This article has been written by Sakshi Kumari, pursuing the Diploma in Advanced Contract Drafting, Negotiation, and Dispute Resolution from LawSikho. This article has been edited by Ruchika Mohapatra (Associate, Lawsikho).
In India, after the formation and registration of any company, it becomes a separate legal entity. After that, the company is able to form contracts in its name and bear all the liabilities of an entity. After the incorporation of a company, it goes through various contracts and agreements daily. But, “the promoters” of the company are able to form contracts even before the incorporation of the company. These contracts are valid in the name of promoters and are known as pre-incorporation contracts. Pre incorporation contracts or preliminary contracts are made by promoters of the company on behalf of the company before its incorporation for acquiring some property or rights for the company. Pre incorporation contract is binding on a company or promoters after incorporation when it is according to the object of the company and it is accepted after incorporation. After acceptance of pre-incorporation contracts by the company, it should also be communicated to parties. Pre incorporation contracts get their validation from the “Specific Relief Act” and “Companies Act, 2013”.
There are various types of pre-incorporation contracts that can be made by a company according to their need before incorporation, such as a lease agreement, employment agreement, founder’s agreement, shareholder agreement, etc. That’s why it becomes a very important legal document for any company that is going to be incorporated or for any promoters who are going for incorporation of a company. Therefore, one should know the essential clauses of pre-incorporation contracts which ought to be included in the contract to make it more beneficial and how to draft it. The most important clauses of a pre-incorporation contract such as the corporate name, object clause, term and termination clause, methods of enforcing the agreement after incorporation of agreement, and so on.
What are pre-incorporation contracts?
Contracts that are made on behalf of the company by the promoters before the incorporation of the company for gaining some rights and property are called pre-incorporation contracts. A corporate promoter is a firm or person who does the preliminary work related to the formation of a company, including its promotion, incorporation, and flotation, and solicits people to invest money in the company when it is being formed. Therefore, they are bound to promote their company at the operational level or make sure that their company is running successfully. For that, they enter into various contracts. Pre incorporation contracts are those contracts that are necessary to run a business or incorporation. When promoters make pre-incorporation contracts, the company is just an artificial entity which means at that time, the company does not exist. So basically, it cannot be executed at the time of incorporation. It will only be executed after the incorporation is formed. Therefore, promoters who are making these contracts before incorporation bear the liability at that time. These contracts are formed pre and not post-incorporation, and therefore, are called pre-incorporation contracts.
Significance of pre-incorporation contracts
As we already know, the incorporation of a company gives various advantages to a person in a corporate structure as it helps individual owners or shareholders to protect themselves from financial liabilities as, after incorporation, it is the company that goes into debt. Therefore, before the incorporation of any company, we can consider pre-incorporation contracts to decide the roles, functions, and liabilities of any company before its incorporation. There are two situations where individuals can prefer to draft pre-incorporation contracts.
Before the incorporation of the concerned company through this agreement, we can decide about the roles, functions, and liabilities of each and every incorporator such as who will be directors, financial head, legal head, etc., and what are their liabilities. We can also draft rules and regulations of the company once it is incorporated completely. By this agreement, we can also decide what benefits will be given to incorporated employees who are going to be part of the company such as apartments, cars, and all other benefits which they will receive.
When we incorporate any company, then it is obvious that the company goes and deals with various other firms and companies on a regular basis. So, a pre-incorporation contract will protect your company’s operations before its incorporation as this contract may specify that this company is of limited liability or not before its actual issuance of incorporation details. This agreement also specifies that the actual ownership will be transferred from promoters to a company after incorporation.
Pre-incorporation contracts are crucial documents; it is very important to incorporate any company control or operation for the proposed business during its pre-incorporation period. An absolute incorporation contract helps to avoid future disputes by drafting a pre-agreement by negotiation on complicated matters. By drafting a pre-incorporation contract with promoters in stores that everyone who is involved in the incorporation of this company should be clear about the idea, strategy and have a proper understanding of business which helps to avoid future disputes.
Key concerns to keep in mind while drafting and negotiating a pre-incorporation contract
This agreement lays out the basic structure and function of a company: what will be the name of the company, its purpose, its vision, who will be the directors, what will be the roles, what should be the capital investment of promoters, and so on.
So, while drafting any pre-incorporation contract and negotiating it, the following are the key concerns which one should keep in mind:
- To include the purpose clause which defines what should be the main purpose of the company, shareholders clause which discusses the name of the shareholders, corporate name, corporate address, capital contribution and all the clause which gives the basic structure of the company.
- While drafting and negotiating the incorporation clause, one needs to keep in mind that it should be better if the state of incorporation should be the same as the state in which business is going to be carried out after incorporation. Although all the companies are incorporated through the Companies Act which means all of them are governed by the law all over the country, it would be better to incorporate the company in such states which have better corporate support means the state which has better stamp duty acts, where registration of the property is easy, etc. For example, Maharashtra, Karnataka, New Delhi, etc. have a good corporate structure.
- While negotiating the capital contribution it should be kept in mind that the promoters with less capital contribution should also get equal or proportional rights in the decision making. No decision should be taken by any partner/ promoter who has a major contribution without informing all the partners.
- Clearly negotiate about voting rights for any decision-making.
- While negotiating, it must be decided who will be the authorized person because he/she will be the person who is going to sign on all the legal documents or perform all legal actions of the company in future. Always keep in mind to draft it in a way that he has no authority to sign anything without prior concern of all the partners unless required.
Important clauses of a pre-incorporation contract
- Corporate name- Name of the company which is going to be incorporated.
- Incorporation- The state in which the company is going to be incorporated in the future.
- Corporate address- The official address of the business which is mentioned in the memorandum of association and article of association is mentioned here.
- Directors- Names of all the proposed directors must be mentioned here.
- Object clause – It defines all the purposes and objects of the company once it is incorporated. It also describes the license which may be required for the incorporation and how it will be received.
- Due date – The targeted date on which all the procedures of the corporation are completed and the company is finally going to be incorporated.
- Capital contribution – This clause discusses what will be the total capital contribution of all the subscribers and what should be the mode of subscription? should be discussed here.
- Bank account – It discusses the opening of a separate corporate bank account in the name of the company and who will be the authorised signatory who will be responsible to carry out all the transactions in the name of the company.
- Authorized person- This clause discusses who is the authorized person to carry out all the actions of the company, sign contracts, and borrow on the behalf of the company.
- Reimbursement of expenses- This clause talks about the reimbursement of money of shareholders and any other persons for handling all the incorporation matters.
- Corporate stock – It is a very important clause that discusses all the authorised and issued share capital of the company by the shareholders. It also discusses in detail about what is the total authorised capital of the company, what is the issued capital, and what is paid and unpaid capital of all the shareholders of the company is going to be incorporated.
- Jurisdiction of court- discusses what is the jurisdiction of court- for any matter which arises in the company in the future.
- Confidentiality – This clause discusses how to keep safe all the confidential information shared amongst the promoters and others during the process of incorporation and with whom should the liability lie in case of its breach.
- Termination – The termination clause discusses all the circumstances in which this agreement is terminated. For example, if any of the party declared insolvent by the band, became insane, the death of any promoter ( in case there are only two promoters and so on).
There are various other boilerplate clauses that are drafted in a pre-incorporation contract such as damages to be paid, methods of incorporating the agreement after the company is formed, dispute Resolution, notice clause, and so on but these are some important clauses that are present in a pre-incorporation contract. Here is a sample template of a pre-incorporation contract for a better understanding.
Enforceability of pre-incorporation contracts
According to the Indian Contract Act, 1872, pre-incorporation contracts are not valid as for the formation of any contract there should be two parties and in the case of a pre-incorporation contract, the company is not incorporated at the time of agreement. Hence, no legal entity is there in the contract on whose behalf the contract is going to be made. The second reason is that in pre-incorporation contracts, parties form the agreement as agents of the company but without the presence of the principal itself, how could parties nominate themselves as agents? Per Section 230 of Indian Contract Act 1872, an agent cannot personally enforce or bind the principal on their behalf as in this case the company that is principal is not legally present as this agreement is made before incorporation of the company.
Therefore, enforcement of pre-incorporation contracts in India comes from the Specific Relief Act 1963. Section 15(h) of the Specific Relief Act, 1963 says that when promoters of any company form a contract for the purpose of the company before its incorporation, it is said that the company has accepted the agreement and warranted it, and also communicated this to other parties. This section means that if promoters of the company on behalf of it then it is said that the company has accepted the agreement and will incur all the liabilities of the contract and it was also assumed that promoters have communicated the same to other parties. Hence, this section basically gives the concept of a pre-incorporation contract. Section 19(e) of this Act says that to give relief to the promoters of the company who entered into a contract before its incorporation which is warranted by the term of incorporation, then it is said that the company has accepted this contract and also communicated it to the other parties. This section gives relief to the promoters of the company who have entered into a pre-incorporation contract.
Weaver Mills LTD. v. Balkies Ammal
In this case, Madras High Court gave a judgment that can give a broad aspect of pre-corporation contracts. In this case, motors of the company have agreed to purchase a property on the behalf of the company before its incorporation after that when the company is incorporated the as zoomed the position and start the construction of a structure on it but they have not transferred the title of the property in the name of the company. Court held that even in the absence of the transfer of property in the name of the company the title of the company over any property cannot be set aside.
Kelner v. Baxter
In this case, the promoters of a hotel company entered into a pre-incorporation contract for the purchase of wine. Here, in this case, wine was consumed earlier and due to some reasons, the company went on liquidation. Another party to the contract sued the promoters for the non-payment of wine. Promoters claimed that as this was pre-incorporation contract liabilities were transferred to the company and hence they were not personally liable for it. The court held that as the company was not incorporated at the time of the contract that’s why it can not relieve them from the responsibility and hence were personally promoters were liable to compensate the other party.
Phonogram Ltd v. Lane
In this case, there was a group of people trying to incorporate a new company that will run a group of pop artists and for that, they took a loan from a recording company. However, due to some reason, this company never came into existence, and hence, money is due on them, recording company filed a suit, and then the court held that as the company was not in existence at the time of contract. That’s why promoters are personally liable.
This principle of liability of promoters is also followed in India. In the case of Seth Sobhag Mal Lodha v. Edward Mill Co. Ltd., the Rajasthan High Court held promoters of the company personally liable for the non-performance of obligations decided in the pre-incorporation contract.
Pre incorporation contracts are preliminary contracts that are formed before the incorporation of a company. This basically helps the company set up the rules and regulations for the future. It decides the roles and responsibilities of all the promoters for shareholders who are going to be a part of the company in the future which helps in dispute resolution which may happen in case of ambiguities. It might seem that pre-incorporation contracts have no legal validity but as proven by the aforestated case laws, they are valid and valuable which helps promoters of the company to gain rights and properties before the incorporation of any company. Pre-incorporation contracts may or may not be undertaken by the company after its incorporation. It is totally dependent upon the promoters of the company whether they want to incorporate it or not. It can be incorporated by novation or by only accepting the benefits of this contract either expressed and implied.
- Weaver Mills LTD. V Balkies Ammal (AIR 1969 Mad 462),
- Kelner v Baxter (1866) LR 2 CP 174
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