Understanding Pre-Incorporation Contracts and Promoter Liability
The incorporation of a company marks the official creation of a legal entity, a corporate personality, under statutes such as the Companies Act, 1956 in India. Before incorporation, any agreements or contracts entered into by a group intending to form a company are known as pre-incorporation contracts. These contracts, essential for the groundwork of the forthcoming company, are legally complex due to the non-existence of the company at the time of their formation. Consequently, understanding the liability associated with these contracts is crucial, especially the role and responsibility of the promoter.
Defining the Promoter and Pre-Incorporation Contracts
Who is a Promoter?
While the Companies Act, 1956 lacks a clear definition of a promoter, various judicial interpretations and legislative references provide insight. A promoter is typically an individual or entity involved in the formation of a company. Bowen J. described a promoter as a business term rather than a legal term, emphasizing the functional role in setting up the company. Cockburn CJ in Twycross v Grant characterized a promoter as one who undertakes to form a company with a specific project and executes the necessary steps to achieve that purpose.
What is a Pre-Incorporation Contract?
Pre-incorporation contracts are agreements entered into by promoters on behalf of a company that is yet to be incorporated. The nature of these contracts is inherently different from ordinary contracts due to the non-existence of the company at the time the contract is made. These contracts, although bilateral between the promoter and a third party, benefit a prospective company which is not yet a party to the contract.
Legal Implications and Promoter Liability
Common Law Position
Under common law, a promoter who enters into a contract before the incorporation of a company is personally liable for the contract. This principle was firmly established in Kelner v Baxter, where it was held that the non-existent company could not be a party to the contract, thus placing liability on the promoter. Similarly, in Newborne v Sensolid (Great Britain) Ltd, the Court of Appeal reinforced that an unincorporated company cannot be party to a contract and thus cannot sue or be sued under it.
Exceptions and Developments
Recent legal developments have introduced exceptions to the general rule of promoter liability. For instance, in the United States and India, statutory provisions allow for the shifting of liability from the promoter to the company upon incorporation under certain conditions.
Liability of Promoter Under Various Jurisdictions
Indian Law
The Specific Relief Act, 1963, particularly sections 15(h) and 19(e), provides mechanisms by which a company can adopt pre-incorporation contracts, thus shifting the promoter’s liability to the company. Section 15(h) allows a company to enforce the contract if it is warranted by the terms of incorporation. Section 19(e) permits the other party to the contract to enforce it against the company.
English Law
While English common law traditionally held promoters liable for pre-incorporation contracts, the Contracts (Rights of Third Parties) Act, 1999, introduced some flexibility. However, it does not fully align with the more promoter-friendly provisions seen in Indian and American law.
American Law
In the United States, the common law position also held promoters personally liable. However, modern statutory provisions and case law have evolved to allow companies to adopt pre-incorporation contracts, thereby relieving promoters of personal liability upon the company’s incorporation.
Mechanisms to Shift Promoter Liability
Adoption and Ratification
Under Indian law, the Specific Relief Act allows a company to adopt pre-incorporation contracts. The promoter’s liability can be transferred to the company if the contract is adopted as per the terms of the company’s incorporation documents.
Novation
Novation involves replacing the original contract with a new one, involving the company once it is incorporated. This method effectively transfers all rights and obligations from the promoter to the company, creating a new contractual relationship between the company and the third party.
Doctrine of Equity
In India, equity principles can also hold a company liable for pre-incorporation contracts if the company benefits from the contract. This doctrine was applied in Weavers Mills Ltd. V. Balkies Ammal, where the company was held liable for a pre-incorporation contract due to the benefits derived from it.
Comparative Analysis
Indian vs. English and American Law
While the common law principles in India, the UK, and the USA initially placed personal liability on promoters, statutory innovations in India and the USA have provided more mechanisms for shifting this liability to the company. English law remains more conservative, with limited provisions for adoption or ratification of pre-incorporation contracts.
Conclusion
Promoters play a pivotal role in the formation of a company, but their liability for pre-incorporation contracts varies across jurisdictions. In India, statutory provisions under the Specific Relief Act, 1963, offer promoters avenues to transfer liability to the company. American law also supports similar mechanisms, while English law remains more restrictive. Understanding these legal nuances is essential for promoters to navigate their responsibilities and mitigate personal liability effectively.