The company did not exist for legal purposes until incorporated
Therefore promoters could not be seen as the company's agent. Circumstances such as this are problematic and raise difficult questions as to the enforceability of the contract and the availability of damages for its breech. At common law, a company was also incapable of ratifying a pre-registration contract after it was registered. "This was because under the law of agency , ratification has a retrospective effect and the contract was regarded as being made at the time it was entered into by the agent when the company was not in existence" .A company could only be held liable for a pre-registration contract if it entered into a new contract with the same terms as the pre-registration contract after it was registered. This is called 'novation'. Seeing as though a company would not be held liable on a pre-registered contract, the courts recognised that innocent third parties could be prejudiced. Accordingly "the courts were prepared on occasions to infer an intension by the promoter to assume personal liability on the contract" An important case is Kelner v Baxter (1866) where the promoters who had signed the contract on behalf of an unformed company were held to be personally liable. In this particular case the promoters of an unformed company agreed to purchase stock and signed an agreement, which stated 'on behalf of the Gravesend Royal Hotel Alexandra Hotel Company Limited'.
A difficultly had arisen as since the company had not yet been formed the promoters who signed the agreement could not be seen as agents of the company. The court found the promoters to be personally liable. This case shows that a promoter who is aware when negotiating the contract that the company does not yet exists, faces a strong 'presumption' that the promoter intended to take personal liability, and will need to produce strong evidence to rebut this presumption. One of the leading cases on the common law position of pre-registration contracts is the decision of the High Court in Black v Smallwood. 'The High Court rejected the argument that kelner v Baxter created a rule of law that whenever a person contracted for an unformed company, they must be assumed to have attended personal liability' .
The outcome shows us that although promoters were sometimes held personally liable for pre-registered contracts (kelner presumption) that there are instances in which promoters were found not to have intended to undertake personal liability on a contract for an unregistered company. An example of this would be the promoter believing that he was acting for a company that was already registered. The common law view also created problems for promoters. If a promoter used his personal money or performed services on an unregistered company's behalf, the promoter can not require the company when it was later registered to reimburse the expenses. The directors could decide to reimburse the money if they chose to do so but the promoter had no common law remedy if they refused.
To overcome the difficulties with the common law position on pre-registration contracts and to introduce a greater fairness and certainty into this area ss131-133 of the Corporations Act 2001 deal with contracts made before a company is registered. A major impact of section 131 is that it "enables the outsider to enforce a pre-registration contract against the company if it ratifies the contract after it has been registered. However, if registration does not occur or the company does not ratify the pre-registration contract , the person who entered the contract on behalf of the company becomes personally liable to pay damages to the other party" . Section 131 is only for contracts which are made before a company is registered. It does not apply where a company was registered at the time of a contract and changed its name.
This is shown in case of Commonwealth Bank of Australia v Australian Solar Information Pty Ltd (1987) where it was made clear that a change of name is of no significance in determining the application of s81 to the material facts. Although this case was decided under the former s81, they would still seem to apply under s131. Another major impact of s131 is the changes to the common law rule that a company cannot ratify a pre-registration contract. This is a contrast to previous provisions as there is now no ratification procedures specified in s131 and therefore ratification can be made in any appropriate way. "Section 131(1) applies where a person enters into a contract 'on behalf of' a company before it is registered.
This covers situations where a person enters a contract as an agent or trustee of the company before it is registered. By using the expression 'for the benefit of' s131 also applies where a person enters a pre registration contract in the name of the company" . If, after ratifying a contract, the company fails to comply with its contractual obligations and the third party decides to sue for damages the court is able to order the promoter to pay any damages in which the ratifying company is ordered to pay. This can be seen in s131(4) which states: 'Where the company is registered and ratifies the pre-registration contract, but subsequently fails to perform all or part of its contractual obligations, the promoter may be held liable'. The court may take into account as to the extent to which the promoter controls the company when deciding whether to impose secondary liability on a promoter.
The outcome of Tracy v Mandalay shows us that the courts are more reluctant to impose secondary liability in the case of a 'passive' promoter who plays no active part in the formation or running of the company. Under the provisions of s131 the company is primarily liable once it ratifies the contract and the promoter retains a potential secondary liability. This is in order "to ensure that the other contracting party is not left without a remedy if the company fails to properly carry out the contract which it has ratified" Sections 131 and s132 have a major impact in respect to the rights and obligations of the promoters. The promoter has primary liability where the company is not registered within the stipulated time (time agreed upon by the parties) or when the company fails to ratify the contract within the stipulated time. Though section 132(1) says, the person who enters into a pre-registration contract will not bear a liability for damages if the other contracting party signs a release to that effect. The amount of damages the promoter may be liable under s131(2) is the amount that the company would have had been liable to pay if it had ratified the contract but did not perform all or part of the contractual obligations. This includes any wasted expenditure on reliance of the contract being performed aswell as any loss of profits the other party expected to make.
"Section 131(2) imposes a liability for damages only on the person who enters into the pre-registration contract on behalf of a company even though that person may have acted on behalf of others" An example of this is seen in Bay v Illawarra Stationary Supplies Ltd. In this case an accountant who was one of the companies four promoters entered into a contract on behalf of a unformed company. The company failed to ratify the contract and the supplier attempted to sue all four promoters. The Supreme Court of New South Wales found that only the account was liable since he was the only person who had signed the contract. The court also made it aware that the accountant has a separate right to claim against the other promoters if he acted as their agent in regards to the contract.
"While the promoter is primarily liable in these circumstances, the company does have a potential secondary liability. Hence "where the company is registered but does not ratify the pre-registration contract within the prescribed time, the court may 'do anything it considers appropriate in the circumstances'. The courts powers include the option of ordering the company to rectify the unfairness" . The courts are able to this by ordering the company to pay for part or all of the damages for which the promoter is liable, transferring property received under the contract to a party to the contract or paying an amount to a party to the contract.