Introduction:
‘while the company is a legal person it is not of course a natural one and therfore for a company to do or think anything a human being has to do it on its behalf’
-John Stuart Gatgat
In fact Arnold is acting as both a promoter and an agent on behalf of Sella Ltd company which is an unformed private company. He entered into two different contracts with Dokshred and Buya One (new name Buya Two). His first contract is with Dokshred’s company, who are claiming to sue him for their unpaid fees and the second company, Buya Two, is refusing to go ahead with the contract. Importantly, whether these contracts have the effect of creating a binding agreement are dependent upon the circumstances of each of the cases which follows.
Contract with Dokshred:
Dokshred, supplier of consultancy services, would instute proceedings against Arnold, claiming that they relied on a ‘letter of intent’ which constituted a contract on behalf of Sella Ltd by Arnold. Considering the formation of Sella Ltd never existed in reality, Arnold would be personally liable due to their unpaid consultancy fees. Arnold on the other hand would argue to escape his liabilities in establishing that the ‘letter of intent’ did not constitute a binding agreement but merely an expression of intent to conduct any future business negotiations.
There is a clear indication in the facts that Arnold is both a promoter and an agent of Sella Ltd company, having the aspect of one who under takes to form a company for a given project and who does all that is necessary for that purpose1. There is no statutory definition of a promoter; however, the most comprehensive description was given by Lindley J in Emma Silver Mining Co v. Lewis & Son2. Promoter owe fiduciary duties to the company, although he/she can not be treated as its agent during the period of promotion:Kelner v. Baxter3, for the company is never formed. It can also be said that Arnold is not a trustee of the company, he is seeking to bring into existence4 The promoter is often the company’s first director so Arnold may become liable to third parties for misrepresentation under agency principles in Partnership Law5. This is also because promoter is in a position of total dominance over the company and there is much scope for him / her to profit from the promotion.
Arnold had been signed the letter ‘subject to contract’ which raised the question of whether or not it creates a legal relationship and purports a contractual binding with Dokshred. This is the situation when a pre-incorporation contract is generally rise6. A pre-incorporation contract can be loosely defined as a contract made by one party acting on behalf of a company(‘the agent’) with another party (‘the contractor’), where the company has not been formed at the time of contracting7.
However,it can be said that the ‘letter of intent’ constituted a contract as it had been presented in a commercial context and fell to be objectively construed8.Therefore, Arnold would be liable on the contract because he made the contract on behalf of Sella Ltd, an unincorporated company9. Furthermore, he had contracted ostensibly as an agent for Sella Ltd, which made clear in fact that he was acting as a principal, so it might hold him personally liable that any effect can be given to the contract, he will be liable10. In other words, it would be permissible for Dokshred seeking to hold Arnold liable by showing that , he , though he had contracted as agent, is himself in fact the principal11.
Arnold on the other hand would not be liable for breach of contract if he can show that he entered into the contract signing his name and adding after his name the description of the office that he would hold liable only if the company is incorporated12. The general proposition in Common Law13 made clear that if a pre-incorporation contract is purported to be made by a promoter on behalf of a company which does not exist, the contract is a nullity, and neither the company, when formed, nor the promoter whose signature is added can normally be sued on the contract14. It can also be argued that an enforceable contract required an existing person (Sella Ltd ) to be party to the necessary acts of offer and acceptance, without which there would be no contract and neither the company nor the agent would be held liable15. So, the question should be I think in the problem is what is the real intent as revealed in the contract. Did Arnold intend to make himself personally liable or was the intention that Sella Ltd should be the only person liable, in which case there was no contract?16Therefore, the pre-incorporation contract could have legal effect as a contract to hold liable Arnold but only if he was the intended contractual party17.
The companies Act 1985, S36 (C ) deals with pre-incorporation contracts18. However, Arnold would be personally liable in relation to S36(C) whether he purports to act ‘on behalf of ’ Sella Ltd company or signs the contract in the companies name alone; and he may be liable though, as both parties know, Sella Ltd is about to be formed and is not yet at the stage of actually being formed19.
On the other hand, Arnold could argue that S36 (C) does not fit in this case. As Sella Ltd did not exist at the time the contract was entered into, and is clear from the facts that he had no honest intention to form a company when the contract was entered into20. Another situation when the S36( C ) does not apply, provided the promoter made it clear that he/she was acting as agent for the company and the company is in existence at the time a promoter makes a contract21.
Contract with Buya One (new name Buya Two):
Arnold would bring an action against Buya Two, claiming that they were in breach of contract. He had entered into a contract with Buya Two, an unlimited company, as an agent on behalf of Sella Ltd22 and excluded his liability23.
An agent in the normal sense is a person who has the authority to enter into a contract that binds another person, called the principal, in favour of a third party. The contract is between the principal and the third party – the agent is not a party to it. However, anyone can have an agent- but a company can only contract through an agent23.
As far as the law of agency is concerned, a person can not be an agent of a non-existent principal and so it is right to define Arnold as both a promoter and an agent, so he has rights to sue Buya Two under a pre-incorporation contract24. However, it is not entirely clear from the wording of S 36 ( C ) that the contract deemed to take effect is a normal contract which is enforceable by the agent as well as by the contractor25. The provision’s objective also does not require that the agent should be denied to enforce a contract against the contractor. It seems to be the case that the contract is enforceable by both parties and the limits on the scope of the provision should apply to them equally26.
On the one hand, Arnold may have the ultimate ability to enforce the contract against Buya Two even if Sella Ltd never existed. On the other hand, Buya Two might have ulterior commercial reasons for trying to escape from the contract because they are reluctant to deal with the agent personally or with some one other than the company named in the contract27 Undoubtedly, Arnold could hold Carol personally liable for breach of contract in establishing that she carries bussiness for more than six months with fewer than two members and since David died in February his shares have not been transferred to anyone else. Section 24 of the Companies Act 1985 provides that if a public or a private unlimited company carries on business for more than six months with less than the statutory minimum number of members, any person who is a member after those six months may be liable jointly and severally with the company for the payment of its debts28. Therefore, it is clear from the proposition that Arnold could enforce his contract with Buya Two without having to put it into liquidation.
Arnold might highlight Carol’s intention that the series of events were an arrangement to avoid the execution of the contract. There are three specific events in the facts which suggests a deliberate isolation of Arnold’s claim such as : Carol transferred funds from Buya One to her new Limited Liability Partnership, passed a special resolution to change Buya One’s name to Buya Two and expressed intention to refuse contract. The court could show willingness to lift the veil to protect Arnold from abuse of the corporate form due to fraudulent trading29. The court may further consider three leading cases on the ground that the corporate form has been used for purposes of fraud:Gilford Motor Co v. Horne30, or as a device to evade legal obligations: Jones v. Lipman31, or as an avoidance for payment of damages:Creasey v. Breach wood Motors Ltd32. In fact under the common law, director of a company is under a duty to act with reasonable care and skill and, in discharging his or her duties, he or she must act honestly and with utmost good faith for the benefit of the company and not for any collateral purpose33. While what was done was contrary to the duties owed by Carol as a director of Buya Two, on the basis of facts it might suggest that she was not acting as responsible director rather than acting to obscure the truth34.
Carol on the other hand might argue that there was no evidence to suggest that the company was a mere façade or concealed the true facts. On the aspect of lifting the veil the Court of Appeal in Ord v. Belhaven Pubs Ltd35, concluded that there was no evidence that any assets had been transferred at undervalue nor was there any improper motives for the transactions. However, the two cases are factually different, which can be shown in further discussion. In particular, in the Belhaven Pubs case, there was no evidence that any assets had been transferred at an undervalue nor was there any evidence of an improper motive such as to indicate that there might have been a breach of fiduciary duties on the part of the respective directors of Belhaven, Holdings and Estates36. This may be contrasted with the problem as Carol was in breach of her fiduciary duties in reducing Buya Two (old name Buya One) to a dormant company.
Buya Two is an unlimited company. Members of an unlimited company acquire the advantage of incorporation but their personal liability to creditors of the company is unlimited37. So, shareholders of the company are not protected by limited liablility. In that case the contracts are still with the company, but the shareholders can be made liable to satisfy the company’s liabilities if its assets are insufficient38. On the other hand, the unlimited companies have the benefits to be derived from incorporating, they also have two significant advantages over companies incorporated with limited liability: the unlimited company is normally exempted from delivering accounts and reports to the Registrar of Companies (in other words it can keep its financial affairs private); and the company may be able to return its capital to its members without the consent of the court39.
Carol changed her company name Buya One’s to Buya Two in passing special resolution. Section 28 of the Companies Act 1985 provides that a company may change its name by special resolution in general meeting. The same rules apply on a change of name as apply to the initial choice of name40. The change is effective from the date on which the incorporation of certificate is issued: SS 28(6) and 32(5). However, Buya Two remains the same corporate body and the change does not affect any of its rights or obligations or render defective any legal proceedings by or against it:SS28(7) and 32(6). Hence contracts entered into prematurely under the new name will not be pre-incorporation contracts on which, under S36C, the individual who acted would be personally liable. But if the new name was used prior to the date of the issue of the certificate (or the old name used thereafter) there would be a risk of personal liability under S 34941.
In conclusion, it can be said that the pre-incorporation contract could have legal effect as a contract to hold Arnold liable but only if he was the intended contractual party. Secondly, the court might consider, without having put Buya Two into liquidation, substituting Carol’s new (LLP) as a defendant in the action. It seems that the court would consider that the cost of Arnold suing Carol, or putting Buya Two into liquidation, to enable the liquidator to pursue the claim against Carol, might result in costs being greater than what Arnold would recover.
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1See, defination of promoter is given in Twycross v. Grant 1877 2 CPD 469.
2(1879) 11 Ch D 918, 40LT 804, where he said it is now clearly settled that persons who get up and form a company have duties towards it before it comes into existence: Bagnall v. Carlton(1877) and per Lord Cairns LC in Erlanger v. New Sombrero Phosphate Co (1878)
3 (1866) LR 2 CP 174
4 See, .Re Leeds and Hanley Theatres of Varieties Ltd(1902) .In particular he must not make a secret profit out of the process of formation: Omnium Electric Palaces Ltd v. Baines 1914, 1 , CH, 332
5 See, Farrar J, Company Law, Butterworths, 4th edition, 1998, p-51
6 However, pre-incorporation contracts are contracts purported to be made on behalf of an unformed company before its incorporation.
7 See, Gower (Davies P L / Prentice D), Principles of Modern Company Law, Sweet and Maxwell, 6th edition, 1997, p-142.
8 See, Hellmuth Obata & Kassabaum Inc v. King Technology & Construction Court 2000, WL 1480/87.
9 See, Kelner v. Baxter 1866, LR 2 CP 174. Where a promoter who signs an agreement ‘on behalf of ’ a company which is about to be formed is held to be personally liable on the contracts as principles in place of the non-existent company.
10 See, Kelner v. Baxter; for an explanation of this case see Newborne v. Sensolid Ltd 1954 1 QB, 45, 47.
11 The interpretation of Farker J statements in Newborne’s case on Kelner v. Baxter.
12 See, Newborne v. Sensolid.
13 On the position under the Companies Act 1985.
14 See, Newborne v. Sensolid Ltd; Tinnevelly Sugar Refining Co v. Mirrlees, Watson & Varyan Co 1894, 21 R. 1009, 2 S. L. T 149; Cummings and Ors v. Quartzag Ltd 1981 S.L.T 205
15 . This is the premise of the case law on the common law effect of pre-incorporation contracts. See, for example, Kel, New; Black v. Smallwood 1966, 117 CLR 52; Hawke’s Bay Milk Corporation v. Watson 1974, 1 NZLR 236; Marblestone industries v. Fairchild 1975, 1 NZLR 543.
16 See,Oliver L.J in Phonogram Ltd v. Lane 1982 QB 938; see also Cotronic Ltd v. Dezonie1991, B.C.L.C.721.
17 See, Iona Ventilation Co. Ltd v. La Fiorentiona Ltd 2002 G.W. D. 11-329; in reality the parties may have had no genuine common intention as to who was to be the contractual party. Instead, some form of objective test would have to be applied to ascertain what they must reasonably be taken to have intended. A similar approach is adopted by the law of contract to other problems such as common mistake and mistaken identity. See, for example, A Goodhard ‘Mistake as to identity in the Law of Contract’ 1941, 57 LQR 228 and Ingrams v. Little 1961, 1 QB 31.
18 See, Section 9(2) of the European Communities Act 1972, now S36 C (1) of the Communities Act 1985; Article 7 of EC Directive 68/151, OJS edn 1968, p-41 states that 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 action, the persons who acted shall, without limit , be jointly and severally liable therefore, unless otherwise agreed’. The philosophy underlying the First Directive was examined by N. Green in ‘Security of Transaction after Phonogram’ 1984, 47 MLR 671, who termed it ‘Security of Transaction’.
19 See, Phonogram v. Lane 1982 QB 938 was the first case to consider the wording of this section.
20 See, Cotvonic Ltd v. Dezonie 1991 BCC 2000
21 See, Oshkosh B’Gosh Inc v. Dan Marbel Inc and Craze 1988 4 BCC 795). However, S36( C ) will only protect third parties where the contract identifies a specific company has not yet been incorporated.
22 Sella Ltd is never formed
23 He can exclude personal liability by clearly stated as an express term of the contract.
23 See, Gower (Davies P L / Prentice D), Principles of Modern Company Law, p-201
24 An agent acting for a non-existent company to enforce a pre-incorporation contract against third party was presumed to be the intended contractual party at common law.
25 See, John Lowry & Loraine Watson, Company Law, 1st edition, 2001, p-2.8
26 See, Pettet B, Company Law, Longman, 1st edition, 2001, p-77
27 See, Rajak H, Sourcebook of Company Law, Jordans, 2nd edition, 1995,p-99
28 The companies Act 1985 and the Insolvency Act 1986 contain provisions which pierce the corporate veil. However, the requirement was effectively undermined by the decision in Salomon’s case, and since parliament chose not to reverse that decision. The Twelfth company Law Directive on single-member private limited liability companies which had the consequence that private companies limited by shares or by guarantee were excluded from section 24.
29 S 213 of the Insolvency Act 1986
30 1933, Ch 935
31 1962, 1 All ER 442
32 1992, BCC 638
33 See, Re Smith and Fawcett Ltd 1942, Ch. 304.
34 See, Creasey v. Breach wood Motors Ltd32
35 See, 1998 2 BCLC 447
36 See, Jason-Lloyd L / Mead L, The Legal Framework of the Modern Company, 1st edition, 1996, p-167.
37 . However, a member may incur unlimited liability if his company’s membership falls below two ( CA 1985, S24)
38 See, Gower (Davies P L / Prentice D), Principles of Modern Company Law, 6th edition, 1997, p-126
39 See, Geoffrey Morse, Partnership Law, 5th edition, 2001, p-15
40 See, Farrar J, Company Law,4th edition, 1998, p-128
41 See, Gower (Davies P L / Prentice D), Principles of Modern Company Law, 6th edition, 1997, p-102