Liability of members in pre-incorporation contracts and partnership law

BUSINESS AND CORPORATION
LAW

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QUESTION 1
ISSUE
Whether a suit for recovery of damages can be filed against Steve for the beach of the
contract?
LAW
While forming a company, the promoters have to comply with the guidelines given under
the Corporations Act 2001 (Cth) which is implemented by the government to regulate the
companies operating in Australia. The act provides various provisions regarding
incorporation of a company. A corporation is considered as a separate legal entity which has
a different entity from its owners. This provision was established in the case of Salomon v
Salomon & Co Ltd (1897) AC 22. In this case, a company became bankrupt, and the
unsecured creditors did not receive any money. They filed a suit against Salomon who was
the debenture holder and shareholder of the company to recover their money. The court
provided that the entity of Salomon and the company is different from each other based on
which Salomon cannot be held liable for repaying the debts of unsecured creditors of the
company (McLaughlin, 2018). Thus, the liability of the members of a company is limited to
their share in the company after which they cannot be held personally liable for repaying
the liabilities of the enterprise. The corporation has the power to sign a contract under its
own name and bind it into the contractual liabilities. However, the promoters of the
corporation can also form a contract on behalf of the company even before it is registered.
Section 119 provides that the separate entity status of a company is gained when it is
registered. However, the enterprise can be held liable under the contracts which are formed
before its incorporation as per the provisions given under section 131.
These contracts are referred as pre incorporation contracts, and they bind the company into
a legal relationship after its registration as given under section 131 (1). The organisation also
has the right to rectify the terms of the pre incorporation contract; however, these changes
must be made within the appropriate time. However, these contracts have the ability to
bind the promoters into legal relationships as well according to the provisions given under

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section 131 (2) (CSU LAW504 Modules, 2018, Topic 14). As per this section, the promoters
of the company who formed the contract can be held liable by the third party in case the
company is not registered. Moreover, the promoters will also be liable in case the terms of
the contract are not rectified by the company within the appropriate time. Section 131 (3)
provides that the court can decide between the three options while a case is filed under
section 131 (2). Firstly, the court can enforce the company to pay the liability formed under
the contract either partial or full. Secondly, the court can enforce the enterprise to give back
the property which is received under such contract. Thirdly, the court can enforce the
promoter to repay the debts which arise under the pre incorporation contract. Therefore,
the company has a separate entity due to which its members cannot be held personally
liable by the court, however, they can be held liable if the company failed to comply with
pre incorporation contracts.
APPLICATION
A pre incorporation contract is formed by Steve on behalf of WA Gold Exploration Company
before the registration of the company is completed. The contract was formed for the
purchase of a drill machine from Thor Mining Machinery Ltd. After the incorporation of the
company, the board of directors did not rectify or made changes in terms of the contract
formed with Thor. Since the company has failed to rectify the terms of the contract within
an appropriate time, the contractual liability can be imposed on Steve by Thor under section
131 (2). The company can hold Steve liable for the pre incorporation contract and demand
damages for breach of the contractual terms by the enterprise. While entering into the
contract with Volvo Trucks (Australia) Ltd for purchasing five trucks for the business, the
company was incorporated. The corporation has become a separate personality, thus, the
liability of its members become limited as provided by the court in Salomon v Salomon & Co
Ltd case. Steve was a shareholder of the company based on which his liability is limited, and
he cannot be held personally liable by Volvo in case the company is unable to pay back the
debts of its business. Thus, Volvo can satisfy its debts based on whatever percentage it
receives after the liquidation of the company.
CONCLUSION