This article will be dealing with a practical issue regarding the “embryo” stage of any new venture – the period of time where the idea of the venture, even if only partially, is already solidified, business discussions are taking place between the entrepreneur and potential partners, but a limited liability has yet to be established.
There are many reasons why a company should be established as close as possible to the beginning of the venture (especially technological companies, in which there is significance to the date the entrepreneur’s intellectual property rights are assigned to the company). However, reality is often quite different. Due to economic and other constraints, the entrepreneur finds himself promoting the venture’s affairs before the establishment of the company. Is this possible? Can an entrepreneur commit on behalf of a legal entity that hasn’t been formed yet? Well, the Israeli legislator has considered this situation and the answer to this question is positive.
Who is an “entrepreneur” according to the Israeli law (a “promoter” as officially defined)? According to section 1 of the Companies Law 5759-1999 (the “Act”), a promoter is “a person who performs an act in the name or in place of a company that has not yet been incorporated”, i.e., the person who initiates the establishment of the company, and who is the life spirit behind it and acts on its behalf, is the entrepreneur.
Section 12 of the Act gives a company the right to adopt agreements signed by the entrepreneur prior to its inception and take on its rights and obligations. Namely, if we return to our question above, according to Section 12 of the Act, an entrepreneur can commit today on behalf of a company that is yet to be formed, and when it is established, the company will adopt the contractual obligations taken on its behalf before establishment.
Section 12 of the Act deals with the “simple” situation where the company embraces the entrepreneur’s actions. However, what happens when the company does not endorse the entrepreneur’s actions? The situation is covered by Section 13 to the Act.
According to Section 13, a third party who signed an agreement that was later not approved by the company, can then choose one of two options: (1) see the entrepreneur as a party committed by contract, i.e. regard the entrepreneur as “his counterparty” or (2) withdraw from the action, namely cancel the agreement and claim for damages which may have been caused to him. The choice between the two options above is given if: (1) the company did not ratify the act within a year from the date of its formation; (2) the circumstances show that the company is not likely to become incorporated, provided that the third party has notified the entrepreneur thirty days before terminating the agreement; or (3) the company did not ratify the act within thirty days from requirement by the third party.
According to section 13(b) of the Act, a company that retroactively ratifies the agreement, excuses the entrepreneurs from personal liability. In his book “New Israeli Companies Law” (third edition, 2003), Prof. J. Gross refers to Section 13(b) and says: “if a company ratified an act while the third party was aware of the existence of entrepreneurship, the entrepreneur is not obligated or entitled to it. It seems that an act was made in lieu of a corporation if two conditions are fulfilled: first – the Act’s appearance from a third party’s point of view indicates that it is done for a corporation in its name or on its behalf, and second – that at the time of the act the entrepreneur has a certain corporation in mind for which the act is being made (see Gross, p. 64-65).
What happens, though, in a situation where the third party that signed the agreement with the entrepreneur was not aware that the agreement was signed on behalf of a company that is yet to be formed? The situation is discussed in Section 14 of the Act.
According to the Act, the entrepreneur is then exposed to the risk of becoming a party to the agreement he had signed, and being excused from his personal liability. Pursuant to Section 14(b) of the Act: “once a company is incorporated, it may ratify the act, provided that such ratification is not inconsistent with the essence of the act, its conditions or the circumstances of the matter; where the company ratifies an act, the promoter’s act shall bind both the company and the promoter, jointly and severally, and shall benefit the company alone.”