Pre Incorporation Contracts and Liability

The question relates to pre-incorporation contracts and whether Ben or Cape Bicycles ltd would be bound or liable in terms of the contract entered into before the company’s incorporation.

A company which must still be incorporated, does not have the necessary capacity to enter into contracts until it has been incorporated and in the case of a company with a share capital, had been issued with a certificate to commence business.

Under the common law it is impossible to enter into a contract as an agent where the principal, the company, does not yet exist. Such a contract would be a void ab initio from the date of the conclusion of the contract, and the company could not validly ratify the contract upon its incorporation. Under the common law the agent would be personally liable for any debt incurred under such a contract. The lease signed on 02 May 2011 with Merlin Ltd is void ab initio because the company did not exist because the company was only incorporated and came into existence on 15 July 2011. It is impossible to ratify the contract after incorporation by the company and Ben would be personally liable for any debts.

The common law provision of the law of agency could be bypassed by way of the Stipulatio alteri. The Stipulation Alteri allows a person to enter into a contract as a principal, on behalf of a company that does not exist (Cape Bicycles Ltd), with a second party (Merlin Ltd). When the company is incorporated, it can decide to take over the contract and the rights and duties in terms of the contract would exist between the company and Merlin Ltd. It is argued that the contract that is accepted by the company in terms of the Stipulatio alteri, is not the same contract entered into between the trustee and the third party, but that the stipulatio alteri enables a process to conclude a new contract that will be formed between the company and the third party. Under the law of contract the duties and liabilities in terms of a contract does not automatically transfer to another party, who is not an original party to a contract, unless session takes place or a new contract has been entered into.

The stipulation alteri does not find application as Ben signed as Chairperson of Cape Bicycles Ltd, indicating that he acted as an agent and not as principal. He was therefore acting as an agent for a non-existing principal and would be personally liable in terms of the common law.

Ben will have to look at legislation to protect him from personal liability.

The companies act 71 of 2008, as amended, section 21 makes provision 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 the act, but does not yet exist at the time.

Under the new companies act the only formal requirement for a Preincorporation contract is that it must be concluded in writing and that the person promoting the company must act ‘in the name of’ or ‘on behalf of’ the company yet to be incorporated. This requirement has been met as Ben signed the lease on behalf of the company as Chairman of Cape Bicycles ltd on 02 May 2011.

Section 21 (b) indicates that any person who enters into a preincorporation contract will be jointly and severally liable with any other persons as provided in the preincorporation contract if the company is not duly incorporated or where the company decide not to ratify the contract or decides to reject any part of the contract.

Ben informed Merlin limited of the decision not to proceed with the lease agreement on 20 July 2011; 5 days after the company had been incorporated. Under section 21(b) he would be liable as the promoter for the debts in terms of the lease, because the company rejected the lease and failed to ratify the Preincorporation contract after its incorporation.

Section 21(3) however provides that where the company after its incorporation enters into an agreement on the same terms as the preincorporation contract, the promoter is relieved of his liabilities as the new contract would replace the preincorporation contract and the conditions would be fulfilled in terms of the original agreement.

The company decided to adopt the lease agreement with Merlin Ltd on 25 July 2011 after it decided to reject the preincorporation and section 20(3) comes into operation where the new contract replaces the preincorporation contract and the promoter is absolved of his liability.

Section 21(6) (b) of the act does not find application as there was no valid ratification of the preincorporation contract but section 21(3) does find application. When the new contract replaces the preincorporation contract, then the promoter’s liability in respect of the preincorporation contract is discharged.

It can also be argued that even if Cape Bicylces Ltd did not ratify the contract, Ben would not be liable in terms of the lease agreement, because there was compliance with the formal requirements of section 21 and would not be liable for the lease amount of R 6000.

If the contract was not ratified Merlin Ltd would have been entitled to claim the cost of renovations in a personal action against Ben for R 17 000.

The contract had been adopted on 25 July 2011 and Cape Bicycles Ltd is liable for the cost of the renovations valued at R 17 000 and the lost rent for three months valued at R 6000. Merlin Ltd can claim the amount from Cape Bicycles ltd.

Question 2

Upon the incorporation a company gains a separate legal personality from its members and becomes a juristic person [1] . It has all the rights and all the rights and duties of a natural person [2] , unless a juristic person is incapable of exercising such powers [3] e.g. to marry or where the memorandum of incorporation does not make provision or limits such capacity. The company has the right to sue or be sued in its own name. [4] The company is able to acquire its own assets and enter into contracts via its agents. The assets that the company possess are its own and not that of the shareholders, and the shareholders have no claim to ownership on the assets. The shareholders also have no right to the profits of the company unless a dividend had been declared for a particular year.

The benefits of incorporation include the perpetual existence of the company as it continues to exist until it is deregistered. The company does not seize to exist when shareholders die or sell their shares. [5] 

The separate existence also creates limited liability of the shareholders. Any debts and liabilities that the company incur during its business becomes its own. Shareholders are only liable for the investments they have made towards the company as far as their investments and not in their personal capacity. Their personal assets are not at risk in the event that the company is unable to pay its debts. If the company is unable to pay its own debt the creditors of the company cannot claim the unpaid debts from the shareholders.

This limited liability is one of the main reasons why a company is incorporated as the limited liability affords a measure of protection to its directors and shareholders.

In the case of Salomon v Salomon [6] the court found that a company upon incorporation gains a separate legal personality that exists separate from its members. The company can therefore sue and be sued in its own name. This was confirmed in the case of Dadoo Ltd v Krugersdorp Municipal Council [7] where Innes CJ confirmed that a registered company exists separate from its members. The separate existence does not depend on the number of shareholders or whether the controlling interest is held by a single member. It was also indicated that the company exist separate from its shareholders and that property vested in the company belongs to the company and not in its shareholders.

The separate existence of the company from its members is known as the corporate veil. Under certain circumstances the separate existence of the company from its members may be discarded. In the matter of Lategan v Boyes [8] , the view was expressed that South African courts will not be prepared to disregard the corporate veil except upon proof of fraud.

In the case of Botha v Van Niekerk en 'n Ander [9] the court indicated that the corporate veil would be lifted where there was improper conduct that lead to unconscionable injustice. In the matter of Cape Pacific Ltd v Lubner Controlling Investments (Pty ) Ltd and Others [10] the court concluded although the transfer of shares from LCI to GLI could be described as ‘clearly improper’, it was not appropriate or permissible to disregard the separate corporate personalities of LCI and GLI as their transfer did not amount to an 'unconscionable injustice'.

On appeal the court in [zRPz] Cape Pacific Ltd v Lubner Controlling Investments (Pty ) Ltd And Others [11] considered the unconscionable injustice test to be too rigid and the court found that the facts of each case should determine whether the corporate veil should be discarded. Smallberger JA in the majority judgment indicated that there was no rule that the corporate veil should only be pierced where no other remedies are available to the plaintiff. The court indicated that where another remedy exists it may be a relevant consideration on whether to pierce the corporate veil, but that it cannot be considered a complete prohibition to remove the veil.

Van Den Heever JA concurred with the factual findings in the Majority judgement but in a minority judgment he indicated that where an alternative remedy exists, the separate legal existence is sacrosanct and should be upheld, rather than allow the piercing of the corporate veil. [12] He agrees that the transaction in question can regarded as a sham but argues that “just as the Court should not permit its process to be abused it should not permit the notion of legal entity to be used to 'justify wrong, protect D fraud or defend crime' . [13] 

In order for the corporate veil to be lifted it was not requirement that a company should have been incorporated and created based deceit, however what is important is that at the time of the relevant transaction the company was used as a ‘façade’..

Under section 20(9) of the companies act the court may pierce the corporate veil where an transaction is deemed to be an unconscionable abuse of the juristic personality [14] .

The biggest problem with the piercing of the corporate veil is that no clear guidance is given by the courts under what circumstances the separate existence of the company may be lifted. By indicating that fraudulent activity may be sufficient to consider the lifting of the corporate veil is a point in the right direction, however clearer guidance should be given of the policy considerations that should be weighed against the lifting of the veil of separation. To imply that the facts of each case need to be considered may lead in one matter where alternative remedies is available that the veil may be lifted while in another matter it may lead to the veil remaining intact. The separate existence of the company from its members is a major consideration for incorporation and it is my view that it should not be discarded where alternative remedies exist. By indicating that cases where alternative remedies are available, the alternative remedies should merely be taken as a consideration undermines the importance of separate legal personality of a company. It is my view that where alternative remedies are available, the alternative remedies should be considered a bar to the piercing of the corporate veil. Until courts or legislation gives clear guidance on what policy considerations should be taken into consideration when deciding to lift the veil, the outcomes of cases may lead to inequitable conclusions whether the actions was fraudulent or not.


Benade et al, Entrepreneurial law

The new companies act and amendment Bill: Comparative consolidation, 2010