Liability of Promoters under Pre-incorporation Contracts

The key issue, in this case, is whether Steve can be held personally liable for the contract formed by him on behalf of the company?

While managing their operations in Australia, companies are subject to a wide range of legal regulations which they have to comply with in order to avoid penalties. The Corporations Act 2001 (Cth) applies throughout Australia, and it provides provisions which organisations have to comply with while operating in Australia. Moreover, provisions are given under the common law which also applies to corporations operating in Australia and the company can be held liable for breaching the provisions given under the common law. Salomon v Salomon & Co Ltd (1897) AC 22 is a significant case in which the key characteristics of a company were established by the court (CSU LAW504 Modules, 2018, Topic 14). The court provided in this case that a corporation has a separate legal entity which differentiates it from its members or shareholders. Due to this separate entity, the liabilities of a company are its own, and its shareholders cannot be held personally liable by the court to pay back the debts of the company in case it becomes insolvent. The corporation has the right to enter into a legal contract with third parties such as customers, suppliers, creditors, investors or others under its own name.

It means that the liability raised under these contracts is limited to the company and its shareholders can only be held liable up to the amount they invested in the enterprise. Since a company is an artificial persona, it operations are managed by directors who are responsible for entering the company into a legal relationship. However, before the incorporation of the company, its promoters have the right to sign contracts under the name of the company to create contractual relationships. Section 119 provides that a company get its separate legal entity when it is registered, thus, the contracts formed on behalf of the enterprise before its registration are called pre-incorporation contracts. The provisions regarding pre-incorporation contracts are included in both common law and the Corporations Act. The guidelines regarding liability raise under a pre-incorporation contract are given under section 131 (CSU LAW504 Modules, 2018, Topic 14). The law provides that the contract which is formed before the incorporation of a company can bind the corporation under its terms after its incorporation. Furthermore, the company also has the right to rectify the contract within appropriate time as given under the terms of the contract.

Liability of Partners in Contractual Relationship

The corporation has the right to enjoy the benefit raised from the contract which is formed on its behalf before its incorporation. However, the person forming the contract can be held personally liable in case the corporation failed to comply with the contract or its terms. Section 131 (2) provides that the person who entered into a contract on behalf of an enterprise which is not yet registered can be held personally liable by the third party in case the company failed to register. Furthermore, if the company failed to rectify the terms of the contract within an appropriate time, then the person who initiated the contractual relationship can be bound by the third party. Section 131 (3) provides that in case a proceeding is brought before the court for recovery of the damages under subsection 2, then the court can evaluate the circumstances of the case to (a) ordered the company to partly or fully pay the damages to the person who was held personally liable (b) transfer the property which the enterprise received due to the contract (c) pay the amount to the party with whom the contract is formed (CSU LAW504 Modules, 2018, Topic 14).

A pre-incorporation contract is formed by Steve on behalf of WA Gold Exploration Company regarding the purchase of a drill for business purposes. The contract is formed with Thor Mining Machinery Ltd while Steve was acting as the promoter of the enterprise. This contract comes under the regulations given under section 131. The board of WA Gold Exploration Company failed to rectify the contractual terms which are formed between the company and Thor Mining Machinery Ltd. The benefit which is raised under the contract is rejected by WA Gold Exploration Company since it rejected the delivery of the drill. As per the provisions of section 131 (2), Steve signed the contract on behalf of WA Gold Exploration Company, thus, Thor Mining Machinery Ltd has the right to hold him personally liable under the terms of the contract since the contractual obligations are not discharged by WA Gold Exploration Company. The contract formed with Volvo Trucks (Australia) Ltd was formed after the registration of WA Gold Exploration Company was completed. The enterprise has gained it separate legal entity based on which its shareholders cannot be held personally liable to comply with the contractual terms as discussed in the case of Salomon v Salomon & Co Ltd. Thus, Steve can be held personally liable by Volvo Trucks (Australia) Ltd because the company has failed to comply with its contractual obligations.

Remedies against Breach of Internal Agreements

Conclusion

Based on the above analysis, Steve can be held personally liable under Thor Mining Machinery Ltd as per the provisions to section 131 (2), however, Volvo Trucks (Australia) Ltd cannot hold Steve liable, and in this contract, the liability is limited to the enterprise.

The key issue, in this case, is whether other partners can be held liable under the contract which is formed by George while breaching the internal agreement between the partners? What remedies did other partners have against George?

Partnership Act 1892 (NSW) provides the key regulations which apply over partnerships and regulate the relationship between partners. The partnership is referred to the relationship which is formed between two or more individuals regarding management of a business in common, and the objective of such business is to generate profits for its members as given under section 1 (1). Unlike a company, the partnership business structure did not have a separate legal entity which differentiates it from its members. All the partners in the business are jointly or severally liable towards the debts of the partnership. While acting in the ordinary course of business, the partners can hold each other liable under the contractual relationship. All the partners have a fiduciary duty towards other partners based on which they can hold each other liable under the contract formed while acting in business as usual (CSU LAW504 Modules, 2018, Topic 13). All partners act as the agent for other partners as given under section 5 (1) based on which they have a fiduciary duty towards each other. The contract which is formed by a partner with a third party regarding the business of the partnership can bind other partners liable as well.

However, actions which are outside the scope or ordinary course of business of the partnership are not covered under section 5 (1) based on which the actions of a single partner cannot bind other partners liable. The actions must come under the definition of business operating in “usual way” as given under section 5 (2) of the action based on which other partners cannot be held liable by the actions of a single partner. However, the provisions given under section 7 contradicts the policies of section 5 (2) because it provides that actions which are outside the scope of the business will still bind the other partners liable to a third party based on which actions of a single partner which an expressed authority is given to such partner to operate outside the authority (CSU LAW504 Modules, 2018, Topic 13). However, the contract which is formed by the partner for personal liability did not have the authority to bind other partners liable under its terms. Section 8 provides a key regulation regarding the relationship between the partners. It provides that in case an internal agreement is formed between partners in order to restrict the liability of partners to form contractual relationships on behalf of the business, then the contract formed with third parties will not bind other partners if such party knew about the internal contract formed between the partners.

However, if the third party is not aware regarding the internal contract which is formed between the partners, then such party can hold all partners liable under the contractual agreement. In case a partner breached the contractual terms of an internal contract, then the other partners can take legal actions against such partner for breaching such contract and held the partner liable for breaching the contract. In Mercantile Credit Ltd v Garrod (1962) 3 All ER 1103 case, an internal contract restricted the authority of partners to buy or sell cars in the business (CSU LAW504 Modules, 2018, Topic 13). However, a partner sold a car on behalf of the business to a third party who was not aware of the internal contract, thus, the contract binds all partners of the partnership, and they were held liable towards the third party. The partners are also liable for the tortious actions of a single partner which are taken by him during the ordinary course of business as given under section 10 of the act. Polkinghorne v Holland & Whitington (1934) 51 CLR 143 case is a good example in which the fraud conducted by a single partner by investing the money to the client to form a sham company hold other partners liable as well since it was taken during the ordinary course of business.

Based on an internal contract formed between the partners, they are not authorised to form a contractual relationship with third parties in which the amount of investment in more than $10,000. The prior approval of other partners is mandatory before making an investment of above $10,000. Simon purchased a 50TB hard drive for the company from Sunstar Computer Hardware while he was acting within the ordinary course of business. However, the company was not aware of the internal agreement of the partners; thus, it can hold all the partners liable for the contractual liabilities. On the other hand, the decision taken by Simon to purchase a second hand Ute from You Beaut Ute Ltd was outside the scope of the business. Other partners did not give any expressed authority to Simon to purchase the Ute for the business. Thus, the action of Simon was outside the definition of business as usual based on which other partners will not be held liable by You Beaut Ute Ltd. Other partners can demand compensation from Simon since he acted while breaching the internal agreement formed between the partners.

Conclusion

Based on the above analysis, Simon acted inside the scope of the business while entering into a contract with Sunstar Computer Hardware and the company was not aware of the internal agreement, thus, all partners are liable. However, Simon acted outside the scope while purchasing a Ute for the business; thus, You Beaut Ute Ltd can only held Simon liable for his actions. Other partners can hold Simon liable for breaching the internal agreement and demand compensation.

References

Corporations Act 2001 (Cth)

CSU LAW504 Modules, 2018

Mercantile Credit Ltd v Garrod (1962) 3 All ER 1103

Partnership Act 1892 NSW

Polkinghorne v Holland & Whitington (1934) 51 CLR 143

Salomon v Salomon & Co Ltd (1897) AC 22