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Company formation and constitution — SQE1 BLP question

A worked single-best-answer question on company formation and constitution, with why each wrong option is wrong — the way SQE1 traps candidates.

Company formation and constitution

Priya is setting up a bakery business and intends to trade through a private limited company, Willow Bakes Ltd. Before the company is registered, Priya signs an order for two commercial ovens from Ferro Equipment Ltd, signing 'for and on behalf of Willow Bakes Ltd'. Nothing in the order deals with who will be liable if the company is not yet formed. Willow Bakes Ltd is incorporated one week later and the ovens are delivered to its premises. The invoice has not been paid and Ferro Equipment Ltd wishes to sue.

Which of the following best describes who is liable on the contract for the ovens?

  1. AWillow Bakes Ltd is automatically bound, because it took delivery of and used the ovens after its incorporation.
  2. BPriya is personally liable on the contract, because it was made on behalf of a company that had not yet been formed and there is no agreement to the contrary.
  3. CWillow Bakes Ltd may ratify the contract by a board resolution, after which it alone will be liable to Ferro Equipment Ltd.
  4. DNobody is liable, because a contract made in the name of a company that did not then exist is a nullity.
  5. EPriya is personally liable only if she knew at the time of signing that the company had not yet been incorporated.
Show answer and reasoning
B is the best answer. Under s 51(1) Companies Act 2006, a contract that purports to be made by or on behalf of a company at a time when it has not been formed has effect, subject to any agreement to the contrary, as one made with the person purporting to act for it, who is personally liable. A company cannot ratify a contract made before it existed (Kelner v Baxter); it would need a new contract (novation) with Ferro. Priya's knowledge is irrelevant to s 51 liability.

Rule: A contract made on behalf of an unformed company takes effect, subject to any agreement to the contrary, as one made with the person acting for it, who is personally liable (CA 2006 s 51).

  • A Taking delivery after incorporation does not make the company a party; at most a new contract would have to be inferred, which is not the general rule. (wrong rule)
  • C A company cannot ratify a pre-incorporation contract because it did not exist when the contract was made; a novation would be needed. (wrong rule)
  • D Section 51 prevents the contract being a nullity by making the person acting for the company liable. (wrong rule)
  • E Liability under s 51 does not depend on the agent's knowledge that the company was unformed. (wrong rule)

Source: Companies Act 2006, s 51(1); Kelner v Baxter (1866) LR 2 CP 174; Phonogram Ltd v Lane [1982] QB 938

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