Signing a contract for a company to be incorporated: legal impacts of the pre-incorporation contract

It happens that a person proposes to buy a business or a building on behalf of a company to be incorporated after the conclusion of a promise to purchase. This is often the case when a developer proposes to purchase a building in the name of a company which has not yet been created. But who is responsible if everything does not go as planned? The future company or the signatory personally?

Author: M^e Manuel St-Aubin, lawyer and partner at St-Aubin avocats

Date of writing: 2024-07

Last updated: n/a

1. The conclusion of a contract on behalf of a future company: general rules

Generally, the company shareholders are not responsible for its obligations. Therefore they benefit from the “corporate veil” (art. 309 CCQ).

However, when a person enters into a contract on behalf of a soon-to-be-formed company, he or she becomes personally responsible for the obligations under the contract under article 320 CCQ:

• 320. A person who acts for a legal person before it is constituted is bound by the obligations so contracted, unless the contract stipulates otherwise and includes a statement to the effect that the legal person might not be constituted or might not assume the obligations subscribed in the contract.

In order to avoid this liability, a stipulation in the contract to this effect must exist.

This type of act is called a “ pre-constitutive contract ”. The Court of Appeal, in the case of Grostern c. Syrros, 2007 QCCA 262 , defines it as follows:

• [TRANSLATION] [33] A pre-constitutive contract is defined as an act carried out in the name or on behalf of a company before its constitution […] . The classic example is a contract for the purchase of a good where the buyer declares to act on behalf of a company to be incorporated.

When such a contract is concluded for a possible company, it is important that this company subsequently ratifies the act so that a substitution of the parties takes place, all according to article 319 CCQ:

• 319. A legal person may ratify an act performed for it before it was constituted; it is then substituted for the person who acted for it.
• The ratification does not effect novation; the person who acted has thenceforth the same rights and is subject to the same obligations as a mandatary with respect to the legal person.

In other words, at the moment when the company confirms that it is a party to the contract, the person who initially concluded it is no longer a party to it and is released from the obligations arising from it, subject to the obligations relating to the rules of the mandate (art. 319 al. 2 CCQ).

Ratification of contracts will preferably be made in the company's organizational resolutions (art. 11 et seq. LSAQ and 104 LCSA) so that everything is clear and unambiguous (although tacit ratification by the company may also be valid [1] ).

The Quebec Court of Appeal summarizes these principles well in the case of Société sylvicole de l'Outaouais c. Rasmussen, 2005 QCCA 729 :

• [TRANSLATION] [49] In summary, we must remember from art. 319 CCQ that the initial signatory, the promoter, following ratification, ceases to be the co-contracting party and finds himself in an agent relationship with the recently incorporated legal entity. Faced with the co-contracting third party, its liability is now defined by arts. 6, 7 and 1437 CCQ [sic] relating to extra-contractual liability (in the presence, for example, of abusive or fraudulent ratification) and, where applicable, by art. 317 CCQ on the lifting of the corporate veil (if the promoter is the shareholder of the legal person).

• [50] I now turn to art. 320 CCQ Case law has established that a third party who contracts with the promoter of a legal person that he knows does not exist is presumed to be contracting with the promoter unless proven otherwise (Smith and Renaud, supra, p. 78, par. 7). Codifying this principle, art. 320 CCQ prescribes that as long as there is no ratification, the promoter is the co-contracting party and, consequently, is bound by the obligations provided for in the contract . However, it is possible to limit, and even exclude, this liability conventionally. Art. 320 CCQ therefore completes the situation.

2. Case law example

The Superior Court decision Jozsa c. Patel, 2013 QCCS 593 is an interesting example, because the case takes place in a frequent context of an promise to purchase a building.

In this case, “an offer to purchase signed by the defendants in the name of a company to be incorporated did not materialize at the agreed time with the notary [TRANSLATION]” (para. 1).

The seller therefore sued the promising buyer “for the difference between the price agreed in this offer to purchase and the price he obtained during the sale of the building a few months later” (para. 2).

The following questions therefore arose:

• Are the signatories personally liable for the damages claimed despite the incorporation of the company?
• Did the company “ratify” the promise to purchase after the fact, and if so, is the ratification valid?

The transaction documents provided that a company was to be incorporated following the promise to purchase and acquire the building (paras. 4 and 63).

The said company was indeed incorporated following the conclusion of the promise to purchase (para. 64).

Finally, due to certain financing difficulties, the promising-buyer defendants did not respect the promise to purchase even though it was enforceable, engaging their liability towards the seller (paras. 88 and 89).

Thus, the question arose to determine whether the company has indeed ratified the promise to purchase in accordance with the Civil Code of Quebec . If this were the case, the buyers would not necessarily have been liable for all damages.

In this case, the court explains the following:

• [TRANSLATED] [52] The law also does not specify the modalities required for ratification to take place in such a context.

• [53] The dictionary specifies, however, that ratify means “to sign, approve and confirm”. Case law endorses such a definition.

• [54] Case law also teaches that ratification can be express or tacit.

• [55] Although it is desirable that a ratification of the actions taken by the initial contractor be communicated to the other contractor, if only for the sake of transparency, nothing requires such communication for the ratification to be enforceable against it according to the current state of law.

• [56] Thus, the ratification will be express if the company adopts a resolution ratifying the act carried out or if the act of sale is signed by the corporation, in the case where the pre-incorporative act in question is an offer to purchase.

• […]

• [61] The Court understands that a distinction must be made between the intention of a person to take actions in the name of a corporation to be created and the concrete ratification by the latter of the actions taken by the first; ratification happens to be the materialization of the intention. The mere incorporation of a company is therefore not enough.
• [62] For there to be ratification, once created, the company must carry out acts which are linked to those carried out by another person before incorporation. A reasonable person to whom the facts and actions subsequent to incorporation are presented must be able to conclude that the initial project was approved, resumed, continued or carried out by the corporation announced and finally created .

In this case, no resolution from the company was made to ratify the promise to purchase and it was not possible to establish tacit ratification within the meaning of the case law (para. 65). Thus, in the presence of an enforceable promise to purchase, the people who signed the promise to purchase found themselves personally liable for the damage caused to the seller.

3. Key points to remember

The applicable rules and case law regarding pre-incorporation contracts teach us the following:

• A person who concludes a contract for a company to be incorporated is personally responsible for the obligations contracted unless an express stipulation of exclusion of liability is indicated (art. 320 CCQ);
• This person is released from personal liability only when the company is incorporated and has ratified the contract (art. 319 CCQ);
• The company's ratification of the contract may be "express or tacit", but it is better if it is recorded in a resolution of the board of directors to avoid any ambiguity;
• This ratification does not necessarily have to be transmitted to the other party to the contract to be valid, but it is preferable that it be [2] .

It is therefore important when concluding a contract for a company to be incorporated to protect itself against personal liability by following the terms and conditions provided for by law.

NOTICE: The information in this article is general and does not constitute legal advice nor does it necessarily reflect the state of the law exhaustively. For any legal questions relevant to your situation, we advise you to contact a lawyer.

[1] Jozsa c. Patel, 2013 QCCS 593 , para. 54.

[2] Jozsa c. Patel, 2013 QCCS 593 , para. 55.