Pre-Incorporation Contracts under CAMA

1 INTRODUCTION

• OBJECTIVES
• MAIN CONTENT
• CONCLUSION
• SUMMARY
• TUTOR MARKED ASSIGNMENT
• REFERENCE/FURTHER READING

INTRODUCTION

The common law position has remained unchanged since the over 100 year old rule was laid down in the case of Kelner v Baxter which seemed not only to declare and uphold the common law position but also retarded the development of the law in this area. The rule as we have seen has worked untold hardships both in the company and to outsiders, or unwary third parties who may have innocently contracted with promoters of the company with the assurance that they are actually contracting with the company. It also works hardship on the promoter who had assisted the company to enter into pre-incorporation contract with the third party on behalf of the company with the aim of getting the company to ratify the pre-incorporation contract. The obvious solution is for the legislature to intervene and make the necessary amendments.

OBJECTIVES

At the end of this unit students should be able to critically examine the position of the law on pre-incorporation contract under the Companies and Allied Matter Act.

MAIN CONTENT

The law obviously does not help businessmen and does not accord with current economic realities. Only the legislature is capable of effecting any change in this area of the law. The wind of change started moving all over the world and most jurisdictions have changed their laws to accord with social and economic realities. Section 13(1) of the Ghana Companies Code 1963 has abolished the rule laid down in Kelner v Baxter and has made ratification possible contrary to the position under common law which do not allow the company to ratify pre-incorporation contracts.

In Europe, Section 9(3) of the European Committees Act 1972 (see also Article 7 of the First Company Law Directive, and Section 36 of the Companies Act 1985 UK, and now section 51 of Companies Act 2006 UK. which provides that,

“A contract which 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.”

Davies is of the opinion that the aim of the provision, which is in line with the first directive, is to increase security of transactions for third parties by avoiding the consequences of the contract with the company being a nullity. See Davies, 1997, Gower’s Principles of Modern Company Law, Sweet and Maxwell International London) p. 142 see also section 72(2) of Companies and Allied Matters Act 1990.

In Nigeria the legislature took the opportunity of the global trend to reform the law.

This is that by enacting section 72(1) of the CAMA which provides.

Any contract or other transaction purporting to be entered into by the company or by any person on its formation may be ratified by the company after its formation and thereupon the company shall become bound by and entitled to the benefit thereof as if it has been in existence on the date of such contract or other transaction and had been a party thereto.

Section 72(1) has finally abolished the over one hundred year law as laid down in Kelner v Baxter, and has also made some improvements which needs to be examined. In the first instance, the law acknowledged the common law distinction between the rule laid down in Kelner v Baxter and that of Newborne v Sensolid (Great Britain) Ltd. The party contracting may have contracted on behalf of the unformed company or he may contract by himself as an agent to the unformed company. In the Newborne’s case, it was held that where the promoter singned on behalf of the proposed company, the promoter will be personally liable, but where the promoter merely wrote the name of the unincorporated company as the contracting party and signs for it, then, the contract is a nullity and unenforceable. In the case of MoukarimMetal Wood factory Ltd v Durojayie (1976) 1 A.L.R (Comm). 264, the court held inter alia.

“In the present case, it is clear that the plaintiffs believed at the time of the negotiation and up till the time of the sale and delivery of the goods in question, that the real purchasers were Messrs. Durmaking& Co. Ltd… on the other hand, it is equally clear that the defendant entered into the contract for the purchase of the goods in question, M.A. Durojaiye& Co. Ltd before the incorporation of that company. In the circumstances the company is not bound by the said contract and cannot therefore be sued on it unless a new contract to the effect of the previous agreement is established.”

The distinction which hitherto has introduced some difficulties in this area of the law has now been resolved. There is no distinction again between the two situations. At common law, if the parties intend to contract with non-existent company, the result will be a nullity, the third party is left without remedy. Under the statute, a contract which purports to be made with the company will only render the promoter personally liable.

Ratification

Ratification has been used interchangeably with adoption, see( (1976) 1 ALR (Comm) 264.) The effect of ratification will be to make the company adopt as its act, or authorized act something that was done before its incorporation. This we must note is not possible under the common law, as the only option available under the common law is for the company to enter into a fresh agreement on the same terms with the pre-incorporation contract, failure to do this; the company cannot enforce the contract and is not binding on it. As we have explained, this works injustice on the parties as well as the company. The statutory modification now allows the company to ratify the pre-incorporation contract which will have the effect of not only rendering the contract enforceable by or against the company, it now becomes the act of the company and dates back to the period when the company has not been incorporated.

The company must first ratify the contract before it becomes binding on it. How this is to be done is not specified in the Act. However, in contract, ratification may be express or in writing or by implication. In the case of companies, ratification may come in various ways, and therefore there is no specified method, each company is allowed to adopt its own style so far as the intention is clear and unambiguous. The directors may simply write a letter to confirm and ratify a pre-incorporation agreement. The company may pass a resolution at a meeting regularly convened by the company. It may be done by the Board of Directors resolution communicated to the parties ratifying the contract. In order to streamline the position and remove ambiguities, the law ought to specify a particular method. Where for instance the articles allow and even ratifies the pre-incorporation contract, will this amount to proper ratification under the law?. We may need to await judicial interpretation.

Another issue we may need to clear is the apparent conflict in the provisions of section 37 and provides that the company comes into existence only after its incorporation and cannot acquire contractual liability until then. However, section 72(1) makes ratification to date back to pre-incorporation period. The conflict must be resolved in order not to render the good legislative motives useless. (C.K. Agomo, the Status of Pre-incorporation  Contracts, in Akanki (ed) Essays on Company Law p.73 at 87 has suggested and I agree with her, that the addition of the phrase, “and notwithstanding any other provisions to the contrary in this or any other statute.” To section 72(1) to clear the conflict between the two sections.

The time frame within which the ratification by the company should be done ought to have been clearly specified in the law. Ratification ought to be done within a reasonable time and if the transaction is not ratified by the company then the promoter will be held personally liable. This is important, as, if the company is allowed to ratify at any time, it will work injustice on the third party and may lead to uncertainty as to who to be held liable. The position of the law is that until the company ratifies, the promoter will continue to be personally liable, and immediately the company ratifies the personal liability of the promoter terminates.

Further, the concept of corporate personality is well entrenched in the law. Section 72(1) provision is capable of being used for fraudulent purposes. If the promoter enters into a transaction on behalf of a yet to be incorporated company and later incorporates a company which thereafter ratifies the pre-incorporation contact, the promoter will cease to be liable  and the company assumes liability, and at the end of the day if it turns out to be a shell, it leaves the third party with nothing to rely upon. In cases like this the only option is for the court to lift the veil of incorporation in order to strike at the people behind the company.

Section 72(2)

The sub-section provides,thus,

Prior to ratification by the company, the person who purported to act in the name of or on behalf of the company shall, in the absence of express agreement to the contrary be personally bound by the contract or other transaction and entitled to the benefit thereof.

The sub-section has removed any ambiguity as to who will be liable on pre- incorporation contract pending a formal or proper ratification by the company. The promoter will continue to be bound thereby. The only saving grace provided in the exempted from personal liability where there is an express agreement entered into for this purpose. The meaning and scope of this provision was subjected to considerable scrutiny by the Court of Appeal in England in the case of Phonogram Ltd v Lane (1982) QB 938 Lord Denning MR, with whom Shaw LJ agreed, that the phrase “subject to any agreement to the contrary” (in the section 51 of the 2006 Companies Act UK) means that in order for a promoter to avoid personal liability the contract must expressly provide for exclusion of his liability. The court also held that it is not necessary for the putative company to be in the process of creation at the time the contract was entered into.

We must note that since the company is yet to be incorporated, the contract can only be with the third party contracting with the promoter on behalf of the unincorporated company. However, unless there are other guarantees practically, it may be difficult for a contracting third party to enter into an agreement excluding the promoter from liability. A welcome provision in our law is that section 72(2) clearly makes it possible for the promoter to enjoy the benefit of the contract. This is how it should be, where the promoter is personally bound by the contract, then he should also be able to enjoy the benefits of the contract. It follows that the promoter may also sue to enforce the contract with the third party notwithstanding that his initial intention was to contract on behalf of the yet to be incorporated company. In the case of Braymist Ltd v Wise Finance Co. Ltd (2002) 1 BCLC 415 a firm of solicitors contracted as agents on behalf of a company yet to be incorporated in which the promoter agreed to sell land to property developers. Subsequently, the developers changed their minds and the solicitors sought to enforce the contract. The issue before the Court of Appeal was whether a person acting as agent of an unformed  company could enforce a pre-incorporation contract under section 51 (Companies Act 2006 U.K) the court, affirming the decision of Eherton J, held that although the terms of the first directive referred only to liability and not to enforcement, it did not follow that section 51 was similarly limited in scope so as to prevent enforcement of contracts made by persons on behalf of unformed companies. The majority found that the words in the section, ‘and he is personally, liable on the contract accordingly’ did not operate to negative this view, but rather the phrase merely serves to emphasize the abolition of the common law distinction between agents who incurred personal liability on pre-incorporation contracts and those who did not. The provision is therefore two edged, the party that is personally liable for the contract is also capable of enforcing it, The Nigerian position is therefore preferable and removes every ambiguity, while the section 51 of the 2006 U.K Act does not specify whether the promoter can enforce the contract or not, the Nigerian legislation by virtue of section 72(2) clearly states that the promoter is entitled to the “benefit thereof”. In effect the promoter continues to enjoy all the beneficial interests in the contract; he may even assign or sell the benefits to another company. The resultant effect is that it becomes a double edged sword, the third party cannot withdraw from the contract as well, and it is binding on them. In the words of Latham

L.J in Baymist Ltd v Wise Finance Co. Ltd (supra)

“I would accordingly hold that the solicitors are entitled to rely upon section 36c (now section 51) in order to enforce the contract in the present case. In my judgement, this produces a just result in that there is no good reason why the defendant should be entitled to resile from their obligations under the contract as a result of a pure technicality when in truth they wish to do so because it proved a bad bargain.”

CONCLUSION

The objective of section 72 is to protect third parties who contracted with the promoters in the belief that they were contracting with the company, by making the promoters personally liable for the contract unless there is express exclusion of liable. The common law position is now substantially modified and amended. The promoter will not only continue to be personally liable but he is also entitled to the benefit of the contract.

SUMMARY

A pre-incorporation contract has for long suffered under the old rule laid down in Kelner v Baxter. This type of contract, instead of being treated as sui generis was regarded as any other contact, so it was difficult to understand its peculiar nature. As the law stands today, the section 72 was introduced in Nigeria to modernize our law and the section has successfully changed the common law position and brought the Nigerian law on pre- incorporation contracts to the position now widely accepted all over the world.

TUTOR MARKED ASSIGNMENT

Examine critically the current position of the law on pre-incorporation contract.

REFERENCES/FURTHER READING

1. KunleAina, 2006, “The Statutory Status of Pre-incorporation contracts in Nigeria Resolved and Unresolved Issues, U.I. P. J. VOL. 5, p. 154.
2. Gross, 1971, ‘Pre-incorporation Contracts’ LQR 367
3. Green, 1984, ‘Security of Transaction after Phomogram MLR 671
4. Digman& Lowry, 2009, Company Law, Oxford University Press, 5^th