Pre-Incorporation Contracts and Resolution of Problems - Case Study Example

Pre-Incorporation Contracts and Resolution of Problems by the Provisions of Section 36C of the Companies Act 1985 Introduction A promoter while inthe process of promoting a company would most likely end up by entering into a contract for the trade of the company. Such contracts are known as pre-incorporation contracts. The major legal issue when it comes to pre-incorporation is that the company on for the sake of whom the contract is entered does not exist. The existence of the company is complete only when it obtains a certificate of incorporation. Thus the promoter is not an agent in law as the principal that is the company does not exist. This was demonstrated in the case of (Kelner v Baxter, 1866). The major issues of such contracts were that: 1. A corporation will not be in a position to ratify such pre-incorporation contracts which a promoter alleged to enter into in lieu of the corporation prior to existence of the corporation (Kelner v. Baxter). 2. A promoter can be held liable for a pre-incorporation contract only if it can be proved that the situation was such and it had the aim to make the promoter a representative to the contract. (Kelner v. Baxter as understood by Newborne v. Sensolid Ltd.,1 Black v. Smallwood,2 and Wickberg v. Shatsky3). 3. If a promoter purports to act as a representative of a corporation before its formation, the promoter can be held liable for a breach of assurance of office (Black v. Smallwood; Wickberg v. Shatsky). On the other hand, the compensation may be insignificant if the corporation, or the business intended to carry on by the corporation, is now bankrupt (Wickberg v. Shatsky). The major problems under the common law in the case of Kelner v Baxter, for both the promoter and the third party were that the contract was not enforceable. As the proposed contract was not reliable this proved to be risky. The faith of reliance in this contract was thwarted as there was an option of either the promoter becoming unjustly richer at the expense of the third party or vice versa. For example, if the courts had not found the liability of the promoters in Kelner v. Baxter then the entire loss on wines supplied to the hotel company would have to be borne by Kelner. Again under common law unnecessary costs are involved. In order to know the position of the company both the parties will have to find out whether the company is a legal entity or not which would involve unnecessary expenditures. The problems which are linked to the pre-incorporation contracts are mainly due to the artificial personality of the company. In reality the existence of a company is not like that of a natural person. Its existence cannot be determined immediately and is a concern of legal formality. Pre-incorporation contracts can be treated as sui generic but till 1973 the legal effects of such contracts were governed by the principles of contract and agency under the common law and not to say there was very little difference between corporations and natural persons. Consequently dissatisfaction prevailed and criticism was extensive. Under S9 (2) the European Communities Act 1972 partly improved this law. But again the ECA did not have any provisions which could deal with the ratification or adoption of the pre-incorporation contracts made by the promoters although this was a key defect of the common law. The provision revealed a more restricted aim to remove the risk to a party which contracts with a company and to prove the contract as null and void. Subsequent case laws proved this risk and many other weaknesses of the provision (Griffiths, 1993. pp 241-253). Former reservations in the law are now resolved by s36C CA 1985, which is as follows: “A contract which purports to be made by or on behalf of a company at a time when the company has not been formed has effect, subject to any agreement to the contrary, as one made with the person purporting to act for the company or as agent for it, and he is personally liable on the contract accordingly (s36C CA 1985). “ The Companies Act 1985 lays down the principles and rules under which the companies in the UK are constituted, registered and governed. This Act was actually projected to ascertain that administration processes were wholly followed during all phases of the company’s life that is right from its inception to existence. Also this Act would administer if required the different processes of bankruptcy and liquidation. Major parts of this 1985 Act have been replaced by the Companies Act 2006. The key points developing out of s36C is that when any contract is made by the promoter either on behalf of or as the company then contractual liability is imposed on the promoter and related rights to enforce the contract as well falls on the shoulders of the promoter. This rule was confirmed in the case of Phonogram Ltd v Lane [1981]. The case of Phonogram Ltd v Lane4 is the first case which came before the Court of Appeal after the creation of section 9(2) of the 1972 Act. The court in this appeal rejected the argument with regard to section 9(2) being interpreted exclusively by referring to the Directive. Lord Denning MR stated thus: “Section 9(2) is in accordance with the spirit and intent of the directive. We should go by our own statute and not by the directive.” The fact which was emphasised in the case was that section 36C neglected to execute that part of article 7 which allows for a company to accept obligations developing from the contract (Lord Denning, 1972). Salomon v A Salomon & Co Ltd 5 is a turning point case in the history of UK company law. In this case the Lords undisputedly ruled the doctrine of corporate personality, as laid down in the Companies Act 1862. After this case several exceptional considerations have been defined, both by legislatures and the judiciary, in England and elsewhere (including Ireland) where courts can lawfully ignore a companys separate legal personality especially at times when crime or fraud were been committed under the corporate veil. The 1985 act attempts to validate agreements to address a number of underlying contradictions that limit the efficiency of pre-incorporation contracts. As Janet Dine indicates, "the paradoxes are understandable and, to an extent, sustainable, as long as you accept that any company will need to sign certain contracts before it can be formally incorporated" (Dine & Koutsias, 2007, p. 158). The certainty of s36C does not represent the desires of the promoter, who wishes to shift his contractual responsibility to the company at the earliest. This procedure is obstructed by the agency principle which the company will not be able to ratify retrospectively. That is the company cannot adopt the contract which was made on its behalf before it was incorporated The statutory provisions are actually meant to render a perfect set of default decrees on pre-incorporation contracts. But the decision in the case of Westcom Radio Group Ltd, v. Maclsaac6 reintroduced unneeded intricacy into the fortitude of rights and liabilities with regard to pre-incorporation contracts. Westcom unproductively sought to deal with a disagreement in the statute pertaining to the term contract.7 Under common law, courts held that if the intention of is only to hold the corporation liable, then no contract can be organised since the Corporation has not come into being at the time of transacting. A contract created under such situations is null and void at common law. A solicitor may sometimes be authorised to sign on behalf of a pre-incorporated company. Also many a times, a solicitor may be required to sign a contract, in that competence, instead of a client. Such situations cannot be strictly governed by law, except for the consideration of identity ratification and individual liabilities. Sometimes when a company signs such pre-incorporated contracts on behalf of another company then issues become more complicated. The main difficulty when a company signs a pre-incorporated contract is that even though the company is a perfectly legal is fundamentally an artificial entity with composite legal conditions in terms of liabilities, possession and corporate lawfulness. Under the present UK law companies have to sign legal manuscripts before they actually exist, which is a grey region of the law which is open to a lot of potential versions. Section 36C of the Companies Act 1985 was partially drafted to assist prevent these problems. According to Derek French, "courts tend to avoid re-writing contracts because... to do so would be to retrospectively apply a new law to a nebulous legal situation" (French, 2008, p. 417). Put differently, it is current on those affected in the contractual negotiations to make certain that they comprehend the legalities adjoining the signing, particularly if it affects a pre-incorporated company being signified by another party. Thus it can be inferred that a contract can be effective only if both parties to the contract are capable of giving effect to it. Also rights to implement developed under the Section and with it there was a danger that unknowingly the circumstances would be produced under which an agent would be in a position to enjoy better rights than existed at common law. Nonetheless the court clarified that the rights interpreted in the section were subject to the rights under common law when it comes to the enforcement of contracts. As French (2008, p. 157) points out, "the possibility of voiding the contract... is available at almost every step... (and) is an obvious solution where it can be seen that all parties are at least partly liable for errors, mistakes and misjudgements". According to Sarah L. Sealy the case brought up one crucial precedent, which is "no individual who willingly acts as the signatory agent for a pre-incorporated company can expect to be able to wash his or her hands of liability for that contract completely when the company becomes fully incorporated" (Sealy, 2008, p. 27). She states that the time of incorporation is not a disconnected point with reference to an individuals duty and responsibility. She further argues that, “this is, in part, in order to avoid the problem of individuals acting counter to the law in the early stages of incorporation and then using such a cut-off point in order to avoid being held responsible” (Sealy, 2008). In Braymist Ltd. and Others v. Wise Finance Company Limited, 2002, the significance of having dealings in position and the necessity to impose those protocols was supported by the flow and result of the case. The case actually involved a disagreement over the sale of some land. An appeal was made to the court, to declare the contract as void and to cancel by notice and forfeit the deposit. This appeal was challenged as there was actually no contract. At this stage particular reference was made to the writings of section 36C [1] and its complications with reference to the Law of Property (Miscellaneous Provisions) Act 1989, section 2. This above mentioned case involved a firm of solicitors to act on behalf of Plumtree Ltd., to sell a piece of land to another company. Mr. Pool who was the managing director of the selling company possessed 75% of the shares. The vendor company was to be a new company and this information was known to both the seller and the solicitors. At the time of the contract the vendor company did not have the legal title of the property and so the situation was addressed in the contract by a term of a rule 72 transfer of the land from the seller to the buyer and the purchaser was to be responsible for the registration of the transfer. Thus only at the time of registration the vendor company was instantly incorporated as an off-the-shelf company. Regrettably, Braymist was not incorporated quickly, and so the contract was signed on its behalf before it actually legally existed. This produced a considerable legal setback that was aggravated, rather than facilitated, by section 36C of the Companies Act 1985 (Roberts, 2006). This case speculates the common legal principle that proposes ownership of contractual liabilities "cant be transferred ad hoc without the explicit written consent of all interested parties" (Dine & Koutsias, 2007, p. 61). Thus the above case is frequently held as a major example to show the means by which pre-incorporation contracts can bring up an assortment of surprising predicaments. But still it does not come as a surprise as well because this case has been carefully and scrupulously examined by observers who seek to find out some general points which might be linked to the ways in which adjudicatory courts would be able to handle cases that involve pre-incorporation contracts. Conclusion Finally it can be said that there remains no clear, centred piece of UK statute law involving pre-incorporated companies and the manner in which they are allowed to enter into contractual accords. What ever legislation there is it focuses on the manner in which individuals can and cannot restrict their responsibility with regard to any activities or contracts that they may enter into for a company. As Janet Dine states, "its hard to believe that such a major area of English company law is left to supposition, interpretation, assumption and precedent" (Dine & Koutsias, 2007, p. 184). Even though it is crucial to acknowledge that it is far from the only significant part of law to continue basically unlegislated. The 1985 Companies Act, even through recognised the issues present in this area, restrained from fully rearranging the business environs so that the state of affairs becomes clearer. It has only enshrined certain inhibitions with regard to the lack of ability on the part of directors or other individuals which includes the solicitors as well to vindicate themselves from any obligation with regard to contracts signed on behalf of the company at its pre-incorporation stage. It is unexpected that the resultant 2006 act also failed to address this area amply. References 1. Andrew Griffiths. 1993. Agents without principals: pre-incorporation contracts and section 36C of the Companies Act 1985. Legal studies, 13 (2) pp.241-253. 2. Braymist Ltd. and Others v. Wise Finance Company Limited, 2002 EWCA Civ. 127 3. Companies Act 2006 4. Companies Act, 1985, section 36C 5. Companies Act 1985 Section 13 6. Dine, Janet & Marios Koutsias (2007). Company Law. London: Palgrave Macmillan 7. French, Derek (2008). ‘Blackstone’s Statues on Company Law’. Oxford: Oxford University Press 8. Kelner v. Baxter (1866), L.R. 2 C.P. 174 (Common Pleas) 9. Law of Property (Miscellaneous Provisions) Act 1989, Section 2. 10. Roberts, Annette (2006), ‘An Unexpected Consequence for a Solicitor Arising from Section 36C of the Companies Act’ in Digman, Alan & John Lowry (2008) ‘Company Law’, Oxford: Oxford University Press 11. Sealy, Sarah L. (2008). ‘Cases and Materials in Company Law’. Oxford: Oxford University Press Read More