SCC Grants Leave to Appeal on Pre-Incorporation Agreement Dispute

In one of its final acts of 2019, the Supreme Court of Canada (“SCC”) granted leave to appeal to a legal dispute over the binding of a pre-incorporation agreement. In The Owners, Strata Plan LMS 3905 v Crystal Square Parking Corporation, 2019 BCCA 145, the owner of an office tower claimed it was not bound by the provisions of an agreement that it entered into before it was incorporated. Whereas the British Columbia Supreme Court (“BCSC”) found for the owner of the office tower (2017 BCSC 71), the British Columbia Court of Appeal (“BCCA”) disagreed. This year, the SCC will weigh in on pre-incorporation contracts and what makes them binding, providing necessary clarification on a legal principle widely used in corporate law.

Factual History

The Crystal is a large development in Burnaby, British Columbia. The development includes seven airspace parcels, which contain a mixed use retail complex, an office tower, a residential tower, a hotel complex and – of particular importance on appeal – a parking lot. The Crystal Square Parking Corporation (“CSPC”), the respondent to the SCC appeal, has owned the parking facility since 2002. The appellant to the SCC appeal is a strata corporation[1] for the owners of Strata Plan LMS 3905 (“Strata”), the office tower in the development.

In March 1999, the Crystal Square Development Corporation (“Developer”) and the City of Burnaby entered into an agreement that contains easements for access to parking facility and covenants to pay for that access (“ASP Agreement”). The ASP Agreement was registered as an easement at the Land Title Office, shortly after the agreement was made but before Strata’s incorporation. The ASP Agreement, known as a pre-incorporation agreement, is the issue in question at appeal.

The ASP Agreement contained particular provisions regarding the parking facility, including parking and access rights, parking fees, and capital costs. While the Strata did not exist when the ASP Agreement was executed, the Developer and the City of Burnaby contemplated its existence by specifically referencing it within the ASP Agreement. Moreover, the ASP Agreement included covenants by the parties to have their successors (the strata corporations) sign assumption agreements to assume ongoing obligations set out the ASP Agreement. The ASP Agreement also contained a provision that such covenants run with the land.

Conflict ensued in January 2012 when CSPC’s agent who operated the parking facility demanded capital reserve payments from Strata, as was allegedly permitted under the ASP Agreement. Strata refused and continued to only pay base rent and operating costs. In response to Strata’s refusal to pay the capital reserve payment, CSPC revoked its parking privileges and threatened to tow any vehicle found in the Parking Facility (BCSC, 38).

Procedural History

Strata launched a civil claim against CSPC, claiming that the Developer breached the duties owed to Strata by entering into an agreement on terms that were unfair to Strata. Strata further sought a declaration that the ASP Agreement was void on the grounds of unconscionability. Finally, Strata claimed they were not bound by the ASP Agreement because they were not parties to the ASP Agreement as it was created prior to Strata’s incorporation. In the alternative, Strata maintained that positive obligations set out in the ASP Agreement including the obligation to pay various parking fees and operating costs did not run with the land, and therefore did not bind Strata.

The Trial Judge held that there was no post-incorporation contract and therefore no binding pre-incorporation contract for three reasons: a) absence of privity; b) misplaced reliance on the benefit/burden exception; and c) non-adoption of the Contract.

Like the Trial Judge, the BCCA found the test in Heinhuis v Blacksheep Charters Ltd., [1987] BCJ No. 2238 [Heinhuis] to be applicable. However, unlike the lower court, the BCCA found that the Heinhuis test was met on the facts. The BCCA rejected Strata’s argument that the Heinhuis test was inapplicable to the case, finding that the test is a general rule “applicable to all cases where a newly incorporated entity shows an intention to be bound by a new, post-incorporation contract identical to that entered into by its predecessor before it was incorporated” (BCCA, 40). In concluding that the Heinhuis test was met, the BCCA allowed the appeal and found Strata to be bound by the ASP Agreement.

Is the Pre-Incorporation Contract Binding?

A pre-incorporation contract is a contract established before a party is incorporated. A pre-incorporation contract “can be the basis for a new, and identical, contract that binds the party once it is incorporated [“post-incorporation contract”], where the party shows an intention to be so bound.” (BCCA, 33). In other words, in order for a pre-incorporation contract to be enforceable, the parties’ conduct must establish an intention to be bound through a new contract containing identical terms (BCSC, 63). The issue in question on all judicial levels, was whether Strata adopted the pre-incorporation agreement after incorporation and would therefore be bound by the obligations under such contract. In finding Strata to be bound by the pre-incorporation agreement, the BCCA considered privity, post-adoption of the ASP Agreement after incorporation and the intention of the parties. 

Privity

The Trial Judge found no privity of contract between Strata and CSPC because Strata was not an original party to the ASP Agreement. On appeal, CSPC argued that lack of privity is indeed the exact purpose of the law surrounding pre-incorporation contracts. In its factum, CSPC stated that by definition, “a corporation cannot be a party to a pre-incorporation contract. Privity will always be absent.” (Appellant’s Factum, 78). The BCCA agreed with CSPC, clarifying that the rationale behind the test set out in Heinhuis was whether the parties have adopted post-incorporation contracts because of the lack of privity between parties during the pre-incorporation. 

Adoption of ASP Agreement

In finding that Strata was not bound by the ASP Agreement, the Trial Judge pointed to the fact that there was no subsequent conduct evidencing that Strata entered or wish to enter into an agreement like that of the ASP Agreement. That is, there was also no adoption (i.e. no execution of documents, no passing of resolutions) of the ASP Agreement or a contract containing identical terms after incorporation. Thus, the BCSC concluded that although the intention for Strata to eventually adopt the ASP Agreement may have been present at drafting, there was no evidence that it was actually adopted.

At the BCCA, CSPC argued that the Trial Judge erred in placing weight on this lack of formal adoption of the ASP Agreement, relying on the law from Heinhuis. The BCCA in Heinhuis placed emphasis on the conduct of the parties involved when evaluating whether each party demonstrates that they intend to be bound by the pre-incorporation contract. In Heinhuis, the court found that a party’s possession of an item and “treating it as its own” constituted acceptance of the pre-incorporation agreement (Heinhuis, 19). The BCCA agreed with CSPC, finding that CSPC’s conduct demonstrated a “continuing offer to afford an easement to the Strata,” and Strata’s conduct in using the easement and paying the parking fees listed under the ASP Agreement constitutes acceptance of the offer and, correspondingly, acceptance of the pre-incorporation contract (BCCA, 48).

Subjective vs Objective Intentions

In order for there to be a valid pre-incorporation contract, there must be an intention by the parties’ to be bound by a new, post-incorporation contract containing identical terms. The Trial Judge found there was no evidence of such intention.

While the BCCA must afford deference to the Trial Judge’s finding of fact, it can and did set aside her conclusion of a mixed question of fact and law: whether the parties’ conduct established an intention to be bound by the contract. The appellant court laid out CSPC’s arguments in support of its final conclusion that the Trial Judge erred in considering the Strata owner’s subjective understanding of their obligations. The Trial Judge relied on the subjective intentions of the Strata owners, particularly the owners’ views eight years after the contract was formed. The Trial Judge concluded that the Strata owners “did not completely understand the ASP Agreement”, because had they fully understood the terms, “I do not believe they would have entered into [the] agreement” (BCSC, 78, 79).

CSPC maintained that the subjective intentions of the owners were irrelevant, particularly when they arose eight years after the ASP Agreement was formed. The BCCA agreed that when assessing conduct to infer intention of being bound by the obligations under a pre-incorporation contract, the court must look to the conduct that “followed closely upon incorporation”, although it did not distinguish between objective and subjective intentions (BCCA, 57). The BCCA did, however look to conduct to infer objective intentions including the fact that Strata conducted itself as if it were bound by the ASP Agreement for many years – even after the dispute arose – by paying the various parking fees and exercising its right under the ASP Agreement to demand documents and information. These actions, the BCCA explained, are important considerations when determining intention: not only had Strata exercised its benefits under the ASP Agreement, it had borne the burden as well. This principle dates back to Heinhuis, where the court stated that a party “could not take the part of the contract that benefits it, while rejecting the part that required it to pay for the benefit” (Heinhuis, 244).

In finding that the Trial Judge erred in relying on the Strata owners’ subjective understanding of the obligations under the ASP Agreement and in concluding that the owners intended to be under the ASP Agreement as evidenced by their actions, the BCCA was satisfied that both parties held the requisite intention to be bound by the obligations set out in the pre-incorporation contract. 

Awaiting the SCC

Pre-incorporation contracts play a vital role in corporate law, stretching across all types of industries. The common law rules of pre-incorporation contracts have been largely replaced by the Canada Business Corporations Act, RSC 1985, c. C-44 [CBCA], with substantially similar provisions in other provincial jurisdictions, such as British Columbia and Ontario. For example, section 21(2) of the CBCA states,

(2) A corporation may, within a reasonable time after it comes into existence, by any action or conduct signifying its intention to be bound thereby, adopt an oral or written contract made before it came into existence in its name or on its behalf, and upon such adoption,

(a) the corporation is bound by the contract and is entitled to the benefits thereof as if the corporation had been in existence at the date of the contract and had been a party thereto; and

(b) a person who purported to act in the name of or on behalf of the corporation ceases, except as provided in subsection (3), to be bound by or entitled to the benefits of the contract. [Emphasis added.]

 

Yet in this case, despite making brief reference to the British Columbia Business Corporations Act, S.B.C. 2002, c. 57, the BCCA put primary emphasis on the common law test in Heinhuis when interpreting terms such as “intention” and “adopt”. This appeal provides the SCC with the opportunity to evaluate and comment on principles set out in Heinhuis, a judgement set out by its former Chief Justice McLachlin, when she sat on the BCCA. Clarification will be welcomed by industries across the board, but particularly the condo industry, where developers frequently wish to enter into agreements or create contractual obligation with yet-to-be-created strata corporations.

[1] A strata corporation is often used in residential and commercial developments. It is created to divide a building and/or a lot into separate and individually owned components. (https://www2.gov.bc.ca/gov/content/housing-tenancy/strata-housing/operating-a-strata/roles-and-responsibilities/strata-corporations)