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Pre Incorporation Contract

Info: 2604 words (10 pages) Essay
Published: 22nd Sep 2021

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Jurisdiction / Tag(s): Australian Law

A pre-incorporation contract refers to a contract where one party of the contract is a company that is yet to be incorporated. The key issue in this case is whether either Lead Balloon or Jeremy will be bound by the pre-incorporation contract. To answer this several underlying legal issues must be looked at from two different angles, one being the general law and the other statutory laws.

The common law position of such contracts is that a person who acts on behalf of the company that is not incorporated cannot have any authority as an agent for the company as no legal authority exists. (Kelner v Baxter) [i] This implies that non-incorporated businesses have no legal capacity and powers of an individual stated in Section 124(1) of the Corporations Act 2001 (Cth). [ii] Kelner v Baxter [iii] case confirms that a corporation cannot ratify a contract that an agent purported to enter into on behalf of the corporation as the corporation did not exist at the time of the formation of a contract. However if there is a clear intended contract, only way in which there could be a valid contract was if the person who represented the company was the other contracting party. Hence person who entered contract was liable in the case. [iv] However further interpretations were made after Kelner’s case and that is promoter is only liable if it can be said that it was intended in the circumstances that the promoter be a party to the contract (Newborne v Sensolid). [v] In Black v Smallwood & Cooper it has been held that if a pre-incorporated contract objectively has an intention to bind the company only then the promoter does not necessarily takes the liability especially if the promoter had not known the fact that the company had not been incorporated. In this case it was held that the company did not exist hence it was a promise with a non-existent party and therefore no contract at all (Black v Smallwood & Cooper). [vi]

If the common law position was to be applied in the case, neither Jeremy nor Lead Balloon is bound by the lease. As shown in Kelner’s case a company cannot ratify the contract even after the incorporation as Lead Balloon did not exist at the time of the formation it is not possible to ratify. Similarly like Black’s case Jeremy had not known about non-incorporation which shows that he had no personal intention to be bound with that contract. He had asked the receipt under the name of Silver Bullet which also shows no intention of it.

Therefore taking the common law position both Jeremy and Lead Balloon are not liable from the lease agreement hence Olaf is better off finding an another tenant to minimize his loss.

As it can be seen from the general law an above decision creates unfairness between the parties and the statutory law addresses the problems.

Question (A)

From the perspective of the statutory law – is Lead Balloon or Jeremy liable by a pre-incorporation contract?

The statutory law has a different approach. Unlike the common law Section 131(1) states that the company becomes bound by the pre-registration contract if the company ratifies the contract within in the reasonable time after the incorporation. Also s 131(1) still applies to when the proposed company name is unavailable as long as the new company is reasonably identifiable with the proposed name. Ratification is done when a company confirms the pre-registration contract expressly or impliedly such as making a payment for the contracted amount. Also statutory assumptions in s 129 apply in this case as well.

In this case Jeremy paid the landlord the rent for the second month from Lead Balloon’s cheque book and gave him ratification by saying ‘the company will definitely honour the lease.’ Lead Balloon may argue that Jeremy had no such authority to make a contract. However s129(3) allows a third party to assume that a person held out as an agent has the usual power of that office. As Olaf had no idea that he had no such power hence limitation of s128(4) does not work on him as he has no actual knowledge or suspicion (Oris v Nab) [vii] . Even Jeremy is only director Olaf is entitled to assume that Jeremy has the power to bind the company when acting alone and can execute a contract on behalf of the company (Hely-Hutchinson v Brayhead). [viii] Therefore the ratification given by Jeremy is valid under the statutory law. Therefore Lead Balloon is bound by the lease contract unless Olaf gives a release under s132(1).

Conclusion: Whilst both Jeremy and Lead Balloon might be able to avoid liability under the common law, under statute Lead Balloon will likely to be bound by the lease agreement unless Olaf decides to release Lead Balloon from the lease agreement.

Question (B) – The sales contact

From the perspective of the common law – is Lead Balloon, Jeremy or Marika liable by the purchase contract?

To determine who has got the liability for the purchase, common law agency principles and the application of the indoor management rule should be analysed. For the purchase contract to be valid behalf of Lead Balloon agent, Marika, should have an actual authority either expressed or implied or an ostensible authority.

It is clear that Marika has no actual express authority of being the managing director and even if he was a managing director there is a constitution that requires a board approval for the payment over $10,000. As for an actual implied authority by virtue of his position of looking after the commercial and contractual arrangement, he may seem to have an implied authority however even if he did have a power no payment over $10,000 could be made. The most important authority in this case is ostensible authority. Rules of ostensible authority says that in order to have an ostensible authority there need to be a representation showing that a person is authorised to represent behalf of the company (Freeman + Lockyer v Buckhurst Park). [ix] This representation can be shown by words or conduct or made by a person with an actual authority such as other members of the board (Crabtree-Vickers v Australian Direct Mail). [x]

While assuming that there is not limitation on the amount for a purchase order, Jeremy, who is another director of the company, let Marika claim that she is a managing director. As decided in Freeman and Lockyer and Crabtree-Vickers case this can be seen as a representation shown by conduct as Jeremy remained silent and did not stop Marika. Hence it can be said that Apple Store could reasonably believe that Marika had an authority and not suspect anything. Therefore Lead Balloon is bound by the contract looking at the discussed facts only.

Does the indoor management rule apply? Was there ratification?

Lead Balloon may try to argue that even if Marika had an actual authority, the company’s constitution rule states that any payments over $10,000 require a board’s approval hence it can be claimed that the company is not bound.

However an indoor management rule set by the common law states that people who are dealing with companies are not affected by irregularities in internal management (Royal British Bank v Turquand) [xi] unless if the third party had actual notice or constructive notice of the irregularity (Northside Developments v Registrar-General) [xii] .

In this case there is nothing to indicate that the Apple Store had any knowledge of irregularity happening within Lead Balloon. Therefore indoor management rule applies in this case hence Apple Store is protected by Lead Balloon’s internal irregularities.

Furthermore if the company make ratification by an adoption of contract then the company is bound by the contract as an adoption of contract shows the company’s intention to be bound (Bolton Partners v Lambert) [xiii] like s131(1).

The case shows that the Lead Balloon had been using the equipment obtained from Apple Store for a month. Lead Balloon clearly obtained the benefits of the equipments and by using the products Lead Balloon adopted the contract showing its intention to be bound.

As the indoor management rule applies here and the ratification was done by Lead Balloon, the common law would likely to confirm that the Lead Balloon is liable to pay the full amount owing.

From the perspective of the statutory law – is Lead Balloon, Jeremy or Marika liable by the purchase contract?

The Corporations Act allows people to rely on the statutory assumptions in s129 when dealing with a company. The relevant assumption in s129 is s129(3). s129(3) allows a party to assume that a person held out as an officer has authority to exercise the powers and perform the duties customarily exercised. A party therefore is entitled to assume that the person has the usual powers of a managing director to bind the company when acting alone (Hely-Hutchinson v Brayhear). This assumption would be valid unless any subsections under s128 can be applied.

In this case Apple Store is not held back from the limitations of s128. Hence Apple Store was entitled to rely on the statutory assumptions and believe that Marika is properly appointed managing director of Lead Balloon. Therefore Lead Balloon’s is bound by the sales contract with Apple Store.

Conclusion: At common law Marika would have ostensible authority to purchase equipment from Apple Store on the behalf of Lead Balloon. The statutory law stands by it and Apple Store can rely on the statutory assumptions. Therefore Lead Balloon will be bound to pay the full amount owed to Apple Store.

Question (C) – A vicarious liability

When an employee in the course of their employment makes negligent mistakes a company is vicariously liable for the torts (Hollis v Vabu Pty). [xiv] This also applies to torts committed by its agents acting with an actual or apparent authority (Lloyd v Grace Smith & Co). [xv] To examine whether Lead Balloon is liable many underlying issues must be looked from the common law and the statutory law.

From the perspective of the common law, could there be an employer-employee relationship?

Unlike other cases the employment contract was signed between Faye and Silver Bullet and Alexander was acting like an agent for a non-existing company hence this makes it pre-incorporation contracts. Determining whether Faye has an employment contract with Lead Balloon is very important as if there was no such contract Lead Balloon is not liable for Faye’s tort at all.

At the common law, it has been said that there could not be an employment contract before the incorporation (Wickberg v Shatsky). [xvi] As stated in (a) the common law states that no ratification can be given by a corporation that did not exist at the time of forming a contract [xvii] and only a promoter may be liable if the clear intention exists from the promoter at the time of formation of the contract [xviii] .

Faye was hired by non-incorporated company hence according to Wickberg v Shatsky case there could not be an employment contract. It is clear that Alexander had no knowledge about not being incorporated and like Black v Smallwood&Cooper case it is not possible to conclude that Alexander personally had an intention to bind himself in that circumstance.

Therefore the common law is likely to say because there is no employment contract between Faye and Lead Balloon, Faye’s negligence is unfortunately not in the course of the employment therefore the company itself cannot be liable for Faye’s tort as Faye is not employed by Lead Balloon.

From the view of the statutory law, is Lead Balloon liable for the tort?

As explained in (b) if ratification is shown then a pre-incorporation contract is bound (s131(1)). s181(3) also states that company is still liable if an employee acts fraudulently. Applying all principles and authorities mentioned previously along with s181(3) the legal issue can be looked from the statutory law.

When another director, Marika, found out about the new employee, Faye, she called her to fire her. This action itself can be seen as ratification as it evidences the fact Faye was an employee of Lead Balloons. Therefore the statutory law may say that Faye and Lead Balloon had an employment contract. If this is the case it puts Lead Balloon into a position where it could be vicariously liable for Faye’s tort. Lead Balloon might argue that Faye had no such authority to bind the company. However there was an ostensible authority given by Alexander and Bright Spark can rely on assumptions in s129(3) that a person is properly appointed and has the power to do so. Faye’s negligence is also caused by Alexander and like Lloyd v Grace Smith [xix] case and s181(3) says that the company shall be liable for such cases. Therefore from the view of the statutory law Lead Balloon is liable for Faye’s tort.

Conclusion: Although the common law would say no employment relationship exist to have vicarious liability, the statutory law goes against that and will likely to conclude that Lead Balloon is liable for Faye’s tort.

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