Meaning and Legal Position
Pre-incorporation contracts are agreements entered into by promoters on behalf of a company before the company is legally incorporated. At this stage, the company does not exist as a legal person, so it cannot itself enter into contracts. Under Section 2(69) of the Companies Act, 2013, a promoter undertakes preliminary activities necessary for incorporation, which often include entering into such contracts. However, since a company comes into existence only after incorporation under Section 7, these contracts are not binding on the company at common law. The rationale is simple: a non-existent entity cannot consent to a contract. Therefore, traditionally, the liability for such contracts rests personally on the promoters who entered into them. This principle ensures certainty in contract law while protecting third parties from dealing with a legally non-existent entity.
Statutory Recognition and Enforcement
Indian law, however, provides limited statutory recognition to pre-incorporation contracts through Section 15(h) and Section 19(e) of the Specific Relief Act, 1963. These provisions allow a company, after incorporation, to adopt or ratify a pre-incorporation contract, provided the contract was entered into for the purposes of the company and is warranted by its objects clause. Once adopted, the company can enforce the contract, and the promoter may be relieved from personal liability. This statutory exception balances business practicality with legal theory, recognizing that many commercial arrangements are essential even before incorporation. Nevertheless, until such adoption, promoters remain personally liable, and third parties cannot directly sue the company. Thus, the law ensures accountability while allowing flexibility for genuine commercial needs.
Rights, Liabilities, and Limitations
The rights and liabilities arising from pre-incorporation contracts are clearly demarcated. Promoters are personally liable unless the contract expressly provides otherwise or is novated after incorporation. The company cannot be sued on such contracts unless it formally adopts them post-incorporation. Even adoption does not amount to ratification in the strict sense, as ratification requires the principal to exist at the time of contract. Courts have consistently emphasized that adoption creates a new contractual relationship between the company and the third party. Moreover, contracts that are ultra vires the objects clause cannot be enforced even after incorporation. These limitations ensure that pre-incorporation contracts do not undermine the doctrine of corporate personality or statutory compliance under company law.
Realtime Example
Suppose X and Y plan to incorporate a software company. Before incorporation, X, acting as a promoter, enters into a lease agreement for office space in the proposed company’s name. After incorporation, the company starts operating from the same office and passes a board resolution adopting the lease. In this case, under Section 19(e) of the Specific Relief Act, 1963, the company can enforce the lease against the landlord, and the landlord can enforce it against the company. However, if the company had refused to adopt the contract, X would have remained personally liable for rent and other obligations. This example shows how adoption transforms a promoter’s personal arrangement into a corporate obligation.
Mnemonic to Remember
A simple mnemonic to remember pre-incorporation contracts is “P-N-A-L”:
P – Promoter enters contract
N – No company existence at that time
A – Adoption after incorporation
L – Liability shifts (if adopted)
This mnemonic helps students quickly recall the sequence and legal effect of pre-incorporation contracts in exams. By remembering “P-N-A-L,” one can easily structure an answer covering the role of promoters, non-existence of the company, statutory adoption, and liability implications.
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