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Validity and Ratification of Pre-incorporated Contracts in India
Dilpreet Singh 5 Mar 2020

Validity and Ratification of Pre-incorporated Contracts in India

Introduction

The prime feature of a company is that it is considered a separate legal entity, enabling it to enter into contracts with others and own properties in its name. Since a company is an artificial person who is unborn unless the process of registration is complete, it cannot enter into any agreement before incorporation. However, more often, the promoter is obligated to bring the company into legal existence and in order to ensure its successful running and   fulfill his obligations, on behalf of the prospective company, he may enter into some contract. Such contract is called 'pre-incorporated contract' or promoter’s contract’. Such contracts are inevitable for the registration of companies and are therefore also recognized by The Companies Act,2013 and The Specific Relief Act,1963.

Promoter's Liability

During execution, the promoters enter into the contracts on behalf of the company. Although, the promoters act as company's agent to represent their interest, the principal is not in existence while registration. The contracts entered into by the promoters are therefore not binding on the company or third parties.  The validity and enforceability of pre-incorporation contracts lie in Section15 and Section 19 of The Specific Relief Act,1963.

Section 15(h) of The Specific Relief Act,1963 specifies that, where the pre-incorporated contracts are entered into by promoters for the purpose of the company and subject to terms of incorporation of the company, the company may ask for specific performance from the third party.This condition can only be applied if, after incorporation, the company has expressly demonstrated acceptance of such contracts, and communicated the same to the third party concerned (i.e. the other party). Under similar 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 contract unless the contract is accepted by the company and the promoters would be personally liable for the contracts.

In the event that the company does not accept the said contract at its meeting, such contract is binding on the promoters and the both, promoters and other party may demand specific performance against each other.

Ratification of the pre-incorporated contracts

Ratification of contracts by company is inevitable for the purpose of enforcing it. The promoters can follow either of the methods stated below for such acceptance or ratification:

1.      Accept the contracts by passing a contract acceptance resolution and the action of promoter for incorporating the company and related matters.

2.      Novation of contract: Novation of contract is defined in Scarf v Jardine 1882 7 APP CAS 345 – 198, 371, 431 435 as, ‘being a contract in existence, some new contract is substituted for it either between the same parties (for that might be) or different parties, the consideration mutually being the discharge of the old contract’.

The Company may replace the promoter from the pre-incorporation contract in the situation of Novation of Contract. Though it could be said that such a contract would not be called a pre-incorporated contract, but it should be called a post-incorporation contract; as novation of contract results in a new contract.

These acceptance acts are necessary after private company registration, as it possesses a separate legal identity to operate in its own name. This action would also be beneficial for promoters who are not personally liable for such a contract entered into for and on behalf of the company.

Validity of the Pre-incorporated Contracts

Company is an artificial entity which comes into being after the incorporation process has been completed. Unless a company is born, it cannot execute any contract or be a contracting party. Those contracts entered in name of the company are therefore not valid due to their non-existence. These contracts would be doubtful and enforceability can also be denied. Hence, the promoters are the person who are obliged to promote a company upto operational level to ensure that it is running successfully. The promoters therefore enter into various contracts necessary to promote the company

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