Saturday, March 3, 2012

Pre-Incorporation And Provisional Contracts


A company being a separate legal entity can contract only through its agents.  Sometimes contracts are entered into on behalf of a company even before it is duly incorporated.  Such contracts will not be binding on a company unless it becomes capable of contracting by incorporation.  In Kelner v. Baxter, (1866) LR 2 CP 174, it was held that “two consenting parties are necessary to a contract, whereas the company, before incorporation, is a non-entity”.  The Full Bench of the Supreme Court of India, in Commissioner of Income-tax, Tamil Nadu v. City Mills Distributors (P) Ltd., AIR 1996 SC 2888, has held that "A company becomes a legal entity in the eye of the law only when it is incorporated.  Prior to its incorporation, it simply does not exist.".

When a company is being incorporated, the promoters, purporting to act on behalf of such company, enter into contracts such as for purchase of property, or for securing the services of managers or other experts.  Such contracts are obviously made before the formation of the company.

There are three instances, in case of a public company, where contracts are entered into as follows:

(a)  Contracts entered into on behalf of the company prior to its incorporation, which are called as Pre-incorporation contracts;

(b)  Contracts entered into after the incorporation but before obtaining the certificate of commencement of business, which are called provisional contracts; and

(c) Contracts entered into after obtaining the certificate of commencement of business.

Since a private company can commence its business immediately after obtaining a certificate of incorporation, the question of provisional contracts in case of a private company does not arise.

Pre-incorporation contracts are contracts purported to be made on behalf of a company prior to its incorporation.  Prior to its incorporation, a company doesn’t exist and bears no capacity to contract.  Therefore, nobody can contract as agent on its behalf because an act which cannot be done by the principal himself cannot be done by him through an agent.  Hence, a contract by a promoter purporting to act on behalf of a company prior it its incorporation never binds the company because at the time the contract was concluded the company was not in existence.  Therefore, it has no legal existence.  Even if the parties act on the contract it will not bind the company.  [Northumberland Avenue Hotel Co., (1886) 33 Ch.D 16 (CA)]  Thus, even if the company takes some benefit from a contract which is made before its incorporation, the contract is not binding on the company [In Re. English and Colonial Produce Co. (1906) 2 Ch. 435 (C.A.)].  A company is not entitled to take the benefit of a pre-formation contracts made by its promoters. [Natal Land Co. v. Pauline Colleiry Syndicate Ltd., (1904) A.C. 120; also see: Newborne v. Sensolid Ltd., (1950) 1 All ER 708 (C.A.)].  A company cannot ratify a pre-incorporation contract, but it is open to it to enter into a new contract after its incorporation to give effect to a contract made before its formation [Howard v. Patent Ivory Co. (1888) 38 Ch.D].

Thus, the upshot of the English decisions is that a company can not by ratification obtain the benefit of a contract purportedly made on its behalf before it came into existence.  Because, the creation of a contract by ratification presupposes that the only element lacking when the pretended agent purported to make the contract was the actual authority of his principal, but in the case of a company which was not incorporated at that date, actual authority could in no way have been given to the agent, because the company did not yet exist at the material time.

In India, however, Sections 15 and 19 of the Specific Relief Act, 1963, have considerably alleviated the difficulty as prevailing in England.

The relevant portion of the Section 15 reads as follows:

“Except as otherwise provided by this Chapter, the specific performance of a contract may be obtained by –


(h)  when the promoters of a company have, before its incorporation, entered into a contract for the purposes of the company, and such contract is warranted by the terms of the incorporation, the company:

Provided that the company has accepted the contract and has communicated such acceptance to the other party to the contract.”

The relevant portion of the Section 19 reads as follows:

“ Except as otherwise provided by this Chapter, specific performance of a contract may be enforced against,–


(e)  when promoters of a company have before its incorporation, entered into a contract is warranted by the terms of the incorporation, the company :

Provided that the company, has accepted the contract and communicated such acceptance to the other party to the contract.”

Thus, so far as the company is concerned, it is neither bound by, nor can have the benefit of,  a pre-incorporation contract.  By virtue of Sections 15 and 19 of the Specific Relief Act, 1963, a company is bound by, and entitled to take the benefit of, the pre-incorporation contracts made by its promoters if such contracts are warranted by the terms of incorporation.  "Warranted by the terms of incorporation" means with in the scope of the objects of the company as stated in the memorandum.  The contract should be for the purposes of the company.

Sub-section (1) of Section 36 of the Companies Act, 1956 reads as follows:

“Subject to the provisions of this Act, the memorandum and articles shall when registered, bind the company and the members thereof to the same extent as if they respectively had been signed by the company and by each member, and contained covenants on its and his part to observe all the provisions of the memorandum and of the articles.”

A moot point which arises in relation to the provisional contracts, however, is that whether a company can ratify such contracts after obtaining the certificate of incorporation and before obtaining the certificate of commencement of business by amending its Memorandum and Articles of Association.

Sub-section (4) of Section 149 of the Companies Act, 1956 reads as follows:

“Any contract made by a company before the date at which it is entitled to commence business shall be provisional only, and shall not be binding on the company until that date, and on that date it shall become binding.”

It is pertinent to note that sub-section (1) of Section 36 of the Companies Act, 1956 begins with the words “Subject to the provisions of this Act”.  Since sub-section (4) of Section 149 of the Companies Act, 1956 stipulates that provisional contracts shall not be binding on the company until the company is entitled to commence the business on the grant of the certificate, a company cannot ratify provisional contracts after obtaining the certificate of incorporation and before obtaining of the certificate of commencement of business.  However, on the issue of the certificate to commence business such contracts automatically become binding i.e. without any ratification.

If, therefore, a public company is wound up before it is entitled to commence business the persons who have rendered services or supplied goods or materials to the company can have no claim against it. [In Re. Electrical Manufacturing Co. (1906) 2 Ch. 390]
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18 comments:

  1. Thanyou very much sir for this post.

    One more thing, now if ratification by company is invalid then the concerned alteration of AOA in this regard will also be invalid or not?
    waiting for your reply.

    ReplyDelete
    Replies
    1. Dear Neelabh,

      Thank you for writing.

      If I may draw your attention to Section 149(4) of the Companies Act, 1956, it specifically says that unless and until the certificate of commencement of business is granted, provisional contracts are not binding. So to carry out an amendment, to the Memorandum and Articles of Association, contrary to Section 149(4) would tantamount to conflict between Memorandum and Articles of Association and Section 149(4)of the Companies Act, 1956.

      Section 9 of the Companies Act, 1956 gives overriding effect to the Act. Consequently, any clause which is contrary to the provisions of the Act or of any other law for the time being in force, is simply inoperative and void. See: [Noble v. Laygate Investments Ltd.(1978) 2 All ER 1067], where the provisions of a company's articles had to give way because they were in conflict with the Income and Corporation Taxes Act, 1970.

      Hence, any alteration of Memorandum and Articles in this regard would be null and void.

      Trust that answers your query.

      Delete
    2. Could please explain the scope of Section 149(2A) in this regard?

      Delete
    3. In A.Ramaiya's Guide to the Companies Act, 17th Edition 2010 at 1888 the reasons for insertion of sub-sections (2A) and (2B) in Section 149 of the Companies Act, 1956 were stated as follows:

      "Sub-sections (2A) and (2B) were amended in thier present for by the Joint Committee who explained the same as follows: The Committee feels that this clause should not apply to-

      (a) any existing company except where it commences any new business which is not germane to the business which it is already carrying on at the commencement of this Bill, when enacted;

      (b) any new company except where it commences any business in relation to its objects which are not its main objects or objects incidental or ancillary thereto.
      ...
      The Committee further feels that even if a special resolution cannot be passed when it is required, the Company Law Board should be empowered to allow the company to commence such business even if it is passed by a simple majority which is not sufficient for the passing of a special resolution.

      The clause has been amended accordingly.

      The amendments made by the Joint Committee were adopted by Parliament except that in place of the words "Company Law Board" the words "Central Government" were substituted."

      Where a contract to start a new business which requires approval under this sub-section is entered into without complying with the formalities under this sub-section, the contract does not become void but is provisional only, i.e., it does not bind the company until the formalities are complied with. See: Otto Electrical Mfg. Co. (1905) Ltd., Jenkin's Claim, (1906) 2 Ch 390, followed in Ambica Textiles Ltd., Re, (1950) 20 Comp Cases 160, 163. See also, New Druce-Portland Co. Ltd. v. Blakiston, (1908) 24 TLR 583.

      In view of the above, the special resolution that would change a provisional contract into a binding contract is only in the context of Section 149(2A) or Section 149(2B), as the case may be, which pertains to the commencement of business that is not germane as stated in in the aforesaid sub-section.

      To all other provisional contracts, sub-section (4) of Section 149 would apply.

      Delete
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