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This article is written by Abhishek Sharma who is pursuing a Diploma in Advanced Contract Drafting, Negotiation and Dispute Resolution from Lawsikho.

Introduction

It is a universal and wide known fact that the company is considered to be a separate legal entity and all the members of the company are separate from its members. Since a company is an artificial person and separate from its members, therefore it can enter into its own contracts and on the property in its own name. Since a company is an artificial person who is not born at the time of the incorporation, it cannot enter into any agreement before incorporation. It is the time where the work of the promoter comes into the picture where he is responsible and obliged to bring the company into the legal existence. Now, therefore, in order to ensure that the company is successfully brought into existence and is running smoothly and fulfilling its obligations, the promoter has to enter into some contracts on behalf of the company. Such contracts are called the contracts formed before the incorporation stage or the Promoter’s Contract. Such contracts cannot be ignored before the incorporation of the company and are inevitable for the registration and are therefore recognized under The Companies Act, 2013 and The Specific Relief Act, 1963. 

Legality of the Pre-Incorporation contract in India 

The legality of the contracts formed before the incorporation stage is a little difficult to define because if we see it strictly through the definition as mentioned under the Indian Contracts Act, there have to be at least two people who enter into the contract with each other. So, going by the general principle of law of contract, it is very essential that the parties who are entering into the contract act are in existence at the time of making of the contract. But it may very well be argued that the promoters enter into the contract on behalf of the company. The promoters act as the agent of the company but it is also arguable that the principle is also not in existence. But anyhow, the promoters are themselves liable for all the contracts entered into by them. But if we go by the definition of Section 230 of the Indian Contracts Act, a person who is acting as an agent cannot in his personal capacity enforce the contracts on behalf of the principle at the time of making the contract. 

Section 15 (h) and Section 19 (e) of the Specific Relief Act, 1963 makes the pre-incorporation contracts valid. In the case of Weavers Mills Ltd. v. BalkiesAmmal AIR 1969 Mad 462 – the promoters entered into the contract on behalf of the company and purchased some properties. The company after incorporation assumed possession of the properties and constructed structures on it. The court delivered the judgement that the company’s right and title over the property cannot be set aside. 

Promoter’s Liability During Incorporation 

Although the Promoters of the Company act as the agent of the company to represent their interest but the unique thing is that the Principal is not in existence while registration. Therefore, it becomes all the more important for the promoter to act diligently because due to non-existence of the principal the contracts are not binding on the company or third parties. Therefore, the validity and enforceability of pre-incorporation contracts lie in Section 15 and Section 19 of the Specific Relief Act, 1963. 

Section 15(h) of the Specific Relief Act, 1963 if we go by the definition of this, it expressly states that the contracts incorporated before the incorporation stage are entered into by the promoters of the for the very purpose and utility of the company and subject to terms of incorporation of the company, the company may ask for specific performance from the third party. However, this condition can only be applied if, after the registration/incorporation, the company has expressly demonstrated acceptance of those contracts, and communicated such contracts to the third party concerned. Under identical circumstances the other party to the contract under Section 19(e) of The Specific Relief Act, 1963 may enforce specific performance against the company.  Accordingly, in order for the company to enforce the contract against the other party to contract, the members must ratify the contract followed by a communication of acceptance. The company may not receive any benefit from such a contract unless the contract is accepted by the company and the promoters would be personally liable for the contracts.

Responsibilities 

For Non-Disclosure:

The promoters have a responsibility to make full disclosure at the time of making the contract, otherwise the company may either: 

  • Revoke the contract and can recover the price of the contract, or 
  • Recover the profit even though rescission is not claimed or not possible,
  • In case there is any breach of the fiduciary duty which the promoter was obliged, the company can claim damages.

Liabilities Under Companies Act

Section 56 of Companies Act, 2013 – Promoters liable in case of non-compliance

This section states that the matters and the reports are to be mentioned in the prospectus and non-compliance of these provisions will make the promoter liable.  

Section 62(1)(C)- Liability for false statements 

It is a well-known principle that the promoter of the company is made liable for the false statements which are made to the person who has subscribed to the securities of the company in good faith. False statements may lead to any of the below-mentioned circumstances. 

  • The allotment made of the securities may be set aside
  • May be sued for the damages and compensation to be paid
  • The promoter may also be charged with criminal liability

Section 63 – Punishment for deceiving public

Section 63 lays down the punishment for the promoter for deceiving the public with false statements in the prospectus. The punishment set under section 63 is 2 years of imprisonment or fine which may extend to 50,000 INR or both. However, the promoter may escape his liability if he could prove himself innocent. 

Section 478 – Liability for fraud during incorporation or promotion of company 

Section 478 applies at the time of winding up of the company wherein the court or the liquidator may report any sort of fraud at the time of incorporation or the promotion of the company, then the promoter, as well as other officers or directors, shall also be liable.  

Section 542 – Restraint imposed on guilty Promoters

This is a very unique section where the court can order a very special notice – rather order and put a restraint on the promoter of the company from engaging into the daily management of the company for a period up to 5 years if he is guilty under section 542 or otherwise being charged with fraud.

Section 543 – Consequences in case of breach of duty 

Where it appears that the promoter of the company has retained any property of the company during the time of incorporation of the company, he could be easily sued by the members of the company for breach of duty or deceit. 

Conclusion

The promoter is obligated to bring the company into the legal existence and to ensure its successful running, and in order to accomplish his obligation, he may enter into some contract on behalf of the prospective company. These types of contract are called ‘Pre-incorporation Contract’. Therefore, Pre-incorporation contracts, though at first stage may appear to be with no legal status but they are very much legally acceptable and enforceable in the tribunal and courts. There are many forms that may be taken by the company after the incorporation either by incorporating the contract in terms of incorporation, by making fresh contracts with the other party or with promoters of the company, or by accepting the benefits from the contract which may be either expressly or impliedly.  

References

  1. Dilpreet Singh, Validity and Ratification of Pre-incorporated Contracts in India available at https://www.soolegal.com/roar/validity-and-ratification-of-pre-incorporated-contracts-in-india (Last Visited 13 September 2020)
  2. Suryabhan Singh, Pre-incorporation Contracts, available at http://www.legalservicesindia.com/article/134/Pre-incorporation-contracts.html (Last Visited 14 September 2020)
  3. UKDiss.com, Pre-Incorporation Contracts and Promoters and their Liability, available at https://ukdiss.com/examples/pre-incorporation-contracts-liability-india.php (Last Visited 12 September 2020)
  4. Hemant More, Pre-Incorporation Contracts, available at https://thefactfactor.com/facts/law/civil_law/company-law/pre-incorporation-contracts/3917/ (Last Visited 14 September 2020)
  5. Pre-incorporation Contracts and the Promoter, available at https://www.lawteacher.net/free-law-essays/business-law/pre-incorporation-contracts-and-the-promoter-business-law-essay.php (Last visited 19 September 2020) 

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