This article is written by Pallavi Chandrasekhar, pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from lawsikho.com.

Meaning 

A pre-incorporation contract is an agreement that is made by a person at the behest of a company or corporation that does not exist at the time of signing such agreement. These agreements are entered into as there are preliminary contracts and expenses incurred before an organization takes form. An example of a pre-incorporation contract is a co-founders’ agreement.  The person who is signing the agreement on behalf of the company intends to bind the company to the agreement in future when the company is finally incorporated.  

The person who enters into a pre-incorporation agreement is usually called the Promoter.  The Indian Companies Act 2013 (hereinafter “the Companies Act”) defines the Promoter under Section 2(69) as a person who has been (a) named in the prospectus, (b) who has control over the affairs of the company, and (c) according to whose directions the Board of Directors acts.  But this definition only defines the Promoter once the company has been formed and not before its incorporation.

Legal status of pre-incorporation contracts in India

The legal status of pre-incorporation contracts is not easy to define.  According to the Indian Contract Act 1872 (hereinafter “the Contract Act”) all agreements are contracts if they are made with free consent of the parties who are competent to contract for a lawful consideration.  However, during the pre-incorporation stage the company on whose behalf the Promoter is entering into an agreement, does not exist.  Hence, a company cannot enter into a contract before its existence.  It can only sign an agreement after its name is registered with the Registrar of Companies in accordance with the Companies Act.  Furthermore, the Promoters are acting as “agents” of the company while entering into these pre-incorporation contracts.  However, if the principal i.e. if the existence of the company itself is not an actuality, how can the Promoter nominate herself as an agent of the company?  Hence, the Promoters themselves become personally liable for all agreements entered by them on behalf of the company, even though they claim to have entered into contracts for the benefit of the company.

Under Section 230 of the Contract Act, an agent cannot personally enforce or bind the principal on her behalf.  In the present case, the principal i.e. the company does not exist, thus she cannot bind the company by an agreement.  Similarly, if the Promoter is acting as agent of the principal company, she cannot be personally held liable for breach of contract.  If this principle is followed, the contract becomes unenforceable as neither principal (to be incorporated company) nor the agent (the Promoter) can be held liable for breach of contract.  Here is where the Indian Specific Relief Act of 1963 (hereinafter “the Specific Relief Act”) comes to the affected party’s rescue.

Making them enforceable in India

According to Section 15(h) of the Specific relief Act, specific performance of a contract can be obtained by any party thereto or a representative in the interest of the principal, when the Promoters of a company have entered into a contract before the incorporation of a company and such a contract is warranted under the company’s incorporation terms.  Similarly, under Section 19(e) of the Specific Relief Act if the newly incorporated company has accepted the pre-incorporation contract and has communicated its acceptance to the other party, relief against parties can be claimed under subsequent title. 

Therefore, pre-incorporation contracts can be enforced in India by (i) incorporating the contract in the terms of incorporation, (b) by entering into a new contract with the other party or the Promoter, (c) by expressly or impliedly accepting the benefits of the pre-incorporation contract.

Types

There could be various types of preliminary or pre-incorporation agreements.  This could range from a co-founders’ agreement wherein the founders of a company yet to be incorporated agree for their rights and responsibilities before incorporating the company.  It could also be an employment agreement with a manager or a company secretary whose skills are required for the company to be incorporated.  The manager or company secretary’s remuneration, obligations to the future company, etc would be included in this pre-incorporation employment agreement.

Instructions for drafting pre-incorporation contracts

Any pre-incorporation contract must have the following items:

• Shareholders’ name: The shareholders’ names including the names of the promoters in the future company must be mentioned.
• Incorporation: The State in which the company would be incorporated must be mentioned.  Although the Companies Act is a central legislation and would govern all the companies incorporated under it; incorporating it in certain States can have some advantages.  Such benefits can include having courts in the State jurisdiction that support corporate businesses as opposed to State courts that do not.  Some States can be communistic and not support policies that would help capitalistic trade and businesses such as Kerala and West Bengal.

An ideal place of incorporation would be the State where the future company would conduct its business with other corporations.  It is good to attach a draft copy of the Articles of Association and Memorandum of Association with the pre-incorporation agreement. 

• Corporate name: The name of the future company must be added to the pre-incorporation agreement.  It is important to ensure whether the name for the company is available.  For this, the Ministry of Corporate Affairs website can be used to search for already registered company names. 
• Corporate Address: The corporate address that would be mentioned in the Articles of Association and Memorandum of Association must be written in the pre-incorporation agreement.
• Name of the proposed Directors: Any Director chosen or proposed Director must be stated in the agreement signed before the company’s incorporation.
• Capital Contribution: The capital contribution of the subscribers and the mode in which they would contribute must be added to the pre-incorporation agreement.
• Opening of Bank Account: Every company must open a corporate bank account for its income and expenditure.  In which bank will the future company open its corporate account and who would be the authorized person(s) to transact on behalf of the company must all be stated in the pre-incorporation agreement.
• Corporate Purpose: The purpose of the company would have to be inserted in the pre-incorporation agreement.  Simple language must be used, and the purpose must be broad enough to cover all the intended purposes and possible activities of the future company.

Samples:

1. To operate one or more retail stores for the sale of computer equipment.
2. To manufacture and distribute equipment for preparing cappuccino.
3. To design websites for law firms.
4. To cater parties, weddings, and other events requiring food services, decoration, and to rent equipment to be used in connection for these services.

• Due Date:  A target date by which time the company would be duly registered and incorporated with the Registrar of Companies must also be mentioned in the pre-incorporation agreement.
• Corporate stock: The total number of shares the corporation will be issuing to the shareholders who would sign the pre-incorporation agreement must be mentioned.  One must not forget the difference between authorized stock and issued stock.  Authorized stock is the maximum number of shares a company can issue, whereas the issued stock is what the company has announced.  It also must be stated that the shares issued would be common stock i.e. it would not be assured that some kind of dividend or profit would be paid on those shares. 
• Reimbursement of expenses: If a shareholder is handling all the responsibilities for the incorporation of the company and its corporate matters, such shareholder must be reimbursed for her fees and expenditure.  Such reimbursement must also be covered under the agreement.
• General Boilerplate clauses: Standard contractual clauses such as dispute resolution, jurisdiction of courts, confidentiality, damages to be paid, termination of the agreement, method of incorporating or enforcing the agreement after the company has been registered and incorporated, etc. must also be included in the pre-incorporation agreement.

Conclusion

The choice of entering into a preliminary or pre-incorporation agreement is up to the parties involved in the incorporation and whether the Promoters believe that it would benefit them and the future company.  However, it is always a good idea to enter into a written agreement with parties to clearly delineate the rights and responsibilities of each side.  Furthermore, it helps in resolving a lot of disputes that merely oral or handshake agreements could bring about.  In the current COVID-19 pandemic time when even parties to written contracts, an unwritten pre-incorporation agreement would add to confusion between the parties and a dispute which could have avoided had they entered into a written agreement.  

Once the company is incorporated the parties can always ask the preliminary agreement to be ratified by the company or ask for novation.  Novation is defined as entering into a new contract thereby either substituting new obligations or parties to the contract for the previous agreement. Under novation, the old contract (the pre-incorporation contract here) and a new contract would be entered into between the parties.  The principle of novation is also recognized under Section 62 of the Contract Act.

Therefore, it can be stated that it is always better to enter into a written agreement between parties  before the incorporation of a company to demarcate the rights and liabilities of each party and to have a mechanism for damages in the event of a breach of a pre-incorporation agreement.

References

1. http://www.legalservicesindia.com/article/134/Pre-incorporation-contracts.html
2. https://www.inc.com/articles/1999/10/14623.html
3. https://enterslice.com/learning/sample-format-pre-incorporation-agreement/
4. https://ukdiss.com/examples/pre-incorporation-contracts-liability-india.php
5. https://blog.ipleaders.in/novation-rescission-alteration-under-the-indian-contract-act/#:~:text=The%20word%20’novation’%20literally%20means,the%20Indian%20Contract%20Act%2C%201872

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