Are pre-incorporation contracts enforceable ? Our Gan Khong Aik and Lee Sze Ching (Ashley) shed light on the question through the case of Dae Hanguru Infra Sdn Bhd v Baldah Toyyibah (Prasarana) Kelantan Sdn Bhd.
Introduction
At common law, a company that is yet to be incorporated cannot enter into a contract, as it is not a legal entity. Accordingly, the company is not bound by a pre-incorporation contract because it does not have a separate legal existence until its incorporation; nor can it appoint an agent before its incorporation. As such, the company cannot ratify a potential agent’s actions, given that any ratification would have to be backdated to the date of the contract, at which time the company did not yet exist.
Notwithstanding the common law position, in Malaysia, there is a principle called “promoter and successor”, as defined under sections 65(1) and (2) of the Companies Act 2016 (formerly, sections 35(1) and (2) of the Companies Act 1965, with slight differences). Where certain legislative requirements are met, a company can be and is bound by a contract or transaction made before its incorporation.
In the case of Dae Hanguru Infra Sdn Bhd v Baldah Toyyibah (Prasarana) Kelantan Sdn Bhd, the Federal Court discussed, among other things, the principle of promoter and successor under section 35 of the old Companies Act 1965.
In 2012, the Kelantan state government issued an open proposal to construct, finance, design and build a highway road from Kota Bahru to Kuala Krai (the project). A subsidiary company of Perbadanan Menteri Besar Kelantan formed a special vehicle, Baldah Toyyibah (Prasarana) Kelantan Sdn Bhd (the respondent), to execute the project. The Consortium Daelim JV (CDJV), a consortium of 13 members that was led by Daelim Industrial Co Ltd, bid for the project.
The respondent then issued a letter of intent (LOI) and a letter of acceptance (LOA) to CDJV as a turnkey contractor. CDJV was required to nominate or incorporate a company acceptable to the respondent, as the turnkey contractor, to implement the project and provide evidence of its incorporation. CDJV informed the respondent that the legal entity responsible for the implementation of the project would be Dae Hanguru Infra Sdn Bhd (the appellant), which was formed after CDJV’s letter of acceptance of the LOI and LOA.
Thereafter, CDJV continued to engage in discussions with the respondent. However, when the respondent requested information pertaining to CDJV to prepare a contract document between the respondent and CDJV, it was the appellant who responded instead of CDJV. The appellant also suddenly circulated a draft contract of the project during a meeting, which indicated the appellant as a contracting party and introduced additional terms.
The respondent sought clarification on the relationship between the appellant and CDJV and informed CDJV that it could agree to the change of the contracting party provided that, among other things, the appellant was part of CDJV and supported by Daelim Industrial Ltd.
However, CDJV did not reply to the queries. Instead, the appellant responded and referred to the LOI, LOA and CDJV’s letter of acceptance and claimed that it was the nominated contractor that the respondent required. In response, the respondent sought clarification from each of the consortium members, but they offered new proposals coupled with the appellant’s proposals, which derailed the matter from what was originally discussed with CDJV. Consequently, the respondent set a deadline for the appellant to proceed with the original terms in the LOI and LOA, but the appellant failed to comply with it. In light of this, the respondent informed the appellant that it was unable to continue with the negotiations. As a result, the appellant sued the respondent and another party for breach of contract.
The High Court allowed the appellant’s claim based on the promoter and successor principle under section 35(1) of the Companies Act 1965. It held that there was a binding contractual relationship between CDJV and the respondent and later with the appellant. The Court further found that CDJV and the appellant were of the same entity and therefore, the LOA was binding on the respondent and CDJV, as well as on the appellant.
The respondent appealed against the High Court’s decision. The Court of Appeal held that there was no contractual relationship between the respondent and the appellant, because neither the LOI nor the LOA carried the appellant’s name. More crucially, the Court found that the appellant was never a member of the consortium, as it was yet to be incorporated. In addition, the Court noted that there was no evidence to substitute the appellant as the contracting party and that the contract was not novated to the appellant. As such, the appeal was allowed, and the High Court judgment was set aside.
Dissatisfied, the appellant filed for an appeal. In affirming the Court of Appeal’s decision, the Federal Court held that there was no consensus ad idem (“meeting of the minds”) to establish a contractual relation between the appellant and the respondent.
The Court referred to section 35 of the Companies Act 1965 and held that there are two requirements to be fulfilled before a pre-incorporated contract can be binding:
- It must be a contract made on behalf of the company (in this case the appellant) prior to its incorporation.
- The contract must be ratified by the company once incorporated.
The Federal Court held that the appellant was not able to rely on section 35, based on the following:
- The appellant had not pleaded the material facts of promoter and successor to anchor its reliance on section 35. In their statement, the appellant pleaded that “the 1st Defendant accepted CDJV (and subsequently the Plaintiff’s) proposal…” and that:
there was a concluded contract between the 1st Defendant acting for and on behalf of the Kelantan State Government’s State Agency which was the 2nd Defendant and CDJV/the Plaintiff.
The Federal Court held that the words in bold above could not be expanded to mean that the respondent had issued the LOI and LOA to CDJV on the basis that CDJV was the appellant’s promoter.
- There was no evidence that CDJV had been negotiating with the respondent and had intended to enter into the agreement on behalf of the pre-incorporated appellant. None of the appellant’s witnesses’ testified that CDJV was the appellant’s promoter.
- The appellant had counter-proposed new terms, which differed from the LOI and LOA that the respondent had issued to CDJV. As such, there was no basis for the appellant to argue that it was the same entity as CDJV or that CDJV was contracting on its behalf.
- In a promoter-successor scenario, the promoter should exit from the scene as soon as the successor is incorporated. However, in this case, the respondent had continued to deal with CDJV only on contractual issues, even after the appellant was formed.
- There was no evidence that the appellant had ratified the LOI and LOA, purportedly entered on its behalf by CDJV.
In light of the above, the Federal Court refused to answer any of the leave questions pertaining to the promoter and successor principle. This was because this principle had not been factually established to enable questions on its application to be answered. The appellant had not proven or satisfied the requirements of section 35 of the Companies Act 1965 to be a successor company to CDJV. Accordingly, the Federal Court dismissed the appeal.
The Federal Court mentioned in passing that the pleading of clear and specific terms (that the appellant was a successor company to CDJV or that CDJV had entered into the negotiation or agreement on behalf of the appellant) would have been desirable.
Despite not answering the leave questions, the Federal Court’s decision has indeed underlined the fundamental importance of pleading material facts to anchor to the principle of promoter and successor.
For further information on this topic please contact Gan Khong Aik or Lee Sze Ching (Ashley) at Gan Partnership by telephone (+603 7931 7060) or email (khongaik@ganlaw.my or szeching@ganlaw.my). The Gan Partnership website can be accessed at www.ganlaw.my