Introduction
It is important for founders or promoters of business to understand their rights and obligations in relation to their proposed business, particularly under shareholders’ agreements, joint venture agreements, memorandum of understanding and other pre-incorporation contracts.
Pre-incorporation contracts are any agreements entered into by proposed founders or promoters of a business that is yet to be incorporated and the said yet-to-be-incorporated company is expected to be liable for or take benefit of the rights and obligations under the said pre-incorporation contracts. Those who sign such agreements on behalf of a yet-to-be incorporated company are known as promoters under Nigerian law.
Before a company comes into existence (i.e. before its incorporation which is its formal birth), the promoters, often referred to as the “father,” “mother,” and “siblings” of the unborn company undertake various acts, decisions or activities in preparation for the company’s formation. Such preparations, acts or decisions may lead to entering into pre-incorporation contracts with consultants, vendors or some other third parties.
The question which then arises is: what are the legal implications or effects of these actions taken before the company’s birth? Can the unborn company later disagree with the decisions made on its behalf, or what happens if it refuses to accept these choices? These issues and their implications will be discussed in detail in the body of this article.
What is the nature and legal effects of pre-Incorporation contracts?
Pre-incorporation contracts are contracts purported to be made usually by promoters, on behalf of a company before it is incorporated. This type of contract is formed on basis or assumption of agency between a principal (i.e. the proposed company) and an agent (i.e. the promoter). Such contracts are ordinarily not binding on the company on the premise that the principal/company is non-existent and that no agent can contract for a non-existent principal.
In Okafor v. Ezenwa (1992) 4 NWLR (Pt. 237) 611 at P. 623, paras. A-C, the Court of Appeal (while relying on Newborne v. Sensolid (O.B.) Ltd. (1954) 1 Q.B. 45) held that:
“If a person contracts ostensibly as agent for a non-existent principal as for example, a company not yet formed, he can be held to be himself personally liable. This is because, it is only by holding him personally liable that any effect can be given to the contract. In the instant case, Emma Okafor contracted with the respondent, both as agent and principal (being the owner of the proposed company) and it is not open to him to repudiate liability for the contract.“
Under the Nigerian law of agency, a principal can be fixed with responsibility for the act of an agent but where the identity or existence of a principal cannot be established by the agent, the presumption of agency will not be made in favour of the agent and the supposed agent will be personally liable for his action. See the case of Sparks Electrics (Nig) Ltd v. Ponmile (1986) 2 NWLR (Pt.23) 525 CA.
In Nigeria, pre-incorporation contracts are regulated by the Companies and Allied Matters Act, Cap C.20, Laws of Nigeria, 2020 (“CAMA”). Section 96(2) of CAMA provides that“Prior to ratification by the company, the person who purported to act in the name or on behalf of the company shall, in the absence of express agreement to the contrary, be personally bound by the contract or other transaction and entitled to the benefit thereof.“
In line with the above, all pre-incorporation contracts are inchoate and valid but voidable at the instance of the company upon its incorporation. Hence, all promoters of companies are personally liable for all pre-incorporation contracts unless their liability is expressly excluded in the pre-incorporation contracts or the company ratifies it.
What are the types of pre-Incorporation contract?
It is important to properly identify the nature of a contract to know if it is a pre-incorporation contract. A company can enter into a contract by deed, in writing or orally made pursuant to Section 95(1) of CAMA; and, as such, a pre-incorporation contract can be by deed, in writing or orally made. The following, amongst others, are the types of pre-incorporation contracts that can be entered into by promoters on behalf of a yet-to-be incorporated company:
- Technical Services Agreement: This is an agreement made by the founders of a company before the company’s incorporation for technical or support services necessary to the formation and operation of a company. The court in the case of Societe Generale Favouriser Le Development v. Societe Generale Bank (Nig) Ltd (1997) 4 NWLR (Pt. 497) 8 at page 25 paragraphs C – F (SC), where Ogundare, JSC held that a Technical Management Agreement dated 7th July 1976 which Dr. Abubakar Sola Saraki, Dr. E.A. Ikomi and Mr. N.A.B. Kotoye entered into on behalf of the respondent (Societe Generale Bank (Nig.) Ltd.) were pre-incorporation contracts. Specifically Justice Ogundare of the Supreme Court read the agreement as a whole, together with Paragraph 4.05 of the Respondent’s Articles of Association and held as follows: “The main purpose of the agreement was to provide for technical management for the new Bank. Dr. Saraki, Dr. Ikomi and Mr. Kotoye obviously acted for and on behalf of the respondent in executing that agreement which, in essence, was one between the respondent and the appellant as the Technical Managers. They ostensibly were Agents of a disclosed principal even though the latter was not yet in existence at the time. And that is why the agreement is referred to as a “pre-incorporation agreement”.
- Joint venture Agreement: Promoters of a yet-to-be formed company may, when necessary, enter into a joint venture with other companies or investors to achieve a specific objective and a timeline. Usually, once this objective is accomplished, the joint venture is terminated. Any agreement to enter into such a joint venture, made by the promoters on behalf of a proposed company with another company or investor, is known as a pre-incorporation contract and same is subject to Nigerian law. According to the Court of Appeal in Galadanchi v. Abdulmalik (2015) 1 NWLR (Pt. 1440) 376 (CA), a joint venture agreement is a contractual agreement that joins together two or more parties for the purpose of executing a particular business undertaking where all parties agree to share the profit and loss of the enterprise.
- Shareholders Agreement: This agreement is made among the shareholders of the company. It describes the rights and obligations of shareholders, issuance of shares, the operation of the business, and the decision- making process. If a shareholders’ agreement is signed before the company in question is formed, the shareholders’ agreement is a pre-incorporation contract.
- Agreement for payment of Promoters’ Expenses: Any agreement in respect to the payment of a company promoters’ expenses made before the incorporation of a company is a pre-incorporation contract. Upon the incorporation of the company, the company can ratify during board or members’ meeting except if such is not included in the Memorandum and Articles of Association of the company. See section 86(1)(2) of the CAMA.
- Memorandum of Understanding (MOU): This is a preliminary document detailing the preliminary understanding of parties who plan to enter into a subsequent contract or some other agreement. For instance, in S.F.P. Ltd. v. N.D.I.C. (2012) 10 NWLR (Pt. 1309) 522, the Court of Appeal held that a memorandum of understanding is not a real agreement but a document guiding a future agreement and that its status is something less than a complete contract. Please note that a memorandum of understanding may have the effect of a contract, depending on its wordings. In our view, the reason the Supreme Court held that the memorandum of understanding was not a binding contract in BPS Constr. and Engr. Co. Ltd. v. F.C.D.A. (2017) 10 NWLR (Pt. 1572) 1 at page 34, paragraph D, was because paragraph 5 of the MoU in contention says “That this memorandum of understanding is subject to the signing of a formal agreement by the parties.” A memorandum of understanding signed or made by promoters on behalf of a proposed company with a binding obligation may be deemed a pre-incorporation contract.
- Take-over Agreement: This type of pre-incorporation contract is peculiar in situations where a company seeks to merge with another company (or companies) to jointly form a new company. The take-over agreement is usually entered into before the incorporation of the new joint company in order to avoid disputes with regards to the terms of the take-over agreement if not expressly written.
- Employment contracts: Before a company is incorporated, promoters may engage the services of various management staff (such as managing director or chief financial officer or chief technology officer) before the completion of the company’s incorporation and licensing process. For instance, in setting up a microfinance bank in Nigeria, the promoters must first obtain the Approval-in-Principle of the Central Bank of Nigeria before the MFB can be incorporated. The process of pursuing the AIP may take 6 months or more. So, the promoters may choose to start paying these employees out of their own pockets, with the understanding that they will be reimbursed by the company after its incorporation. Alternatively, they may agree with the employees that their salary payment will be made once the company is formally incorporated. These transactions are pre-incorporation contracts pursuant to Section 96 of CAMA.
- Loan Agreement: Promoters may enter into a loan agreement on behalf of a company that has not yet been incorporated, when necessary, to facilitate the company’s formation and to cover all initial expenditures of the company. Such an agreement, made before the company legally comes into life, is known as a pre-incorporation contract.
- Procurement Contract: A procurement contract is a formal agreement between a purchaser and a vendor that outlines the terms for purchasing goods or services. This contract may also be made before or during incorporation. This can be seen where the promoters enter into a contract to purchase machines, computers or other items on behalf of a proposed company. For instance, purchase or lease of office property for the company or purchase of furniture to be used in the office are few examples of pre-incorporation contracts or transactions.
How can promoters escape personal liability of pre-incorporation contracts?
By virtue of section 96(1) of CAMA, promoters of a company can only escape liability of pre-incorporation contracts when such contracts have been ratified by the company upon its incorporation. Section 96(1) of CAMA provides as follows: “Any contract or other transaction purporting to be entered into by the company or by any person on behalf of the company prior to its formation may be ratified by the company after its formation and thereupon the company shall become bound by and entitled to the benefit thereof as if it has been in existence at the date of such contract or other transaction and had been a party thereto.“
When a company ratifies a pre-incorporation contract, the company will be deemed to have approved the contract and, hence, the company becomes a party to the contract and enjoys the benefits and bears liabilities that flow from such contract as if it has been in existence since the date the contract was entered into initially. The foregoing aligns with the decision of the Supreme Court in the case of Societe Generale Favouriser Le Development v. Societe Generale Bank (Nig) Ltd (1997) 4 NWLR (Pt.497) 26 SC.
How can the acts of promoters be ratified upon incorporation of the company?
A company cannot take benefit or bear liability for a pre-incorporation contract unless it has ratified the contract. A company can ratify pre-incorporation contracts in the ways or forms provided in section 90(2) of CAMA and section 96(1) of CAMA:
Section 90(1)(a) of CAMA provides that the company, acting through its members in general meeting, board of directors, or managing director, shall have expressly or impliedly authorized such officer or agent to act in the matter ; or The court in the case of Garuba v. Kwara Inv. Co. Ltd & Ors (2005) 5NWLR (Pt.917) 177 SC established to the effect that before the provision of the law in section 96(1) of CAMA which provides that “Any contract or other transaction purporting to be entered into by the company or by any person on behalf of the company prior to its formation may be ratified by the company after its formation….” can apply, there must be evidence of ratification by the new company of the contracts made before its formation.
The evidence of ratification as required by the above case can be in form of the new company entering into a new contract to put into effect the terms of the pre-incorporation. The new contract can be in express terms or can be implied from the acts of the company after incorporation as well as from the minutes of its general meetings and board meetings. The forgoing was established in the case of Societe Generale Favouriser Le Development v. Societe Generale Bank (Nig) Ltd.
Where the pre-incorporation contract entered into by the officer or agent is acquiesced by all the members of the company or by the directors or by the managing director for the time being, such shall be equivalent to ratification by the members in general meeting, board of directors, or managing director, as the case may be. See section 90(2) of CAMA.
By virtue of section 86(3) of CAMA, any transaction made on behalf of a company before its incorporation can be rescinded by the company upon incorporation except where the promoters give full disclosure of all material facts known by the promoters. Where that is done, such pre-incorporation contract can then be ratified on behalf of the company by:
- The company’s board of directors independent of the promoter;
- All the members of the company; or
- The company at a general meeting at which neither the promoter nor the holders of any share in which he is beneficially interested shall vote on the resolution to enter into or ratify that transaction.
Statutory Duties of Promoters under Nigerian law
Fiduciary duty: Every promoter of a company occupies a special position which, if compromised, can injure the finances and reputation of a company. This duty, called fiduciary duty, is premised on section 86 (1) of CAMA which provides that a promoter stands in a fiduciary relationship to the company and shall observe utmost good faith towards the company in any transaction with it or on its behalf and shall compensate the company for any loss suffered by reason of his failure to do so.
Duty to account: A promoter shall not make secret profit at the expense of the company. The duty to account derives from section 86(2) of CAMA which provides that a promoter, who acquires any property or information in circumstances in which it was his duty as a fiduciary to acquire it on behalf of the company, shall account to the company for such property and for any profit which he may have made from the use of such property or information.
Duty of disclosure: A promoter’s duty of disclosure is predicated on section 86(3) of CAMA provides that any transaction between a promoter and the company may be rescinded by the company unless, after full disclosure of all material facts known to the promoter, such transaction shall have been entered into or ratified on behalf of the company by —
(a) the company’s board of directors independent of the promoter ;
(b) all the members of the company ; or
(c) the company at a general meeting at which neither the promoter nor the holders of any share in which he is beneficially interested shall vote on the resolution to enter into or ratify that transaction.
Time Within Which a Company May Sue its Promoters
There is no period of limitation to any proceeding brought by a company to enforce any of its rights against a promoter under Section 86(4) of CAMA but in any such proceeding the Court may relieve a promoter in whole or in part and on such terms as it deems fit from liability if in all the circumstances, including lapse of time, the Court deems it equitable to do so.
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