General
A number of fundamental principles are at the base of modern corporate law, when most of the provisions of the Companies Act, 5799-1999 (hereinafter: “the Act”) relate to a wide range of rules pertaining to the nature of the corporate – commercial conduct.
These rules cannot be fulfilled completely without the existence of 2 main principles in corporate law: the principle of the separate legal entity of a company, and the principle of limited liability of shareholders and directors in the company. These principles are entwined and together they create a barrier, limiting the personal liability of shareholders and company directors, and places the company before them, as a separate legal entity, which enables proper business engagements with third parties, without the concern for personal damage to the assets of those who control the company and/or its directors, beyond their undertakings in the company’s articles of association. This is not the case when individuals act without the mediation of a sole separate legal entity, in which case the Act subordinates each individual’s entire assets to his entire undertakings.
These fundamental principles encourage economic growth and business engagements where initiatives and businesses can be established and developed and even have the ability to initiate and undertake in the name of a company, which, as stated, constitutes a separate legal entity.
Without derogating from the above, there are some cases where an individual will engage with another individual or with a corporation for the purpose of initiating a business venture, in the framework of a company which has not yet been established.
The purpose of this paper is to examine the definition of the term “entrepreneur” in the eyes of the Companies Act, as well as to review the main foundation stones when engaging with this type of entrepreneurs.
Who is an Entrepreneur?
An entrepreneur is defined in Article 1 of the Act, as: “Anyone who performs an action, in the name of or in the place of a company which has not yet been established”, where an action is defined in the Act as “A legal action, whether by action or omission”. It is possible to infer that these definitions do not constitute a closed and defined legal framework of actions which constitutes actions of an entrepreneurial nature.
In the past, corporate law has tried to attribute liability to the entrepreneur by using agency laws and trust laws, however these attempts have been omitted in the final version of the Act. Nonetheless, it seems that the courts have expanded the circle of liability so that it will apply to entrepreneurs as well.[1]
The Companies Act as a Mechanism for Approving Preliminary Contracts
The Act acknowledges the problems involved in defining an entrepreneur, and therefore enables entrepreneurial actions for the parties depending on said activity, i.e. the company, in which name the entrepreneur acts and the third party, with whom the business transaction is made.
The provisions of Article 12 of the Act enable the approval of an action and/or contract which was made by the entrepreneur on behalf of the company retroactively after establishing it, provided that there is no harm to a right which another person has acquired in good faith and for consideration prior to the retroactive approval. Thus, the company takes upon itself obligations which were taken for it prior to its establishment.
If a company chooses not to approve the entrepreneur’s actions retroactively, there is importance in characterizing the entrepreneurial activity as a visible initiative or a hidden initiative, with regards to the reliefs available to the third party.
If the entrepreneurial action is visible, namely, the third party is aware that the entrepreneur engages in the name of a company which has yet to be established, he has the choice of whether to see the entrepreneur as a legal party, or alternatively, whether to terminate the transaction and to take legal actions against the entrepreneur for any damage he caused.
However, if the entrepreneurial action is hidden, namely, the third party is not aware that the entrepreneur engages in the name of a company which has yet to be established, but rather he thinks that he is engaging directly with the entrepreneur, the entrepreneur shall be considered as engaging personally, and the entire obligations and rights stipulated in the specific transaction, shall apply to him.
If the company will approve the transaction retroactively, all of the obligations shall apply to the entrepreneur and the company jointly and separately.
The Relationship between Joint Entrepreneurs
The principal-agent problem is usually created on all the levels in which the entrepreneur is active, when the most prominent ones are the level between the company and the third party and the level between the entrepreneur and the company (which is in the process of establishment).
However, another level of activity exists between entrepreneurs amongst themselves. There is a structural difficulty in maintaining business relations with a number of entrepreneurs who act separately and not under a single entity. It seems that in these cases, the “partnership relations” between the entrepreneurs in accordance with Article 1 of the Partnership Ordinance do not exist in light of the foregoing, therefore it is important that the partners regulate the relationship between them via a founders agreement, an action which shall also benefit third parties engaging with the entrepreneurs, due to the option of enforcing mutual undertakings taken by the entrepreneurs in the framework of the transaction.
Due to the uniqueness of the relationship between the entrepreneurs and the pseudo-partnership relations applied to them, there is a difficulty in enforcing mutual undertakings. Thus, in the ruling on the case of Agassi vs. Hilan et al.[2] it was ruled that there shall be no enforcing of a founders agreement which applies an undertaking on the founder of a company to hold a minimal amount of shares upon finishing his role in the company due to differences of opinion with the other founders.
This judgment has significant implications on the manner of engaging with other entrepreneurs, as well as with third parties who rely on the provisions of the Act in order to receive reliefs upon the occurrence of a contractual violation by an entrepreneur acting in the name of a company which has yet to be established.
Conclusions
The free market and the business activity resulting from it, does not prevent engagements with an entrepreneur operating on behalf of a company which has not yet been established, as well as the entrepreneurs acting in this manner. However, the uncertainty increases when having business relations with entrepreneurs who engage in preliminary contracts without any reference for their certification or for actually establishing a company, both for the company which is intended to be established and its directors, and for third parties and additional entrepreneurs.
However, the Act imposes duties on entrepreneurs who are partly similar to those imposed on directors in a company, such as imposing personal liability to an entrepreneur, setting preliminary conditions regarding the manner of establishing the company, as well as regulating the contractual relationship between entrepreneurs, if there are a number of entrepreneurs acting jointly.
In order to continue encouraging transactions and stable business relationships, even at the preliminary stages prior to the establishment of a company, the parties involved must have business relations in complete transparency and with good faith while disclosing information in an extensive manner in order to avoid risks which might damage the quality of the engagement.
[1] For this matter, see Civil Appeal 585/82 Kosoy vs. Feuchtwanger Bank, Supreme Court Rulings 38(3) 253, 278.
[2] Civil Appeal 552/85 Agassi vs. H.I.L.A.N Israeli Company for Data Processing Ltd. (published on Nevo 25/01/1987)