Tutorial Tutorial 1: Promoters and Pre-incorporation Contracts 1. What is the the effect effect of a pre incorpo incorporated rated contra contract ct on the company company.. Answer:
At times, promoters will have to enter a contract with a third party though the company has yet to be registered. A pre-incorporation contract is one which is purportedly made by or on behalf of a company at a time when the company has not yet been incorporated. At common law such contracts were totally void. void . This was because until a company was incorporated it has no capacity to contract. A company company could not not ratify the contract after after its incorporation incorporation Kelner v Baxter (1886) Baxter and two others agreed on behalf of a company yet to be formed to purchase trade stock for its business. ater the company was formed and accepted and used the trade stock, but failed to pay for the stock.
HE!: The company was not liable as it could not ratify a pre incorporation contract with retrospective effect to a date before the company e"isted. #a"ter and friends were therefore unable to recover their money. Thus, in Kelner v Baxter , it was held that the pre-incorporation contract contract was not bindin$ on the company after its formation% and that the promoters or persons actin$ on behalf of the company before the formation were personally liable.
!urther, no ratification could release them from such liability.
The "nited "nited #ingdom #ingdom subse$ue subse$uently ntly introduce introduced d s&'C Companies Act 1()*, 1()*, which provides% A contract which purports to be made by or on behalf of a company at a time when when the the comp compan any y has has not not been been form formed ed has has effe effect ct,, sub+ sub+ec ectt to any any a$reement to the contrary, contrary, as one made with the person purporting to act for the company or as agent for it, and he is personally liable on the contract accordingly. This rule may be avoided by any & a$reement to the contrary,.
Phonogram Ltd v Lane [1981] confirmed that such a provision must be e"pressly and unambi$uously included in the a$reement and will not be implied. ( Note: Note: This case was decided under a prior enactment of s36C.)
'. Briefly explain the (alaysian position on pre)incorporated contracts. Answer: The alaysian position is $overned by section &*1/ and 0/ of the Companies Act 1('*. #y virtue of section &*1/ of the Companies Act 1('*% any contract or other transaction purportin$ to be made by a company prior to its formation may be ratified by the company after its formation. After such ratification% the company shall become bound by and entitled to the benefit thereof as if it had been in e"istence at the date of the contract or other transaction% and as if it had been a party thereto. #y virtue of section &*0/ of the Companies Act 1('*% prior to ratification by the company% the person or persons who purported to act on behalf of the company shall in the absence of e"press a$reement to the contrary be personally bound by the contract or other transaction and entitled to the benefit thereof. Thus% in alaysia% a pre-incorporation contract can be ratified by the company after its incorporation. nce ratified% either party can sue the other party for breach upon the contract as illustrated in Cosmic Insrance Co! Ltd! v Khoo Chiang Poh (1981).
*. +n the event of a secret profit made by a promoter of a company, what are the remedies available to the company Answer:
Erlan$er v 2ew 3ombrero Phosphate Co 41)5)6. Erlan$er% the promoter% ac7uired on his own account but in the name of another a 8nominee,/ the lease of a phosphate mine in the 9est ndies for ;**%<<<. He then proceeded to sell the minin$ ri$hts to the newly formed company for ;11<%<<<. The purchase was approved by the board of directors of the company% who had been appointed by Erlan$er and was either under his influence or% as in the case of one of the directors% who was the ord ayor of ondon% simply did not have time to $ive to the enterprise. The prospectus that offered the company=s shares to the public did not disclose the promoter=s profit. 9hen the ori$inal board of directors was replaced% the new directors% on discoverin$ the swindle% sued Erlan$er to have the contract for the sale of the minin$ ri$hts rescinded.
t was held that the contract should be rescinded because the profit made by Erlan$er had not been properly disclosed in this case to an independent board/ and therefore could not be >ept by him.
This case illustrates the fiduciary nature of the promoter=s role% which puts him very much in the same position of 7uasi-trusteeship as a company director. A >ey feature of this status is that such a fiduciary must not ma>e a secret profit. The promoter can avoid contravenin$ this re7uirement in a number of ways. #y ma>in$ a proper disclosure of any profit he has made thus removin$ any element of secrecy/ to either an independent board of directors or to the e"istin$ or prospective members of the company or n the case of a public company% compliance with the rules on prospectus disclosure is sufficient.
"lc#stein v Barnes (19$$) Promoters of a company had ac7uired a property intendin$ its resale throu$h the sale of shares in the company. n doin$ so the ori$inal directors made a substantial profit which they did not disclose thou$h it was discoverable/. The company became insolvent and investors sou$ht repayment of the hidden profit. Held: The action succeeded.
As promoters they were under a duty to declarations of the profits already made.
ma>e
e"plicit
3o a promoter has to disclose any transaction entered% either by% disclosin$ in emorandum ? Articles@ by communicatin$ to an independent #oard of !irectors@ #y communicatin$ to the e"istin$ and intended members of the company. ailure to disclose% the company has options: Company may rescind the contract %rlanger v &e' omrero Phos*hate/% and n certain circumstances% company may be able to claim the secret profit obtained by the promoter "lc#stein v Barnes/% Company may file suit for dama$es for the breach of fiduciary duties +e Leeds , -anle. /heater / f the company elects to affirm the contract% company may have a cause of action a$ainst promoters for: deceit% fraud ne$li$ent misrepresentation
-. What are the roles played by a promoter before the formation of the company
Before a company can be formed, there must be some persons who have an intention to form a company and who ta>e the necessary steps to carry that intention into operation. /etting up the company0 per Coc>burn% C.B in /'.cross v "rant 1)55/% a promoter is described as one who underta!es to form a company with reference to a gi"en pro#ect and to set it going, and who ta!es the necessary steps to accomplish that purpose.$
This classic definition includes anyone who% either ta>es the procedural steps necessary to form the company or sets up the company=s business involving entering into pre)incorporation contracts0 but does not include those who act merely in a professional capacity actin$ on the instructions of a promoter% for e"ample a solicitor or an accountant.
2romoters owe fiduciary duties towards the company, not to the individual members of the company.
f the promoter is in breach of his fiduciary duties% it is the company who may ta>e le$al action a$ainst the promoter.
A promoter owes fiduciary duties towards the company% To act in good faith To ensure that there is no conflict of interest 3efer to cases% %rlanger v &e' omrero Phos*hate Co (1808) "lc#stein v Barnes (19$$)
4. +f there is a contract entered into before the formation of the company, can the company choose not to honour the contract 2lease state your answer with the support of case law. Answer:
At times, promoters will have to enter a contract with a third party though the company has yet to be registered. This has to be analysed from two viewpoints i.e. the position in the "nited #ingdom and the (alaysian position. A pre)incorporation contract is one which is purportedly made by or on behalf of a company at a time when the company has not yet been incorporated. At common law such contracts were totally void. This was because until a company was incorporated it has no capacity to contract. A company could not ratify the contract after its incorporation Kelner v Baxter (1886) Baxter and two others agreed on behalf of a company yet to be formed to purchase trade stock for its business. ater the company was formed and accepted and used the trade stock, but failed to pay for the stock.
567% The company was not liable as it could not ratify a pre incorporation contract with retrospective effect to a date before the company existed. Baxter and friends were therefore unable to recover their money.
Thus, in Kelner v Baxter , it was held that the pre)incorporation contract was not binding on the company after its formation, and that the promoters or persons acting on behalf of the company before the formation were personally liable.
!urther, no ratification could release them from such liability.
The "nited #ingdom subse$uently introduced s&'C Companies Act 1()*, which provides% A contract which purports to be made by or on behalf of a company at a time when the company has not been formed has effect, sub#ect to any agreement to the contrary, as one made with the person purporting to act for the company or as agent for it, and he is personally liable on the contract accordingly. This rule may be avoided by any &agreement to the contrary8. Phonogram Ltd v Lane [1981] confirmed that such a provision must be expressly and unambiguously included in the agreement and will not be implied. %Note: This case was decided under a prior enactment of s36C.)
9. +n :anuary ';;<, Annie Apples and Betty Berry decided to form a company to manufacture wine. +n (arch ';;<, Annie without telling Betty purchased a plot of land, &=rapefield8 at a properly conducted auction for a price of 3( *>4,;;;. This was actually more than 1;;? less than its true market value at that time. &=rapefield8 was then transferred to the sole name of Annie. +n August ';;<, Annie approached 7ave =lee and explained to him that she was forming a wine manufacturing company. /he entered into an agreement with 7ave to supply a hydraulic grape press machine for the sum of 3( 4;,;;; which shall be payable within three months of delivery. +n 7ecember of ';;<, Annie and Betty formed a company, &/loshed /dn. Bhd.8 and that company was duly incorporated in accordance with the @ompanies Act 1<94. They each held 4;;,;;; 3(1 fully paid up shares in the newly formed company. +n :anuary of ';1;, Annie sold &=rapefield8 for 3(1.' million the actual market value at that time0 to /losh /dn. Bhd. ast week, they sold the company to /ean #ayne who has now discovered all these facts. /ean has been receiving phone calls from an irate 7ave demanding payment. 7iscuss.
+n :anuary ';;<, Annie Apples and Betty Berry decided to form a company to manufacture wine.
+n :anuary ';;<, Annie Apples and Betty Berry decided to form a company to manufacture wine. 9hen AA and ## decide to form a company% the issue is whether this will amount to promotion of a company. The law provides that there must be some persons who have an intention to form a company and who ta>e the necessary steps to carry that intention into operation. 3ettin$ up the company/. As per Coc>burn% C.B in /'.cross v "rant 1)55/% a promoter is described as one 'ho nderta#es to 2orm a com*an. 'ith re2erence to a given *ro3ect and to set it going4 and 'ho ta#es the necessar. ste*s to accom*lish that *r*ose!5 This classic definition includes anyone who: Either ta>es the procedural steps necessary to form the company@ or sets up the company=s business involvin$ enterin$ into pre-incorporation contracts/@ but does not include those who act merely in a professional capacity actin$ on the instructions of a promoter% for e"ample a solicitor or an accountant.
+n (arch ';;<, Annie without telling Betty purchased a plot of land, &=rapefield8 at a properly conducted auction for a price of 3( *>4,;;; and transferred to the sole name of Annie. This action a$ain do not amount to formation of a company% as althou$h there were actions ta>en% but the action was to transfer the property to the sole name of Annie without the >nowled$e of #etty. This may not amount to ta>in$ action to form a company and a such AA in purchasin$ the land is not ta>in$ action to form the company.
This was actually more than 1;;? less than its true market value at that time. &=rapefield8 was then transferred to the sole name of Annie.
Half- price from true value.
+n August ';;<, Annie approached 7ave =lee and explained to him that she was forming a wine manufacturing company. /he entered into an agreement with 7ave to supply a hydraulic grape press machine for the sum of 3( 4;,;;; which shall be payable within three months of delivery. 9hen Annie informs !ave of her intention and then enters into a contract to purchase hydraulic $rape press machine for *<%<<< for the company. This fulfils the re7uirements that there must be some persons who have an intention to form a company and who ta>e the necessary steps to carry that intention into operation. 3ettin$ up the company/.
As per Coc>burn% C.B in /'.cross v "rant 1)55/% a promoter is described as one 'ho nderta#es to 2orm a com*an. 'ith re2erence to a given *ro3ect and to set it going4 and 'ho ta#es the necessar. ste*s to accom*lish that *r*ose!5 •
This classic definition includes anyone who: Either ta>es the procedural steps necessary to form the company@ or sets up the company=s business involvin$ enterin$ into pre-incorporation contracts.
+n 7ecember of ';;<, Annie and Betty formed a company, &/loshed /dn. Bhd.8 and that company was duly incorporated in accordance with the @ompanies Act 1<94. They each held 4;;,;;; 3(1 fully paid up shares in the newly formed company. n !ecember 0<<(% when Annie and #etty formed a company 83loshed 3dn. #hd.% with 1%<<<%<<< shares of 1 fully paid-up this fulfill the re7uirement of section D 1/ of the Companies Act of formation of a limited company 8as a company limited by shares or $uarantees,.
+n :anuary of ';1;, Annie sold &=rapefield8 for 3(1.' million the actual market value at that time0 to /loshed /dn. Bhd. The issue that is in contention would be whether Annie fulfilled her fiduciary role as a promoter. +n Erlan$er v 2ew 3ombrero Phosphate Co 41)5)6% it was held that the contract should be rescinded because the profit made by Erlan$er had not been properly disclosed in this case to an independent board/ and therefore could not be >ept by him. A >ey feature of this status is that such a fiduciary must not ma>e a secret profit. The promoter can avoid contravenin$ this re7uirement in a number of ways. #y ma>in$ a proper disclosure of any profit he has made thus removin$ any element of secrecy/ to either an independent board of directors or to the e"istin$ or prospective members of the company or n the case of a public company% compliance with the rules on prospectus disclosure is sufficient. "lc#stein v Barnes (19$$) Promoters of a company had ac7uired a property intendin$ its resale throu$h the sale of shares in the company. n doin$ so the ori$inal directors made a substantial profit which they did not disclose thou$h it was discoverable/. The company became insolvent and investors sou$ht repayment of the hidden profit. Held: The action succeeded. As promoters they were under a duty to ma>e e"plicit declarations of the profits already made.
3o a promoter has to disclose any transaction entered% either by% disclosin$ in emorandum ? Articles@ by communicatin$ to an independent #oard of !irectors@
#y communicatin$ to the e"istin$ and intended members of the company. ailure to disclose% the company has options: Company may rescind the contract %rlanger v &e' omrero Phos*hate/% and n certain circumstances% company may be able to claim the secret profit obtained by the promoter "lc#stein v Barnes/% Company may file suit for dama$es for the breach of fiduciary duties +e Leeds , -anle. /heater / f the company elects to affirm the contract% company may have a cause of action a$ainst promoters for: deceit% fraud ne$li$ent misrepresentation
ast week, they sold the company to /ean #ayne who has now discovered all these facts. /ean has been receiving phone calls from an irate 7ave demanding payment. 3ean Fayne as the new member of the #oard of !irectors may have the followin$ options: Can use Erlan$er% Gluc>stein and e eeds to discuss: ailure to disclose% the company has options: Company may rescind the contract with the former owner of the company% namely AA and ## %rlanger v &e' omrero Phos*hate/% and in this case we were told that the company had already been sold to 3ean. nly if the nature of the company has completely chan$ed then 3ean would not be able to rescind the purchase of the company with AA and ##. escission means that 3ean would be placed bac> in a position before the contract was made would only be possible if the nature of the company had not chan$ed. As the company had only recently chan$ed hand recession may be possible. n certain circumstances% where the 3ean cannot rescind the contract the company may be able to claim the secret profit obtained by the promoter "lc#stein v Barnes/% and failin$ which% The Company may file suit for dama$es for the breach of fiduciary duties +e Leeds , -anle. /heater / f the company elects to affirm the contract% company may have a cause of action a$ainst promoters for: deceit% fraud
ne$li$ent misrepresentation. The machine supplied by !ave could have been used by the company in which case the company must affirm the contract and pay !ave for the amount owin$ and pursue to recover from the past !irector% Annie. f the company elects to affirm the contract% company may have a cause of action a$ainst promoters for: o o o
deceit% fraud ne$li$ent misrepresentation.
