Pre-incorporation matters Flashcards
What is the significance of pre-incorporation matters and what are some common law hurdles to them?
Before companies are formed, investors require confidence from promoters that the company will be operational, with assets and liabilities, once it has been established. Thus, there is a need for binding legal arrangements to be made prior to the incorporation of the company (ratification problem). At common law level, it is impossible for a company to contract if it is not yet in existence. Similarly, it cannot act as a principal to an agent (law of agency problem).
What is a promoter?
A person who undertakes to promote the interests and development of the pending company before its incorporation. They do so in their personal capacity, and not as an agent to a principal. To be a promoter, one must have:
- intention to promote
- actually done something
The nature of a promoter is sui generis, because it is uncertain what their duties and obligations are.
What is the common law stipulatio alteri?
This is a contract for the benefit of a third party. Here, the promoter acts as the principal and contracts in their own name, for the benefit of the company to be formed [McCullough v Fernwood]. Under the Act, this common law method may only be used where the promoter acts as a principal, and not as an agent.
What election does a company face upon its incorporation - common law stipulatio alteri?
When the company is incorporated, they have an election to either accept or reject the benefit of the contract within the time limit stated in the contract, or within a reasonable time. The company’s decision must be relayed to the promisor either expressly or tacitly. Upon acceptance, the company becomes bound to the contract. Essentially a new contract is created. The promoter and promisor are essentially offering a contract to the new company. During that time, the promisor cannot unilaterally withdraw from the contract. Otherwise, the promoter may obtain an interdict against them to prevent the promisor from abandoning the contract, or they may claim damages for a breach of contract. Specific performance will not be provided. One disadvantage of this form is that the promoter and promisor may mutually agree to cancel the contract, to the detriment of the company.
What is the liability of the promoter under the common law stipulatio alteri?
Should the company not come into existence, the contract simply lapses and the promoter cannot be held personally liable (unless stated so). Similarly, the promoter cannot accept the benefits of the contract if the company does not come into existence.
What does Section 21 of the Act cater for?
This section enables persons acting as agents to contract on behalf of non-existent companies that are yet to be formed, and enables companies on their formation to ratify such pre-incorporation contracts. These must be:
1) written agreements
2) entered into before the incorporation of the company
3) by a third party acting in the best interests or on behalf of a proposed company
4) with the intention/understanding that
5) the proposed company will be incorporated and
6) will thereafter be bound by the agreement
Once ratified, the agreement becomes enforceable against the company.
Elaborate more on ratification under Section 21
The company must ratify the contract within three months after its incorporation. This responsibility lies with the board of directors of the company, who may either accept or reject the contract wholly, partially or even conditionally. If a company fails to ratify the contract within three months, then the company is regarded to have ratified it (deemed ratification). At issue is whether the contract applies retrospectively i.e. back to when it was entered into by the agent, or only when the company was incorporated [s21(6)(a)].
What is the liability of the promoter under Section 21?
The promoter is jointly and severally liable (with other co-promoters) for liabilities created in terms of the pre-incorporation contract in two circumstances:
- if the company is not subsequently incorporated
- if the company rejects any part of the pre-incorporation contract
If the pre-incorporation contract is abandoned, but the company makes a new contract with the third party on the same terms, then the promoter is also released from liability.
The risk of ‘fly-by-night’ companies. When a company does not like a pre-incorporation contract, they can buy a shelf company and make that weak company with little assets liable to the third party. Hence, the third party would only have a claim for breach of contract against the weak shelf company. This way, promoters can avoid personal liability for a contract that the company chose not to ratify.
What are three other important issues that the Act is silent on in relation to Section 21?
1) What happens in the interim period between the creation of the contract and the incorporation of the company?
2) Can the third party unilaterally withdraw from the contract before its ratification?
3) Can a promoter contract out of their liability?
What are three other methods of overcoming the common law hurdles?
a) contract of cession
b) nominee arrangement
c) transferable option
