Meaning of Preliminary or Pre-incorporation Contracts Entered by the Promoters (Companies Act, 1956)

Cases:

(i) N & Co. entered into an agreement with one C, who acted on behalf of a proposed syndicate. Under the agreement N & Co. was to give the syndicate a lease of coal mining rights. The syndicate was then registered and asked N & Co. to give these rights, which N & Co. refused.

An action by the syndicate for specific performance of the agreement or in the alternative for damages was not maintainable as “a company cannot by adoption or ratification obtain the benefit of a contract purporting to have been made on its behalf before the company came into existence.”

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(ii) On the request of the promoters of a company; a solicitor prepared the Memorandum and Articles of Association of a company, paid the registration fees and got the company registered. The company was not held bound to pay for the services and expenses of the solicitor.

“The company could not be sued in law for those expenses in as much as it was not in existence at the time when the expenses were incurred and ratification was impossible.”

A company cannot adopt contracts entered into before its incorporation even by passing a special resolution or with the unanimous consent of its members. Thus, preliminary contracts will either have to be left as mere “gentlemen’s agreements” or the promoters will have to undertake personal liability; which of these courses will be adopted depends largely on demands of the other party.

‘Since the reincorporation contracts purported to be made by a company which does not exist is a nullity, neither the company when formed nor the promoter whose signature is added can sue or be sued on contract.

‘Though a company cannot ratify a reincorporation contract, it may make a new contract after it is incorporated to carry into effect a contract made before it is formed.

Liability of the Promoter on preliminary contract:

The nature of the liability of the promoter on preliminary contracts depends on the tenor of such contracts. He can be held personally liable if he has purported to act as an agent and the non-existence of the company was known to both the parties.

This is because where a contract is made on behalf of a principal known to both the parties to be non-existent the contract is deemed to have been entered into personally by the actual maker. Case of Kelner v. Baxter (1866) provides an illustration:

Baxter, a promoter and a prospective director of a company to be formed, entered into a contract with Kelner on behalf of the company. Baxter signed the contract adding the words “for and on behalf of XY Co. Ltd.” On a suit by Kelner for the performance of the contract, it was held that Baxter was liable as he had contracted on behalf of a principal who did not exist.

But, if the contract is purported to be made by the company itself, the person so acting i.e., the promoter, cannot be held personally liable, for he shall be taken to have simply authenticated the contract and the company shall be taken to have entered into the contract and the company being non-existent the contract shall become nullity. Case of New Borne v. Sensolid (GB) Ltd. (1954) may be cited:

L.N. was a promoter and a prospective director of a company to be formed “Leopold Newborne (London) Ltd.” A contract for the supply of certain goods by the company (not formed till then) to Sensolid was signed thus “Leopold New borne (London) Ltd.” and the name L.N. was written underneath.

In an action for breach of contract by L.N. against Sensolid, it was held that the contract was signed in the proposed name of the company and L.N. added his name only to authenticate it. Since the company was not at all in existence at the time of signing the contract, there was no contract at all. Hence, Sensolid had no liability.

In case of personal liability, the promoters will continue to be liable until the company adopts the contracts. The company will adopt these contracts by entering into new contracts with the third parties on the same terms as were embodied in the original contract. Such a new agreement of adoption may not be expressly made but may be implied by the acts of the company.

In order to avoid their liability, the promoters usually insert a clause in the original contract to the effect that if the contract is not adopted by the company after its incorporation within a limited time, both the promoters and the third party will be exonerated from liability. Some of the promoters simply agree to the draft contract to be entered into by the vendor and the company after incorporation.

However, Specific Relief Act, 1963 provides relief in case of preliminary contracts. Sections 15(h) and 19(e) of the Act provide that a contract entered into by the promoters on behalf of the company before its incorporation can be enforced by or against the company, if the following two conditions are satisfied:

(a) If the contract is entered into, for the purposes of the company and such contract is warranted by the terms of incorporation. The term “for the purposes of the company” implies that the contract should be for the working purpose of the company.

(b) The company accepts the contract after its incorporation and communicates such acceptance to the other party to the contract.

Imperial Ice Mfg. Co. v. Manchershaw:

The promoters of an ice manufacturing company entered into a contract with M for the purchase of ice manufacturing machinery for the company. The company on its formation subsequently adopted the contract and sent the communication of acceptance to Mr. M. Held, the contract was for the purposes of the company, and was therefore, enforceable by or against the company.