(b) A pre-incorporation contract is a contract which promoters enter into, naming the company as a party, prior to the date of the certificate incorporation and hence prior to its existence as a separate legal person. However, in law, the company cannot enter into a binding contract until it has come into existence through incorporation. The legal consequences of this situation are that:
– the company, when formed, is not bound by the contract even if it has taken some benefit under the contract.
– the company cannot ratify or adopt the contract even if it wishes to after it has become incorporated.
– The person who purportedly contracted on behalf of a company in respect of pre-incorporation contract is treated as if he had contracted on his own behalf.
These consequences are a result of the ordinary rules of agency law as stated in Kelner v Baxter (1866) but the third one has been restated and confirmed in s.51 Companies Act (CA) 2006, which provides that: ‘a contract that 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.’
It can be seen from the wording of s.51 that liability of the agent is contractual, but it should be noted that this liability arises whether the promoter contracts as agent or not. Thus in Phonogram Ltd v Lane (1982) it was proposed to form a company, FM Ltd, to run a pop group. L made a contract with Phonogram Ltd ‘for and on behalf of FM Ltd’. However, FM Ltd was never actually incorporated. Consequently the court held that Lane was personally liable for the money advanced to FM Ltd by Phonogram Ltd. The Court of Appeal held that the fact that Lane had signed ‘for and on behalf of FM’ made no difference to his personal liability.
To give effect to the words ‘subject to any agreement to the contrary’ in s.51, the words used would need to amount to an express exclusion of liability. However, promoters can avoid liability for pre-incorporation contracts in a number of ways. For example:
– it is possible to avoid entering the contract until the company has actually been incorporated.
– the promoter may enter into an agreement ‘subject to contract’ with the effect that there is no binding agreement until the company itself enters into one. As the promoters are usually the first directors of the company, they can assure that the company does in fact enter into the pre-arranged contract.
– the promoters can expressly provide that they will bear no responsibility for any pre-incorporation contracts. |
