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Into the Strata-sphere (of Pre-Incorporation Contracts)

Into the Strata-sphere (of Pre-Incorporation Contracts)

In the world of startups, it’s common for entrepreneurs to come together as co-founders of a new business and hack together a product as quickly as possible. Moving quickly in developing a product and getting to market is crucial, and the entrepreneurs focus all their energy on getting their brand off the ground.

So, while the entrepreneurs plan to eventually incorporate their business, they leave that time-consuming formality for later. In the meantime, they reach out to potential third party suppliers, service providers or sub-contractors, maybe even clients, and enter into business relationships. In short, they favour traction over protocol.

What happens when they finally do incorporate? Many third parties probably enter into these business relationships believing that the eventual corporation will be bound by the contracts they enter into. But is that always the case?

As the recent Supreme Court judgment in Owners, Strata Plan LMS 3905 v. Crystal Square Parking Corp, 2020 SCC 29 reminds us, not necessarily. After all, agents who enter a pre-incorporation contract as a representative of a soon-to-be-incorporated corporation cannot bind the corporation if it does not yet exist. However, corporations “acting as if” bound by the pre-incorporation contract, who continue relations as usual with the third party, may be held to have entered a new post-incorporation contract on the same terms – at least in the common law.

In Strata Plan, the developers of the Crystal Development, a large, multi-use development consisting of air space parcels, one of which had a parking facility, entered into a contract that required the owners of the parking lot parcel to provide parking for a monthly fee to the owners of the other parcels (the “ASP Agreement”). The ASP Agreement envisaged that the air space parcels might be subdivided by strata plans, in which case the strata corporation so created would enter into an assumption agreement to adopt the obligations under the ASP Agreement.

As anticipated, one of the parcels was indeed subdivided according to a strata plan and a strata corporation (“Strata Co”) was established. However, Strata Co never entered into the assumption agreement with the owners of the other air space parcels as planned.

For 12 years thereafter, Strata Co’s members parked in the parking facility and it paid the fees at the rate contemplated in the ASP Agreement. Eventually, a dispute arose between the parties and Strata Co. ceased paying the parking fees. The parking corporation countersued to recover the unpaid fees under the ASP Agreement.

Was Strata Co bound by the ASP Agreement?

The Supreme Court of British Columbia held no. Strata Co. had effectively performed the terms of the agreement for 12 years, but this was done under a mistaken belief that the ASP Agreement was already binding on Strata Co., when agency law is clear it was not: a corporation cannot be bound by a contract entered on its behalf before it ever came into existence.

[12]    Justice Young held that Strata Co. was not bound by the ASP Agreement. In her view, Strata Co.’s conduct did not evince an intention to enter into a post-incorporation agreement on the same terms as those of the ASP Agreement: para. 64. She observed that Strata Co.’s members had parked in the parking facility and made corresponding payments as contemplated by the ASP Agreement, but that this conduct was animated by their mistaken belief that they were already bound by that agreement: paras. 76-77. She held that conduct flowing from a mistaken belief that a pre-incorporation contract is binding is not sufficient to find that the newly incorporated entity has entered into a post-incorporation contract: para. 77.

Justice Côté, writing for the majority of the Supreme Court, agreed with the BCCA in overturning the lower level court: there was evidence in the objective conduct of the parties of offer and acceptance of a new, post-incorporation contract based on the terms of the pre-incorporation contract. For one, the parking company provided the same number of valid parking passes to Strata Co’s members that it would have been obliged to under the ASP Agreement, and Strata Co paid the fees that would have been owed under the ASP Agreement. The Court explained:

[26]  An agreement entered into prior to incorporation, even one that was purportedly entered into on behalf of the corporation, is not binding on the corporation once it comes into existence: Kelner v. Baxter (1866), L.R. 2 C.P. 174, at pp. 184-85, per Willes J., at p. 186, per Byles J. At common law, a corporation is incapable of ratifying or adopting a pre-incorporation contract, because a person cannot ratify or adopt a contract if they were not in a condition to be bound by it at the time it was made: Kelner, at p. 183, per Erle C.J., at p. 184, per Willes J., at pp. 185-86, per Byles J.; In re Empress Engineering Co. (1880), 16 Ch. D. 125 (C.A.), at p. 128, per Jessel M.R., at p. 130, per James L.J.; In re Northumberland Avenue Hotel Co. (1886), 33 Ch. D. 16 (C.A.), at p. 20, per Cotton L.J.; Natal Land and Colonization Co. v. Pauline Colliery and Development Syndicate Ltd., [1904] A.C. 120 (P.C.), at p. 126. A corporation can, however, enter into a post-incorporation contract on the same terms as the pre-incorporation contract: Empress Engineering, at p. 128, per Jessel M.R.; Natal Land, at p. 126.

[27]     In contrast to the position at common law, company legislation throughout Canada generally provides that a business corporation may adopt a pre-incorporation contract by any act or conduct signifying its intention to be bound by the contract: e.g. Business Corporations Act, S.B.C. 2002, c. 57s. 20(3) (“BCA”); Canada Business Corporations Act, R.S.C. 1985, c. C-44, s. 14(2)Business Corporations Act, R.S.A. 2000, c. B-9s. 15(3)Business Corporations Act, R.S.O. 1990, c. B.16, s. 21(2). Thus, company legislation permits a business corporation to adopt the pre-incorporation contract, whereas the common law rule is that a corporation must enter into a new agreement on the same terms as the pre-incorporation contract. In British Columbia, the statutory framework does not enable a strata corporation to adopt a pre-incorporation contract, because s. 20 of the BCA does not apply to strata corporations: SPA, s. 291. Instead, the corporation must enter into a post-incorporation contract on the same terms as the pre-incorporation contract. This begs the question of what is required to establish a post-incorporation contract that is binding on a strata corporate at common law. [emphasis added]

What kind of conduct establishes a post-incorporation contract? It looks a whole lot like performance of the pre-incorporation contract.

[33]                          In sum, an “outward manifestation of assent by each party such as to induce a reasonable expectation in the other” is required in order to find that a binding post-incorporation contract exists: Waddams, at §25. The test is objective. It requires an examination of how each party’s conduct would appear to a reasonable person in the position of the other party: P. Benson, Justice in Transactions: A Theory of Contract Law (2019), at pp. 112-13. Thus, a court should determine whether a reasonable person in the position of one party would consider that the other party’s conduct constituted an offer: Grant v. Province of New Brunswick (1973), 1973 CanLII 1765 (NB CA), 6 N.B.R. (2d) 95 (S.C. (App. Div.)), at para. 12. And, conversely, whether a reasonable person in the position of the latter would consider that the former’s conduct constituted an acceptance: Saint‑John Tug Boat, at pp. 621-22. The pre-incorporation contract is merely one aspect of the objective circumstances that can be used to interpret the parties’ conduct and from which the terms of a post-incorporation contract may be inferred.

[…]

[49]                          […] there is strong evidence of both offer and acceptance of a post-incorporation contract between Strata Co. and CSPC. After purchasing the parking facility, CSPC objectively manifested an intention to offer Strata Co. a contract on the terms of the ASP Agreement by making valid parking passes available to Strata Co.’s members in a quantity which corresponded to their share of parking spaces under s. 7.5 the ASP Agreement: trial decision, at para. 2; appeal decision, at para. 51. As well, CSPC’s maintenance and operation of the parking facility over the years would have required significant capital expenditures. The ASP Agreement in fact provided for such expenditures in its definition of “Operating Costs”, which were factored into the parking fee paid by Strata Co. Strata Co.’s members ought to have known that valuable consideration was being rendered for their benefit with an expectation that they would pay for it on terms corresponding to those set out in s. 7.5 the ASP Agreement.

[50]                          In turn, Strata Co. objectively manifested an intention to accept CSPC’s offer by paying the fees contemplated in the ASP Agreement, and its members exercised the rights corresponding to those payments by parking in the facility after CSPC became the facility’s owner: trial decision, at paras. 67, 76 and 93. The members, having either assented to the consideration or acquiesced in its being rendered, taking the benefit of it when it was rendered, should be taken impliedly to have requested its being rendered: Saint John Tug Boat, at p. 622. Thus, a reasonable person in CSPC’s position would consider that Strata Co.’s course of conduct constituted assent by Strata Co. to the terms set out in s. 7.5 of the ASP Agreement.

As the Court points out, in many instances, this scenario will be accounted for by company legislation, such as section 14 of the CBCA, which derogates from common law agency principles by creating a statutory ability for the corporation to ratify the pre-incorporation contract without even requiring the creation of a new post-incorporation contract.

Personal liability

14 (1)  Subject to this section, a person who enters into, or purports to enter into, a written contract in the name of or on behalf of a corporation before it comes into existence is personally bound by the contract and is entitled to its benefits.

Pre-incorporation and pre-amalgamation contracts

(2)  A corporation may, within a reasonable time after it comes into existence, by any action or conduct signifying its intention to be bound thereby, adopt a written contract made before it came into existence in its name or on its behalf, and on such adoption

(a)  the corporation is bound by the contract and is entitled to the benefits thereof as if the corporation had been in existence at the date of the contract and had been a party thereto; and

(b)  a person who purported to act in the name of or on behalf of the corporation ceases, except as provided in subsection (3), to be bound by or entitled to the benefits of the contract.

However, in common law jurisdictions where there is no such legislative protection, the Court’s judgment helps provide some certainty to dealings with early-stage businesses. In the startup world, where “stability” is not the first word that comes to mind, this judgment may serve to provide a little peace of mind to founders and their counterparties alike.

 

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