Novation Of Promoter Contracts.
NOVATION OF PROMOTER CONTRACTS
1. Meaning of Promoter Contracts
A promoter contract (also called a pre-incorporation contract) is a contract entered into by promoters on behalf of a company before the company is incorporated.
Since a company does not legally exist before incorporation, it:
Cannot enter into contracts
Cannot appoint agents
Cannot ratify contracts made before its existence (under common law)
Therefore, such contracts are initially personally binding on the promoters, unless properly novated.
2. Meaning of Novation
Novation means substitution of a new contract in place of an old one, either:
Between the same parties with altered terms, or
By replacing one party with another
Under Section 62 of the Indian Contract Act, 1872, novation occurs when:
Parties agree to substitute a new contract, or
Rescind or alter the original contract
In promoter contracts, novation means:
The company, after incorporation, enters into a fresh contract
The promoter is released from personal liability
The company becomes liable instead
3. Why Novation is Necessary
Under common law:
A company cannot ratify a contract made before incorporation.
Therefore, without novation, the promoter remains personally liable.
Novation ensures:
Legal transfer of rights and obligations
Discharge of promoter liability
Binding obligation on the company
4. Essential Requirements for Valid Novation
Company must be legally incorporated.
All parties must consent to substitution.
A fresh contract must be entered into.
Promoter must be expressly released from liability.
Terms must be clear and enforceable.
Mere adoption or informal acceptance is insufficient — there must be a legally binding novation.
5. Legal Position in India
Unlike strict English common law, India provides statutory relief under:
Specific Relief Act, 1963 (Sections 15(h) and 19(e))
A pre-incorporation contract may be enforced:
If the contract was for the purposes of the company, and
The company has accepted the contract and communicated acceptance after incorporation.
However, even here, courts look for clear evidence of substitution or adoption.
6. Key Case Laws
1. Kelner v. Baxter (1866)
Facts: Promoters entered into a contract to purchase wine before incorporation.
Held: The company did not exist at the time of contract; therefore, promoters were personally liable.
Principle: A company cannot ratify a pre-incorporation contract; promoter remains liable unless novation occurs.
2. Natal Land & Colonisation Co. v. Pauline Colliery Syndicate (1904)
Facts: Contract entered into before incorporation; company later attempted adoption.
Held: Company cannot ratify a contract made before its existence.
Principle: Ratification is impossible; only novation can transfer liability.
3. Phonogram Ltd v. Lane (1982)
Facts: Individual signed contract on behalf of a non-existent company.
Held: Promoter personally liable because company did not exist at time of agreement.
Principle: Signing on behalf of a non-existent company does not avoid personal liability.
4. Newborne v. Sensolid (Great Britain) Ltd (1954)
Facts: Contract signed in company name before incorporation.
Held: Contract was void; promoter not personally liable because he did not contract in personal capacity.
Principle: If contract is made only in the company’s name, and company does not exist, contract may be void unless novation occurs.
5. Weavers Mills Ltd v. Balkis Ammal (1969, India)
Facts: Promoters purchased property before incorporation; company later accepted the contract.
Held: Under Specific Relief Act, company could enforce the contract.
Principle: Indian law allows post-incorporation adoption where statutory conditions are satisfied.
6. Vali Pattabhirama Rao v. Sri Ramanuja Ginning & Rice Factory (1924)
Facts: Promoters entered into land purchase agreement before incorporation.
Held: Promoters remained personally liable in absence of clear novation.
Principle: Without clear substitution of liability, promoter continues to be bound.
7. Howard v. Patent Ivory Manufacturing Co. (1888)
Facts: Promoter attempted to escape liability after company formation.
Held: Liability continues unless new contract substitutes company in place of promoter.
Principle: Novation must be clear and intentional.
7. Effect of Novation
Once novation is validly executed:
| Before Novation | After Novation |
|---|---|
| Promoter personally liable | Promoter discharged |
| Company not bound | Company becomes liable |
| Third party contracts with promoter | Third party contracts with company |
| No corporate obligation | Binding corporate obligation |
8. Risks if Novation is Not Done
Promoter remains personally liable.
Contract may become unenforceable.
Disputes may arise regarding liability.
Third party may sue promoter directly.
Corporate governance complications.
9. Practical Safeguards
To ensure proper novation:
Insert clause in original contract stating it is subject to incorporation and novation.
After incorporation, pass board resolution approving fresh contract.
Execute written novation agreement.
Clearly release promoter from liability.
Communicate substitution to third party.
10. Key Takeaways
A company cannot ratify a pre-incorporation contract under common law.
Promoters are personally liable unless novation occurs.
Novation requires consent of all parties and a fresh enforceable agreement.
Indian law under the Specific Relief Act allows limited enforcement of pre-incorporation contracts.
Courts strictly examine whether substitution was clear and intentional.
Proper documentation is essential to discharge promoter liability.
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