Should You Risk Signing A Pre-incorporation Contract?

Commercial contract breaches can result in one party having to pay a vast sum of money to another, as compensation for the breach. The financial ramifications can affect not only the signatories, but other entities reliant upon them. As a result, there are many rules and regulations that govern the formation and enforceability of contracts. However, a pre-incorporation contract carries an additional layer of risk for the parties and should only be entered into following the receipt of experienced legal advice.

The law allows for individuals to limit their liability in commercial contracts by entering into the contracts on behalf of a company. However, there may be times when the founders / owners of a company need or desire to enter into a contract on behalf of that company, before it is even incorporated. This is known as a pre-incorporation contract.

The applicable legislation governing liability in a pre-incorporation contract is s.51 of the Companies Act 2006 (which replaced a corresponding provision, s.36C, in the Companies Act 1985).

It reads as follows:

(1) 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.

The case of Royal Mail Estates v Maples Teesdale [2015] EWHC 1890 (Ch)[1] highlights the risks involved in entering into such a transaction. The case demonstrates why it is vital for anyone signing or entering into an agreement on behalf of a company to be sure that the subject company is validly incorporated and that it remains so before the agreement is entered into.

To put in perspective how easy it is to be caught out in a pre-incorporation contract, it is worth noting that the defendants, in this case, were a firm of solicitors.

The case concerned the purchase of a commercial property by a company, before it had been incorporated. The contract was signed by a law firm on behalf of the company and featured a provision which stated that the “benefit of this contract is personal to the buyer.” The ‘buyer’ in the contract was the company.

At the time of the contract, the parties were unaware that the company had not been incorporated.

The Royal Mail Estates applied to enforce the contract, claiming that the defendants (the solicitors), who had purported to act as the company’s agents, were liable for performing the contract’s obligations.

The court had to rule on whether the wording, “benefit of this contract is personal to the buyer” was sufficient to be an “agreement to the contrary” under s. 51 of the Companies Act 2006.

There is a presumption in English law that agreements entered into by commercial parties are intended to be legally binding.

At the time of the contract, the Companies Act 1985 was the applicable legislation and was therefore relied upon by the High Court.

Judge Klein of the High Court took a restrictive approach to the interpretation of s. 36C. He stated that for an “agreement to the contrary” to apply, the parties to the agreement had to have s.36C in mind when drafting, deliberately constructing wording to exclude s.36(C)(1).

The fact that neither party was aware the company was not yet incorporated meant they could not have had s.36C in mind when drafting and agreeing to the contract. The actual intention of the wording in question was more likely to prevent or restrict a third party from becoming a third-party purchaser by way of assignment or sub-sale in circumstances where the original contracting party was the company.

Those entering into a pre-incorporation contract need to be aware that the threshold for being covered by the exclusion phrase “any agreement to the contrary,” under s.51 of the Companies Act 2006 (section 36(C)(1) of the 1985 Act), is high.

Without properly excluding s. 51, the agents / signatories who are acting on behalf of a company, can risk being personally liable for any obligations.

It is crucial to obtain legal advice, which should include the solicitor checking to see if the company purporting to enter the agreement has in fact been incorporated.

If you are planning to engage in a pre-incorporation contract, Royal Mail Estates v Maples Teesdale makes it clear that s.51 must be in the minds of the parties when drafting words to exclude liability. This needs to be made unambiguous in any agreement entered into.

Saracens Solicitors is a multi-service law firm based opposite Marble Arch on the North side of Hyde Park in London. We have years of experience advising on commercial and company law matters. For more information, please call our office on 020 3588 3500.

[1] http://freecases.eu/Doc/CourtAct/4713059