Promoters Liability To Third-Party Contracts - Essay Example

PROMOTERS’ LIABILITY TO THIRD PARTY CONTRACTS FORMED BEFORE A COMPANY CAME INTO EXISTENCE – A REVIEW OF THE COMMON LAW AND THE COMPANIES ACT, 2006. Contents Introduction 3 Promoters and Pre-Incorporation Contracts 3 Pre-Incorporation Contracts not Enforceable 4 Liability for Pre-Incorporation Contracts 6 Voluntary Acceptance of Pre-Incorporation Agreements in Common Law 7 Modern Statutes and the Perfection of the Law on Promoters & Third Party Contracts 8 Companies Act, 2006 8 First EC Company Law Directive 9 Conclusion 9 Bibliography 11 Books 11 Journal 11 Cases 11 Statutes 11 Introduction The position of promoters in corporate law is complicated because it is difficult to draw the line between the promoter’s individual liability for his actions and the actions of the company the promoter initiates. In UK corporate law, the Common Law attempted to deal with the problems between company promoters and companies. The purpose of this paper is to examine the liability of company promoters and their contracts with third parties in relation to the Common Law and the Companies Act, 2006. Promoters and Pre-Incorporation Contracts The lessons of Salomon V Salomon1 indicate that a company has a completely separate existence from its owner(s). However, prior to the formation of A Salomon & Co Ltd, there was a process through which some groundwork was done in order to make it possible for the company to be formed. This shows that there is a cut off point between the creation and the making of a company and its actual operation. Prior to formation and operation, persons involved in the creation and organisation of activities that lead to the formation f a company are called promoters. The definition of a promoter is found in the case of Twycross V Grant2 as “one who undertakes to form a company with reference to a given subject and to set it going and who takes all necessary steps to achieve that purpose”. This implies that a promoter lays the foundations for the establishment of a given business. This means doing all the necessary groundwork relating to the company formation and the putting together of all administrative elements. The definition of a promoter also encompasses the one who starts negotiations, registers the entity and obtains directors and shareholders to give the company the necessary form to keep it going as a legal entity. However, before incorporation, the promoter’s action has been seen to be doubtful and problematic. This is because there is a tradition conflict in the Common Law that makes it difficult to classify contracts and obligations owed to third parties that are directly attributable to the promoter before the company was formed. The position of a promoter is very ambiguous in Common Law and the question of whether a promoter is responsible for contracts made before the company came into existence or not has been a major point of contention in legal cases3. The enforceability of pre-incorporation contracts between a promoter and third parties is not clear. The decisions and rulings of these cases vary according to the facts and circumstances at hand. Pre-Incorporation Contracts not Enforceable The default position of the Common Law is that pre-incorporation contracts between a promoter and a third party are difficult to be categorised. However, in the landmark ruling of Kelner V Baxter4 where it was recognised that pre-incorporation contracts will occur when an individual who actually acted as promoter on behalf of the non-existing entity will be liable to the contract. However, it was established in the case that when the company came into existence, it could not ratify such a contract because the company was no in existence at the time such contracts were formed. Therefore, it lacks the legal capacity to ratify or take a decision that had retrospective legal effects on the company. This means that there was no possibility for the ratification of a pre-incorporation contract because a company will lack the legal capacity to do so. This is based on two main interpretations: 1. The strict interpretation and 2. The constructive interpretations. The strict interpretation is known as the rule of law and it implies that the firm did not had the legal form and legal existence at the time the contract was formed. Therefore, the promoters are the only ones who can be held accountable for the elements of any contract that was formed before incorporation. The constructive approach is based on the fact that the promoter’s liability depends on whether it was intended that the promoter was just a party and the company was liable or not. This is known as the rule of construction. In the case of Newborne V Sensolid (GB) Ltd5 a contract for a sale of goods was signed in the name of the unincorporated company, followed by the signature of the founder and ‘director’6. The strict approach was applied in the court of first instant and it was stated that the contract was void because the company was not in existence and it is clear that appending his signature was merely a charade with absolutely no legal power. However, when the case was sent to appeal, it was held that the promoters were not able to transfer the obligation to a company because the company was not meant to be liable, even though it was in the same name as the “director”. Therefore the two approaches indicate that a contract cannot be formed without a company actually being formed or being in existence. Liability for Pre-Incorporation Contracts Another angle from which pre-incorporation contracts can be evaluated is through the assessment of who is actually liable for these contracts formed before a company comes into existence. Is it the promoter or the company? This is a question that has been answered in the English Common Law. In the case of Buffington V Bardin7 it was established again in the English Common Law that in case of liability, a corporation can only be liable when it comes into existence. And this is because a corporation becomes a legal entity when it is registered and given a status in the legal system and the legal structure8. Therefore, it is not possible to hold a company liable for the actions of its promoter because the actions of the promoter predate the company. Secondly, until a company comes into existence, no one can claim to be its agent or promoted. This is because the status of being an agent or a promoter is futuristic in outlook. A person can only become an agent on the condition of the firm coming into existence and gaining legal recognition in the form of incorporation. Therefore, the claim that a person is going to be an agent of an organisation that will come into existence in future is contingent on the actual incorporation in the future. Therefore, liability for a pre-incorporated contract is unclear and cannot be established until future events are fulfilled. This implies that Buffington V Bardin shows taht there is absolutely no contract at all and no one is liable for the pre-incorporation contracts of a company. Therefore, there is absolutely no contract and no one can be held liable for these contracts and promises. This makes pre-incorporation contracts either unenforceable or void when they are made with the promoters. Voluntary Acceptance of Pre-Incorporation Agreements in Common Law Thus far, it has been established that in Common Law, a promoter can either be personally liable for the terms of a pre-incorporation contract9 or such a contract is absolutely void in law because it lacks the legal substance10. However, what if a contract was actually signed by a promoter in good faith and a company wants to accept it? It is clear that there are some contracts made by promoters that are essential to the survival of a company, once they come into existence. These contracts are institutionalised and accepted through the concept of novation. As identified, it is not possible for a company to ratify a pre incorporation contract made on its behalf by a promoter11. However, through the process of novation, an exception can be made and the contract can be transferred from the promoter to the company. Novation is a process whereby the contract made by the promoter and a third party is discharged and the company enters a new contract with the third party12. Therefore in novation, there is a total discharge of the contract between the promoter and the third party entity. This means that the contract is viewed as a completed contract. This lays the impetus for the creation of a new contract which binds the new company to the agreements with the third parties. Novation is therefore a legal agreement and arrangement that is somewhat distinct and different from the original contact. It implies putting aside the previous contract and accepting a new contract. This confirms the fact that a contract between a promoter and a third party is a completely distinct and different agreement that is treated independent of the contract of the company. However, novation makes it much easy and simple to transfer a selected contract from the promoter to a company that the promoter forms. Modern Statutes and the Perfection of the Law on Promoters & Third Party Contracts New laws and regulations have been made that simplify and guide the way and manner through which pre-incorporation contracts can be accepted and implemented. This includes the Companies Act, 2006 and the First EC Company Directive. Companies Act, 2006 Section 51 of the Companies Act, 2006 states that subject to the contrary, a person purporting to act for a company as an agent of the company is personally liable on the contracts they make before the company comes into existence. This means that the law makes it officially makes the company promoter liable for the terms of contracts they form. This is an establishment of the rules of Phonogram Ltd V Lane13. However, from recent case law, it can be stated that a person who enters a contract as a promoter of a company can also enforce a pre-incorporation contract14. This was also unclear under the old legal systems of the Common Law where it was held that a contract by a promoter is absolutely void. Therefore, the ruling makes it possible for a promoter of a company to set up a pre-incorporation contract that is voidable. And the contract can be enforced. Furthermore, Section 598 of the Companies Act, 2006 states that non-cash assets cannot be sold to a public company unless independently valued and members have approved the sale15. This implies that it is not possible for a promoter to impose the terms of a contract made before incorporation unless due diligence is done on such a contract and the members of the company have voted on the issue. This implies that pre-incorporation contracts cannot be imposed on people until they properly checked. Thus, there is some kind of moderation that guide the process through which firms can do their novation processes and activities. First EC Company Law Directive Article 7 of the First EC Company Law Directive indicates that actions carried ou in the name of the company before it acquired legal personality does not automatically devolve to the company. The person who acted shall be without limit, jointly or severally liable unless otherwise agreed. Therefore, there is the restatement of the obligation to hold promoters personally responsible for these pre-incorporation contracts, and not the company. Conclusion The Common Law, prior to the Companies Act 2006 was ambiguous on the position of pre-incorporation contracts between promoters and third parties. It had a position that oscillated between viewing these contracts as void and regarding them as voidable. However, the universal position of the Common Law precedents was that a pre-incorporation contract entered into by a promoter was not binding on a company. The only way they could be binding on a company was through the process of novation, whereby a company entered a new contract with the third party after it came into existence. How these contracts related to a company varied according to different rulings and different views taken by judges. The Companies Act 2006 (Section 51) made it clear that a promoter was personally liable to pre-incorporation contracts. Also, a promoter could enforce pre-incorporation contracts. The first EC Company Law Directive Article 7 confirms this and makes it clear that a pre-incorporation contract does not automatically devolve to a company. Furthermore it can be said that Section 598 of the Companies Act makes it imperative for non-cash assets like a pre-incorporation contract to be independently valued and approved by shareholders before they can be accepted by a firm. Bibliography Books Judge, Stephen & Moore Imogen, Q and a Revision Guide Company Law 2014 And 2015, Oxford, Oxford University Press, 2014 Roach Lee, Company Law Concentrate Oxford: Oxford University Press, 2014 Journal Singh, Prasidh Raj. “Promoter and Pre-Incorporation Contracts” Orissa: National Law University, 2011 Cases Bryanston Ltd V Wise Fiannce Co. Ltd [2002] EWCA Civ 127 [2002] 3 WLR 322 Buffington V Bardin [1891] 80 Wis 635 Kelner V Baxter [1866] 2LR 2CP 174 Newborne V Sensolid (GB) Ltd [1954] 1 QB 45 Phonogram Ltd V Lane [1982] QB 939 Re: Northumberland Avenue Hotel Co [1886] 33 Ch D 16 Salomon v A Salomon & Co Ltd [1897] AC 22 Twycross v. Grant [1877] 2 C.P.D. 469 Statutes Companies Act, 2006 First EC Company Law Directive Read More