Canada: Pre-Incorporation Contracts And The Court Of Appeal

The Ontario Court of Appeal continues to do surprising and alarming things with pre-incorporation contracts.¹ In Benedetto v. 2453912 Ontario Inc., 2019 ONCA 149 (Hourigan, Miller & Paciocco JJ.A.), the Court of Appeal has just held that, notwithstanding that the promoter sought to protect himself from personal liability under subsection 21(4) of the Ontario Business Corporations Act, he was unable to recover the deposit he had paid on the purchase of land to be bought by the corporation-to-be-incorporated.

The decision is wrong on two grounds. The first ground is based on the expectations the parties will have had in the circumstances of the case. The second ground is based on a contractual or restitutionary analysis.

With respect to the first ground, the important paragraph in Miller J.A.'s reasons (for the Court) is:

[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.

This argument makes no sense. The vendor who agrees to sell to a person representing a corporation-to-be-incorporated when that person disclaims all personal liability under subsection 21(4) of the Ontario Business Corporations Act, takes the risk that the corporation may not adopt the contract and that no sale will occur. In other words, the vendor can have no reasonable expectation that there will be a sale if the contract is not adopted. To say, as Miller J.A. does in the last sentence of paragraph 16, that any result other than forfeiture of the deposit would provide no incentive to close, is to acknowledge the existence of an expectation in the vendor that, given the disclaimer in the context of a pre-incorporation contract and the law governing such contracts, the vendor had no business entertaining. The result protects no reasonable expectation that the vendor could have had and defeats the entirely reasonable expectations that, based on subsection 21(4), the promoter almost certainly had.

The premise of the second ground, viz., that the deposit and the contract of purchase and sale reflect different obligations — see para 7 of Miller J.A.'s reasons — is simply flatly wrong: there is one contract, under the terms of which a deposit was paid. Once the contract of purchase and sale is unenforceable against the purported purchaser, the vendor can have no contractual claim to keep the deposit. A deposit paid by a purchaser when the vendor breaches the contract or the contract is otherwise unenforceable — whether or not the agreement deals with the return of the deposit — cannot be retained by the vendor because, the contract being unenforceable by the vendor, it cannot resist a claim in restitution by the purchaser: there is no juridical basis for the vendor's claim to keep the deposit. This situation existed in Benedetto; the nominal party, the corporation-to-be-incorporated, could not be sued when the contract had not been adopted, just as the promoter, who had disclaimed personal liability, could not be sued, and, the contract being then unenforceable by the vendor against anyone, the vendor has no defence to the promoter's claim in restitution for money had and received or money paid.

All standard disclaimers under subsection 21(4), or subsection 14(4) of the Canada Business Corporations Act, must now be re-drafted to protect the promoter to the extent that, before this case, it was entirely reasonable for such a person to expect.

Footnote

1. See, e.g., Sherwood Design Services Inc. v. 872935 Ontario Ltd., (1998), 39 O.R. (3d) 576, 158 D.L.R. (4th) 441, 38 B.L.R. (2d) 157 (C.A., Carthy & Abella JJ.A. & Borins J. (ad hoc)). There is a very polite annotation to the case by Dick Potter (1998), 38 B.L.R. (2d) 159, and a scathing comment by Bill Estey, "Pre-Incorporation Contracts: The Fog is Lifting" (2000), 33 Can. Bus. L. J. 3. The decision is as wrong a decision on corporate law as can be imagined. The decision was in fact reversed — yes, reversed! — six months later in Szecket v. Huang (1998), 42 O.R. (3d) 400, 168 D.L.R. (4th) 402, 42 B.L.R. (2d) 1 (C.A., McMurtry C.J.O., Laskin & Borins JJ.A.). The lesson of Szecket has not, however, been accepted; the Court of Appeal still refers to Sherwood Design and ignores Szecket. See Shoppers Drug Mart Inc. v. 6470360 Canada Inc. (Energyshop Consulting Inc./Powerhouse Energy Management Inc.), 2014 ONCA 85, 372 D.L.R. (4th) 90 (Goudge, Watt & Pepall JJ.A.).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.