Topic 2 : Promoters and Pre-Incorporation Contracts

Identifying a promoter
According to the case of Twycross v Grant (1877) ‘A promoter is the one who
undertakes to form a company with reference to a given project and to set it going, and
who takes the necessary steps to accomplish that purpose, and so long as the work of
formation continues, those who carry on that work must retain the character of a
promoter’. Based on the case of Tengku Abdullah ibni Sultan Abu Bakar v Mohd
Latiff bin Shah Mohd [1996], it was held that ‘A promoter is one who starts off a
venture – any venture – not solely for himself, but for others, of whom he may be one’.
However, in the case of Tracy v. Mandalay (1953), it was held that active steps or
participation is not always necessary. According to Section 2(1) of Companies Act 2016
(CA 2016), it states that a "promoter", in relation to a prospectus issued by or in
connection with a corporation, means a promoter of the corporation who was a party to
the preparation of the prospectus or of any relevant portion of the prospectus but does not
include any person by reason only of his acting in a professional capacity.

In order to briefly define what a promoter, it refers to the person who undertakes the
formation of a company by carrying out the procedure necessary for incorporation.
Promoters are also those persons who enter into contracts on behalf of a company before
incorporation. However, those merely acting in capacity on behalf of the person who
intends to set up a company are not promoters, for instance, lawyers and accountants. In
the case of Bagnall v. Carlton when the defendants were held to be promoters “because
it was their intention and conviction to sell the prospect of the company” .There we
witness the element of intention and the fulfilment of this intention as the criteria.

There are 2 types of promoters. First, active promoter who undertakes the formation of a
company by carrying out the procedure necessary for incorporation. Second, the passive
promoter who takes no active part in the incorporation of a company and the raising of its
share capital, but leaves this to others on the understanding that he or she is to profit from
the enterprise.
Duties of promoters
The promoters are in a fiduciary relationship with the company where they are under a
strict obligation to act and perform duties in the interest of the company. The promoter
must make full disclosure of any personal interest in the promotion process and
accordingly. Non- disclosure would amount to a breach of the duty of the promoter. A
promoter will also be breaching his/her duty if they make any undisclosed profits at the
expense of the proposed company. Based on the case of Erlanger v New Sombrero
Phosphate Co (1878), it was held that a promoter must not make any form of secret
profit and they must not exercise undue influence and fraud.

1. Disclosure of interest in dealings

In the case of Erlanger v New Sombrero Phosphate Co (1873), a syndicate led by
Erlanger bought an island for the cost of £55,000 which was allegedly contained
phosphates. The company was formed the directors consisting of one independent
director, two abroad directors and the rest were puppets. The island was sold for £110,000
to the company where the purchase was ratified by the board of directors. However, it
turned out that the island was worth considerably less than the purchase price. It was held
that the company was entitled to rescind the contract and the promoters were liable for
breaching their duties towards the company. In short, based on this case it was concluded
that a promoter has the duty to disclose any profit that he makes to the company by
disclosing it to an independent board of directors or to the existing or future shareholders.
In another case of Fairview Schools Bhd v Indrani a/p Rajaratnam (No.2) [1998], it
was clearly held that a promoter has a legal duty to not make any secret profit out of the
promotion of the company without the consent from the company.

1. Not to make secret profit

In the case of Gluckstein v Barnes [1900], a syndicate headed by the appellant bought
land and resold it to a newly formed company. The profit made on the transaction was
disclosed in the prospectus. However, the additional profit made by way of
reimbursement of outstanding charges on the land which the syndicate had bought at a
discount was not disclosed. It was held that a disclosure must be made in full and frank
by the promoters. Disclosure is not the most appropriate word to use when a person who
plays many parts announces himself in one character what he has done and is doing in
another; to talk of disclosure to a company where there are no shareholders as yet is a
mere farce. To the intended shareholders there was no disclosure at all .In short, the
promoters owe a fiduciary duty where the is trust owed by them and they must act
honestly to benefit the company.

In the case of Lagunas Nitrate Co v Lagunas Syndicate Ltd, it was held that that
disclosure to the members (current or potential) would be equally effective. Lindley J in
that case said disclosure was deemed necessary ‘to all available members of the
company’. Disclosure to directors who are mere nominees of the promoter will not be
sufficient to relieve the promoter of liability.

In the case of Salomon v Salomon, it was held that in which disclosure of the balance
between the true value of Mr. Salomon’s business and the overvalued price paid by the
company, which he promoted, was never made to an independent board of directors. The
House of Lords recognised that where there was not an independent board there may be
sufficient disclosure if all the original shareholders are told of the material facts. As a
consequence of the House of Lords’ decision in Salomon, it is sufficient for a promoter to
satisfy the disclosure duty by making disclosure to those who have invested or are about
to invest in the company, i.e. the company’s shareholders or potential shareholders.

In the case of Fairview Schools Bhd v Indrani a/p Rajaratnam & Ors, it was held that
promoters have a legal duty not to make any secret profit out of the promotion of the
company without the company’s consent and also to disclose to the company any interest
the promoters have in any transaction proposed to be entered into by the company’.

In the case of Re Leeds & Hanley Theatre of Varieties, the defendant company
purchased two music halls and had them conveyed to its nominee. The purchase price
was £24,000. The defendant company then promoted the plaintiff theatre company and
sold the two music halls to it for £75,000. The original board of the plaintiff was not
independent and the prospectus issued to the public failed to disclose the interest of the
defendant company or the profit it was making. It was held that the prospectus should
have disclosed its interest and profit and the defendant company was in breach of his
fiduciary duty. The company was liable in damages.

In the case of Hichens v Congreve, where the promoter acquired the property on his or
her own account before the commencement of the promotion it belongs to him or her in
law and equity and he or she can sell at a profit provided he discloses the facts. If he or
she does not make disclosure the contract is liable to be rescinded.

Remedies

1. To company

If a promoter breaches his / her fiduciary duties owed to the company, the company is
entitled to rescission of contract, recovery of secret profit or damages. Rescission of
contract generally mean that the default party has to return whatever that has been sold
and getting back the money. Company has the right to rescind the contract if there is non
disclosure irrespective of whether or not the promoter has made a secret profit.

Rescission
Equitable remedy is available to the company in respect of any contract entered into as a
result of non-disclosure or misrepresentation. It is irrelevant that the promoters made no
profit or had no dishonest motive in respect of the contract. S19(1) of the Contracts Act
1950 provides that when consent to an agreement is caused by coercion, fraud, or
misrepresentation, the agreement is a contract voidable at the option of the party whose
consent was so caused. The remedy must be exercised on normal contractual principles;
the company must not ratify the agreement and this remedy is not available if the
company is in liquidation.
Recovery of secret trust
The promoters are responsible for the profit they make at the expense of the company. At
this point, the company will not be able to rescind the contract. In the case of Gluckstein
v Barnes [1900], allegedly, Gluckstein and three others bought property for £140,000 and
then promoted a company to which they sold the property for £180,000. The first
directors of the newly founded business were then made up of these individuals. The
£40,000 profit was revealed, but not another £ 20,000 profit, since they initially bought
the property for £120,000 and not £140,000. The issue was whether the promoters
violated the company's fiduciary responsibilities? The House of Lords held that their
fiduciary responsibilities had been abused by the syndicate and were responsible for
accountability to the company for the hidden benefit they had made when independent
directors while absent from the company. In Fairview Schools Bhd v Indrani a/p
Rajaratnam (No.2) [1998], If the promoter acquires land for personal benefit, the
company should obtain a constructive order of trust and involve the promoter to hand it
over.

Damages
The company will be entitled to claim for damages if it suffers loss due to the breach of
the promoter's duty. In Re Leeds & Hanley Theatres of Varieties Ltd [1902], the
promoter sold a property to the company, which he developed at an overvaluation. The
court held that it was the promoter's violation of duty. Since the defendant’s company
owed a fiduciary duty towards the company and it had breached that duty, it was liable to
an action in damages which was assessed as the difference between the market price and
contract price, i.e. the amount of the profit.

In the case of Re Jubilee Cotton Mills, the promoter was held liable in damages for
taking an allotment of shares as consideration for the sale of his property which was over-
valued.
Misfeasance Proceedings
According to Section 541 of Companies Act 2016 it states the power of the court to
assess damages against delinquent officers. This is only applicable in winding up
proceedings. If promoter makes secret profit when forming or promoting the company, he
is guilty of misfeasance or breach of trust or duty.

2. To others

Remuneration
Traditional way is to obtain reward in form of profit made on property sold to the
company or some other ancillary transaction, provided disclosure was made. A valid
contract providing for remuneration of the promoter cannot be enforced since the
company has no capacity to enter into contract because it has not formed yet. The
company cannot ratify a pre-incorporation contract made on its behalf to enter into a new
contract with the promoter because past consideration is no consideration at all. Promoter
cannot be remunerated because the articles stated that he is entitled to a certain sum for
his services since this does not create a binding contract between the promoter and the
company.

Reimbursement of pre-incorporation expenses

The general rule is that a promoter cannot seek reimbursement unless under three
situations that are, there is a contract that binds other promoters directly or there is a
contract made on behalf of the company (before incorporation) and the contract was
ratified under Section 65 CA 2016 or there is a contract made by the company and
promoter after the incorporation.
Pre-incorporation contract

On the date of incorporation, a business comes into existence. On behalf of the company,
the promoter makes contracts before the date of incorporation. For instance, premises,
furniture, employees are required. Prior to incorporation, the promoter(s) of a company
will usually be required to enter into contractual agreements appertaining to the future
needs of the pre-incorporation company. However, until a company is incorporated it will
not exist as a separate legal entity and therefore cannot be bound by contracts made in its
name or on its behalf.

Common law position

In the case of Natal Land & Colonization Co v Pauline Colliery Syndicate, C, as agent
for a company not yet formed, entered into a contract with N Ltd by which N was to grant
a mining lease to the new company. The new company (P) was formed in January 1898
but then N gave notice that it would not grant the lease. P Ltd claimed that it was entitled
to the lease. Although the company had had the benefit of the contract it did not impose
on it any liability to pay since the contract was made before the company was formed. A
company, even after its incorporation, cannot expressly, or by conduct, retrospectively
ratify or adopt a contract made in its name or on its behalf.

In Re Northumberland Avenue Hotel Co, there was a pre-incorporation contract for the
grant to the company of a building lease. After incorporation the company took
possession of the land and began to build on it. But there was no new contract. The
company believed that the pre-incorporation contract was binding upon it. It was held
that the contract could not be ratified retrospectively and the company’s adoption of it
was not the making of a new contract. Neither may a company claim to have adopted a
pre-incorporation contract by including the terms of the contract within its articles.

In the case of Howard Patent Ivory Manufacturing Co, by a pre-incorporation

contract, J agreed to sell property to the company. After the company had been formed
the terms of the purchase were modified and J agreed to accept part of the price in
debentures instead of cash as originally agreed. It was held that the re-negotiation of the
payment terms were sufficient evidence of a new offer and acceptance by which the
company had after incorporation made a new contract.

Liability of a promoter
The general rule is that a contract which purports to be made by or on behalf of a non
existing company cannot be enforced by or against the company, and ratification by the
company is not possible. Demonstrated in the case of Re English and Colonial Produce
Company, the persons who afterwards became directors of the company instructed
solicitors to prepare the memorandum and articles of association so that the company
might be formed. The company failed to pay the solicitors’ charges and denied that it was
liable to do so. It was held that although the company had the benefit of the contract, it
did not impose on it any liability to pay since the contract was made before the company
was formed, thus the company was not bound to pay for the services and expenses
incurred by the solicitor. Liability for pre-incorporation personally at common law
depended on how the contract was signed. Until quite recently English law was governed
by what seemed two inconsistent decisions.

In the case of Kelner v Baxter (1866) on its behalf, Kelner & its partner (the promoters
of the hotel business) had entered into an arrangement to buy wine for the company that
had yet to be incorporated. The company was later established and the wine was
consumed, but the bill was not charged. The company went into liquidation and was sued
for breach of contract by the promoter. The promoter rejected liability on the basis that,
since it had accepted the contract, the company should be held responsible. It was held
that since the promoters had actually had the benefit of these goods it seems right that
they should have been made to pay for them.

If the promoter was to be held liable for contract entered into before the company was
formed and which the company did not take over by entering into a fresh contact to the
same effect, could the promoter also enforce that contract? This was a question which
arose in Newborne v Sensolid (GB) Ltd, the plaintiff (a company) entered into an
agreement to sell defendant ham, but the defendant refused to accept the delivery. The
company then sued the defendant for breach of contract. It was later discovered, however,
that the contract was made on behalf of the corporation which was not yet formed by the
promoter as the corporation was registered the day after the transaction was concluded.
The issue was whether there was a valid contract between the plaintiff and defendant.
Since he had intended to act as MD on behalf of the company and not personally, there
had never been a contract (as there was no company at the time of the supposed
conclusion of the contract.)The promoter entered the contract in the name of the company
and merely authenticated the agreement with his signature, the contract was void and the
promoter was not liable. Pre-incorporation contracts, since they are void, will not be
legally enforced. As a result, the contract against the company will not be executed by
outsiders who enter into contracts with the proposed company before its formation and
sell such goods or real property.

In another case of Black v Smallwood (1966), Black entered into a contract for the sale
of land to Western Suburbs Holding Pty Ltd. Western Suburbs Holding Pty Ltd at that
point of time did not exist, although all parties believed that it had been incorporated and
that Smallwood and Cooper were its directors. The contract was executed by Black as
vendor. The purchasers executed the contract. From the facts it was clear that Black had
intended to contract with a company only, though the company was non-existent. He did
not contract with the promoters in their personal capacity. The High Court of Australia
held that a non existent company was incapable of having agents and subsequently
neither of the signatories was liable. From the facts it as being based on the intention of
the parties.
Position in Malaysia
Pre-incorporation of contract is stated under Section 65 of Companies Act 2016.
Ratification of a pre-incorporation contract has two different positions. It is known under
English common law that a company is not permitted to ratify any contract entered into
on its behalf by an agent with retrospective effect until it was incorporated as seen in the
Natal Land & Colonization Co v Pauline Colliery Syndicate English case. In the
Malaysian position, however, it is given in accordance with Section 65(2) of CA 2016
that a company can be bound by a contract entered into prior to the company's
incorporation, provided that the contract entered into by its agent after its incorporation
has been ratified. After its incorporation, the ratification made by the company offered the
legal capacity for them to enter into the contract and be bound by the contract.

The contract may be ratified in two ways. First, express ratification by way of board
resolution/ resolution of general meeting. In the case of Ahmad Salleh v. Rawang Hills
Resort Sdn. Bhd. [1995], an agreement to sell a piece of land to defendant was entered
into by the plaintiff. There is only part of the purchase price given to the plaintiff & the
land has been divided into two sections (divided). Under the arrangement, it is given that
the process will be resolved within six months of the contract date. The plaintiffs argued
that by not being incorporated when the sale and purchase agreement was entered into,
the defendants had violated the agreement. Although the defendant company was not in
existence when the sale and purchase agreement was signed, the agreement (pre-
incorporation) was ratified by the defendant company by way of resolution under Section
35 of CA 2016. There can be either express or implied ratification. Express ratification
may be settled by passing. The motion to approve the contract should be adopted at a
general meeting by the directors or the shareholders.

Second, is the implied ratification which is based on the conduct of the company in
relation to the contract as to whether it has adopted it. In Chung Yoke Onn v. C S Khin
Development SB [1985], the promoter entered into an arrangement with the architect to
draw up design plans. Eventhough a motion to implement the agreement was not
approved by neither the Board nor the representatives at the general meeting, the
company used the proposal to construct a block of buildings. The court held that adoption
of the agreement was implied.