A pre-incorporation contract is a contract purported to made by or on behalf of a company which has not been formed.
INTRODUCTION
A pre-incorporation contract is a contract purported to made by or on behalf of a company which has not been formed. It is the intention of this essay to examine how the courts have decided on promoter's liability in relation to pre-incorporation contract.
As stated above, a pre-incorporation contract is one which is attempted to be made on behalf of a company which is not yet formed. The problem with these contracts is who exactly is liable under them. The question to be asked is, is the company liable or is it the promoter who incurs liability.
At common law, a number of rules were established. The first one is that until the company is formed it has no legal existence. A company comes into being from the date on its certificate of incorporation (s13 Companies' Act 1985 and Re Jubilee Cotton Mills1). Prior to this a pre-incorporation contract cannot be enforce by or against the company, for it is not possible to contract with a non-existent person.
This is illustrated by the leading case of Kelner v Baxter2. In this case Baxter and two other promoters agreed to buy some wines and spirits from Kelner and signed the order on behalf of a hotel company which they had not yet formed. When the company was formed, the wines and spirits were consumed but the company failed before Kelner was paid. It was held that the company was not liable for the wines and spirits. Earle LJ said: "When the company came afterwards into existence it was a totally new creature, having rights and obligations from that time, but no rights or obligations by reason of anything which might have been done before."3
In an attempt to ratify the contract by the company after it has been formed will not save the contract. This is because notification has retrospective effect and attempts to give authority to a person at the time the contract was made. Since a company will not have been formed at this time, it cannot be given the necessary authority Natal Land Co Ltd v Pauline Colley Syndicate Ltd4. It was also held in Kelner v Baxter that if the company is not liable on the contract, the promoters may be personally liable. If the promoter does not sign the contract as agent, but merely to authenticate the company's signature, then no contract exist at all. This point was made in Newborne v Sensolid (Great Britain) Ltd5.
In this case, Leopold Newbourne Ltd. entered into a contract to sell a quantity of tinned ham to Sensolid. The contract was signed 'Leopold Newbourne (London) Ltd.' and underneath the signature of Leopold Newbourne, the promoter and director. The question which emerged after Sensolid refused to take delivery of the goods was whether the promoter can enforce the contract. It was held that Leopold Newbourne did not enter the contract to sell the ham as principal or agent. Instead the contract was purported to be made by a company which was not yet in existence by one of ...
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In this case, Leopold Newbourne Ltd. entered into a contract to sell a quantity of tinned ham to Sensolid. The contract was signed 'Leopold Newbourne (London) Ltd.' and underneath the signature of Leopold Newbourne, the promoter and director. The question which emerged after Sensolid refused to take delivery of the goods was whether the promoter can enforce the contract. It was held that Leopold Newbourne did not enter the contract to sell the ham as principal or agent. Instead the contract was purported to be made by a company which was not yet in existence by one of its future directors. The contract was therefore a nullity6. In a recent case Braymist Ltd v Wise Finance Co Ltd7, it was held that an individual can enforce a pre- incorporation contract under s36C (1) CA 1985.
The only way a company can obtain rights and obligations under a pre-incorporation contract is by novation8. (Novation is the substitution of a new contract once the company is formed in place of the old pre-incorporation contract). An example of this was in Re Patent Ivory Manufacturing Co Ltd9. In that case, there was a pre-incorporation contract for the sale of land to a company. The payment was to be made in cash. Once the company was formed, there was a change in the method of payment, instead of wholly in cash, now it was to be partly in cash and partly in company debenture (a loan to the company). It was held that this change amounted to a novation. There must therefore be a new contract and not merely a notification or adoption of a new one10.
The common law position as outlined above was altered in 1972 as a result of the UK's entry into the European Community. On entry, the UK had to comply with the first EEC Council Directive (Directive 68/151) which states: 'If, before a company being formed has acquired legal personality, action has been carried out in its name and the company does not assume the obligations arising from such actions, the person who acted shall, without limit, be jointly and severally liable therefore, unless otherwise agreed.' This was originally implemented in s9 (2) of the European communities act 1972 and can now be formed in s36C (1) of the Companies Act 1985. This states that: 'A contract which purports to be made by or on behalf of a company has 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.' However the result of this section is that the promoter is now personally liable irrespective of the capacity in which he contracts and any subtle distinctions raised by Kelner v Baxter and Newborne v Sensolid are rendered irrelevant by s36C(1). However, despite the presence of the section, it still took a court of appeal decision to put the matter beyond doubt.11
In Phonogram Ltd v Lane12 the defendant signed 'for and on behalf of Fragile Management Ltd', a company which has not yet been formed. The plaintiffs sued for the return of an advance payment repayable under the terms of the agreement, claiming that the defendant was personally liable on what is now s36C (1). The Court of Appeal found for the plaintiffs. Lord Denning felt that the section had 'obliterated fine distinctions which had been created by the way promoters sign a contract'. The words "subject to any agreement to the contrary" require an express agreement and cannot be inferred by a promoters signing as agent for the company. For Oliver LJ, liability in cases such as Kelner v Baxter and Newbourne v Sensolid did not turn on how the pre-incorporation contract was signed but as the intention of the parties to the contract. Under s36C(1) this common law intention has been replaced by a presumption that the individual contracting party will be personally liable on the contract unless there is an agreement (express) to the contrary. Lord Denning MR also rejected arguments by Lane's counsel that s9 (2) required the formation of the company to actually have started and that the word 'purport' within the meaning of the section required a representation that a company is already in existence13.
Section 36 has several limitations, however which affect its effectiveness. S36C (1) covers personal liability, it does not cover company liability.
In recent years, an issue of concern has been whether s36C (1) applies to wrongly named companies. In Oshkosh B'Gosh v Dan Marbel Inc and Craze14 the Court of Appeal held that the section did not apply to make a director personally liable where the company was waiting for a new certificate of incorporation to reflect a change in name. The company had ordered goods under its new name before the new certificate of incorporation bearing the new name had been issued. Could it be argued that the company had not yet been formed and that therefore the director who purported to make the contract on behalf of the company was personally liable? Nourse LJ held that that section had no application as the company was formed at the time the contract was made, despite the fact the company was acting and trading under an incorrect name. (If an individual signs a contract, he can be made liable under s349 (4) CA 1985. Craze escaped liability under this provision because he did not sign the contract, and therefore he was held not to have 'signed or authorised' the order of the goods within the meaning of the section).
It has also been held that s36C (1) does not apply to post-dissolution contracts. In Cotronic (UK) Ltd v Dezonie15 a contract was entered into at a time, when, unknown to both parties, the company has been struck off the register five years earlier and therefore did not exist. On discovering this, a new company was formed with the same name. However, it was held that this was not enough to make the defendant liable under s36C (1), because at the time of signing the contract the formation of a new company had not been contemplated. The contract was not in the course of formation however, a claim for quantum meruit was allowed16.
The final limitation of s36C (1) is that the section does not relate to companies formed outside the UK. In Rover International Ltd v Cannon Films Ltd17. It was held that the section will not imply where following the pre-incorporated contract, the companies eventually formed outside the United Kingdom, for example in Guernsey. This situated has been remedied by the Foreign Companies (Execution of Documents) Regulations 1994 (S.I 1994/950). Section 36C now applies to a company incorporated outside the UK18.
CONCLUSION
In conclusion therefore it can be seen that s36C(1) CA 1985, is an attempt to make a company liable under pre incorporation contracts, however the act has several limitations which have been outlined above, the effect of these limitations has been that the common law position has remained largely the same.
The section only mentions individual liability of the promoter, not of the company, thus ensuring that the common law rules still apply when considering the company's position.
The decision in Braymist Ltd v Wise Finance Co Ltd has made it possible for an individual to enforce a pre incorporation contract under the section.
There is need for greater legislative action on this issue in order to remove any uncertainty in the law, and in order to remove any possibility of injustice which can occur.
BIBLIOGRAPHY
Farrar's Company Law Butterworths
Farrar and Hannigan (4th Edition 1998)
Company Law Textbook Old Bailey Press
Barber (3rd Edition 2001)
Company Law 150 Leading Cases Old Bailey Press
Shepherd (2nd Edition 2002)
Gower's Principles of Modern Company Law Sweet & Maxwell
Eds Davies and Prentice (6th Edition 1997)
Company Law Fundamental Principles Longman
Griffin (3rd Edition 2000)
[1920] Ch 100.
2 (1866) LR 2CP 174.
3 Company Law Textbook 3rd Edition Old Bailey Press 2001 page 87.
4 [1904] AC 120. See also Kelner v Baxter (1866) LR 2 CP 174.
5 [1954] 1 QB 45.
6 Company Law: 150 Leading Cases 2nd Edition Old Bailey Press 2002 at page 65.
7 [2002] 2 All ER 333.
8 Company Law Textbook at page 88.
9 (1888) 38 Ch D 156.
0 Re Northumberland Avenue Hotel Co Ltd (1886) 33 Ch D 16 CA.
1 Company Law Textbook p. 88.
2 [1982] QB 938.
3 Company Law 150 Leading Cases p 69.
4 (1988) 4 BCC 795.
5 [1991] BCC 200.
6 See also Badgerhill Properties Ltd v Cotterell [1991] BCC 463.
7 [1989] 1 WLR 912 CA.
8 Company Law Textbook p 89.