Corporate Law for Managers - Essay Example

Corporate Law For Managers - Analyse the major problems surrounding pre-incorporation contracts and evaluate how far these problems have been resolved by the provision of section 36c of the Companies Act. 1985 as amended by the Companies Act. 2006. 1. Introduction The increase of business activities worldwide has led to the introduction of simpler procedures for the incorporation of businesses. However, quite often, the time spent on the completion of the relevant procedure can be longer than was initially estimated; in this case, the emergency for the development of an agreement before the incorporation of a particular firm may appear; this need is covered using the scheme of a ‘pre-incorporation’ contract. In the past, this type of contract was considered as rather risky – the completion of the incorporation procedure was not always guaranteed - a phenomenon also common in modern market. The introduction of the Companies Act 2006 led to the increase of the safety of the specific type of contract – in the section 51 of the above Law it is noted that the person who acted in behalf of the firm or as its agent is considered responsible for the performance of the specific contract; the successful incorporation of the company in the name of which this person acted is not of particular importance regarding the protection of the interests of the party that signed this agreement along with the company’s agent. In this paper the role of the section 51 of the Companies Act 2006 in relation to the problems of pre-incorporation contracts is critically examined; it is proved that the above provision had offered an important framework for the protection of the rights of interests of the parties (individuals or firms) that enter a pre-incorporation contract. 2. Pre-incorporation contracts, characteristics and problems In order to identify the problems related with the pre-incorporation contracts it would be necessary to refer primarily to the concept of incorporation; in accordance with Cross et al. (2007, 13) ‘the incorporation process requires the development of articles of incorporation (sometimes called the corporate charter or certificate), which is publicly available and becomes something like the constitution that governs the corporation’; the founders of the corporation are free to choose the terms of the corporate charter – however, they are bound by the law as the application of specific rules, usually represented by the commercial ethics; moreover, it is required by the law that the corporate charter addresses specific issues; the rest of the content of the corporate charter can be decided by the founders of the organization (referring to the persons signing the specific contract) always in accordance with the laws that govern the commercial transactions in a particular market. Incorporation is a procedure related with a specific business form: the corporation – as opposed by partnership, another type of business entity. Entrepreneurs worldwide prefer incorporation mostly because it is related with the limited liability – or, in cases, with no liability – of a firm’s owners. However, incorporation leads to certain disadvantages of the entrepreneurs that choose the specific business type: ‘a) corporations have continuing obligations to disclose information for the benefit of creditors, b) there are penalties for directors and officers for non-compliance with duties of diligence and loyalty’ (Clarke, 2007, 7). The completion of the phase of incorporation of a particular business means that the specific business begins to exist; from the specific time point and onwards the firm can participate in economic transactions and agreements holding the responsibility for the application of the relevant terms. Problems start to appear when business agreements need to be conducted while the incorporation phase has not been completed; a series of issues need to be addressed in this case in the context described below. Incorporation can takes a specific period of time – especially when the parties do not agree to the rules included in the contract of corporation or when there are other issues to be addressed – like the availability of the assets invested in the particular organization. Apart from these cases, it is also possible that a profitable business initiative has appeared and the parties of the ‘under incorporation’ firm need to sign a relevant agreement for participating in this initiative; the pre-incorporation contracts are used in this case in order to bind the parties of the ‘under incorporation’ firm regarding an obligation undertaken towards a third party. In the legal practice, the scheme of pre-incorporation contract has been chosen in order to explain the nature of obligations of a firm that has participated – through its representatives – in a particular contractual agreement while its incorporation is in progress. Hicks et al. (2008) describe the concept of pre-incorporation contract as follows: the pre-incorporation contract is ‘the contract purported to be made by a company before the date of its incorporation’ (Hicks et al., 2008, 83); in accordance with Hicks et al. (2008) existing common law does not recognize the validity of such a contract; however, the person that participated in the specific agreement – acting in the name of the company – may be held liable; the above assumption is based on the relevant provision of the European Communities Act 1972 which has been ratified in UK by the Companies Act 2006. The obligations imposed to the parties of pre-incorporation contracts are included in the article 51(1) of the Companies Act 2006 – as analytically described in the next section. It is made clear that a pre-incorporation contract can bind the individual(s) acted in the name of a company, which had not been incorporated when the specific contract was signed. The pre-incorporation contracts lead to a series of significant problems: a) as the incorporation phase of a particular organization has not been completed, the specific organization is regarded as non-existent. In this case, if the individual acted in the name of the company would fail to perform in accordance with the contract’s terms how the other party could be protected? Since the other party, i.e. the firm represented by an individual, does not legally exist there could be no way for the party that suffered the damages to be compensated, b) which time period is considered as crucial regarding the credibility of a pre-incorporation contract? Incorporation includes several phases; which time period would be considered as appropriate for legally binding a firm that has not been incorporated – if such a case could exist, c) which would be the characteristics of the individual that would act in the name of a firm in the case of a pre-incorporation contract? In other words, should the agent of firm meet specific requirements in order for his action – referring to his participation in a particular contractual agreement – to be considered as legally binding? Furthermore, it should be made clear whether these requirements need to exist at a specific period of time or if they can be met at a future time point (referring to the case that the firm’s agent is appointed in this position afterwards, i.e. after signing the pre-incorporation contract) and d) in case that a pre-incorporation contract does not meet the requirements of the law for the validity of a contractual agreement (if, for example, is not written or if it includes terms that are considered as not accepted by the law, as the rejection of the right of a party to ask for the protection of his rights – referring to the specific agreement – through the courts) would this contract be regarded as valid? And which would be the criteria applied for the evaluation of the validity of such a contract? There is also another issue related with the pre-incorporation contracts: does the actual tensions of the parties been taken into consideration when deciding on the consequences of these contracts? In other words, if the person that acted as the firm’s agent supports that the other party had knowledge of the risk undertaken and was still willing to participate in the contract which should be the court’s decision on the responsibility of the agent or the level of the compensation awarded to the party that suffered a loss because of the non- performance of the pre-incorporation contract? The above problems have been resolved – at least as satisfactory as possible – through the provision 51 of the Companies Act 2006; the specific law amended the section 36c of the Companies Act 1986 which did not fully recognize the responsibility of the persons acted in the name of a company while its incorporation was still in progress. The courts adopted the specific rule aiming to waive inequalities related with the compensation of individuals or firms that have entered a pre-incorporation contact that was not finally performed. 3. Section 36c of the Companies Act 1986 – as amended by the Companies Act 2006 – as of a rule resolving the problems related with the pre-incorporation contracts. In accordance with the article 51(1) of the Companies Act 2006 – a legislative text amending the section 36c of the Companies Act 1986 – the pre-incorporation contract can be described as follows: ‘a contract that purports to be made by or on behalf of a company at a time when the company has not been formed’ (Companies Act 2006 in Hicks et al., 2008, 86); the contract of this type ‘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’(Companies Act 2006 in Hicks et al., 2008, 86). Using the above rule the problems appeared because of the pre-incorporation contracts scheme – as these problems were analytically presented in the previous section – can be effectively resolved. Regarding the first problem of pre-incorporation contract the solution provided by the provision of the section 51 of the Companies Act 2006 is clear: the interests of the party that participated in the specific agreement along with the company’s agent can be protected – in case that the pre-incorporation contract will not be performed – by bring the case before the courts; the action will be against the company’s agent in his own name (the agent will be himself responsible for any damage caused to the other party of the pre-incorporation contract). At this point the following notification should be made: the previous law did not leave the persons that participated in a pre-incorporation contract totally unprotected; in fact, a party could claim his rights by referring to the ‘de facto’ doctrine of the common law. In accordance with the specific doctrine, ‘so long as ‘a colorable’ attempt to incorporate was made (e.g. articles of incorporation were drafted and submitted to the state, but rejected) the court would frequently hold that the entity was a ‘de facto’ corporation’ (Emanuel et al., 2009, 30); however, a severe problem would appear for those who have contracted with a firm the incorporation of which had not been started; in this case, the court could not make use of the above doctrine and the party (person or firm) that suffered a damage because of the non-performance of a pre-incorporation agreement could not asked for a recovery of this damage. Regarding the second problem of pre-incorporation contracts, i.e. the point of time at which the pre-incorporation contract needs to be signed in order for the third party (referring not to the company’s agent but the other party of the agreement) to be protected, there is no a restriction in the article 51 of the Companies Act 2006. Indeed, in the above provision it is noted that the pre-incorporation contract needs to have been signed ‘at a time when the company has not been formed’ (Companies Act 2006 in Hicks et al., 2008, 86); it is not made clear whether the relevant documents need to have been drafted and submitted; this rule is wide, leaving to the Courts the power to decide on the characterization of a contract as a pre-incorporation contract; at a first sight, it seems that the article includes any phase of the incorporation procedure at the level that the third party (the person contracted with the firm’s agent) could have been reasonably led to the assumption that a corporation is to be formed within a specific period of time. These signs (i.e. indications) of incorporation can be false (i.e. made up by the person that acted as the firm’s agent); the court will have to examine whether logical indications existed at that specific point of time (when the pre-incorporation contract was signed) and will decide accordingly on the rights and the obligations of each party of the above agreement. The solution in the third problem related with the pre-incorporation contracts is rather simple; the only characteristic of the person that participates in a pre-incorporation contract is that ‘he acts for the company or as an agent for it’ (section 51, Companies Act 2006 in Hicks et al., 2008, 86). Probably, his authority to act in behalf of the company is proved through a relevant document – having usually the form of a power of attorney –, which needs to be presented to the party that is interested to enter the specific pre-incorporation contract. At this point the following issues need to be highlighted: a) the person who claims to have the power to sign a contract in behalf of a company needs to meet the requirements of the law regarding the age limit or mental conditions for participating in contractual agreements – the sign of a pre-corporation contract with an agent who is a minor or is under supervision due to mental instability could not produce any effect, b) the third party entering such an agreement would be responsible to examine the credibility of the power of attorney on which the power of the company’s agent is based; however, if there are problems of this document’s validity that cannot be identified by a mid-educated person (referring to the cases that the lack of validity of the particular document could be identified only by a professional) then the third party that signed the pre-incorporation contract will have no responsibility for the document’s validity; instead, his rights against the company’s agent will remain strong – using the provision of the section 51 of the Companies Act 2006. The solution provided to the third problem of the pre-incorporation contracts will be also used in resolving their fourth problem: in many cases, pre-incorporation contracts do not meet all the requirements set by the law regarding their validity; in this case the following question can be developed: will the interests of the party that suffered a damage because of the non- performance of such a contract be regarded as of higher importance compared to the application of the legal rules defining the elements of validity of a contract? The answer to the above question would be positive – using accordingly the ‘de facto’ doctrine of the common law (as explained above); the court that will be asked to examine such a case need to identify whether the party that signed the specific agreement along with the company’s agent had taken all the necessary measures for the contract’s validity (Sealy et al., 2007, 15); if such a fact occurred then the pre-incorporation contract will be considered as valid (based on the fact that in the common sense the particular contract would be characterized as valid and only an expert could identify the contract’s faults). Towards the same direction, if the person that has acted in behalf of the firm had kept secret his potential inability to enter a contract, then this contract would be valid – the legal supervisors of this person would have been asked to cover the damages of the party that entered the pre-incorporation contract under a good will. 4. Conclusion Pre-incorporation contracts can be characterized as forms of common contracts; despite the fact that pre-incorporation contract do not bind the company which is considered as participating in this contract (through its agent or promoter, Keenan et al., 2007, 156), still, the interests of the persons or firms that participated in the specific contract are protected; through the section 51 of the Companies Act 2006 the person that acted in behalf of the company or as its agent is responsible for the performance of the specific agreement; in the case of any damage because of the non-performance of the pre-incorporation contract, the party that suffered the damage can sue the company’s agent or promoter; it should be noted at this point that the parties of the agreement can exclude their contract from the specific provision, a power provided through the section 51 of the Companies Act 2006 (Slorach et al., 2007, 52). At the next level, agreements that are related with the international law should be examined as of the law that would be most applicable in the particular case – the section 51 of the Companies Act 2006 is applied only on contractual agreements that are related with the British law (Morse et al., 2006, 92). The above issues do not reduce the value of the specific provision as a text defining the level of responsibility developed in the context of pre-incorporation contracts. References Clarke, T., 2007. International corporate governance: a comparative approach. Routledge Cross, F., Prentice, R., 2007. Law and corporate finance. Edward Elgar Publishing Emanuel, S., Emanuel, L., 2009. Corporations. Aspen Publishers Online Hicks, A., Goo, S., 2008. Cases and materials on company law. Oxford University Press Keenan, D., Riches, S., 2007. Business law. Pearson Education Morse, G., Palmers company law: annotated guide to the Companies Act 2006, Volume 2006. Sweet & Maxwell Nicholls, C., 2004. Corporate Law. Emond Montgomery Publication Sealy, L., Worthington, S., 2007. Cases and Materials in Company Law. Oxford University Press Slorach, S., Ellis, J., 2007. Business Law 2007-2008. Oxford University Press Read More