Pre-incorporation contracts: legal enforceability

The formation of a legal entity or a company is in simple words

a matter of legal formality. A contract is that legal obligation by
which a legal entity ascertains its legal status. Contracts can be
considered as the basis of these formalities. As the formation of
these contracts involve various discussions at different stages
by more than one person pre-incorporation contracts become
inevitable. A company normally will not be able to enter into a
contract without coming into existence.
Usually a pre-incorporation contract comes into existence prior
to the formation of a company. Such contracts will be entered
into by the promoters of a company on behalf of the company
before the company comes into existence. These promoters are
the people who are involved in the formation of a company.
They deal with the required formalities of a company's
registration from finding directors and share holders to doing
negotiations for business contracts for the new company.
But is it possible for a company which is not in existence to
enter into an enforceable contract on behalf of the company?
According to common law, a company before existence cannot
attain a legal status to attain contractual rights or sustain
contractual liabilities existing from a pre-incorporation
agreement and so the pre-incorporation agreements cannot
oblige a company.
In each case promotion of a company varies according to the
factual circumstances. Those aspects range from the day when
the promoters begin to make contacts on behalf of the
company to the starting of the company continuing to the day
when the directors of the company take their place. The status
of the promoters cease to exist immediately after the formation
of the board of directors and from then onwards they start
controlling the company. In the process they may be required to
constitute different types of contracts.
The promoters of the company may enter into contracts on
behalf of the proposed entity which they may refuse to approve
or consent once it is incorporated. These contracts include pre-

incorporation contracts, provisional contracts and residuary

contracts.
English Law: The Common Law
In English law the case Kelner V. Baxter (1866) 2LR 2CP 174[1]
was one of the first case to consider pre-incorporation
contracts. The court held a pre-incorporation contract shall
exist when the individual who actually acted as a promoter or
agent on behalf of the non-existing entity would be legally
liable. Kelner v. Baxter thus confirmed that a company cannot
ratify a contract, or purported contract, entered into on its
behalf if the company was not in existence at the time a person
purported to enter into a contract on its behalf.
Kelner v. Baxter also highlighted the potential for promoters to
be liable on contracts they purport to enter into on behalf of an
as yet unincorporated entity. What was not clear after Kelner v.
Baxter was whether promoters were automatically liable in
these situations, sometimes referred to as the rule of law
approach, or whether the promoters liability depended on
whether it was intended that the promoter be a party to the
contract, sometimes referred to as the rule of construction
approach.[2]
But while considering the case Newborne v Sensolid (GB) Ltd
[1954] [3] the court took a different approach. A consignment
of tinned ham was sold to Sensolid under a contract headed
"Leopold Newborne (London) Ltd" and ending "Yours faithfully,
Leopold Newborne (London) Ltd" and signed by Leopold
Newborne. Sensolid refused to take delivery of the ham. It was
held that neither the then unincorporated company nor Mr
Newborne personally could sue on the contract. Lord Goddard
said: This contract purports to be a contract by the company; it
does not purport to be a contract by Mr Newborne. He does not
purport to be selling his goods but to be selling the company's
goods. The only person to have any contract here was the
company, and Mr Newborne's signature merely confirmed the
company's signature...In my opinion, unfortunate though it may
be, as the company was not in existence when the contract was
signed there never was a contract, and Mr Newborne cannot
come forward and say: "Well, it was my contract."[4]

The English Court of Appeal held that the correct approach was
a rule of construction approach. The real test was whether the
promoter was intended, in the circumstances, to be a party to
the contract or not. It was held that given the way in which the
contract was signed by Leopold Newborne it was intended to be
a contract with the company and only the company. In other
words, given the way in which it was signed it indicated that it
was not intended that Leopold Newborne be a party to the
contract himself. Thus Leopold Newborne could not enforce the
contract in his own name.[5]
In Buffington v. Bardon 80wis 635(1891) the English court
observed that: The law is that a corporation is liable for its own
acts only after it has a legal existence. Until that time no one
whether a promoter or not can sustain to the corporation the
relation of agent, were this not so, we would have an agent
without a principal, which is an absurdity. That the contract
should be between the contractor and the company, in which
case the company being non existent, there is no contract at
all & no one is liable on it.[6]
Under section 51 of the Companies Act 2006, subject to any
agreement to the contrary, the person purporting to act for the
company, or as an agent of the company, is personally liable on
the contract (Phonogram Ltd v Lane [ 1982 ] QB 939). It was
held that such a person can also enforce a pre-incorporation
contract (Braymist Ltd v Wise Finance Co Ltd [2002] EWCA Civ
127, [ 2002 ] 3 WLR 322).[7]
High Court of Australia
Considering the case Black v. Smallwood & Cooper (1966), 117
C.L.R. 52 the High Court of Australia took the similar rule of
construction approach to Kelner v. Baxter. Western Suburbs
Holdings Pty. Ltd. was not incorporated at the time and
Smallwood and Cooper signed as directors thinking the
company had been incorporated and that they were directors.
The plaintiffs wanted to impose liability on the basis of a rule of
law reading of Kelner v. Baxter saying that a contract was
clearly intended and since it could not be with the principal (i.e.

the company) which was not in existence it must have been

with the purported agents Smallwood and Cooper personally.[8]
The majority of the court followed the earlier English case of
Newborne v. Sensolid Ltd.
It was held that Kelner v. Baxter was not authority for the
principle that an agent signing for a non-existent principal is
bound.[9] Wickberg v. Shatsky (1969), 4 D.L.R. (3rd) 540
(B.C.S.C.) is a British Columbia case that also addresses the
question of the interpretation of Kelner v. Baxter and addresses
the possibility of an action against the promoters on the basis
of a breach of warranty of authority.[10] The court held that it is
not the case that a person signing on behalf of a non-existent
company is automatically personally liable.[11]
The common law position created a risk for both the promoter
and the third party that there would be no enforceable contract.
Black v. Smallwood and Wickberg v. Shatsky involved cases in
which the third party could not enforce the contract against the
company. Newborne v. Sendolid Ltd. involved a situation in
which the neither the promoter nor the company could enforce
the purported contract. This creates a risk that reliance on the
purported contract will be defeated along with the potential for
an unjust enrichment of promoters at the expense of third
parties or third parties at the expense of promoters.[12]
Pre-contractual liability
The German legal system was the most receptive to the idea of
pre-contractual liability. The first one to point out the need to
introduce the concept of pre-contractual liability for failure to
observe the fair conduct (good faith) rule, was the German
lawyer Rudolf von Iering.[13] In India the Specific Relief Act
1963 provides provisions for enforcing performance against a
company where its promoters have entered a pre-incorporation
agreement on behalf of the company. Section 19(e) of the act
can be invoked only if the company after its incorporation have
approved and accepted the contract and have communicated
its acceptance or approval to the other contracting party.
According to section 230 of the Indian Contract Act an agent
cannot enforce a contract personally entered by him on behalf

of his principle, nor he can be personally liable if he clearly

mentions at the time of entering the contract that, he is only
acting on behalf of the principle as an agent and so he is not
personally liable under the contract. Therefore applying this
theory the contract can be infructuous as none of the parties is
legally liable under the contract.
Nevertheless, section 15(h) and 19(e) of the Specific Relief Act
provides specific answer to this. Section 15 states as follows:
15. Who may obtain specific performance.- Except as otherwise
provided by this Chapter, the specific performance of a
contract may be obtained by(a) any party thereto;
(b) the representative in interest or the principal, of any party
thereto: Provided that where the learning, skill, solvency or any
personal quality of such party is a material ingredient in the
contract, or where the contract provides that his interest shall
not be assigned, his representative in interest of his principal
shall not be entitled to specific performance of the contract,
unless such party has already performed his part of the
contract, or the performance thereof by his representative in
interest, or his principal, has been accepted by the other party;
.
(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.[14]
The section enables pre incorporation contracts valid even
though it is slightly contrary to the common law principles to a
certain extent. Going by the act specific performance of a
contract is enforceable against a company where its promoters
or agents have entered into a valid contract on behalf of the
company before its incorporation. In such a situation a contract
is acceptable by the stipulations of the company's
incorporation.

The Madras High Court while considering the case Weavers

Mills Ltd. v. Balkies Ammal [AIR 1969 Mad 462][15] had made a
comprehensive decision. The promoters of the company had
consented to buy for the company some properties on behalf of
the company to be incorporated. After incorporation structures
were constructed on the property by the company after
assuming possession. The court took its view that even if the
properties were not conveyed on to the company at the time of
making the contract by its promoters the company's title over
the property could not be set aside.
Therefore, in India, despite the fact that pre incorporation
contracts are entered into by promoters or agents of the
company before the company's existence they are legally
enforceable and has contractual obligations that continue to
exist under the Specific Relief Act.