Irregular Companies and Actions By Interested Third Parties

Associate Carlos Fernández, lawyer in El Salvador, shares this article on the concept of irregularity in commercial companies in El Salvador and the legal implications of operating beyond the limits of their articles of association.

In what cases will contracts signed between an irregular society and its suppliers, consumers, and third parties not be legally binding if their purpose is not included in the social objective?

Commerce is an activity involving persons and legal entities. Within this realm, situations arise that specifically affect legal entities due to their nature, such as the possibility of entering into contracts outside of the scope of their purpose.

Companies are constituted by the collective will of their founders, partners, or shareholders, comprising both natural and legal persons. They acquire legal personality upon registration of their articles of incorporation in the Commercial Registry. However, in cases where a company operates without registration, despite being irregular, it may still enjoy legal personality through a judicial process.

Furthermore, the governance and development of a corporation are governed by its articles of incorporation/bylaws, which constitute the internal regulatory framework through which a company conducts its activities. These articles establish its corporate name, address, duration, regime, purpose, administration, etc.

Once fully formed and operational, this corporation will engage in activities, enter into contracts, incur obligations to third parties, become a creditor, and operate in commerce, among other activities. The representative, as determined in the articles of incorporation, will be responsible for administration, either freely and with full authority or with varying degrees of restriction imposed by the corporation as per the intentions within the bylaws.

But what happens when a regular corporation operates beyond the limits established in its bylaws?

The scenarios that arise from this question are extensive and encompass a variety of possibilities and combinations of situations in which a society may exceed its social pact, making each case unique and worthy of in-depth study. These cases result in a state of irregularity or nullity of a corporation.

In this article, the main focus will be on irregularities, particularly on the granting of contracts by a society that exceeds its contracting capacity, as these actions fall outside of its purpose.

1. Is irregularity a state or a characteristic?

Regarding its constitution and perfection, the jurisprudence of El Salvador establishes that "irregular corporations are those that, despite acting before third parties as a legal person, lack the requirements for their constitution according to one of the associative forms recognized by the legal system (Article 346 C. Com.), or in any case, the deed of incorporation does not meet all the necessary requirements (Article 347 C. Com.), so it has not been possible to register it and thereby have the birth of its legal personality."1

Once constituted and perfected, a corporation may find itself in irregularity due to various reasons. These may include: the social pact not meeting the necessary requirements; when it engages in illicit acts despite being duly constituted; the society being reduced to a single partner; and when it prolongs its existence beyond the term established in the bylaws 2. These causes are outlined in Articles 347, 356, and 357 of the Commercial Code. Additionally, from the reading of Articles 113 and 354 of the Commercial Code, we can infer that granting acts and contracts outside the scope of the corporate purpose constitutes a state of irregularity, which can be remedied by requesting the reform of the bylaws.

Based on the foregoing, we can infer that a corporation may find itself in a state of irregularity when. However, it can rectify this situation in order to develop, fulfill its obligations, and enforce its rights. In other words, irregularity is a remediable state, sometimes even before undergoing a dissolution process.

2. Corporations in a state of irregularity when they operate beyond their intended corporate purpose

In accordance with the provisions set forth in Articles 113 and 354 of the Commercial Code, a society is deemed irregular when it grants acts and contracts beyond its corporate purpose. However, this irregularity can be rectified by amending the bylaws of the corporation to encompass such activities within its corporate purpose.

Based on the preceding explanation, it's clear that the corporation wasn't initially in an irregular state upon its formation. It's assumed that the corporation was properly established, adhering to all legal requirements, and its incorporation documents were duly registered. However, when it began to engage in acts or contracts outside its intended corporate purpose, it transitioned into an irregular state.

For instance, consider a company that was properly established with all the legal formalities, registered in the appropriate registry, and whose stated purpose is construction. However, at a certain point, this company decides to offer legal services, which are not within its stated scope. As a result, it becomes irregular. In such cases, it is possible to rectify this situation so that the company does not remain irregular. Article 354 of the Commercial Code mandates that the company must amend its corporate purpose to include the new activity within its stated scope.

Now, let's consider another scenario where there is a different company, also duly established with all legal formalities and registered in the Commercial Registry, whose legal purpose is to provide legal services. However, for various reasons, it decides to start managing trusts, an activity clearly outside its social purpose. In this case, rectifying the situation wouldn't be possible because merely modifying the social purpose within the social pact wouldn't suffice. According to Article 1238 of the Commercial Code, only banks or credit institutions authorized by law can act as trustees. This would be a scenario where the sanction outlined in the same Article 354, second paragraph, would apply, which states: "Any interested party shall have the right to demand the reform; the Judge shall set a period of four months for it to be verified and, once this period has elapsed, if the company has not complied with the requirement, it shall be liquidated."

From the above examples, it becomes evident that despite a company being established in compliance with legal requirements, circumstances may arise during its legal existence that can render it irregular, and these situations may not always be remediable.

Actions by third parties against irregular companies

Our legislation defines various types of actions that can be taken by an interested third party against a company operating in a state of irregularity. These include the request for nullity and the request for reform of the social pact. The first action would lead to the dissolution and liquidation of the company, involving a process of distributing the company's assets in accordance with the various interests involved. The second action is provided for in Article 354 of the Commercial Code, allowing an interested company or trader to request that a company with which they are contracting regularize its situation. This can be achieved by modifying the social pact to overcome the state of irregularity, without requiring dissolution and liquidation, as long as the period established for resolving the situation lasts.

In the case at hand, our legislation includes a specific section that is even more rigorous regarding irregularities when a company operates outside its social purpose. This is established in Article 350 of the Commercial Code, which states that in El Salvador, certain activities are regulated and permitted only for certain types of companies, such as trusts. Therefore, a company that administers trusts without prior authorization and without being of the specific nature required may be requested to nullify its activities and initiate the process of liquidation and dissolution. This type of irregularity cannot be rectified and could result in its activities being deemed illicit, even if all the necessary requirements for its existence have been met.

Is a contract considered valid if it is made by a company whose purpose does not align with the nature of the contract?

In the case of contracts granted by a company whose purpose is exceeded by the contract itself, Article 17 of the Commercial Code provides the initial parameter to address this question. It states that the purpose serves as the limit to which companies enjoy legal personality. Therefore, exceeding this purpose leads to a breach of legal personality, resulting in liability for the partners, shareholders, or the legal representative or administrator of the company. It is essential to emphasize that this is a condition that can be remedied, as a third party can request the amendment of the company's social contract if it is found to be in a state of irregularity.

Based on the above, and provided that good faith exists on the part of the interested third party, the contract will be valid. The obligations arising from it will be enforceable, and compliance will be required. This aligns with Article 252 of the Commercial Code, which outlines the responsibility not only of the company but also of its shareholders and administrators.

Proposed Solutions:

Commerce is an activity that continues to grow and evolve every day. Regarding the limitations that may arise from establishing very specific purposes within the social pact of a company, commerce has evolved to use concepts or texts that encompass a greater variety of social purposes, thus facilitating the granting of acts or contracts without this constituting a breach of the Company's bylaws.

In light of the above, commerce could be facilitated if all companies incorporate texts in their purposes that are not restrictive, enabling easy access to all types of businesses, without having to limit themselves because the purpose of the company is a margin of action, but rather because it could become a tool for the commercial development of a society.