For a newly formed company, it is extremely important that it is aware of its position, with regards to contracts already entered into on its behalf before its incorporation. It is indeed a major issue as to who is responsible for contracts already entered into on the company’s behalf even before the company existed or incorporated.
Under Section 23(h) of Specific Relief Act 1877, specific performance of a contract may be obtained by “public company” when the promoters of a public 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. Similarly, Section 27(e) of Specific Relief Act provides that specific performance of a contact may be enforced against the “public company” when the promoters of a public company have, before its incorporation, entered into a contract provided that the contract is warranted by the terms of the incorporation. Thus, a public company can obtain specific performance to enforce a contract entered by its promoters before its incorporation if such contact is warranted by the terms of the incorporation. Furthermore, under Section 27(e) of Specific Relief Act relief can be sought against public company only if the company has ratified and adopted the pre-incorporation contract.
Interestingly, both the abovementioned provisions of the Specific Relief Act are silent on instances where promoters of a private limited company entered into a pre-incorporation contract. Therefore, the question which arises is whether the law is inadequate to provide protection to the promoters for contracts executed before the incorporation of the proposed private limited company.
A possible remedy seems to be available in the Contract Act, 1872. Section 230(3) of the Contract Act provides that, unless the principal, though disclosed by an agent, cannot be sued, the agent cannot personally enforce contracts entered into by him on behalf of his principal, or he is not personally bound by such contract. In a situation where the promoter enters into a contract on behalf of a proposed company, the promoter can enforce or be sued under the contract as the proposed company cannot sue or be sued as it is non-existent.
But what if the promoter wants to be protected from liability under a contract which he executes on behalf of a proposed yet non-existent company? Section 230(3) of the Contract Act seems to enable a private company to sue or be sued only if that company ratifies the pre-incorporation contract entered into by its promoter on behalf or for the company. It is evident from the wording of section 230(3) of the Contract Act that a promoter (agent) can only enforce a pre-incorporation contract where the principal (the proposed company), though disclosed by the promoter, cannot be sued. However, once the company is incorporated and ratifies the preincorporation contract, it may sue or may be sued on that contract. Therefore, Section 230(3) of the Contract Act seems to give protection to the promoters of a private limited company in case of pre-incorporation contract which is currently unavailable under Section 23 and Section 27 of the Specific Relief Act.
Therefore, the Special Relief Act should be amended to provide a remedy for pre-incorporation contracts executed by promoters of private limited company as well.
Written by Junayed Chowdhury, Managing Partner
† Disclaimer: The opinions and comments expressed in this Blawg are not to be regarded or construed as legal advice by and from Vertex Chambers or any of its members. It is highly advisable that any person should seek independent legal advice before relying on any of the contents of this Blawg.