Between the moment partners agree to form a company and the moment it is registered in the commercial register, weeks or months may pass. Business does not wait during that period: premises are leased, furniture bought, suppliers engaged, staff hired, and a bank account may be opened. The decisive legal question is who is bound by these transactions while the company does not yet exist as a legal person, and what happens if formation stalls and the company is never registered. These matters are governed by Companies Law No. 1 of 2016 and the general rules, and they are among the greatest surprises for entrepreneurs. This article explains this critical phase.
When a Company Acquires Legal Personality
This is the pivotal point around which everything else turns:
- Registration as the condition of existence: a company acquires legal personality only on registration in the commercial register and completion of the prescribed publication formalities. Before that it has no legal existence.
- Consequences of non-existence: before registration a company has no separate patrimony, no capacity to contract, and no standing to litigate, so no action may be brought by or against it.
- The constitutive contract: signing it creates obligations among the partners themselves but does not create a new legal person as against third parties.
- The formation phase: comprises preparing and notarising the contract, depositing capital, and obtaining approvals and licences, each step with its own effect.
- Bank account: an under-formation account is usually opened for depositing capital and is subject to restrictions on withdrawal before registration is complete.
Founder Liability for Pre-Registration Transactions
Here lie the gravest surprises entrepreneurs encounter:
- The rule: a person who contracts in the name of a company in formation is personally liable for that transaction in their own assets, because the entity in whose name they contracted did not exist.
- Solidarity: where several founders undertook or ratified the transaction, they are solidarily liable to third parties, so a creditor may claim the whole obligation from any of them.
- Effect of registration: where the company is registered and ratifies the transactions concluded on its behalf during formation, their effects attach to it retroactively and the founders are discharged. This is the most important point in practice.
- Ratification required: the obligation does not transfer automatically on registration. Ratification by the company's competent organ after formation is required, and an express resolution at the first meeting is advisable.
- Unconnected transactions: what a founder concluded for their own benefit or beyond what formation required remains their own and cannot be charged to the company.
- The third party's position: where the company ratifies, the founder is ordinarily released. Where it does not ratify, or is never registered, the third party remains with recourse against the founders personally.
When Formation Stalls
Not every attempt at formation ends in registration, and failure raises delicate questions:
- Deposited capital: returned to the partners after deducting what was actually spent on formation, and the allocation of those expenses should be agreed in advance.
- Formation expenses: borne by the partners in proportion to their agreed shares absent contrary agreement, and the absence of agreement is a recurring source of dispute.
- Liability for the failure: where failure is attributable to a partner's refusal to honour their undertaking or to false information they provided, the others may claim damages.
- Concluded contracts: remain the obligation of whoever concluded them personally, who must negotiate their termination and bear the consequences.
- Staff appointed: a person appointed and who began work acquires employment rights against the person who engaged them, and a founder is not excused by the company's failure to come into existence.
De Facto and Void Companies
What if the partners actually carried on business without completing the formalities, or the constitutive contract is invalid?
- De facto company: a situation arising where persons carry on a joint activity in a manner presenting them as partners without valid registration, sharing profits and losses and dealing with third parties.
- Liability to third parties: the partners may not rely on the company's non-existence to escape obligations towards third parties and answer personally and solidarily for the dealings that arose.
- Invalidity is not retroactive as to third parties: where the company is declared void, this does not affect the rights of third parties in good faith who dealt with it, preserving the stability of dealings.
- Liquidation: a de facto or void company is liquidated as the law provides, with assets collected, debts paid, and any surplus distributed among the partners.
- Relations between partners: their shares are determined by what they actually agreed and by the contributions the facts establish, and where this cannot be determined the shares are equal.
- Additional risks: carrying on business without a licence may attract administrative and criminal breaches independent of the company question.
Protecting Founders
Most of these risks can be avoided by simple arrangements made at the right time:
- Founders' agreement: a document concluded before the constitutive contract specifying who may transact and within what limits, how expenses are shared, and what happens if formation fails.
- Signing in a stated capacity: when contracting before registration, state in the contract that it is concluded on behalf of a company in formation, with an express clause transferring the obligation to it on registration and releasing the signatory.
- Limiting early commitments: deferring long-term contracts and substantial obligations until after registration wherever possible.
- Conditions precedent: making early contracts conditional on completion of registration, so that failure dissolves the contract without liability.
- Ratification resolution: passing an express documented resolution at the first meeting after registration ratifying all transactions concluded during formation, listed in an annexed schedule.
- Separating funds: not mixing personal funds with those of the venture from the first day, even before registration.
Closing Guidance
- Do not commence actual trading before registration and licensing are complete, as the exposure extends beyond civil liability.
- Retain documentation for every formation expense, the basis of accounting between the partners.
- Do not sign substantial contracts personally in reliance on a promise that they will transfer to the company later without an express clause.
- Fix in the founders' agreement a period for completing formation after which the agreement dissolves automatically.
- Check in advance which activities require licensing, as some approvals take considerable time that must be factored in.
- Instruct a lawyer to draft the founders' agreement before the constitutive contract. It costs far less than settling a later dispute.
The pre-registration phase is the period of a company's life that carries the greatest personal risk for its owners and usually receives the least attention. Yamnak Law Firm drafts founders' agreements and constitutive documents and manages registration procedures, and handles disputes over founder liability and the liquidation of de facto companies.
