Why pre-incorporation contracts are not binding on the company?

Pre-Incorporation Contracts and their Legal Status:

1. Definition and Nature of Pre-Incorporation Contracts:

• Pre-incorporation contracts are agreements entered into by promoters on behalf of a company that has not yet been incorporated. Promoters are individuals who take the necessary steps to form a company, such as drafting the memorandum and articles of association and raising initial capital.
• These contracts are made with third parties before the company is officially incorporated and therefore before the company comes into existence as a legal entity.

2. Legal Status of Pre-Incorporation Contracts:

• No Legal Entity to Perform: One of the primary reasons pre-incorporation contracts are not binding on the company is that at the time the contract is entered into, the company does not yet exist as a legal entity. Therefore, there is no entity in existence to be bound by the contract.
• Doctrine of Post-Incorporation Ratification: Once the company is incorporated, it has the option to ratify the pre-incorporation contract. Ratification is the act of adopting a contract entered into on the company's behalf before it was incorporated. If the company ratifies the contract, it becomes binding on the company, and the company becomes liable to perform its terms.
• Promoter's Personal Liability: In the absence of ratification, the promoter who entered into the pre-incorporation contract is personally liable to perform the contract. This liability arises because the promoter acts as an agent for a principal (the company) that does not yet exist. The third party who entered into the contract with the promoter can enforce the contract against the promoter personally.

3. Reasons for the Rule:

• Protecting Third Parties: The rule that pre-incorporation contracts are not binding on the company protects third parties who enter into contracts with promoters. It ensures that they are not left without a remedy if the company fails to come into existence or refuses to perform the contract.
• Promoters' Risk and Responsibility: Promoters are typically aware of the risks involved in entering into pre-incorporation contracts and should take steps to protect themselves, such as including clauses allowing them to withdraw from the contract if the company is not incorporated by a certain date.

4. Exceptions to the Rule:

• Express Agreement: In some cases, the parties may expressly agree that the contract will be binding on the company once it is incorporated. This is known as a "contract subject to ratification."
• Implied Ratification: Ratification can also be implied from the conduct of the company after incorporation. For example, if the company starts performing its obligations under the contract without explicitly ratifying it, this may be considered implied ratification.

5. Conclusion:
Pre-incorporation contracts are not binding on the company because the company does not yet exist as a legal entity when the contract is made. This rule protects third parties and ensures that promoters bear the risk and responsibility for entering into contracts on behalf of a company that has not yet come into existence. However, there are exceptions to this rule, such as express agreement or implied ratification, which can make a pre-incorporation contract binding on the company. Understanding these principles is essential for promoters, investors, and stakeholders involved in the formation of companies.