation stage and ratification is still
not permitted.35 English Law bars ratification of a pre-incorporation contract by the
company on the basis that even for ratification, the company needs to have legal
capacity at the time the contract was completed, which is absent for a pre-
incorporation contract.36 The doctrine of persona ficta is so strictly followed in England
that unless novation of the contract takes place to replace the company as a party to
the contract, no unilateral ratification is permitted.37 Any act of ratification or adoption
by the

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company is treated to be that of an offer to third party, and not acceptance of the offer
of the third party.38 This is in spite of the recommendations of Jenkins Committee to
allow for ratification for commercial expediency reasons.39 One strand of theory
suggests and which has been adopted with some flexibility in certain jurisdictions is to
allow the company to ratify pre-incorporation contract.40 Analogy is drawn to
ratification of unauthorized acts of agent by the principle.41

South African Law confers the power on the board to ratify and in fact, has a
provision for deemed ratification, i.e. if within 3 months the corporation doesn't act on
the contract, it will be deemed to be ratified by the company.42 This provision though
is a step ahead of other common law jurisdictions might prove harmful for the
company especially because no specific knowledge of the contract is required and the
time period might be arbitrary, without giving consideration to the kind of contract.
Some contracts might take longer than 3 months to be examined and be ratified.43
American jurisprudence tries to skirt the theoretical difficulty of ratification by
introducing another concept of ‘adoption’ instead of ratification.44 Though the legal
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effect for both of them is the same, the difference lies in being technically correct.45
The company by adopting the benefits of the contract automatically becomes a party
to the contract.46 The liability, which is to be impinged on the company, is not justified
on the basis of abstract principal-agent relationship but the power can be located
within its inherent powers of forming contracts as body corporate.47 Thus, the
company though might not be free to ratify in the strictest legal sense, but is
definitely free to adopt the contract with the equitable reason to protect third parties,
especially if the company has taken use of the benefits of the contract.48 But it also
becomes necessary to

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protect the shareholders of the company from any undesired liability that Express
ratification and acceptance are not the only ways to enforce the company may attract
because of the promoter. Certain safeguards have been put in place to protect them
which include that merely benefitting from an unsolicited act doesn't amount to
acceptance and some affirmative act would be needed along with the requirement of
having full knowledge of the contract, with the knowledge to the promoter not
amounting as knowledge to the company.49

It has been noted that Indian Law along with South African law has been very
liberal in this aspect and gives companies the power to ‘ratify’ pre-incorporation
contracts entered on its behalf.50 Under Indian Law, the same power can be located
within the framework of Specific Relief Act under Section 15(h) and Section 19(e).
It is respectfully submitted that in the case of Seth Sobhag Mal Lodha v. Edward
Mills Co. Ltd.51 , the court erroneously denied any scope for enforcement of a pre-
incorporation contract. However, it has been noted that the judgment failed to take
provisions of Specific Relief Act into account for consideration of the matter.52
A breakdown of Section 19(e)53 & 15(h)54 of the Specific Relief Act points that for a
pre-incorporation contract to gain validity in the eyes of the law, it must have been
entered into for the purposes of the future company and must have been warranted by
the terms of the incorporation. Further, the acceptance of the contract must be
communicated to the third party.55 The questions raised in this regard would involve
how one is to interpret “warranted by the terms of incorporation” and how one is to
interpret ‘acceptance of the contract’. Does warranted by the terms necessarily imply
that it must be expressly included in the articles of association or it means that such
contract can be ratified as long as it is not against the objects of the company? Further
can implied acceptance be considered valid i.e. by utilizing the benefits of the
contracts?

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Express ratification and acceptance are not the only ways to enforce a contract. If a
company has accepted benefits of a pre-incorporation contract,56 the contract won't be
a complete nullity and claims can be adjudicated based on such a contract. The Apex
court in India has held that the term “warranted by the terms of incorporation” must
be construed to mean that it must not be ultra vires of the object of the company and
dismissed the submission that an express condition needs to be articulated in the
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articles for the acceptance of a pre-incorporation contract.57 Even a company's

declaration of ownership to the property conveyed under the contract would suffice for
the purpose of acceptance under Specific Relief Act. Thus, acceptance of benefits of
the contract by the company should then essentially entail it to accept the burden of
the contract too.58
However, a blanket rule under Specific Relief Act can't be formulated for all pre-
incorporation contracts, at least in India. It must be read in conjunction with other
statutes and relevant framework. Thus, in Jai Narain Parasurampuria (Dead) v. Pushpa
Devi Saraf,59 the Supreme Court upheld the validity of the land transfer agreement,
after concluding that it doesn't conflict any provision of Transfer of Property Act.
However, another case held that a pre-incorporation share transfer agreement couldn't
be enforced because a company not in existence can't be registered as a transferee in
the register.60 The case can also be interpreted harmoniously with Apex court ruling
and with the Act by regarding that such a share transfer certificate is strictly speaking
not “for the purposes of the company”61 and hence, while interpreting the given term,
care must be taken to evaluate that the contract should not only be ultra vires the
objects but also must in some

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way contribute beneficially to the principal business for which the company is
purported to be formed.62 This makes the line very blurred and obfuscated and renders
the interpretation highly subjective. Hence, it is submitted that the position
formulated by the Supreme Court should be upheld, which states that as long as it is
not ultra vires the objects clause of the company, it must be left to the company to
ratify it.

The difference between English, Indian and American Law lies in allowing the
company to have the requisite flexibility to continue with a contract that was made on
its behalf before its existence. English Law, however, has been unable to grant the
same power to the contracts. American law on the other hand has struck down the
English Law approach in favor of the commercial benefits of the parties involved and
has come up with its own techniques to enforce the contract, which is much more
flexible compared to Indian law. The theories that have emerged from judicial re-
thinking under American jurisprudence are - ratification, adoption, acceptance of
continuing offer and novation.63 Continuing offer is synonymous to adoption wherein
the pre-incorporation contract is considered to be an open-offer for64 the corporation,
which it may choose to accept by receiving or rejecting the benefits. This can be
treated to be the position under Specific Relief Act, since only on the company
accepting the contract, can it have some legal effect. However, the next section will go
beyond the Specific Relief and look into the common law to further examine the
contract.
IV. PERSONAL LIABILITY OF THE PROMOTER
Though Specific Relief Act has spoken on conditions of enforcement between the
company and the third party, there is a legal vacuum in India when it comes to the
enforcement of the contract without such ratification.65 Can the promoter be held liable
personally for this contract as is followed in a number of jurisdictions e.g. UK, EU, and
USA? There is another important question i.e. whether the promoter can be relieved of
liability when the company ratifies the pre-incorporation contract. The judiciary in
India is silent on this aspect of the law.
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A. Non-Ratification
An inroad to the Common Law position would be helpful in this regard. The common
Law in this context gave prime importance to the intention of the parties in
adjudicating the contract.66 If the promoter purported to act for the corporation, then
he was held personally liable for the contract. However, if the contract is entered in
name of the proposed company and the promoter merely authenticated the signature,
the promoter was absolved from all liability.67 The justification for the same was based
on the intention of the parties i.e. who they look to when contracting. The illustration
for the same could be found in the two English cases, which rendered the distinction
highly technical.68 The most often cited authority for enabling enforcement against the
promoter has been Kelner v. Baxter69 in which, the promoter signed “on behalf of the
proposed company”. The company wasn't formed and the enforcement of the contract
was bought before the court. Here the court held that since it was evident to both the
parties that the company was ‘proposed’ to be formed, hence the intention of both the
parties could be to hold promoter personally liable in case, the company is not
formed.70
However, a different approach was taken in the case of Newborne v. Sensolid71 In
this case, a contract was entered into at a time when the company was not properly
formed. From the signature, the court concluded that since the director authenticated
the signature of the company and didn't purport to sign as an agent of the company.
Hence, in this case the contract was rendered void.72
This distinctive approach has often been criticized as too technical with intention
being reduced to focus on the form of signature.73 Lord Denning also propounded that
the real intent is to be discerned by the knowledge of the parties and the contract
itself rather than the technical

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distinctions of signature and he criticized this approach.74 However, Newborne doesn't

stand as an authority to deny enforcement of the contract vis-à-vis the promoter.75 In
this case, the parties wrongfully assumed that the company was in existence when the
contract was entered into. The company pleaded its unconstitutionality to get away
with the contract.76 Thus, the principle that can be filtered from these two cases is that
when both the parties were aware that company was non existent, then the question
that must be asked to determine the intention of the parties is whether promoters had
wished to assume liability in case the contract was not novated.77 Further, in
Newborne the court failed to account the promoters for breach of warranty or
authority.78

The common law distinction between the signatures was obliterated by Section 9(c)
of the EEC directive and further Section 36 of the Companies Act which laid down that
any person who purports to contract for a company, will be held liable for it personally,
unless expressly agreed otherwise by the parties.79 Thus, to prevent the contract from
being declared a nullity, and leaving behind a dead tree where no one is held liable,
the statutory enactment reinforced the security of transactions. In India, in the
absence of such statutory enactment, the question of liability is left open.80
Section 36C of the Companies Act, which crystallized common law and obliterated
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technical inconveniences, also took within its fold cases where no formal contract was
entered into but services were rendered under some arrangement.81 In the case of
Braymist Ltd. v. Wise Financial Co. Ltd.82 , it was held that not only can the agents be
sued under the contract but can also sue on the contract.
A look at the American jurisprudence suggests a strict liability for the promoter in
case the corporation is not formed or doesn't adopt the

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contract. Thus, in the case of RKO-Stanley Warner theatres, Inc. v. Graziano83 , the
promoter was held personally liable in spite of explicitly denying the liability for such
contract and placing it on the corporation to be formed. Even after the corporation was
formed, it never adopted the contract, hence the court turned down to the plea to limit
the personal liability to the pre-incorporation stage.84

Restatement of Agency suggests three routes available in case of a pre-

incorporation contract: make the corporation liable on the contract; liability of the
promoter to ensure that the corporation adopts the contract or; termination of
promoter's liability on the corporation adopting the contract.85 The default rule
however, is to make the promoter personally liable on all such contracts.86 Out of these
alternatives, the first one would not be allowed in India since Specific Relief Act
requires acceptance by the company and such acceptance can't be pre-imposed on the
company without its will. The third case in India is ambiguous.
South African Law not only makes the promoter personally liable but also holds him
in breach of dual warranty of statutory authority. One is that promoter will incorporate
the company within reasonable period of time and also that the company would ratify
the contract. This provides the third party with much needed security of transaction
but “the statutory warranty approach begets uncertainty by leaving lacunae and gaps
during the interim period between the execution of the pre-incorporation contract by
the agent and its ratification by the company. This gives rise to a number of practical
problems and challenges, such as the issues of unilateral withdrawal of the third party
and mutual cancellation of the agreement during the interim period.”87
The question of promoter's liability on the contract is an unsettled issue in Indian
law due to the absence of any statutory enactment to the effect and lack of any
judicial pronouncements to define the contours of the issue.88 Ramaiyya's commentary
suggests that under Section 230 of the Indian Contract Act, a promoter can't be held
liable under a pre-incorporation contract since under Section 230 of the Indian
Contract

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Act, an agent is not personally bound by the contract entered for his principal.89 Thus,
once the company is incorporated, the promoter can't sue or can be sued in case the
company refuses to ratify the contract90 except on the principle of quantum merit or
breach of warranty of authority.91 Quantum merit would imply that if the promoter has
rendered services to other party and it has been accepted by the other part, then he
can sue under the contract.92 However, it is submitted that such position is incorrect
because it assumes an agent principal relation. The move to make promoter personally
liable would depend on the intention of the parties and no such rule to make the
contract void can be deduced from even Indian jurisprudence.
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The promoter's personal liability can be avoided by construing a pre-incorporation

agreement as a revocable offer or “gentle-man's agreement” under which, if the offer
is not revoked, the corporation can on adoption accept the contract.93 The advantage
for the promoter under this interpretation of the contract is that he has no rights or
liabilities regarding the contract provided there was no fraudulent intent or breach of
warranty of authority.94 A look at the Specific Relief Act also suggests that one can
interpret the Company's ratification as acceptance of an offer by the third party. The
promoter merely locks in the third party for the company.95 However, this doctrine is
not very popular with American Courts since it can be nugatory defeating the very
intention of the parties to give some legal effect to the contract.96
An issue however arises because of the note put in the Name Approval Certificate.
The Certificate, issued by the Registrar under its statutory power clearly says that no
contract can be entered on behalf of the proposed company till it is registered i.e. it is
incorporated.97 It is not

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clear if it is a condition subsequent to issuance of certificate and to harmoniously

construct this note with the Specific Relief Act, one might come to conclusion that
until and unless the Company ratifies the contract, any such contract can never bind
the company. Thus, one strand of interpretation suggests that the contract can't be
enforceable and hence would be void. Other strand would still hold the promoter liable
personally and would only bar burdening the company with any such contract.

B. On Ratification By Company
Another problem with ratification/adoption is the uncertainty that underlies the
continuance of the promoter's liability after the corporation ratifies or adopts the
contract.
As mentioned before, the English Law denies ratification of a pre-incorporation
contract. Under the English Law, novation is permitted which requires the corporation
to take promoter's place. Such substitution of parties is termed novation.98 This theory
of novation has been propounded by Williston99 and has been accepted by the courts
too.100 Novation undoubtedly releases promoter from all liability under the contract.101
With Specific Relief Act in place and unilateral ratification being permitted, the
position resembles the American position more. The Specific Relief Act only requires
the company to convey the acceptance to the other party and doesn't necessitate
express assent by the third party. Thus, the position resembles American position in
that respect. For this precise reason, American jurisprudence will be looked into to
ascertain the position and Goodman v. Darden102 clarified that merely because the
corporation adopted the contract, doesn't dissolve the promoter of his personal
liability. In this case, both the parties were aware that corporation is non existent at
the time of making of contract and further that, the corporation did accept the contract
and the promoter directed all the payments received under the contract to the
company. Still, the court went ahead to hold that the intention

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of the third party was never to release the promoter from the liability. The contract?
Third, have the corporation and the third party contractor very knowledge of it being a
pre-incorporation contract would indicate that to reduce the uncertainty, the third
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party would have intended to make the promoter liable too which didn't end on
corporation adopting the contract.103 This might be to ask for warranty that the
corporation would perform its obligations, which is analogous to the South African
statutory law.104 Thus, what the court examines is the third parties' intention as to
whether the third party intended to limit the liability of the promoter on the
corporation adopting the contract.105

In the Indian context what might be suggested is either to amend the provision for
ratification or ask for novation, otherwise mere adoption by corporation won't be a
guarantee for the promoter to be relieved of all its labilities.106 However, a case for
abolishing promoter liability once the company adopts the contract can also be rooted
on the principles of fairness and equity.107 This would reduce the burden on one party
and would even distribute the benefits and liabilities between the parties. Further, it
would fetter the third party's choice of holding anyone of his choice liable under the
contract.108 It is also submitted that the case of Goodman has been fallaciously
interpreted the intent of the parties since it failed to give due acknowledgment to the
intent of the promoter, who on adoption by the company would naturally not intend to
be bound personally since incorporation's109 primary feature is that it ensures limited
liability. Another argument in support of abolishing personal lability of promoter would
be by the principle of contractual mutuality. On incorporation, the promoter has no
personal interest in the contract and it is solely by the virtue of the company. Hence, it
is unfair to make the promoter liable. An interesting case would arise when it involves
a One Person Company. Thus, the following test has been suggested:
First, has the promoter entered into a contract on behalf of a non-existent
corporation? Second, has the corporation adopted or ratified the

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entered into a novation to release the promoter from liability, or, has the third party
agreed to look solely to the corporation for liability? Finally, is the corporation genuine
or has it been established to defeat promoter liability in connection with a fraudulent
scheme?110

Further, the practices from other jurisdictions can be of greater help for solving the
issue of the pre-incorporation contracts. In jurisdictions like Germany, Australia and
South Africa, innovative solutions have been introduced by the legislature to deal with
the problem of liability of Promoters for the pre-incorporation contracts. In USA the
ratification of the pre-incorporation contract need not be done expressly. Ratification of
this contract will happen automatically after the company is formed if that contract
has been made for the benefit of the company. Germany, which is a civil law country,
the promoter can make the other promoters liable along with him and the pre-
incorporation association can be treated similar to that of a partnership.111 Another
important aspect of the German Law is that there is a theory called theory of Identity,
which states that the company formed after the incorporation will be treated similarly
as the pre-incorporation association and after the incorporation that body will get the
same rights and obligations as enjoyed by the pre-incorporation association prior to
the incorporation of the company.112 This theory was later named as the theory of
Continuity and under these theories the company after its formation need not adopt or
ratify the contract and the obligations and rights will be accrued to the company as if
under the succession.113
It is submitted that this theory as adopted in Germany can be considered as the
best solution to avoid the liability for the promoter. In India, as stated earlier, it will
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be usually the promoters who will have a major control in the company so if the
contracts are accrued to the company as if under succession then the promoters will
be saved from liabilities and even the third parties will also have a better debtor as the
company will get obligations towards them and they will have a better security against
the dues that have to be paid to them or any service if any, has to be rendered to
them. In the Indian context, this will be apt as the most of the companies are family
based and the pre-incorporation

Page: 50

contracts entered also will be beneficial to the company in most of the instances.
Legislature should also consider this option as the issue of pre-incorporation contracts
is a special case and it's not a simple one as it appears. Under the Australian laws,
where Section 131 of the Australian Corporation Act, 2001 states that the Court can
interfere into this matter of the pre-incorporation contract if the Companies won't
ratify the contracts. Under this law the court can order for the payment of damages to
the promoter if it thinks that it's appropriate to grant such an order. It is submitted
that this law is a radical step as the courts can interfere to protect the promoters
whose contracts haven't been ratified by the company. In the Indian context also this
may hold well because there may be a promoter who also may be a minority
shareholders and the majority might not ratify the contract after the incorporation of
the company. This might suit for our country as even the available remedies are not
targeted to protect the promoters but only for the protection of the third party and this
also depends upon the discretion of the company.

V. RELATIONSHIP BETWEEN THE PROMOTER AND THE COMPANY

Though the case laws and the academic discourse on this issue has been
multifaceted and inconclusive, but the Indian Supreme Court has affirmed a previous
high court ruling which defined the relation between the two as that of a fiduciary
relation.114 It rejected the position of the promoter with respect to that of the
unincorporated company as that of agency or trustees.115 In the case of Weavers Mills
v. Balkis Ammal,116 was held that even without express conveyance of property by the
promoter to the unincorporated company, since the promoter stands in fiduciary duty
to the company, all the benefits of the pre-incorporation contract would pass on to the
company.
“While we accept the position that a promoter is neither an agent nor a trustee of
the company under incorporation, we are inclined to think that in respect of
transactions on behalf of it, he stands in a fiduciary position. The legal position of a
promoter in relation to his acts, particularly purchase of Immovable properties on
behalf of the company

Page: 51

under incorporation, is a peculiar one not capable of being brought into any
established or recognized norms of the law as to its character as an agent or a trustee.
But, at the same time, it is impossible, to our minds, to deny that he does stand in a
certain fiduciary position in relation to the company under incorporation. When he
does certain things for the benefit of it, as for instance, purchase of Immovable
properties, he is not at liberty to deny that benefit to the company when incorporated.
We are prepared to hold that in such a case the benefit of the purchase will pass on to
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the company when incorporated.”117

Being in a position of fiduciary duty, can the promoter force the company to
compensate it for the pre-incorporation expenses that the promoter incurs on behalf of
the company? One position can be that if the company accepts the benefits of the
contract, then it must accept the burden too and hence must compensate the
promoter for all his expenses under the said contract. However, if the company doesn't
ratify the contract, then the promoter can't claim for reimbursement.118
The reimbursement can be in the form of increased pay up during the allotment of
shares.119 However, allotment of shares in lieu of pre-incorporation services is not
treated as a good consideration in a number of American jurisprudences.120 Under the
Indian Contract Act however, since consideration for past services is considered to be
good consideration,121 allotment of shares in lieu of pre-incorporation services can be
permissible.
A. Liability of A Co-Promoter
Here the issue of non-existence of a principle doesn't arise. This especially becomes
pertinent when the promoter acts to incorporate a subsidiary of a foreign company.
One can claim that the promoter is acting as agent of an already existing holding
company, and hence could asks for his remuneration and re-imbursement from this
company.
English Law however, restricts the liability of co-promoters only to cases where an
express authority to act as agent is conferred. The courts

Page: 52

have been slow to read implied authority122 and have explicitly rejected conferring
such liability.123 English law suggests, albeit weakly, that pre-incorporation association
to be that of partnership. However, what it is pertinent to prove is that the association
is with the common objective of earning profit.124 This becomes difficult to show when
the object is merely administrative in nature i.e. to get the company organized.
However, when it was shown that the object was more than administrative, i.e. for
acquiring a business and operating it before incorporation (pre-ordering goods for
restaurant), then it can be considered to be a partnership and expenses were
recovered from all promoters.125 It is difficult to hold them liable as an association sui
generis but if the association was a partnership that was later incorporated then one
can say that the acts of the promoter can bind the partnership as a whole.126

In India, partnership act lays down that partnership must be the result of an
agreement,127 which need not be formal or written,128 but the requirement to carry out
business is indispensable under the Indian partnership Act.129
South African law has again taken a leap forward by holding all promoters jointly
and severally liable for a pre-incorporation contract entered into by any of the
promoter.130 Care must be taken to not focus merely on the signatory but also on any
implied authority by other promoters.131
VI. PRE-INCORPORATION OR DEFECTIVE CORPORATION?
Often Newborne case and Kelner case is commented upon by mentioning how the
intention of holding promoter liable hinged on

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technical distinction of how the contract was signed. However, it must be noted that
Newborne dealt with a contract with a defective corporation. The confusion is not new
and people often tend to put both of them under the same umbrella.132 It has been
suggested that the doctrines of corporation by estoppel and de facto corporation can
be used to deal with the problem of pre-incorporation contracts.133 These doctrines
protect the promoters or directors from being personally liable on contracts that were
entered into with a company, that both parties, in good faith, believed to have been
incorporated, when it was not.134

What most commentators can miss is that the distinction lies in the knowledge of
the parties. In a pre-incorporation, no effort is undertaken to incorporate. Merely
having good faith intent to incorporate is not a sufficient requirement for the doctrine
of corporation by estoppel to operate. Some attempt must be undertaken to bring it
into operation. Further, another difference that lies is in the knowledge of the parties.
Whereas in pre-incorporation contract, both parties know that the company is yet to
be incorporated, in a defective incorporation both have a bona fide but fallacious belief
in the existence of the company. If the promoter lies about the same to the other
party, then he can clearly be held liable for fraud or breach of warranty of authority.135
In the Indian scenario, on account of the name approval certificate, it is quite clear
that the doctrine of corporation by estoppel or de facto corporation would come into
play only when attempts are made to file certificate of registration.
VII. CONCLUSION
This paper would conclude with some drafting suggestions for a pre-incorporation
contract and might look at some favorable alternatives that can be made a part of the
law itself. Half of the problems of pre-incorporation

Page: 54

contract can be resolved by apt drafting which clearly sets out the intention of the
parties.136

Regarding the drafting suggestion, the promoter must limit his risk by explicitly
bargaining for no personal liability in case of failure of non-ratification and that in case
of ratification, his liability would end. A further rider must be put indicating the status
of the corporation and the promoter can also disown liability for making the
corporation compulsorily ratify the contract. This is because the contract per se can't
include a clause for compulsorily burdening the company with any liability it didn't
consent too and the shareholders can't be forced with such contract.137 It is further
consistent with principle of preserving the share capital of the company.138 Though
sometimes the promoter, who might become the majority share - holder can enforce
the ratification as an incident of his power but legally such enforcement is not
voluntary.139 Rights and obligation of the promoter, of the contemplated corporation
along with consequences (which follows if the contemplated corporation repudiates the
agreement or does nothing regarding the agreement, with or without accepting the
benefits) with respect to ratification/non-ratification must be followed.140 The promoter
can also put in a clause of indemnification of all pre-incorporation expenses.141
Under the Indian law, one can conclude that the corporation can adopt the contract.
However such adoption/ratification is no guarantee that the contract will release the
promoter from the liability and hence the promoter must undertake appropriate
safeguards to protect himself and press for novation of the contract. In case of non-
ratification by the promoter, it is quite possible that Indian courts might take the
common law road to make the promoter personally liable on the contract. However,
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interpretation to deny this personal liability also exists especially if one construes the
pre-incorporation contract to be that of a continuing offer for the corporation. Though
South African law might hold other co-promoters jointly or severally liable, Indian
Courts

Page: 55

might take the English path and would be slow to read in liability for all co-promoters.
A strong case can be made by the promoter to be indemnified for all the pre-
incorporation contracts especially if the Corporation adopts the same and
reimbursement for services can commonly be sought by increased allotment of shares.
Finally, care must be taken to not club all pre-incorporation contracts as one that
being made by defective corporations.

———
* Students, NALSAR University of Law, Hyderabad.
1 Indian Contract Act 1872, §10.

2Companies Act 2013, §9 states that once the company is registered, the body incorporated has the “power to
acquire, hold and dispose of property, both movable and immovable, tangible and intangible, to contract and to
sue and be sued, by the said name.”
3 Companies Act 2013, §21 provides that a person authorized by the Board or a key Managerial Person can enter
into the contract on behalf of the company. Key Managerial person is further defined in Section 2(51) of the said
act as: Chief Executive Officer or Managing Director or Manager, Company Secretary, the whole time director,
Chief Financial Officer, or any such officer as may be prescribed.
4 Solomon v. Solomon, (1896) UKHL 1.
5
M.J. Whincop, Of Dragons and Horses: Filling Gaps in Pre-incorporation Contracts, (1998) 12 JCL 223-225.
6 Companies Act 2013, §269 has introduced the definition of the term ‘Promoter’ under the Indian Law for the
first time. Promoter is a person (a) who has been named as such in a prospectus or is identified by the company
in the annual return referred to in section 92; or (b) who has control over the affairs of the company, directly or
indirectly whether as a shareholder, director or otherwise; or (c) in accordance with whose advice, directions or
instructions the Board of Directors of the company is accustomed to act: Provided that nothing in sub-clause (c)
shall apply to a person who is acting merely in a professional capacity. It is to be noted that this definition only
refers to a promoter after the incorporation of the company. Much has to be debated about who can act as a
promoter for a company before incorporation. This will be seen in the next section.
7 STEWART KYD , T REATISE O N THE LAW OF CORPORATIONS § 5:13 (1st ed., J. Butterworth, 1794)
8 This term was introduced in the EEC Directive (EEC 68/151), which in a bid to secure a pre-incorporation
contract, by statutory provision held the promoter personally liable for a pre-incorporation contract. This
security might not be available under the Indian law due to the absence of a statutory provision to the effect.
9Prasidh Raj Singh, Promoter and Pre-incorporation Contract, 6 ASIAN JOURNAL OF INTERNATIONAL LAW , 1-2 (2011),
available at: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1938065, accessed 9 th April 2015.
10 To name a few, different situations that can arise include no ratification by the company, ignorance of the
status of the company, status of the company as a third party to the contract etc. More on this will be
elucidated later.
11 Specific Relief Act 1963, §15(h) and 19(e).
12 Specific Relief Act 1963, §10.
13Somasekhar Sudareshan, India cuts a sorry figure with Contracts, BUSINESS STANDARD, 9th May 2011, available
at: http://www.business-standard.com/article/economy-policy/india-cuts-a-sorry-figure-with-contracts-
111050900030_1.html, accessed 9 th April 2015.
14 Ponzetto & Fernandez, Case Law versus Statute Law: An Evolutionary Comparison, 37 JOURNAL OF LEGAL
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STUDIES (2008).
15William J. Rand, High Pressure Sales Tactics and Dead Trees: What to do with Promoters' Pre-Incorporation
Contracts, 4 RUTGDER 'S BUSINESS LAW JOURNAL 1 (2007).
16 AVA Professionals, Time Frame for Incorporation, AVA Professional Consultants, available at:
http://www.avaprofessionals.com/knowledge-center/company-registration-india/time-frame-for-incorporation/,
accessed 9 th April 2015.
17 Madan & Co., Incorporating a company in India, Madan & Co., available at:
http://madaan.com/incorporate.htm, accessed 9 th April 2015.
18Thomas Reith, The Effect of Pre-incorporation Contracts in German and English Law, 37 INTERNATIONAL AND
COMPARATIVE LAW QUARTERLY 109 (1988).
19 These arrangements, at least in India might not be legally binding.

20 Maleka Femida Cassim, Difficult Aspects of Pre-Incorporation Contracts in South African Law and Other
Jurisdictions, 13 Bus. L. Int'l (2012)
21 EDWARD F R Y , A T REATISE O N THE SPECIFIC PERFORMANCE OF CONTRACTS 200 (BiblioLife, 2009)
22 Dr. Joseph H. Gross, Liability of Pre-incorporation contracts: A Comparative Review, 18 Mcgill Law Journal
(1972), available at: http://www.lawjournal.mcgill.ca/userfiles/other/1732404-gross.pdf, accessed 9th April
2015. The present state of the law is considered in most common law countries as “unsatisfactory and replete
with serious difficulties for promoters, companies and the public at large” and the rules on this subject are
“highly technical and inconvenient and it is clearly desirable that they should be abrogated.
23 A. RAMAIYA , GUIDE TO COMPANIES AC T (17th ed., 2010).
24
Erlanger v. New Sombrero Phosphate Co., [L.R.] 3 App. Cas. 1218.
25
Twycross v. Grant, [L.R.] 2 C.P.D. 469 (CA).
26 Anonymous, Role of Promoter in Company establishment, Law Teacher, available at
http://www.lawteacher.net/free-law-essays/business-law/role-of-promoters-in-company-establishment-
business-law-essay.php, accessed 1st March 2015.
27 SEBI (Substantial Acquisition of Shares and Takeovers Regulations) 1997, Regulation 3.
28 SEBI ICDR Regulations 2011, Regulation 2(ZA).

29 Companies Act 2013, §2(69).

30 Kelner v. Baxter, [L.R.] 2 C.P. 174.
31 Supra note 22.
32Outmoded Concept Dominates Law of Promoters' Pre-Incorporation Contracts, 2 Stanford Intramural Law
Review (1948).
33 Ibid.
34 Ibid.
35 Ibid.
36 Joseph Savirimuthu, Pre-incorporation contracts and the problem of corporate fundamentalism: are
promoters proverbially profuse? 24 Company Lawyer p. 196-209 (2003).
37 Ibid.
38 Supra note 18.
39 Ibid.
40 Supra note 36.
41
Supra note 35.
42 Supra note 20.
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43
Ibid.
44
Supra note 22
45
Supra note 15.
46 Ibid.
47
Supra note 36.
48 Wall v. Niagara Mining & Smelting Co. of Idaho, (1899) 20 Utah 474.
49 Supra note 22.
50
ANDREW GRIFFITHS , CONTRACTING WITH COMPANIES (Hart Publishing, 2005).
51 Seth Sobhag Mal Lodha v. Edward Mills Co. Ltd., (1972) 42 Com Cases (Raj).
52 Supra note 23.
53
To be enforced by the third party.
54 To be enforced by the company.
55 Specific Relief Act 1963, §15(h) and 19(e).
56
Weaver Mills v. Balkis Ammal, (1969) AIR Mad 462; The Company took possession of the land transferred in a
pre-incorporation contract with promoter acting on behalf of the company and the company improved on the
land. Held, title vests in the company.
57 Jai Narain Parasurampuria (Dead) v. Pushpa Devi Saraf, (2006) 7 SCC 756.
58 Ibid.
59
Supra note 51.
60 Inclec Investment Pvt. Ltd. v. Dynamatic Hydraulics Ltd., (1989) 3 Comp LJ 221, 225 (CLB).
61KM GHOSH AND KR CHANDRATRE , K.M. GHOSH & DR . K.R. CHANDRATRE 'S COMPANY LAW : WITH SECRETARIAL PRACTICE,
(13th ed., Bharat Law House, 2007).
62
Ibid.
63 Ibid.
64
Ibid.
65
Supra note 23.
66 Supra note 15.
67 ARDEN & PRENTICE ED., BUCKLEY ON COMPANIES AC T (17th ed., Lexis Nexis),
68
NN Green, Security of transaction after Phonogram, 47 THE MODERN LAW REVIEW 671-691 (1984).
69
Supra note 30.
70 Ibid.
71
Newborne v. Sensolid, (1953) 1 All ER 708.
72 Ibid.
73 Supra note 68.
74
Phonogram Ltd. v. Lane, [1982] Q.B. 938.
75 SI R F RANCIS BEAUFORT PALMER , PALMER 'S COMPANY LAW (25th ed., Sweet and Maxwell, 2013).
76 Supra note 36.
77
Ibid.
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78 Ibid.
79 Supra note 68.
80
Supra note 23.
81Hellmuth, Obata & Kassabaum Inc. v. Geoffrey King (unreported, Sept. 29 2000, QBD, Technology &
Construction Court).
82
Braymist Ltd. v. Wise Financial Co. Ltd., (2002) EWCA Civ 127.
83
RKO-Stanley Warner theatres, Inc. v. Graziano, (1975) 355 A.2d 830.
84
Ibid.
85 Supra note 15.
86
Ibid.
87
Supra note 20.
88 Supra note 23.
89 Ibid.
90
Ibid.
91 Royal Bank of Canada v. Starr, (1985) 31 BLR 124 (Canada).
92 Cotronic (UK) Ltd. v. Dezonie, (1991) BCLC 721 (CA).
93
HARRY G. HENN & JOHN R. ALEXANDER, LAW OF CORPORATIONS (3rd ed., West Publishing Co. 2007).
94Ibid; RAC Realty v. WOUF Atlanta Realty Corp, (1949) 205 Ga. 154 : 52 SE 2d 617; Strause v. Richmond
Woodworking Co., (1909) 109 Va. 724 : 65 SE 659.
95 Supra note 93.
96 Ibid.
97 Sample available at: http://coconutboard.in/kadathanad/pdfs/Certificate%20of%20Approval%20of%
20Name.pdf, accessed 9th April 2015.
98 Supra note 68.

99 Supra note 22.

100 Ibid.
101 Supra note 67.
102 Goodman v. Darden, (1983) 670 P.2d 648.
103
Ibid.
104 Supra note 93.

105 Wolfe v. Warfield, (1972) 296 A.2d 158.

106 Supra note 22.
107Eddie R. Flores, The Case for Eliminating Promoter Liability on Pre-incorporation Agreements, 32 Ariz. L. Rev.
405 (1990).
108 Ibid.
109 Ibid.
110 Ibid.
111 Id at p. 11.
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112 Id at p. 12.
113 Ibid.

114 Supra note 50.

115 Ibid.
116 Weavers Mills v. Balkis Ammal, (1969) AIR Mad 462.

117 Supra note 50.

118 Supra note 93
119
Supra note 68.
120 Supra note 93
121 AR Mohammed Jalaludeen v. VS Dhakshinamoorthy, Second Appeal No. 980 of 2009 (Mad HC).
122
Supra note 18.
123 Supra note 81.
124 Indian Partnership Act 1932, §1(1).
125
Keith Spicer Ltd. v. Mansell, [1970] 1 WLR 333.
126 Supra note 18.
127 Indian Partnership Act 1932, §4.
128 Abdul v. Century Wood Industries, (1954) AIR Mys 33.

129The Indian Partnership Act 1932, §4; AVATAR SINGH, INTRODUCTION TO LAW OF PARTNERSHIP (10th ed., Eastern
Book Company, 2010)
130 Supra note 20.

In the case of Bay v. Illawarra Stationery Supplies Pty Ltd., (1986) 4 ACLC 429; even when four promoters
131

were acting together, only one of the signatory promoter was held liable.
132
Norwood P. Beveridge, Corporate Puzzles: Being a True and Complete Explanation De Facto Corporations and
Corporations by Estoppel, Their Historical Development, Attempted Abolition, and Eventual Rehabilitation, 22
Okla. City U.L. Rev. 935, 938 (1997).
133
Supra note 9.
134 Supra note 15.
135 Ibid.
136 Supra note 93.
137 Supra note 18.

138 Ibid.
139 Supra note 68.
140 Supra note 93.
141
Ibid.
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