The Overlap between Company Law and Contract Law: A Doctrinal and Practical Analysis

Abstract

The two major pillars, on which commercial jurisprudence is based, are company law and contract law. They both possess different focuses and specifications, and they overlap in various ways, with the most important one being the manner in which corporations are established, the way agreements between stakeholders are made, and enforcement, as well as mechanisms of governance within corporate entities. The article analyses the exposure of contract-law principles to company-law because it highlights doctrines that include offer and acceptance, consideration, and privity in company incorporation as well as shareholder agreements and corporate governance. It borrows examples on the Indian side of the equation using the precedent of Indian courts in addition to the intended statutory sources of the Companies Act, 2013 in combination with the Indian Contract Act, 1872. The article concludes with remarks about the practical implications of these overlaps to commercial transactions and in corporate litigation, and recommends that more clarity, particularly when the rules remain unclear, would help.

Introduction

There is a strong relationship between the company law and contract law. The law of company defines the processes that occur during the formation, management, and then demise of company and the law of contract covers the terms and duties and obligations that parties voluntarily enter into. The company as a juristic person, however, mainly conducts its business by making use of contractual instruments, both in dealing with shareholders, directors, employees, creditors, or customers.

Such an intersection is the most visible in the following aspects:

• The fact that the company incorporation is contractual;
• Articles of Association (AoA) and shareholder agreement;
• Employment of directors and of key managerial staff; and
• Service, purchase or supply contracts signed on behalf of the company.

Even though the company law defines the structural and procedural framework of companies, the contract law provides them the life. Offer, acceptance, and consideration are key to the parties in both dealings of the company with third parties and dealings among stakeholders in the company.

Theoretical Intersection: Distinction vs. Dependence

In legal theory, the company law and the contract law can be considered as separate branches. The Indian company law is legislative, and is governed by the Companies Act, 2013[1] whereas the law relating to contracts is a general law, and mostly based on the Indian Contract Act, 1872[2]. Nevertheless, the reliance of company law as a subdivision of law on contract law is large:

• Articles of Association of every firm represent a contract between the shareholders and a contract between shareholders and the company.
• Agreements, MOUs and other contracts between the promoters before the incorporation of the company often spell out the corporate structure and shareholding pattern.
• Shareholder Agreements (SHAs) are strictly contractual instruments that yet have very influential impact on the process of corporate governance and forms of control.

Contract law therefore not only supplements but most times it functions within the context of company law.

Key Areas of Overlap 

1. Articles of Association as a Contract

By opening the Companies Act, 2013 we obtain at Section 10[3]:

On its registration the memorandum and articles bind the company and its members to the same extent as they respectively would have been signed by the company or by each member…

In other words, this provision states that the company and its members bind themselves as opposed to the memorandum and articles to the same extent as though it were signed by the signatory itself. The contractual language has been used to parent it in the courts and the articles of association (AoA) have been approached as a contract.

There are however two twists to that contract: 

1. It integrates the company with the members.
2. It also unites the members to one another, but not personally, except as members.

One is the decision of the Supreme Court set out at V.B. Rangaraj v. V.B. Gopalakrishnan (AIR 1992 SC 453). It was in the same place that the Court stated that a shareholder agreement which contradicts the AoA was not binding on the company and emphasized that a shareholder agreement cannot be said to override the AoA in the case of company rules[4].

2. Shareholder Agreements (SHAs)

Institutional investors usually enter into additional contracts otherwise known as shareholder’s agreement (SHAs), which set forth additional rights in relation to other shareholders in the firm in addition to the firm itself. Such arrangements can include: (1) rights of first refusal, (2) tag-along or drag-along provisions, (3) voting rights or (4) board nomination rights. Regardless of their contractual nature, these disputes will always emerge when circumstances occur where such arrangements are not compatible with the memorandum and articles of association (M&As)[5]. In Western Maharashtra Development Corporation Ltd. v. Bajaj Auto Ltd. (2009), the Indian courts summarized that the contractual clauses outside the M&A cannot be enforced against the firm.

3. Contracts with Promoters: Pre-Incorporation Agreements

Promoters can sign contracts in advance of the formation of the company. Under the general contract law, these contracts turn out to be illegal as the company is not in existence and so cannot have the legal capacity[6].

But Sections 15(h), 19 (e) of the Specific Relief Act, 1963[7] allow such contracts to be ratified after being incorporated, depending upon the conditions. There is also the aspect of the principle of novation taken into consideration under contract law and here, the new company might take the place and replace the promoter as the contracting party.

4. Contracts with Directors and Key Personnel

Directors even acting as the company agents are usually subjected to service contracts. These contracts of employment or consultancy are under contract law. The remedies will be enforced by the terms of contract by termination, or by resignation, or by a breach.

In Lee v. The Privy Council in Lee’s Air Farming Ltd [1961] AC 12 found that a director can be an employee and a shareholder which further entrenches the belief that the contractual relation existing in corporate structures are valid and enforceable[8].

5. Agency and Authority

In the matter of the contract law, assumptions imply that both sides work within the confines of a legal framework. Considering the business environment, there are two things which are prominent:

1. A business can only be done through the Board of Directors or authorized employees.
2. When a director or officer purports to have authority, doctrine of ostensible authority will usually intervene[9] when a contract is made by the director or officer with a third party.

The classical case in point here is of Royal British Bank v. Turquand (1856), which declared the principle of indoor management, which offered protection to the outside parties with which a company contracted in good faith against irregularities within the company.

Points of Tension between Company Law and Contract Law

Despite the rather harmonious interaction between the statutory and terms of contracts, frictions exist in three major areas: (1) the statutory primacy of Companies Act over other agreements in the context of the companies, (2) the limited enforceability of shareholders rights not explicitly stipulated in the Articles, and (3) the validity of the pre-incorporation contracts that, according to the strict contract law may not be enforced without following ratification.

These tensions foster ambiguity in interpretation especially those relating to enforcement of side agreements, which are outside the normative jurisdiction of the Articles, effects of rights based on sources beyond the Companies Act and jurisdictional separator of contractual dispute resolution forums and tribunals authorized to engage the company law.

Court’s Way of Reconciling the Overlapping

All said and done, Indian courts have most often attempted to keep a balanced tone. An example is where they have also applied contractual agreements made between the owners that are not contradictory to the company law (Crawford Bayley & Co v. Union of India, 2006) confirmed principles of the contract law in relations to the director service contracts dispute, and customary practice when interpreting the Articles and treating the shareholders[10].

An example was S.K. Ghosh v. Ganga Dhar Dalmia (AIR 1963 Cal 580) where it has been held by the Calcutta High Court, that though internal affairs of a company are principally regulated by the Articles of the company, still, private agreements can supplement the Articles-but they cannot substitute them[11].

 Comparative Perspective

When we consider the courts of such countries as UK or US, we can observe that, in most cases, the courts will tend to uphold the contracts between the individual or the private shareholders – even when they have not adhered to the Articles of a company- so long as there is no breach of a statute. In comparison, India remains more conservative and gives a stern focus to corporate personality and action in accordance to the rule of the law.

Way Forward and Recommendations

In the pursuit to counter overlaps and legal ambiguities, the following measures are necessary:

1. Codification of Shareholder Agreements: India can also come up with provisions that require or as a minimum allow registration of core terms of shareholders agreements in the articles of association.
2. Clarity of the Pre-Incorporation Contracts: The introduction of an official process and adoption or novation of pre-incorporation contracts during post-incorporation would significantly decrease the number of disputes the court will have to settle.
3. Jurisdiction Tribunal Clarity: The National Company Law Tribunal should have jurisdiction in the adjudication of disputes governed by the contract and parties to a disputed contract should either be corporate entities or groups or formations of such or their combination jurisdiction should be aligned with the civil courts to decide disputes.

The result of such trends is that legal education and commercial practice is being forced to adjust to a hybrid form of legal relations where statutory corporate governance and the freedom of contract in the form of contracts exist side by side with each other, causing conflict.

Conclusion

Company law and contract law are independent but interdependent areas of the law as they exist in a harmonious relationship in the context of business. Whereas the company law sets forth the forms and legal existence of a corporate body, the contract law imparts to this structure the day-to-day functioning life. Their convergence on one particular understanding is not only essential in cases of legal practitioners, but as well as promoters, investors, and people enacting the policy in the public life. It remains the task to reconcile the individual freedom inherent in the contractual relationship with legislative requirements laid down on corporations without destroying the advantages of legal certainty and the flexibility, which modern business so crucially needs.

References

1. Indian Contract Act, No. 9 of 1872, INDIA CODE.
2. Companies Act, No. 18 of 2013, INDIA CODE.
3. B. Rangaraj v. V.B. Gopalakrishnan, AIR 1992 SC 453.
4. Royal British Bank v. Turquand, (1856) 6 E&B 327.
5. Lee v. Lee’s Air Farming Ltd, [1961] AC 12.
6. Western Maharashtra Development Corporation Ltd. v. Bajaj Auto Ltd., (2009) 4 Comp LJ 263 (Bom).
7. K. Ghosh v. Ganga Dhar Dalmia, AIR 1963 Cal 580.
8. Crawford Bayley & Co. v. Union of India, (2006) 131 CompCas 729 (Bom).

[1] Companies Act 2013 (India)

[2] Indian Contract Act 1872 (India)

[3] Companies Act 2013 (India)

[4] V. B. Rangaraja v V. B. Gopalakrishnan

[5] Western Maharashtra Development Corporation Ltd. v Bajaj Auto Ltd.

[6] Indian Contract Act 1872 (India)

[7] Specific Relief Act 1963, ss 15(h), 19(e) (India)

[8] Lee v Lee’s Air Farming Ltd.

[9] Royal British Bank v Turquand

[10] Crawford Bayley & Co v Union of India

[11] S. K. Ghosh v Ganga Dhar Dalmia