Clause 52

Company Law Reform Bill [Lords] – in a Public Bill Committee at 6:15 pm on 20th June 2006.

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Pre-incorporation contracts, deeds and obligations

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry

I beg to move amendment No. 183, in clause 52, page 21, line 17, at end insert

‘but he may not enforce the contract against any person who did not know, and who had reasonable grounds for not knowing, that the company had not yet been formed and for whom the identity or characteristics of the other party to the contract would have been a relevant consideration in entering into the contract'.

The amendment is mainly a probing one, but it raises a problem that has the potential to be the Hickman of the 21st century. The problem is what happens when someone purports to deal on behalf of a company that has not yet been formed. The situation does not arise often, but it is likely to arise in fast-moving business situations in which people are forming new companies and new businesses.

Originally, the problem was that, since the company did not exist at the time, since no one can be an agent for something that does not exist, and since agents have, in normal circumstances, no liability for the contracts that they make—it is their principals who are banned—someone who made a contract with a person purporting to act on behalf of a non-existent company had no rights at all. A legislative change was brought in to alter that situation. It gave rise to wording similar to that in the Bill. That wording has the effect of saying that, in such a situation, the person who purported to act on behalf of the non-existent company becomes banned by the contract. Therefore, the person on the other side has some recourse.

The problem is that the clause does not say what happens if the situation is reversed. It does not say whether the person who purported to act on behalf of the non-existent company gets rights in contract against the other party to the deal. The clause is silent on that point, which can be commercially important. There was a case in the Court of Appeal called Braymist Ltd v. Wise Finance Co. Ltd. It occurred in 2002. The Court of Appeal decided that in such a  situation the person who purported to act on behalf of the company not yet in existence did get rights against the other party. Unfortunately, the Court was divided as to why. A majority of members thought that the meaning of the existing section meant that rights in contract were created, subject to common law restrictions if there were any. The other members thought, on the contrary, that the existing section had no effect on the situation but that contractual rights could be created by common law doctrines.

Why is that a problem? It sounds like the same thing. On one side, people say that the section creates rights subject to common law and on the other, people say that the section creates no rights but the common law can create a contract. The problem is that the area of contract law with which we are dealing is the most notoriously difficult and unclear area of contract law—namely, the area to do with mistake and, especially, with mistake of identity. The difference between the two sides of the Court will be of significance because on one side there is a presumption in favour of the creation of rights and on the other there is a presumption that may work in the opposite direction.

The amendment seeks to put into words the view of one side of the Court of Appeal and to invite the Government to think about whether they want to put into statutory form a solution to the problem, which may in years to come become a difficult and significant one.

Photo of Margaret Hodge Margaret Hodge Minister of State (Industry and the Regions)

I bow to the hon. Gentleman’s greater knowledge and his long experience of teaching and researching in the area. My attention was also drawn to the case that he mentioned. One part of the judgment that he did not bring up was how liabilities and rights should be dealt with and whether their treatment should be enshrined in law or a matter for courts to decide. The judgment stated:

“Parliament intended to preserve the process of common law adjudication in this respect and to leave it to the courts to complete the exercise of defining the relevant circumstances.”

The matter that the hon. Gentleman wishes us to set out in the Bill is one that we have decided is best defined through common-law adjudication. The questions about liabilities and rights should be determined by the courts. The court made it clear that someone who is personally liable may be able to enforce the contract. I hope that that gives some comfort to the hon. Gentleman.

The amendment would define the circumstances in which an agent can enforce a contract, but the company law review examined the issue and did not recommend any change. I do not know whether the hon. Gentleman has a view on that, but what the courts have said and the process of the company law review mean that the clause covers the matter in the best way that it can. We should leave the courts to decide the rights and duties of all parties to contracts entered into before a company is formed.

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry

I am perfectly happy with the Minister’s reply. It is a rational response for the Government to say that this is a difficult area and they will leave it to the courts to work out, but it is important that lawyers and those relying on the Act  will know that that is the intention of the Government and Parliament. There may be further confusion; we are considering a Court of Appeal judgment and in the future there could be further developments in a higher court. At that point, we might have to return to the matter.

Photo of Paul Farrelly Paul Farrelly Labour, Newcastle-under-Lyme 6:30 pm, 20th June 2006

Does the hon. Gentleman agree that if the amendment were to be accepted, apart from creating perhaps the longest and clumsiest sentence in a long Bill it would introduce a dangerous element of subjectivity by using the words “know” and “knowledge”? Those words could be prejudicial to future contracts, as people could have great scope to claim that they did not know something and therefore withdraw. The matter is best left to the courts on a case-by-case basis.

Photo of David Howarth David Howarth Shadow Minister (Energy), Trade & Industry

I do not wish to go into the details of the law of contractual mistake, but the hon. Gentleman will find that that area has some relevance when it comes to dealing with the subjective knowledge of parties. If the matter is left to the courts, it will at some point be set out in rules of the kind to which he objects. It might be better to put into statute a solution that is workable all round. Given the Minister’s reply, however, and the Government’s intention that the matter will be left to develop in the courts, I beg to ask leave to withdraw the amendment.

Amendment, by leave, withdrawn.

Clause 52 ordered to stand part of the Bill.

Clauses 53 to 55 ordered to stand part of the Bill.