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The Law on Pre-Incorporation Contracts in Zambia: Comparative Analysis

Pre-incorporation contracts refer to contracts made before a company is incorporated. They are contracts made by a pre-existing company’s company promoters. 

The English Position:

The common law position on pre-incorporated contracts was founded in the English case of Kelner v Baxter1, which brought out the principle that a company cannot adopt pre-incorporated contracts once established on the premise that a company cannot contract prior to its incorporation as it does not yet exist. The holding of this case and the principle it consequently established is that a contract entered into on behalf of a company before its establishment is void and, thus, incurs no liability on the company. However, the company’s promotor or any other person who acted on behalf of the pre-existing company is liable and bound by the contract.2.

For a company to be bound by a contract, it must be one that was created after the incorporation of the company.

The present state of the Law is considered in most common law countries as “unsatisfactory and replete with serious difficulties for promoters, companies and the public at large”, and the rules on this subject are “highly technical and inconvenient, and they should be abrogated.”3.

Despite the rigidity in the rule formulated in Kelner v Baxter, there is a way in which a company can enter into a pre-incorporated contract through the Novation of Contract. Novation of Contract refers to substituting one of the parties to a contract with a new party, with all three parties’ consent. In a novation, the original contract is essentially replaced by a new one, with the new party taking on the rights and obligations of the outgoing party.4. In the case of Linden Gardens Trust Ltd v. Lenesta Sludge Disposals Ltd (1994)5 the Court of Appeal stated that for novation to be effective, all parties must have a clear intention to release the original party from their obligations and substitute the new party. The consent of all parties involved is crucial, and the intention to replace the original contract must be unequivocal. Thus, a company and a third party can create the same contract under a new contract by releasing the company promoter of their legal obligations to the third party.

The Zambian Position:

The Companies Act no 10 of 20176 (the “Companies Act”) makes provision for pre-incorporation contracts under section 20. For a pre-incorporated contract to be valid, it must be adopted by a company by an ordinary resolution before a fifteen-month period elapses from the date of the company’s incorporation by Section 20(3) of the Companies Act. The provision above applies whether such a contract is evidenced by writing. The Act further provides under Section 20(3)(a) of the Companies Act that a company that has adopted a pre-incorporation contract derives can derive benefits from such contract and is bound by such contract, and further that any person who acted on behalf of the company when creating such contract ceases to be bound by it.

The Companies Act further provides that in instances when a party seeks to enforce a pre-incorporated contract that has not been adopted by a company, such a person can institute legal proceedings against the company, companies’ promotors or the person/persons who acted on behalf of the company when the contract was created. Section 20 (4) of the Zambian Companies Act thus provides:

(4) Subject to subsection (5), whether or not a contract specified in subsection (3) is adopted by the company, a party to the contract, may apply to the Court for an order fixing obligations under the contract as a joint party or joint and several parties, or apportioning liability between or among the company and, the person who purported to act in the name or on behalf of the company, and on such application, the Court may make any order it considers appropriate in the circumstances.

However, the foregoing provision does not apply where the pre-incorporation contract expressly provides that the person who purported to act in the name or on behalf of the company before it was incorporated shall not be bound by the contract nor entitled to the benefits thereof. What is not clear is whether this means that the company will be bound by the pre-incorporation contract where it expressly provides that the person who purported to act in the name or on behalf of the company before it was incorporated shall not be bound by it or entitled to the benefits. Currently there is no case law that has interpreted the provisions of the Companies Act on pre-incorporation contracts.

The South African Position:

Pre-incorporation contracts in South Africa are governed by the South African Companies Act of 2008 (the “SA Companies Act”). Under section 21 of the SA Companies Act, company promoters are permitted to create contracts on behalf of a company not yet in existence. The section thus reads,

(1) A person may enter into a written agreement in the name of, or purport to act in the name of, or on behalf of, an entity that is contemplated to be incorporated in terms of this Act, but does not yet exist at the time.

The SA Companies Act further provides that “(4) Within three months after the date on which a company was incorporated the board of that company may completely, partially or conditionally ratify or reject any pre-incorporation contract or other action purported to have been made or done in its name or on its behalf, as contemplated in subsection (1).” Under Sub-section 5 of section 21, the SA Companies Act states that if the three-month period under Sub-section 4 elapse and a company does not ratify or reject the pre-incorporation contract, such a contract will be deemed to have been endorsed and the company will be liable under such a contract.

Clearly, the South African Position resembles that of the Zambian Position, in the sense that the two jurisdictions have permitted the adoption of pre-incorporation contracts, this depicts that most common law jurisdictions are opting away from enacting the strict position in Kelner v Baxter.7.

The Indian Position:

The general position of Indian Law was identical to that of the English position. The view by lawmakers was basically along the lines of the courts in England. The stance was premised on the fact that the company was not in legal existence at the creation of the pre-incorporation contract. It was understood that if an entity is not in legal existence, then it cannot be a party to a contract, and the ‘Privity to Contract’ doctrine excludes the company from liability.8. However, many promotors of various companies found it a difficult task to pursue the incorporation of a company without entering into any form of agreement with third parties; thus, to add some flexibility to the general rule, India decided to enact the Specific Relief Act in 19639. Section 15(g) of the Specific Relief Act reads,

“When the promoters of a company have, before its incorporation, entered into a contract for 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.”

This provision allowed company promoters to create pre-incorporation contracts for the yet-to-exist company.

The American Position:

No American jurisdiction has a statute specifically dealing with promoters’ contracts as such10, however, various cases have touched on the matter, for example, Kirkup v. Anaconda Amusement Co.11 it was stated,

The mere fact of incorporation does not of itself affect the promoter’s contract, and the newly formed corporation does not thereby become a party to the contract made before incorporation in its name and for its benefit.

The stance on pre-incorporation contracts is relatively the same across all states of America. In the case of Gardiner v. Equitable Office Bldg. Corp 12 the court took the view “that a contract made by the promoters of a corporation on its behalf may be adopted by the corporation, and thereupon the corporation is liable on the contract itself, not merely for the benefits received.” Furthermore, in the case of New England Oil Co. v. Wiltsee 13 it was stated that “a corporation may be found liable on a promoter’s contract where it affirms or ratifies by receipt of benefits with knowledge.” Based on the precedents above, the American standpoint appears to be on the same footing as Zambian and South African Law. The only differentiating factor is that they have not attempted to codify these principles.

In conclusion, most Jurisdictions support the new outlook that a Company can indeed endorse a pre-incorporation contract as opposed to the stagnant rule under Kelner, which stands on the premise that the latter is not probable, plausible or even possible.