Businesses are often negotiated before the company that will run them exists. Division 2 of Part X of the Companies Act 1997 deals with the consequences.
Section 157(1) — what counts
(a) a contract purporting to be made by a company before its incorporation; or
(b) a contract made by a person on behalf of a company before and in contemplation of its incorporation.
Paragraph (a) covers the case where the contract is signed in the company’s name as though it already existed. Paragraph (b) covers the promoter who signs openly on behalf of a company to be formed. Both are within the Division.
At common law a company could not ratify a contract made before it existed — there was no principal at the time of the act. The contract bound the promoter personally, or nobody. Sections 157 to 160 replace that with a statutory scheme in which the contract can be brought to life, and in which the promoter carries defined warranties in the meantime.
Sections 157(2) to (4) — ratification
Notwithstanding any law, a pre-incorporation contract may be ratified within such period as may be specified in the contract, or where no period is specified, within one month after the incorporation of the company in the name of which, or on behalf of which, it was made.
A contract that is ratified is as valid and enforceable as if the company had been a party to the contract when it was made.
Ratification is effected in the same manner as a contract may be entered into on behalf of a company under section 155.
The default is one month after incorporation. That is easily missed while a new company is opening bank accounts and appointing officers. The fix is simple: state the ratification period in the contract itself, since section 157(2) gives the contractual period priority.
Ratification should be a formal act — a board resolution recorded in the minutes, and where the contract had to be by deed, executed under seal in accordance with section 155(1)(a). Do not rely on conduct.
Notwithstanding any law, where a pre-incorporation contract has not been ratified by the company, or validated by the Court under section 159, the company may not enforce it or take the benefit of it.
So an unratified contract is a one-way street against the company: it cannot sue on it, and it cannot claim the benefit of it. The other party’s position is dealt with by the warranties in section 158 and by the Court’s powers in section 159.
Section 158 — what the promoter warrants
(a) that the company will be incorporated within the period specified in the contract, or where none is specified, within a reasonable time after the making of the contract; and
(b) that the company will ratify the contract within the period specified, or where none is specified, within a reasonable time after incorporation.
The amount recoverable for breach of an implied warranty is the same as the damages that would be recoverable in an action against the company for breach by the company of the unperformed obligations under the contract, if the contract had been ratified and cancelled.
This is the sharp edge of the Division. The promoter does not merely lose a deposit; they are exposed to the full loss the other party would have recovered from the company. A promoter who signs for a company that is never formed, or that never ratifies, personally answers for the whole bargain.
The warranties can be excluded — but only by express words in the contract. A promoter who wants to avoid personal exposure must negotiate that exclusion up front, and a counterparty who agrees to it must understand that it is left with no one to sue if the company never comes into existence.
Section 158(3) — the discharge
Where, after its incorporation, a company enters into a contract in the same terms as, or in substitution for, a pre-incorporation contract (not being a contract ratified under section 157), the liability of the promoter under subsection (1) — including any liability under a Court order for damages — is discharged.
This is the practical escape route where the ratification window has closed. If the company, once formed, simply enters into a fresh contract on the same terms, the promoter’s warranty liability falls away — and it does so even if damages have already been ordered. The new contract must be a real one, entered into by the company after incorporation in accordance with section 155.
Practical steps
| If you are the promoter | If you are the other party |
|---|---|
| Specify the incorporation and ratification periods in the contract | Insist on short, certain periods so you know where you stand |
| Consider expressly excluding the section 158(1) warranties | Resist any exclusion — without the warranties you may have no one to sue |
| Incorporate first where you can, and contract in the company’s name afterwards | Check the certificate of incorporation, which under s 15 is conclusive evidence of incorporation |
| Diary the ratification and pass a formal board resolution | Ask for a copy of the ratifying resolution |
| If the window is missed, have the company enter a substitute contract — s 158(3) | Consider a section 159 application to validate the contract or recover property |
| Avoid part performance before ratification; it complicates everything | Do not part with property or money before ratification if you can avoid it |
Note finally that these rules sit alongside sections 19 and 20, which protect people dealing with a company that does exist. Before incorporation there is no company to bind, and it is Division 2 — not section 19 — that governs.
Sources
- Companies Act 1997 — ss 15, 19, 20, 155–160
Before relying on anything here, read the current text of the Companies Act 1997 and check for later amendments. If a decision matters to you, get advice — start with the Office of the Public Solicitor, or find a firm in the law firms directory.