The Interplay Between Pre-Incorporation Contracts and Real Estate Deposits
Updated: May 16, 2019
A pre-incorporation contract is one in which a person (known as a functionary or promoter) enters into a contract on behalf of a corporation before the corporation comes into existence (i.e., before it has been incorporated). Once the corporation is formed and adopts the contract, it assumes all the obligations and benefits of the contract, while the promoter is released from all liability (and any entitlement to its benefits). However, section 21(4) of the Business Corporations Act (Ontario) (“OBCA”) provides that the functionary or promoter purporting to act in the name of or on behalf of the corporation yet to be incorporated is not personally bound to the contract (or entitled to the benefits thereof) if no corporation is ultimately formed, if this relief from personal liability is expressly provided for in the contract. When buying real property, purchasers typically submit a deposit with their offer to purchase. The deposit is considered part of the purchase price and is ultimately credited towards the purchase price on closing. In this way, a deposit is a down payment, but it is also a sign of good-faith. It is intended to bind the contract, guarantee its performance and, in the event the deal doesn’t close due to non-performance of the purchaser, provide the vendor with compensation for having taken the property off the market and for revealing the market price at which the vendor is willing to sell the property.
Many real estate investors provide offers to purchase properties in the name of the real estate investor “in trust for a company to be incorporated without personal liability”. In pre-incorporation contracts like these, how is the deposit treated when the purchaser subsequently fails to close the transaction? Should the deposit be returned to the purchaser, given that the purchaser entered the contract on behalf of a corporation yet to be formed and stipulated that he/she was doing so without personal liability? According to a recent Court of Appeal decision, Benedetto v 2453912 Ontario Inc., the answer is no.
The Court in this decision unanimously held that deposits exist separately from agreement of purchase and sale and that, where a purchaser provides a deposit to secure performance of a contract but later fails to close the transaction, the deposit is forfeit unless the parties bargained to the contrary. This forfeiture is not considered damages for breach of contract, but rather stands for the performance of the contract. The Court accepted the vendor’s argument that if the deposit were to be returned to the purchaser due to the purchaser attempting to opt out of liability vis-à-vis the words “without personal liability”, it would render the deposit meaningless and leave the vendor without remedy for the purchaser’s failure to close. To the Court of Appeal, adding the words “without any personal liability” was insufficient to contract out of section 21 of the OBCA or to avoid the presumption at common law that a deposit is forfeit if the purchaser fails to close. Accordingly, the purchaser’s deposit was forfeited to the vendor.
Some legal professionals believe this decision by the Court of Appeal is simply wrong. These dissenting advocates argue that a 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 OBCA assumes 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.
Regardless of this dissenting view, the decision should serve as a cautionary tale to real estate investors and would-be purchasers – particularly those attempting to purchase property on behalf of corporate entities in the pre-incorporation phase, as well as their financial and legal advisors. It stands as the current state of the law in Ontario regarding the interplay between the treatment of deposits in real estate transactions and section 21 of the OBCA. If the deposit is meant to be protected from forfeiture, the purchaser’s lawyer should ensure such provision is expressly included in the agreement. Alternatively, if the vendor is not agreeable to a purchaser entering into the contract “in trust for a corporation to be incorporated without personal liability”, the other option for the purchaser is to bargain for an assignment clause in the agreement, allowing the purchaser to assign the agreement to any other person (e.g., corporation) at any time prior to closing; upon the assignment, the original purchaser would be relieved from liability under the contract. In any case, as a general rule of thumb, the real estate lawyers involved in the proposed transaction should ensure that the intentions of the parties are carefully documented and expressly bargained for in the agreement to help avoid an adjudicative body relying on a contrary interpretation in the event of a contract dispute.