Separate Legal Identity of a Company
Steve Jones is an entrepreneur with a variety of business interests. He learned of a gold deposit in Western Australia. Because he was anxious to exploit the opportunity, he flew to Perth on 6 July and entered into a contract to buy a drilling machine from Thor Mining Machinery Ltd, to be used to drill a test shaft. The contract specified that the drill would be delivered, and payment of the $ 125 000 price would fall due, on 30 July. He signed the contract as follows:
Steve Jones, on behalf of WA Gold Exploration Ltd.
WA Gold Exploration Ltd was registered as a company by ASIC on 10 July, with Steve as 60% shareholder. He and the other shareholders met on 11 July, to elect a board of five directors. Steve himself was not elected to the board, because although he had originally discovered the opportunity, he had no experience in mining operations, and so did not want to be involved in day to day running of the company.
On 14 July, the board signed a contract to purchase a fleet of five ore trucks from Volvo Trucks (Australia) Ltd, costing a total of $ 500 000, to be delivered on 30 September. The board also established a sub-committee to determine the company’s technical needs, and on 25 July the board accepted the committee’s recommendation that the company buy a drill from United Mining Machinery Ltd for $ 100 000. The board also contacted Thor Mining Machinery Ltd and told it that it would not be taking delivery of the drill or paying for it.
Unfortunately, in mid-September it became clear that the gold deposit was not as large as hoped, and the board ceased trading on the basis that the company had only $ 400 000 in assets and had accumulated $ 2 million in liabilities. The company is therefore unable to pay for the trucks. Steve, who has personal assets of $ 1 million, has now been sued for breach of contract by both Thor Mining Machinery Ltd and Volvo Trucks (Australia) Ltd. Assume you are his legal advisor. Prepare advice for him citing full legal authority, as to what his legal position is.
Simon, George, Sara and Mary were all employed by different IT companies. However, they felt that they could do better if they went into business themselves. They pooled their available cash and drew up a partnership agreement, which stated that each partner had authority to enter into transactions on behalf of their firm, which they called Computer Solutions. The firm operates in Sydney and provides a service of storing data for customers. The agreement states that partners have authority to enter into contracts of up to $ 10 000, but that any contract for more than that must be approved unanimously by all partners.
George, Sara and Mary approach you for legal advice in relation to two transactions entered into by Simon, who had acted without referring back to the partners. One was for a 50GB hard-drive, bought by Simon on behalf of Computer Solutions, from Sunstar Computer Hardware Ltd, costing $ 15 000. The other was for a second-hand ute, costing $ 9 000, which Simon ordered for the firm from You Beaut Ute Ltd, on the basis that the partnership should branch into the freight business – an idea that the other partners had previously rejected. Sara had refused to accept delivery of both the hard drive and the ute and the partnership has been sued by both Sunstar Computer Hardware Ltd and You Beaut Ute Ltd. Give them legal advice, referring to statutory and case-law authority.
This assessment task will assess the following learning outcome/s:
- be able to identify the different types of business organisation and the law regulating them;
- be able to explain the rules of law regulating the internal relationship between the participants in business organisations and between the organisation and third parties.
- be able to apply the law to legal problems.
And more specifically:
- Your knowledge of the law relating to the concept of incorporation.
- Your knowledge of the law of partnership.
- Your ability to complete an assessment task which is relevant to professional practice and the giving of advice in the workplace.
The central concern in wake of the given facts is to outline the potential liability of Steve (the promoter) in relation to a contract formed after the company registration and a preregistration contract which was subsequently not ratified by the board.
A key aspect of company is that it possesses a separate legal identity as has been outlined in s. 124(1) Corporations Act 2001. This provides the company the capacity to enact various contracts in its name. This has significant implications for the shareholders of the company. This has been witnessed in the landmark verdict of Salomon v A Salomon and Co Ltd  AC 22 case. Since the company is a different legal entity, hence the liabilities arising out of contractual relationships it has formed through its agents, would be borne only by the company and not by the shareholders. Hence, there is no personal liability on the shareholders for any unsettled contractual liability or claim on the company (Cassidy, 2013).
It is a common practice that promoter(s) tends to enact contracts on behalf of company before registration and such contracts are categorised as pre-registration contracts. For these contracts to be legally binding on the company, the same needs to be ratified by the board of directors after registration of company (Baxt, Fletcher & Fridman, 2016). If the board of the registered company does not ratify the pre-registration contract, then the same would not be binding on the company and the promoter enacting the contract would be held personally liable as per s. 131(2) (Harris, 2014). However, as per s. 131(3), secondary liability of the pre-registration contract may be borne by the company if the court deems so. The relevant case law demonstrating the above understanding is Commonwealth Bank of Australia v Australian Solar information Pty. Ltd. (1987) 5 ACLC 124 (Ciro & Symes, 2013).
Based on the above law, the liability of a pre-registration and post registration contract needs to be highlighted.
Pre-Registration Contract – This has been enacted by Steve (promoter) on behalf of WA Gold Exploration Ltd (Company) for the supply of drill machines from Thor Mining Machinery Ltd which are required by the company for conducting the business. The board of directors of the registered company does not ratify this contract and instead execute a contract with United Mining Machinery Ltd for supply of drill machines. Hence, as per s.131(2), Steve would be personally liable to Thor Mining for the breach of contract.
Post Registration Contract – The board of the company has executed a contract with Volvo Trucks Australia for the supply of ore trucks. The company before taking the delivery of these trucks becomes bankrupt. In this scenario, the company would be held liable by Volvo Trucks for breach of contract. Steve along with other promoters would not be personally held liable for this contract in accordance with Salomon v Salomon case.
The discussion carried out above clearly highlights that Steve would be held liable by Thor Mining for breach of pre-registration contract while the company would be held liable by Volvo Trucks for breach of post-registration contract.
The key concern is to offer advice in relation to legal enforceability of the two contracts that have been enacted by a partners Simon, for the partnership firm.
It is noteworthy that partnership is a type of agency relationship where there is principal agent relation between the partners. This is because each of the partners acts as agent when entering into contracts on behalf of the firm. This partner (acting as agent) who is executing the contract represents the other absent partners (acting as principal). This understanding has been highlighted in s. 5, Partnership Act 1892 (NSW) (Gibson & Fraser, 2014).
The implication of the above relation between partners is that a contract enacted by one of the partners would be binding on all the other partners provided that the contract is related to partnership business’s normal scope of activities (Carter, 2012). A relevant case law is Mercantile Credit Co Ltd v Garrod  3 All ER 1103 in which a partner executed a contract in business related activity despite lacking the appropriate authority. However, the contract was still held as binding on all the partners (Davenport & Parker, 2014). If any contract deals with a subject that lies outside the normal scope of business activities of the firm, then such a contract would not be held binding on the other partners if the contracting partner lacks the requisite authority. Also, the innocent partners can sue the partner at default for claiming damages caused owing to contract (Vermeesch & Lindgren, 2011).
There is a partnership firm named Computer Solutions with Simon being one of the partners. No partner is allowed to execute contracts of more than $ 10,000 without consent from all other partners. Simon has enacted a contract for 50GB hard disk purchase with Sunstar Computer. Simon lacks authority to execute the contract since the deal size is $ 15,000 (i.e. exceeds $ 10,000) and he has failed to obtain consent from others. But since the purchase of hard disk is related to business of the firm, hence this contract is binding on the other partners who would have to pay $ 15,000 for the 50GB hard disk.
The another contract which Simon has enacted is with You Beaut Ute Ltd with an intention to diversify the business into freight as well. Since the contract value if less than $ 10,000, hence despite not having the support of the other partners, the contract would be considered binding on the other partners. This is because legal authority is present with Simon to enact this contract. The other partners can sue the erring partner Simon and claim damages for the losses caused owing to entering these two contracts.
The two contracts enacted by Simon are binding on all the partners of the partnership firm. The partners can sue Simon for claiming damages incurred due to these contracts.
Baxt, R., Fletcher, K.L. & Fridman, S. (2016). Corporations and Associations Cases and Materials (10th ed.). Butterworths: LexisNexis Australia.
Carter, J. (2012). Contract Act in Australia (3rd ed.). Sydney: LexisNexis Publications
Cassidy, J. (2013). Corporations Law Text and Essential Cases (4th ed.). Sydney: Federation Press.
Ciro, T. & Symes, C. (2013). Corporations Law in Principle (9th ed.). Sydney: LBC Thomson Reuters
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