UNIT 3

PRE-INCORPORATION CONTRACTS

1. Introduction

Usually, a company is formed in order to acquire a business, property, or rights. Before

expenses are incurred in connection with formation and incorporation, its promoters may

want to be sure that the company will be able to acquire the specific assets. It is therefore

often necessary that the terms of acquisitions of such assets should be settled in advance of its

incorporation by contracts that will be binding, as far as legally possible, on the parties

concerned.

In terms of the common law principles of agency it is not possible for an agent to represent a

principle that does not exist. Since a company only comes into existence upon its registration,

it follows that its promoters cannot enter into contracts on its behalf prior to its registration.

In this unit we will find out how this difficulty can be overcome

Objectives

At the end of this unit you should be able to:

 provide reasons why an agent cannot enter into a contract with a company that has

not yet been registered

 explain what pre-incorporation contract is

 discuss why there is a need for pre-incorporation contracts

 state the requirements for a pre-incorporation contracts in terms of section 42 of

the Companies Act of 2004 to become binding on a company

 list the different methods by which a company can obtain rights arising from a
 contract entered into prior to its registration

 compare a pre-incorporation contract in terms of section 42 of the Companies Act

with a stipulatio alteri

 apply the contents in this unit to factual scenarios and give appropriate advice

Additional reading

Beuthin, RC et al. (1992). Basic Company Law (2nd edition), Durban. Butterworths.

(Pages 39-46)

Cilliers, HS et al. (2003). Entrepreneurial Law, Durban. Butterworths. (Pages 97-102)

Cilliers, HS et al. (2000). Corporate Law, Durban. Butterworths. (Pages 55-64)

1. The common law rule

Under common law company promoters were often faced with the problem that, although

it was necessary to conclude pre-incorporation contracts, the company to be a party to such a

contract and nor could the promoters act as agents of a non-existent company.

This is because in terms of the common law principles of agency, it is not possible for an

agent to represent a principle that does not exist. Prior to its incorporation the company is not

yet a juristic person, and it follows that the promoters of a company can therefore not act as

representatives for and bind a company which has not yet been registered.

Can you think of some examples of when it may be necessary to bind a company before

its incorporation.
The legislature intervened and made an exception to the common law rule by allowing the

company to ratify a pre-incorporation contract concluded by an agent.

2. The statutory arrangement

In terms of Section 42 of the Act a company can ratify or adopt as its own, after its

incorporation, any written contract entered into by someone purporting to act as the

company’s agent or trustee before its incorporation as if it had been duly incorporated at the

time when the contract was made and such contract had been made without its authority.

These contracts are called pre-incorporation contracts.

In order for a pre-incorporation contract to become binding on the company, the following

requirements must be complied with:

 The contract must be in writing

 It must have been entered into by a person who professed to act as an agent or

trustee of a company not yet formed

 Upon registration the memorandum of the company must contain as one of its

objects the ratification or adoption of the contract

 Two copies of the contract , one of which must be certified by a notary, must

be lodged with the Registrar together with the lodgment for registration of the

memorandum and articles

 The company must be entitled to commence business

 The company must ratify or adopt the contract after its incorporation

We will now look at each of these requirements individually.

The contract must be made in writing.

This means it is not sufficient to record the agreement in writing after the agreement has been

reached. In Pledge Investment (Pty) Ltd v Kramer NO: In re Estate Selesnik (1975 3 SA 696

(A) it was, for example, held that a sale by auction which is concluded orally at the fall of the

hammer does quality as a “contract made in writing” once it has been reduced to writing.

2.2 Agent or trustee of a company not yet formed

The contract must have been entered into by a person who professed to act as an agent or

trustee of a company not yet formed.

We can take “trustee” in this context to mean “agent”, but it can also beat its ordinary

meaning, namely principal. The capacity in which the person acted is decisive and not the

description he/she used. To ascertain the capacity in which the person acted, all the

surrounding circumstances have to be taken into account.

If the person acting on behalf of the company acted as principal, the parties can also make use

of the common law contract for the benefit of a third party (stipulatio alteri).

If the requirements of Section 42 are compiled with, it does not matter whether the written

pre-incorporation contract takes the form of a contract by an agent or a contract for the

benefit of a third party. However, if the requirements of Section 42 have not been compiled

with, the former contract need not be a nullity as far as the company is concerned. It can still
be adopted by the company since adoption in this instance is sanctioned by common law and

not by Section 42. We discuss the stipulatio alteri in context in Section 5 hereof.

Refer back to Commercial Law A if you cannot remember the legal principles

relating

to the stipulatio alteri.

2.3 Reference in the memorandum of association

The memorandum of association of the company must on its registration contain as an object

the ratification or adoption of the contract.

The words “on its registration” were inserted in the previous legislation (Act 61 of 1973)

following the decision in Sentrale Kunsmis Korporasie v NKP Kunsmisverspreiders (1970 3

SSA67 (A) to prevent subsequent insertion of such an object.

The specific contract must be described in the memorandum so that it can be identified with

certainty.

2.4 Two copies of the contract

Two copies of the contract, one of which must be certified by a notary public, must be lodged

with the Registrar together with the lodgment for registration of the memorandum and

articles.

2.5 The company must be entitled to commence business

contract ratified before the date on which the company was issued with a certificate to

commence business is only provisional and cannot become binding until that date.

2.6 The company must ratify the contract

The company must actually ratify or adopt the contract after its incorporation.

The company may choose whether or not to ratify the contact. If the company does not ratify

the contract within the agreed or a reasonable time, or does not come into existence, the

contract simply lapses and no one incurs any liability.

3. Liability

If all the above mentioned requirements have been complied with, the contract comes into

existence between the company and the other party.

Although, in principle, the agent or trustee incurs no liability in terms of the pre-incorporation

contract, such liability may be agreed upon. For example, he/she may guarantee the

company’s ratification after incorporation or the contract may provide for the agent or

trustee’s personal liability should be the company not be formed or should it refuse to ratify

the contract.

4. Alternate Methods

Section 42 of the Act is not peremptory and promoters may still make use of other methods to

obtain rights for a company prior to its incorporation.

alteri)

Section 42 of the Act will also not be applicable if the promoter contracts in his or her

personal capacity prior to the incorporation of the company and then, after the incorporation

of the company, for example:

 Cedes his /her rights under the contact to the company

 Cedes his/her rights under an option (which he/she acquired on the basis that

he/she can either exercise these personally or transfer them to another) to the

company which can then exercise the option

 Nominates the company as purchaser

 Transfer assets he/she acquired to the company

There are certain disadvantages to all the above methods of procuring a contract on behalf of

a company before it is registered. The transfer of immovable property, for example, will

attract additional transfer and stamp duty.

From a practical point of view the procedure laid down by Section 42 of the Act is therefore

often the safest and most cost effective. The disadvantage of this procedure, however, is that

copies of the contract must be lodged with the Registrar, which makes the contents open for

public inspection.

5. Contract for the benefit of a third party

party (stipulatio alteri).

As the third party need not be in existence at the time of the conclusion of the contract by

promoter acts in his/her own name as principal, it can be effectively used in the case of a

company to be formed.

Usually the promoter (X) will conclude a contract with another person (Y) in his/her own

name as principal. In terms of this contract the other person (Y) undertakes to render a

performance to the company to formed (Z). After its incorporation, the company (Z) accepts

performance stipulated for it by the promoter (X). The other party (Y) is then bound as

against the company (Z) to comply with the provisions of the contract. Thus, if the trustee

acting on behalf of the company to be formed enters into a contract of sale or lease with the

other contracting party, an offer in favour of the company to be formed in fact flows from the

agreement between the promoters and the other contacting party. After its incorporation the

company may accept this offer.

What will happen if the company, after its incorporation, fails to accept the benefit under the

stipultio alteri?

Activity 2______________________________________________________

Nashanti wants to buy a shop on behalf of a company that he intends to incorporate in the

near future. He does not want his potential competitors to know the terms of the contract. He

approaches you for advice on how he go about concluding this transaction. Advice Nashanti.
Activity 3___________________________________

List the main differences between pre-incorporation contract in terms of Section 42 of the Act

and a stipulation alteri.

6. Retrospective effect

The question often arises in practice whether the ratification or acceptance of a pre-

incorporation contract operates retrospectively to the date when the contract was concluded

or whether it becomes effective from the date when the company accedes to it.

Why do you think this is relevant?

The answer to this question can, for example, impact on the calculation of the interest or on

the payment of transfer duty, which is payable within 6 months of the date of the transaction.

In cases where the promoter acted as agent for the company to be formed in terms of the Act

the courts have since Peak Lode Gold Mining Co v Union Government (1932 TPD)

accepted that such a contract comes into operation at the time of ratification and not

retrospectively to the time when the contract was concluded. In such instances the 6-month

period for the payment of transfer duty will therefore be calculated as from the date of

ratification, not the date that the pre-incorporation contract was entered into.
In the case of a common law contract for the benefit of a third party, the company succeeds to

the rights retrospectively to the date on which the promoter acquired his/her rights.

Ideally the terms of a particular contract should make specific provision for the stage at

which the rights accrue to the company.

Feedback:

On activities

Activity 2

Since Nashanti does not want the terms of his agreement to become public knowledge, a pre-

incorporation contract in terms of Section 42 of the Act will not serve his purposes. Why not?

He will accordingly have to make use of the other methods discussed in Section 4 and 5. In

this instance the common law stipulatio alteri will most likely to be the best

option .Remember to explain to Nashanti how this works.

Activity 3

Section 42 Stipulatio alteri

.Statutory .Common Law

.Promoter acts as agent for a . Promoter act as principal

company still to be registered

. Must be in writing . Need not be in writing

. Copies of contract lodged with Registrar . No copies need to be lodged

. Effective from date of ratification . Effective retrospectively

In terms of the common law principles of agency it is not possible to bind a company to a

contract prior to its registration. We can overcome this problem by making use of a pre-

incorporation contract in terms of Section 42 of the Companies Act.

There are various other manners in which a company can, after its incorporation, obtain rights

flowing from a contract entered into on its behalf before its registration, for example through

the common law stipulation alteri