A company has its own separate legal entity, distinct from its members, which affords it certain characteristic features. One such feature is that a company can enter into a contract in its own name and entitled to acquire contractual rights and obligations. It is pertinent to note that such contractual powers can be exercised by the company only subsequent to its incorporation and not prior. However as a matter-of-fact, it becomes necessary at times that persons incorporating company enters in agreements on the behalf of a company which is yet to come into existence. Enforcement of such contracts is quite complex as it is difficult to fix the liability albeit, in certain jurisdictions the liability of person concerned has been tried to get fixed but provisions thereby are not justified in Contract and Company Law Jurisprudence.

Common Law Position

The legal position has not been uniform and clear in English law and Indian Law in this regard. Currently the common law position in England is the same as it was before the enactment of European Union legislation in 1972. In common law a promoter can’t enter into a contract with a third party, either in company’s name or by himself on behalf of company as an agent, before its incorporation since the company was not in existence at the time of incorporation and therefore lacks legal capacity and neither can the company ratify such contracts.

However such an agreement can be enforced at the instance of company, by the operation of Doctrine of Novation where such company enters into a contract with third party which put into effect the terms of pre-incorporation contracts or by entering into contract for Past services with the promoter. Furthermore the position in common law, as stated by Oliver J. in Phonogram v. Lane, is that the common law does not depend on the way in which a contract has been entered into on behalf of the company but the real intent of the parties. Interestingly the principle laid down in this case is similar to that of the principle of tort law imposing liability on the director of a company, “Assumed Personal Responsibility”.

English Law Position

After the intervention of European Communities Act, 1972 the heavily criticized common law position underwent a drastic change. This statute gave third parties an enforceable right against the promoter and the liability of the newly formed company was set at nullity. Therefore under the statute, if a contract has been purported to be made with the company, the liability of the promoter will be triggered unless a third party has given up its protections. Despite statutory intervention, there persist considerable problems in its operation. Illustratively, the statute offers protection to third parties regarding the enforcement of their contractual rights, however the statute is silent on the issue of whether a promoter acquires the right to enforce the same against a third party. If we apply the principles of contract law and more specifically the doctrine of mutuality, then promoters will also acquire the right to enforce the contract. In cases which fall outside the scope of the statute, common law position will gain prominence. One thing has remained constant in Law of England that it does not provide for the subsequent ratification of the pre-incorporation contracts.

Indian Law Position

The law in India provides for the ratification of such pre-incorporation contracts. Before 1963 the position in India was same as Common Law but after enactment of Specific Relief Act, 1963, both the promoter and the third party are allowed to enforce the pre-incorporation contract, if the contract is warranted by the terms of its incorporation. Currently Section- 15(h) of the Specific Relief Act, 1963 provides that where the promoters of company have entered into contract prior to the incorporation of company for the purpose of company and if such contracts are warranted by the terms of incorporation then company may enforce it. Similarly, Section- 19(e) of the same Act also provides for enforcement of such contract at the instance of third party (Subjected to warranty by the terms of incorporation).

Issues and Challenges

Even though the position is in India is not as complex as England and legislature here has tried to settle down the perplexities but a jurisprudential analysis of such provision would drastically fail to justify foundational principles of Contract Jurisprudence and certainly for practical purposes there may arise certain situations for which no remedy is present. Flaws in the present scheme of law are as follows:

Firstly, in cases where the company shows reluctance in warranting the terms of contract or has refused to warrant the terms of contract, if a company does not ratify the pre-incorporation contract the parties will be pushed to quagmire of Common Law as arisen in the Newborn case. The case of Phonogram can’t be relied upon since it is based on a statutory law which is the exact opposite of Indian law.

Secondly, even if a company ratifies a pre-incorporated contract, the provisions allowing such ratification would fail to justify foundational jurisprudence of Contract law and Company Law. If the legal base of such ratification is Section- 196 of Indian Contract Act, 1872 then as per law developed in India, once an act done on the behalf of another person is ratified, the relationship of principal agent is thereby created. Since a promoter is neither an agent nor a trustee, how can provisions of agency law be applied. The position of promoter is quite peculiar as it holds the position of quasi-trustee.

Thirdly, in cases where such a contract is ratified, even though it may be admitted that Section- 196 of the Indian Contract Act is applied but again there would arise a different problem. As a relationship of agency is created then enforcement right of promoter would fall under two dichotomized provisions i.e. Section- 15(h) of Specific relief Act and Section- 230 of Indian Contract Act.  Effect of operation of former will make the contract enforceable against the third party whereas in latter’s case the contract will not become enforceable, since as per Section- 230 of Indian Contract Act an agent can’t be sued unless there is an agreement contrary to that effect.

Fourthly, even if a company ratifies a pre-incorporation contract and if such contract falls outside the object clause under Memorandum then it would become ultra vires and such contract would become void and unenforceable, even if all shareholders give assent to it.

Way Forward

Presently under English law the presumption falls in the favour of a third party where a promoter as agent is liable (if there is no contract to contrary), whereas in Indian law such presumption is exact opposite as here the presumption lies in favour of the promoter. On analysis of the legal positions of both the jurisdictions, it is pertinent to note that legal regimes of both the jurisdictions need certain policy reforms. Talking about India, Indian Statutes needs to clarify the positions of both promoter and third party in absence of subsequent ratification by the company. It must strive to provide remedy to both promoters and third parties so as to prevent ends of justice. Indian courts must move away with common law practice in this regard, since common law practices itself ripped with flaws.

Author: Mr. Abhyudaya Yadav, 3rd year B.A., LL.B. (Hons.) student at Dharmashastra National Law University

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Qualification: LL.B / Advocate
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Location: KANNOD, Madhya Pradesh, India
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May 2021