Understanding Pre-Incorporation

Introduction

Pre-incorporation is the period before a company comes into existence as a separate legal person. Decisions made here set the legal, financial, and governance shape of the new venture. Done well, this stage reduces personal risk, avoids void or unenforceable agreements, and prepares the company to trade lawfully from day one.

This guide focuses on UK company law and practice (Companies Act 2006), with practical notes for those preparing for the SQE or advising early-stage clients. You will find simple explanations, core rules, and case examples you can apply immediately.

What You'll Learn

• How to choose between a sole trader, partnership, LLP, private company limited by shares, company limited by guarantee, and PLC
• What to include in articles of association and a shareholders’ agreement
• How separate legal personality and limited liability work in practice
• Why “ultra vires” no longer invalidates acts (and where internal limits still bite)
• How to manage pre-incorporation contracts under CA 2006 s.51
• The scope of promoters’ and directors’ duties under CA 2006 ss.171–177
• Key remedies for minority shareholders (derivative claims and unfair prejudice)
• Professional conduct points (SRA Standards and Regulations) and basic tax considerations

Core Concepts

Choosing a Legal Structure

Your choice affects liability, tax, funding options, and regulatory load.

• Sole trader
  • Simple, low cost, full control
  • Unlimited personal liability; profits taxed as income
• Ordinary partnership (Partnership Act 1890)
  • Two or more persons carrying on business in common
  • Partners are agents of the firm; joint and several liability
• LLP (Limited Liability Partnerships Act 2000)
  • Separate legal person; members’ liability limited
  • Partnership-style management; filing and disclosure similar to companies
• Private company limited by shares (Ltd)
  • Separate legal person; shareholder liability limited to unpaid capital
  • Flexible share structures; easier to raise equity privately
• Company limited by guarantee
  • Often used for not-for-profit activities; no share capital
  • Members guarantee a nominal amount on winding up
• PLC
  • Can offer shares to the public; higher capital and reporting standards
  • Suitable for larger ventures seeking public markets

Tip: Many SMEs start as a private company limited by shares. Consider future investment plans, employee options, and regulatory needs before deciding.

Finance and Capital

Plan how the business will be funded from day one and through early growth.

• Equity
  • Decide initial share capital, nominal value, classes (e.g., ordinary, preference)
  • Consider pre-emption rights, dividend rights, and vesting for founders
  • Map any SEIS/EIS ambitions early due to strict conditions
• Debt
  • Bank facilities, convertible loans, director loans (document terms and interest)
  • Security and priority issues if granting charges later
• Budget and runway
  • Forecast setup costs, early burn, and time to first revenue
  • Agree how pre-incorporation expenses will be reimbursed after incorporation

Constitutional Documents and Key Agreements

The company’s constitution governs how decisions are made and by whom.

• Articles of association
  • Model Articles are a common starting point; tailor where needed
  • Consider director decision-making, quorum, written resolutions, transfer restrictions
  • Objects clause is optional (default is unrestricted: CA 2006 s.31)
• Memorandum of association
  • Now a historic snapshot of subscriber intention at incorporation
• Shareholders’ agreement (recommended)
  • Reserved matters, board composition, information rights
  • Leaver provisions, vesting, drag/tag, valuation on exit
  • Dispute resolution and deadlock mechanisms

Corporate Personality and Limited Liability

• On incorporation, the company becomes a separate legal person with its own rights and liabilities (see Salomon v A Salomon & Co Ltd [1897] AC 22).
• Shareholders’ personal assets are generally protected beyond their investment.
• Piercing the corporate veil is rare and tightly confined (see Prest v Petrodel Resources Ltd [2013] UKSC 34).

Objects, Capacity and Directors’ Powers

• Default position: companies have unrestricted objects (CA 2006 s.31).
• Even where objects are restricted, acts are not invalid for lack of capacity (CA 2006 s.39).
• Third parties dealing with the company in good faith are protected (CA 2006 s.40).
• Internally, directors must act within the constitution and for proper purposes (CA 2006 s.171). Breach can trigger director liability and shareholder remedies.

Historical note: The old “ultra vires” rule limited company capacity and could void acts. Today, the issue is mainly internal (director breach), not external validity.

Pre-Incorporation Contracts

Contracts purportedly made by or for a company before it exists are a common trap.

• Statutory rule (CA 2006 s.51)
  • Such contracts take effect with the person purporting to act; that person is personally liable, unless the parties agree otherwise.
• Key cases
  • Kelner v Baxter (1866) LR 2 CP 174: no ratification by a non-existent company; personal liability arises.
  • Phonogram Ltd v Lane [1982] 1 QB 938: knowledge that the company is not formed does not remove personal liability.
  • Braymist Ltd v Wise Finance Co Ltd [2002] EWCA Civ 127: the signatory can also sue under the contract.
• Risk management
  • Use conditional agreements that require a post-incorporation novation
  • Keep heads of terms non-binding until the company is formed
  • Make it explicit if all parties agree the signatory will not be personally liable
  • Avoid signing solely in the company name before formation

Duties of Promoters and Directors

• Promoters (pre-incorporation)
  • Owe fiduciary duties to act in good faith towards the company to be formed
  • Must not make secret profits; must make full disclosure (Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218)
• Directors (after incorporation)
  • General duties (CA 2006 ss.171–177), including:
    • Act within powers and for proper purposes (s.171)
    • Act in a way they honestly consider most likely to achieve the company’s success for the benefit of its members as a whole (s.172)
    • Exercise independent judgement (s.173)
    • Exercise reasonable care, skill and diligence (s.174)
    • Avoid conflicts of interest (s.175)
    • Not accept benefits from third parties (s.176)
    • Declare interests in proposed transactions (s.177)

Minority Shareholder Protection

Plan for disagreement while relationships are still good.

• Derivative claims (CA 2006 s.260): a member may bring proceedings on behalf of the company for breaches of duty
• Unfair prejudice (CA 2006 s.994): a member may petition the court if the company’s affairs are conducted in a way that is unfairly prejudicial to their interests
• Use the shareholders’ agreement to add practical protections and clear exit routes

Professional Conduct and Tax Notes (for SQE)

• SRA Standards and Regulations
  • SRA Principles: act with integrity, independence, and in clients’ best interests; uphold the rule of law; maintain public trust
  • Codes of Conduct for Solicitors and for Firms: duties on confidentiality, conflicts, supervision, and reporting
  • Firm roles: Managers, COLP, and COFA must maintain systems and controls
• Tax headlines that affect pre-incorporation choices
  • Direct taxes differ by vehicle (income tax for sole traders/partners; corporation tax for companies)
  • VAT registration thresholds and timing
  • Stamp taxes on shares vs assets; EIS/SEIS planning where relevant

Key Examples or Case Studies

Salomon v A Salomon & Co Ltd [1897] AC 22

• Context: Sole proprietor incorporated a company and sold the business to it.
• Point: The company is a separate legal person; creditors of the company cannot generally pursue the shareholder’s personal assets.
• Application: Limited liability is real; document transactions properly to avoid later challenges.

Pre-incorporation contracts: Kelner v Baxter; Phonogram Ltd v Lane; Braymist Ltd v Wise Finance

• Context: Individuals signed contracts for a business before the company existed.
• Point: The would-be company cannot be bound pre-formation; the signatory is personally liable unless all parties agree otherwise. The signatory can also have the right to sue.
• Application: Use novation after incorporation or wait to sign until the company exists.

Randhawa v Turpin [2018] 2 WLR 1175

• Context: Consent under the Duomatic principle where one registered shareholder was a dissolved company.
• Point: Unanimous shareholder consent cannot operate where a registered shareholder cannot consent; you must consider the register as it stands.
• Application: Check the share register, capacity of holders, and quorum carefully before relying on informal consent.

Bowman v Secular Society Ltd [1917] AC 406

• Context: Challenge to the validity of a company’s incorporation on public policy grounds.
• Point: The certificate of incorporation is conclusive for the purpose of incorporation.
• Application: Once issued (now CA 2006 s.15), the certificate settles compliance with formation requirements.

Prest v Petrodel Resources Ltd [2013] UKSC 34

• Context: Attempt to reach company-held assets in matrimonial proceedings.
• Point: Piercing the veil is a narrow exception where a company is used to evade an existing obligation.
• Application: Personal and corporate dealings should be kept separate; courts will rarely disregard separate personality.

Practical Applications

• Name and identity
  • Choose a compliant company name; check Companies House and trade marks
  • Secure domains and social handles early
• Key setup choices
  • Pick your legal vehicle with liability, tax, and fundraising in mind
  • Decide registered office, accounting reference date, and SIC code
• Capital and ownership
  • Set initial share capital, classes, and subscriber details
  • Draft a cap table and plan founder vesting and leaver terms
• Constitution and governance
  • Tailor articles where needed; restrict share transfers if appropriate
  • Agree a shareholders’ agreement that covers reserved matters and exits
  • Appoint directors; confirm eligibility and conflicts checks
• Contracts and trading
  • Avoid binding contracts before formation; if unavoidable, use conditional terms and plan a novation
  • Record pre-incorporation expenses for reimbursement after formation
  • Assign to the company any IP created by founders or contractors
• Compliance and filings
  • Prepare incorporation pack: articles, memorandum, statement of capital, PSC information
  • After incorporation: maintain statutory registers, issue share certificates, consider opening a bank account and registering for VAT if required
• Risk and controls
  • Put in place insurance (e.g., professional indemnity, D&O where appropriate)
  • Set basic AML, data protection (ICO), and information security procedures
• Professional conduct and client work (SQE lens)
  • Identify the client, manage conflicts, and document retainer scope
  • Keep clear attendance notes on advice around personal liability and s.51 risk

Summary Checklist

• Confirm the legal structure (sole trader, partnership, LLP, Ltd, guarantee, PLC)
• Prepare a realistic budget and funding plan (equity/debt; pre-inc expenses)
• Draft tailored articles and a robust shareholders’ agreement
• Set share classes, rights, pre-emption, founder vesting, and leaver terms
• Plan for objects (if any), director powers, and internal approvals
• Manage pre-inc contracts: avoid or use conditional terms with novation
• Map promoter duties and, post-formation, directors’ duties (ss.171–177)
• Capture IP assignments and key commercial terms in writing
• Put in place compliance steps: PSC details, registers, VAT/ICO as needed
• Build in minority protections and dispute routes (s.260, s.994)

Quick Reference