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Corporations - Pre-incorporation Contracts. Benedetto v. 2453912 Ontario Inc.
In Benedetto v. 2453912 Ontario Inc. (Ont CA, 2019) the Court of Appeal addresses the law of deposits in an interaction with corporate law regarding pre-incorporation contracts:[1] This appeal addresses the legal question of how the law governing deposits that secure contracts for the purchase and sale of real property interacts with section 21 of Ontario’s Business Corporations Act, R.S.O. 1990, c. B.16 (“OBCA”), which governs pre-incorporation contracts. On a motion for summary judgment, the motion judge found that the appellant forfeited the deposit when the transaction did not close, even though the pre-incorporation contract stated that the appellant was signing the contract ‘without any personal liabilities’. At the conclusion of the hearing of the appeal, the court announced that the appeal was dismissed with reasons to follow. These are those reasons.
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(2) Pre-incorporation contracts and s. 24 of the OBCA
[8] At common law, a purchaser who breaches a contract of purchase and sale by electing not to complete the purchase will generally be liable to the vendor, who can pursue damages or other remedies. But contracts that are executed by a person acting as a promoter or functionary – that is, executed on behalf of a company intended to be incorporated later – have an added complexity. Section 21 of the OBCA modifies the common law of contract to facilitate such transactions, clarifying the rights and obligations parties assume in pre-incorporation contracts.
[9] The default rule is provided by s. 21(1) of the OBCA:Contract prior to corporate existence
21 (1) Except as provided in this section, a person who enters into an oral or 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 the benefits thereof. [10] This court stated in Szecket v. Huang (1998), 1998 CanLII 4425 (ON CA), 42 O.R. (3d) 400 (C.A.), at para. 33 that, “personal liability of the promoter is established by s. 21(1) and prevails unless either contracted out of pursuant to s. 21(4), or displaced by the adoption of the contract by the company subsequent to its incorporation pursuant to s. 21(2).”
[11] The default rule of personal liability is thus subject to an opt-out under s. 21(4), where the parties make it clear that is what they have chosen:Exception to subs. (1)
(4) If expressly so provided in the oral or written contract referred to in subsection (1), a person who purported to act in the name of or on behalf of the corporation before it came into existence is not in any event bound by the contract or entitled to the benefits thereof. [12] In the event of a breach of a pre-incorporation contract where s. 21(4) applies – such as in this case, where the promoter advised the vendor he would not be completing the purchase – the vendor has no remedy for the breach: 1394918 Ontario Ltd. v. 1310210 Ontario Inc (2002), 2002 CanLII 19996 (ON CA), 57 O.R. (3d) 607. The vendor cannot obtain damages against the intended corporation because the intended corporation – if it even came into existence - did not adopt the contract: para. 9. Neither can the vendor seek damages against the promoter because the vendor and the promoter contracted to the contrary: para. 7.
(3) The application of s. 21(4) to a deposit
[13] Does a deposit stand on a different footing? We were not directed to any authority directly on point. The appellant argued that under s. 21(4), where a contract provides that a promoter is not bound by the contract, neither can the promoter be bound by a deposit given to secure the performance of the contract. That is, if a promoter has no personal obligation to perform a contract, this necessarily entails the promoter is not bound by the terms of the deposit either.
[14] The motion judge made no error in rejecting this argument. As stated above, a forfeited deposit does not constitute damages for breach of contract, but stands as security for the performance of the contract. A purchaser’s obligations under a contract of purchase and sale are thus distinct from the obligation incurred by the payer of the deposit. An implied term of a deposit is that on breach of the contract by the purchaser (or, in the case of a pre-incorporation contract, by the promoter on behalf of the intended purchaser), the deposit is forfeited to the vendor.
[15] Of course, parties can contract otherwise with respect to the deposit. The appellant argues that in this case, where the contract expressly provides that the appellant was signing the contract “without any personal liabilities”, the language was broad enough to exclude personal liability not only for damages for breach of contract, but also with respect to the deposit.
[16] It was reasonable for the motion judge to interpret the phrase “without any personal liabilities” in the context of the contract as a whole, as not applying to the deposit. As he noted, the contract had no express provisions concerning the deposit. In particular, “(t)he terms of the Deposit do not include a provision that if the contract is not performed, the Deposit is to be returned to [the appellant]. Under settled law, such a ‘contrary intention’ must be expressly stated if the deposit is not to be forfeited upon the failure of the purchaser to perform his or her obligations under the agreement of purchase and sale.” As the motion judge found, the interpretation offered by the appellant would render a deposit meaningless, providing no incentive to close the transaction, and no compensation to the vendor for failure to close.
[17] The motion judge also put some stock in the interpretation given to nearly identical contractual language in Adamis v. Aviks, 1983 CarswellOnt 3436 (Ont. Co. Ct.). That case, a decision of the County Court, addressed the liability of a trustee in a real estate contract of purchase and sale, who signed a contract “with no personal liability”. The trial judge in Adamis held that the trustee was not liable for damages for the breach of the contract, but forfeited the deposit.
[18] The appellant argues that it was an error to rely on Adamis, as the transaction arose in a significantly different legal context: the purchaser was a trustee as opposed to a promoter, and the case pre-dated the enactment of s. 21 of the OBCA. Adamis, however, was not binding on the motion judge and the motion judge did not suppose that it was. The motion judge made no error in taking comfort from the fact that the trial judge in Adamis interpreted similar contractual language – given in a different but similar context – in a similar manner. . Owners, Strata Plan LMS 3905 v. Crystal Square Parking Corp.
In Owners, Strata Plan LMS 3905 v. Crystal Square Parking Corp. (SCC, 2020) the Supreme Court of Canada comments as follows on the status of pre-incorporation contracts on the subsequent corporation:[25] I begin on this point by laying out the basic principles applicable to pre-incorporation contracts, which boil down quite simply to the proposition that, although a corporation is not bound by a pre-incorporation contract, it may, after coming into existence, enter into a new contract on the same terms as those of the pre-incorporation contract. I then address what the parties have identified as divergent lines of authority on the analytical approach to be taken in order to determine when a corporation has entered into a post-incorporation contract, as well as on the role of the intentions of the parties to the pre-incorporation contract in that approach.
[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. 57, s. 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-9, s. 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.
[28] There are two divergent lines of authority on post-incorporation contracts. According to the first approach, the conduct of the parties and the surrounding circumstances must be considered in order to determine whether the parties objectively manifested an intention to enter into a post-incorporation agreement on the same terms as the pre-incorporation contract: Touche v. Metropolitan Railway Warehousing Co. (1871), L.R. 6 Ch. App. 671; Howard v. Patent Ivory Manufacturing Co. (1888), 38 Ch. D. 156. The second approach is more subjective than the first. It involves considering whether the company’s post-incorporation conduct was animated by an erroneous opinion that the company was bound by the pre-incorporation contract. According to this second approach, “the acting on that erroneous opinion, does not make a good contract”: Northumberland Avenue Hotel, at p. 20, per Cotton L.J.; see also Bagot Pneumatic Tyre Co. v. Clipper Pneumatic Tyre Co., [1901] 1 Ch. D. 196.
[29] The first approach coincides with the common law’s long adherence to an objective theory of contract formation. The classic statement of the objective theory comes from Smith v. Hughes (1871), L.R. 6 Q.B. 597, at p. 607, per Blackburn J.:If, whatever a man’s real intention may be, he so conducts himself that a reasonable man would believe that he was assenting to the terms proposed by the other party, and that other party upon that belief enters into [a] contract with him, the man thus conducting himself would be equally bound as if he had intended to agree to the other party’s terms. [30] The objective theory has found clear expression in this Court’s contract formation jurisprudence. For example, in Saint John Tug Boat Co. v. Irving Refining Ltd., 1964 CanLII 88 (SCC), [1964] S.C.R. 614, Ritchie J. endorsed the classic statement from Smith and held that an objective approach is required for the purpose of determining whether a course of conduct constitutes acceptance of an offer: p. 622. He found on this basis that a contract had been formed as a result of an oil refinery operator’s acquiescence in the continued provision of a tug boat’s services after an express agreement between them had expired and, crucially, notwithstanding the operator’s subjective opinion that it had not agreed to pay for the continued service: p. 623; see also Scotsburn Co-operative Services Ltd. v. W. T. Goodwin Ltd., 1985 CanLII 57 (SCC), [1985] 1 S.C.R. 54, at p. 63; Chartbrook Ltd. v. Persimmon Homes Ltd., [2009] UKHL 38, [2009] 1 A.C. 1101, at para. 39.
[31] The subjective approach taken in Northumberland Avenue Hotel and Bagot Pneumatic Tyre is anomalous, because parties’ reasonable expectations are generally protected in the common law of contracts: McCamus, at pp. 32-33; Waddams, at §§141 and 148. This general rule means that “a subjective mutual consensus is neither necessary nor sufficient for the creation of an enforceable contract” and that “a person may be bound by contractual obligations that she did not intend (subjectively) to assume”: Waddams, at §§92 and 146. At common law, the risk arising from one party’s reasonable reliance on the existence of an agreement is allocated to the party whose conduct gave rise to a reasonable expectation that a contract between the parties would be legally binding. But the subjective approach in Northumberland Avenue Hotel and Bagot Pneumatic Tyre allocates that risk to the wrong party by excusing the corporation from liability even though the corporation, by its conduct, had objectively manifested its assent to be bound by the terms of the pre-incorporation agreement.
[32] Misunderstandings, errors and other irregularities which may arise during the contract formation process are generally addressed through the doctrines of mistake, misrepresentation, non est factum and — at least to some extent — unconscionability, as well as through the remedies of rectification and rescission. Because of the unfortunate bifurcation of this case, unconscionability and mistake, although pleaded by Strata Co., were not addressed in the courts below and are not before this Court. It would be undesirable for this Court to develop a post-incorporation contract doctrine, particularly in a way that is out of step with its general contract formation jurisprudence, in order to account for the possibility of an irregularity in the contract formation process when other doctrines that have not been argued before the Court serve the same purpose and are better suited to accommodate such concerns. As there is no principled basis for exempting post-incorporation contracts from the generally applicable body of common law principles governing contract formation, the subjective approach to post-incorporation contracts does not apply.
[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.
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