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JOHAN ROODT
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JOHN COHEN
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The new Companies Act of 2008 Pre-incorporation contracts

It frequently happens that an individual is presented with a business opportunity - such as the opportunity to purchase property on a going-concern business - which he or she would like to take up in the name of a company, but they do not have a company available to sign the agreement.

One way of overcoming the problem is to immediately purchase a "shelf company", that is to say, an existing but thus far dormant company that an accountant or attorney has formed, and which is immediately available to enter into the transaction.

The common law rule regarding acting as an agent for a non-existent principal

Why can't you simply enter into the desired contract acting as agent for a company that you intend to form?

The reason is that our common law has a clear and inflexible rule that it is impossible to enter into a contract as an agent where the principal (in this case the company) does not yet exist. Such a contract would be a nullity from the outset, and the company (when it is formed) could not validly ratify (approve and take over) the contract.

To overcome the difficulty presented by this common law rule, both the "old" Companies Act of 1973 and the new Companies Act of 2008 have specific provisions in regard to the way in which a valid pre-incorporation contract can be entered into, that is to say, a contract entered into in the name of the company at a time when the company has not yet come into existence.

Pre-incorporation contracts under the old Companies Act of 1973

The Companies Act of 1973 states that that a pre-incorporation contract will be valid provided that -

  • the contract was in writing;
  • when the company was registered at the Companies Registration Office, the company's memorandum of association stated that one of the objects of the company was to ratify the contract;
  • the pre-incorporation contract was lodged with the Registrar of Companies at the same time as the company's memorandum of association and articles of association were lodged.

If these statutory requirements are met, the company can, after it is registered, ratify (retrospectively approve) and take over the pre-incorporation contract, with all its rights and obligations.

This provision of the old Companies Act was serviceable, but the second and third bulleted requirements, above, were pointless bureaucracy, and did no more than create pitfalls for those not familiar with company law.

Pre-incorporation contracts under the new Companies Act of 2008

The new Companies Act of 2008 states simply and briefly in section 21(1) that-.

A person may enter into a written agreement in the name of ... or on behalf of an entity that is contemplated to be incorporated in terms of this Act, but does not yet exist at the time.

The only legal formalities for a valid pre-incorporation contract under the new Companies Act are thus that the contract must be in writing and must be entered into in the name of or on behalf of the company still to be formed.

The new Act has thus dropped the pointless bureaucratic requirement of the old Act that the memorandum of the company, when it is formed, must state that one of the company's objects is to ratify the contract, and has also dropped the requirement that the pre-incorporation contract must be lodged at the office of the Registrar of Companies together with the company's memorandum and articles.

Section 21(4) and (5) of the new Companies Act make crystal clear how much time the law allows for the envisaged company to ratify the pre-incorporation contract made on its behalf, and lays down a default rule to cover the eventuality that the company neither ratifies nor rejects the contract -

  1. Within three months after the date on which a company was incorporated the board of that company may completely, partially or conditionally ratify or reject any pre-incorporation contract or other action purported to have been made or done in its name or on its behalf
  2. If, within three months after the date on which a company was incorporated, the board has neither ratified nor rejected a particular pre-incorporation contract, or other action purported to have been made or done in the name of the company, or on its behalf the company will be regarded to have ratified that agreement or action.

The new Companies Act goes on to state in section 21(3) and section 21(6)(b) that if the company, after it comes into existence, ratifies the pre-incorporation contract made on its behalf (or if the company enters into another agreement either on the same terms or in substitution for the pre-incorporation agreement) then the individual who represented the company is thereby released from all legal liability, even if the company thereafter is unable or unwilling to carry out its obligations under the contract.

However, as can be imagined, the other party to the pre-incorporation contract may feel justifiably aggrieved at being led down the garden path, if he or she finds that the company, when it comes into existence rejects the pre-incorporation contract or part of the contract.

The new Companies Act deals with this situation explicitly, by providing in section 21(2) that anyone who enters into a contract on behalf of a company not yet formed-

is jointly and severally liable with any other such person for liabilities created as provided for in the pre-incorporation contract while so acting, if-

  1. the contemplated entity is not subsequently incorporated; or
  2. after being incorporated, the company rejects any part of such an agreement or action.

The new Companies Act thus unambiguously imposes personal liability on the individuals who entered into the pre-incorporation contract on the company's behalf if the company thereafter rejects the contract in whole or in part.

Contracting out of liability in the eventuality that the company does not ratify the pre-incorporation contract

Entering into a pre-incorporation contract on behalf of a company as yet unformed is not a step to be taken lightly because of the personal liability that will be incurred by those who professed to act on behalf of the company if the company rejects the contract.

Anyone proposing to enter into a pre-incorporation contract would therefore be well advised to consult a corporate lawyer for advice on how to secure protection against such potential liability.

In this regard, it is not possible for the pre-incorporation contract to state that the personal liability provisions in section 21(2) of the Companies Act of 2008 in regard to pre-incorporation contracts will not apply. This is because these provisions of the Act are not expressed as being "alterable provisions", that is to say, they are not provisions that the Act allows the parties to alter by mutual agreement.

However, the language of section 21(2) (in particular the words "as provided for in the pre-incorporation contract") is such as to allow the pre-incorporation contract itself to be expressed in such a way as to make clear that no personal legal liability will attach to the company's representative in the eventuality that the company is not formed, or is formed and then rejects the contract.

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