"If a man signs a contract for and on behalf 'of his horses', he is personally liable."
– Lord Denning
Too Clever by Half
Not so long ago I received a draft agreement of purchase and sale from a practitioner in which he named his purchaser client as "John Doe, in trust, and without personal liability, for a corporation to be formed".
The draft agreement was prepared in furtherance of an earlier letter of intent that specified that the definitive purchase agreement would not be assignable by the purchaser.
And as I read the draft agreement, trying to reconcile these two concepts, it occurred to me that purchaser's counsel had been too clever by half, for inasmuch as he had tried to skirt the restriction on assignment clause, his proposed language may have inadvertently made the contract not a contract.
Corporate Statutes in Ontario
The seminal case law on point was, at one time, Kelner v. Baxter ((1886), L.R. 2 C.P. 174 at 183), where the Court stated that "... where a contract is signed by one who professes to be signing as 'an agent', but who has no principal existing at the time, and the contract would be otherwise inoperative on the person who signed it, he (the agent) is bound thereby".
This principle makes intuitive sense.
Both Section 21 of the Business Corporations Act (Ontario) and Section 14 of the Business Corporations Act (Canada) recognize the notion of a pre-incorporation contract. In particular, these provisions recognize that where a contract is entered into by an individual for a corporation to be formed, and when that corporation is subsequently formed and adopts such contract, then upon such adoption, the individual is released from liabilities thereunder and the corporation is bound. The provisions under each of the statutes have the same effect, although curiously the Ontario statute specifically includes both written and oral contracts. And for good measure, note that some other similar provincial statutes specifically include language that such adoption can be by "action or conduct", suggesting that formal written adoption is unnecessary (which is, at common law, the Ontario position as well – See Design Home Associates v. Raviv, 2004 CanLII 46690 (ON SC)).
In Pino Tutino Holdings Inc. v. 872935 Ontario Ltd., (1998) CanLII 3116 (ON CA) the Ontario Court of Appeal said exactly what you would hope they would say about the purpose of these provisions:
"The corporate vehicle to replace the parties may not be immediately available, but it is agreed that once it is in place and indicates an intention to adopt the agreement, the individuals on that side of the agreement will have no remaining liability. There is, in those circumstances, no reliance on the individual's covenant, except in the interim. It is not a case of assignment or replacement of a covenant by that of a fresh entity requiring scrutiny. That is why a simple notification of intention is all that is required." {at p 14}
So with this in mind, what purchaser's counsel did was, at least in part, not entirely offensive on its face, and was conceptually possible at law.
But is there a Contract?
Or was it?
The problem arises not with the notion that an individual can create a binding contract for a corporation to be formed later, but rather that such individual can do so "without personal liability" in the interim period.
Had the case law ended with the general principal set out in Kelner above, I would have been generally pleased with the state of the common law on the point. But things went sideways when an Australian court in Black Smallwood ((1965-66), 117 C.L.R. 52) distinguished Kelner and stated that the general principal set out therein is subject to the "fundamental question" of what the parties intended. This put the state of pre-incorporation contracts into dangerous territory, because the liability of the individual contracting party (the so-called "agent") could now be in doubt depending on whether the parties intended him or her to be liable. To put it in the vernacular, if the individual ain't liable and the company ain't liable, then who is liable?
This was the question put before the Ontario Divisional Court in Westcom Radio Group Ltd. v. MacIsaac ((1989) 70 OR (2d) 591 (Div Ct)), and, quite rightly, the Court found that where the contract evidences an intention that the individual was never to be bound, then there never was a contract.
That said, the reasons given by the Court in Westcom Radio for why there is no contract give me academic heartburn. Their train of thought went something like this: (a) Section 21(1) of the OBCA would ordinarily impose liability on the individual for the contract pending the corporation being formed; but (b) because the corporation was never formed by the individual, and because the intention of the parties was that it was to be the corporation that would be liable, there was no "contract", it being void from the beginning.
Put another way, the Court left room for the idea that an individual could void the contract (presumably ab initio) by not forming the corporation, so long as he or she could show that the real intention of the parties was that the corporation, and not the individual, was only ever to be liable thereunder.
So in my case, even if purchaser's counsel had not included the words "without personal liability" there may still have been room for that purchaser to subsequently argue that the parties never intended for the individual to be personally liable on the contract. Following Westcom Radio, the notion is that the pre-incorporation provisions of the OBCA and CBCA do not impose liability on the individual where the evidenced intention that he or she was not to be liable because, there never was a "contract" created for these statutes to apply to.
This was the position I took back to purchaser's counsel, and in fact I took it one step further, as in my view, if the individual purchaser was (as set out in his draft document) to have no liability but still to be able to compel the acquisition of the property to close, then he had perhaps presented me with an "option to buy" in favour of his client.
The Ontario Court of Appeal (1394918 Ontario Ltd. v. 1310210 Ontario Inc., 2002 CanLii 1996) has suggested that it was something as ethereal as a "nascent contract". And if your guttural reaction to that moniker is "a what?", then you and I share an opinion. The Court provided the following comforting characterization of what the parties create in these circumstances:
"Prior to incorporation and adoption, the promoter is not personally bound or entitled to benefits of the contract. He might be described as a functionary, performing such duties as assuring that any necessary inspections of property or title are pursued, that deadlines are met, and defaults avoided which might excuse the third party from the obligations. At the same time, the corporation does not exist or has not adopted the contract and thus is not bound by it or entitled to its benefits. There is an entity called a "contract" under the statute, but no one is entitled to sue for its breach. That is not to say that ongoing obligations can be ignored. I would term this a nascent contract, its enforceability being suspended."
The Court in 1394918 brought an entirely new interpretation to the table. Instead of taking the position that a contract without two liable parties is not a contract as is void from the outset, as suggested by Westcom Radio, the Court in 1394918 took the position that there is somehow a contract of statutory creation. With deference, "hogwash". I would rather swallow the notion that two contracting parties have failed to create a contract by holding no party liable for one set of liabilities, than digest the notion of a suspended, nascent contract.
I don't believe in ghosts.
Assignment of a Purchase Agreement
Stepping back for a moment from the liability issue, let's recall the original conflict that I described, between the pre-incorporation language and the assignment provision. If not restricted, an individual contracting in trust for a corporation to be formed, can use that mechanism as a vehicle for freely transferring the benefit of the purchase agreement. There is nothing in the corporate statutes that require the individual to be the shareholder of the corporation, or to have any relationship to the corporation for that matter. And so where the "business deal" is that the vendor requires control over who the purchaser is at closing, it will need to restrict the ownership and control of the corporation in the same fashion as it would have restricted contractual assignment of the purchase agreement by the purchaser. Another reason to not favour these pre-incorporation provisions.
What to Do?
It's not lost on me that a good many solicitors, especially in real estate transactions, counsel their individual clients to sign offers and purchase agreements in trust for corporate entities to be formed at a later date. The notion is that they want to ensure that their purchaser client has the ability to take advantage of a corporate ownership structure should the transaction proceed.
The corporate statutes are clear that pre-incorporation contracts are, in the ordinary course, valid contracts that become binding upon the corporation once it is formed and adopts the contract. And the common law is clear that such adoption need not be formal, and is (mostly) clear that until such adoption, the individual is to be bound personally.
But there persists the shadowy notion that the parties may, through words or conduct, evidence the intention that the individual was not ever to be personally liable in the pre-incorporation period, and that is not a risk I am comfortable with. Which takes us back to the beginning. The notion of an individual signing an offer or an agreement "without personal liability" in trust for a corporation to be formed, is offensive to a vendor. And more generally, with or without the words "without personal liability", I would, as vendor's counsel, generally avoid accepting this construct. The case law, even in the face of statutory provisions, opens the door not only for an argument that the individual is not liable in the pre-incorporation period but (equally offensively) that there is no contract.
All of the purchaser's needs in this regard can be accomplished by a properly drafted assignment clause wherein the purchaser is stated to be liable and will be released, but for defaults, upon assumption of the contract by a corporation owed by it.
At the risk of repeating the obvious, where the contract expressly provides that the individual is not liable in the meantime, there is no contract.
The consequences of pre-incorporation breaches of confidentiality, misrepresentation or other malfeasance under a "nascent contract" (if such a creature exists) by an individual are uncertain. Uncertain enough, I would venture, to avoid the practice altogether.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
