Introduction
This essay will address whether a company in England and Wales can be held liable under a lease agreement entered into on its behalf before it was legally formed. The formation of a company creates a new legal entity, distinct from its founders, known as promoters. A common issue that arises is the status of contracts, such as a lease for business premises, that a promoter makes in anticipation of the company's incorporation. This essay will argue that a company is not, and cannot be, bound by such a pre-incorporation contract. The legal liability instead falls upon the promoter personally, a position established at common law and now governed by statute. The only way for the company to obtain the benefit and burden of the lease is to enter into a new agreement after its formation.
The Common Law Position on Pre-Incorporation Contracts
The foundational principle of UK company law, established in Salomon v A Salomon & Co Ltd [1897] AC 22, is that a company has a separate legal personality from its owners and managers. A direct consequence of this is that a company does not exist as a legal person until it is formally incorporated and registered by the Registrar of Companies. It logically follows that a non-existent entity cannot enter into a binding contract.
The leading common law authority on this point is Kelner v Baxter (1866) LR 2 CP 174. In this case, promoters of a future hotel company purchased wine on credit, purporting to do so on behalf of the company. The company was later formed and the wine was consumed, but the company went into liquidation before paying the supplier. The court held that the company could not be liable for the debt as it did not exist when the contract was made. Consequently, the promoters who signed the agreement were held personally liable. The court reasoned that the promoters could not have been acting as agents for the company, as their principal (the company) was not in existence at the time.
Furthermore, the common law determined that a company could not simply 'ratify' or adopt a pre-incorporation contract after its formation. Ratification is a principle of agency law which allows a principal to retrospectively approve an act done by their agent. However, for ratification to be valid, the principal must have been in existence and legally capable of performing the act at the time it was done (Hannigan, 2018). As the company was not in existence, it could not subsequently ratify the lease. This was confirmed by the Privy Council in Natal Land & Colonization Co v Pauline Colliery Syndicate [1904] AC 120. Therefore, under common law, a lease made by a promoter before the company was formed is void as far as the company is concerned.
The Statutory Position: Section 51 of the Companies Act 2006
The common law position on the promoter's liability has been placed on a statutory footing. Section 51(1) of the Companies Act 2006 provides:
"A contract that purports to be made by or on behalf of a company at a time when the company has not been formed has effect, subject to any agreement to the contrary, as one made with the person purporting to act for the company or as agent for it, and he is personally liable on the contract accordingly."
This section confirms that the contract does not bind the company. Instead, it creates a contract directly with the promoter, who is personally liable for all obligations under it. In the context of a lease, this means the promoter would be personally responsible for paying the rent and adhering to all covenants, even if they signed the lease "for and on behalf of" the named company. The phrase "subject to any agreement to the contrary" has been interpreted narrowly. In Phonogram Ltd v Lane [1982] QB 938, a case concerning the predecessor to section 51, the Court of Appeal held that there must be a clear and express exclusion of personal liability for the promoter to escape it. Merely signing as an agent for an unformed company is not sufficient.
The Practical Solution: Novation
Since the company cannot ratify the original pre-incorporation lease, the question arises as to how a newly formed company can take over the premises. The legally correct method is novation. Novation involves terminating the original contract between the promoter and the landlord and creating an entirely new contract between the now-incorporated company and the landlord. All three parties—the promoter, the company, and the landlord—must agree to this. The new contract would ideally be on the same terms as the original one, effectively releasing the promoter from their personal liability and substituting the company in their place. This is a distinct legal act from ratification and is the only way for the company to become legally bound by the terms of the lease.
Conclusion
In conclusion, a company is not bound by a lease made by a promoter before the company was formed. The principle of separate legal personality means a company cannot enter into contracts before it legally exists. The common law, as seen in Kelner v Baxter, established that such contracts are not binding on the company and cannot be ratified upon its incorporation. This position is now enshrined in section 51 of the Companies Act 2006, which makes it clear that the promoter who enters into the pre-incorporation contract is personally liable, unless there is an express agreement to the contrary. For the company to be bound by the terms of the lease, it must, after its formation, enter into a new agreement with the landlord, a process known as novation.
References
Hannigan, B. (2018) Company Law. 5th edn. Oxford University Press.
Kelner v Baxter (1866) LR 2 CP 174.
Natal Land & Colonization Co v Pauline Colliery Syndicate [1904] AC 120.
Phonogram Ltd v Lane [1982] QB 938.
Salomon v A Salomon & Co Ltd [1897] AC 22.
Companies Act 2006, s. 51.
