Did you know that limiting your liability in a pre-incorporation contract can be a tricky endeavor?

chinneck  -  Apr 13, 2017  -  No Comments

By Jordan T. Overholt, J.D.  April 13, 2017.

From time to time, a client may find him or herself thinking about whether or not to enter into a contract on behalf of a corporation that does not yet exist.

Generally, the scenario is as follows:

  1. Circumstances are such that a contract must be agreed-to much too quickly to allow the client time to create his or her own party corporation;
  2. As a result, the client enters into the contract “on behalf of” or “in trust for” his or her yet-to-be-created corporation;
  3. The client then creates his or her corporation;
  4. Once the corporation exists, it accepts assignment of the client’s position in the contract; and
  5. By assigning his or her position, the client’s intention is that he or she is then absolved of all personal liability with respect to the contract.

Clients thinking about doing something like this should be cautious: Section 21 of the Business Corporations Act can complicate this seemingly simple series of events.

To start, Section 21 confirms that:

  1. Any client who enters into such a contract is personally liable;
  2. Once the new corporation exists, it can accept assignment of the client’s position in the contract; and
  3. By assigning his or her position, the client ceases to be personally liable with respect to the contract.

However, what many clients may not expect is that—regardless of whether or not this assignment actually occurs—Section 21 always allows an opposing party to ask a court for an order apportioning contractual liability between a client and his or her corporation. Further, a court is always entitled to grant such an order.

It is this last part—this remnant, contingent liability—that could lead to some severe consequences for clients, depending on the circumstances.

Fortunately, Section 21 provides a possible remedy.

By drafting the contract so that it expressly states that the client is not in any event ever bound by the contract or entitled to the benefits thereof, the client can avoid this lingering, possible liability.

Disclaimer: While every effort has been made to ensure the accuracy of this article, it is not intended to provide legal advice. Individual situations will differ and should be discussed with a lawyer. For specific technical and/or legal advice, please contact Chinneck Law.

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