Topic 5 Promoters and Pre Incorporation Contract (1) (1).pptx

Promoters and Pre Incorporation Contract

1. PROMOTERS & PRE-INCORPORATION CONTRACT

2. ‹#› PROMOTERS & PRE-INCORPORATION CONTRACT PROMOTERS DUTIES REMEDIES FOR BREACHES PRE-INCORPORATION CONTRACT COMMON LAW COMPANIES ACT 2016 RATIFICATION

3. INTRODUCTION A company has the ability to enter into a contract in its own name after has been properly incorporated. However, there are instances where the company’s promoters want to enter into a contract prior to its formation. This is to ensure the company to enjoy some benefits before the company is incorporated. i.e. Rental of premises, purchase of stationeries etc

4. WHO IS A PROMOTER? Promoter is a the person who initiates the company’s constitution and intends to use the company as a vehicle to carry on business. He actively participates in the decision to incorporate the company. Sec 2 CA 2016 defines promoter as “ 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 thereof, but does not include any person by reason only of his acting in a professional capacity.”

5. Twycross v Grant (1877) 2 CPD 469 ‘A promoter is one who undertakes to form a company with reference to a given project, and to set it going, and who undertakes the necessary steps to accomplish that purpose’ He is also a person who is a joint adventurer and who will benefit from the incorporation of a company even though he does take an active part in the formation.

6. Tengku Abdullah ibni Sultan Abu Bakar v Mohd Latiff bin Shah Mohd [1996] 2 MLJ 265 ‘ A promoter is one who starts off a venture -any venture – not solely for himself, but for others, of whom he may be one.’ Tracy v Mandalay (1953) 88 CLR- promoter involved the idea of exertion for the purpose of getting up and starting a company

7. DUTIES OF PROMOTER A promoter is in fiduciary relationship with the company promoted. Therefore, he is under obligation to act in the best interest of the company promoted and avoid conflict of interest. He must disclose his interest in any dealings with the company promoted and failure to do so is a breach of fiduciary duty.

8. The fiduciary duties of promoters are owed for the entire period which a person is a promoter; however, it is a question of fact as to when a person becomes and ceases to become a promoter. A person usually become a promoter before the incorporation of company and remains a promoter for as long as the formation continues. However, a promoter may continue to be a promoter even after the appointment of BOD, where the directors are passive.

9. DUTY NOT TO MAKE SECRET PROFIT Under the common law, a promoter has the duty not to make secret profit in relation to the promotion of the company. This is because, a promoter is in a position where he could benefit from his job (to incorporate the company). Secret profit= any profit made or benefit obtained by the promoters without the knowledge and consent of the company in relation to the promotion of the company.

10. GLUCKSTEIN V BARNES [1900] AC 240 4 promoters acquired a property at 140,000 and later resold it at 180,000 to a company which they subsequently incorporated. The prospectus stated about the 40,000 profit they made on the sale but at the same time the 4 promoters did not mentioned the fact that they acquired the property at a discounted price + enjoyed another 20,000 profit. This was not disclosed to the company. Held: the court held that Gluckstein’s disclosure was not effective unless it was made fully and frankly. “Disclosure is not the most appropriate word to use where a person who plays many parts announces to himself in one character what he has done and is doing another. ...to the intended shareholders there was no disclosure at all”

11. Disclosure must be made to an independent BOD – Gluckstein v Barnes If this is not possible, then disclosure should be made to the shareholders of the company. A promoter must make full and frank disclosure of his interest in a dealing with the company promoted. A promoter who acquires any property for the intended company is presumed to do so as the trustee of the company and must hand over the property to the company at the price it was acquired.

12. WHALEY BRIDGE CALICO PRINTING CO V GREEN AND SMITH (1880) 5 5 QBD 109 Green had acquired calico printing work for 15,000 pound. He then sold it to Smith for 20,000 pound. They later incorporated a company and Smith sold the asset to the company at the same price of 20,000 pound. However, Smith promised to give Green 3,000. After the company was incorporated, discovered about the scheme and sought to recover the 3,000 pound. Held: the court allowed the company to recover the amount promised to Green. ‹#›

13. DISCLOSURE OF INTEREST IN DEALINGS Non-disclosure of promoter’s interest in a dealing with the proposed company entitles the company to the equitable remedy of recession of contract. Case: Farview Schools Bhd v Indrani a/p Rajaratnam (No 2) ‘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.’

14. ERLANGER V NEW SOMBRERO PHOSPHATE CO (1878) Emile Erlanger was a Parisian banker. He bought the lease of the  Anguilla  island of  Sombrero  for  phosphate  mining for £55,000. He then set up the New Sombrero Phosphate Co. Eight days after incorporation, he sold the island to the company for £110,000 through a  nominee . One of the directors was the  Lord Mayor of London , who himself was independent of the syndicate that formed the company. Two other directors were abroad, and the others were mere puppet directors of Erlanger. The board, which was effectively Erlanger, ratified the sale of the lease. Erlanger, through promotion and advertising, got many members of the public to invest in the company. After eight months, the public investors found out the fact that Erlanger (and his syndicate) had bought the island at half the price the company (now with their money) had paid for it. The New Sombrero Phosphate Co sued for rescission based on non-disclosure, if they gave back the mine and an account of profits, or for the difference.

15. The House of Lords unanimously held that promoters of a company stand in a fiduciary relationship to investors, meaning they have a duty of disclosure. Further, they held, by majority ( Lord Cairns LC  dissenting), that the contract could be rescinded, and that rescission was not barred by laches. “Promoters stand undoubtedly in a fiduciary position. The have in their hands the creation and moulding of the company; they have the power of defining how, and when, and in what shape, and under what supervision, it shall start into existence and begin to act as a trading corporation” Specially Crafted by | TAQI’UDDIN HAMZAH ‹#›

16. REMEDIES FOR BREACH OF DUTIES Remedies for Breach of Promoter’s Duties Rescission Recovery of secret profits and constructive trust Damages Liability under the Companies Act 2016

17. RESCISSION- LAGUNAS NITRATE V LAGUNAS SYNDICATE [1899] 2 CH 392 Rescission of contract is the remedy that a company will seek where it has entered into a contract in which a promoter has an interest which was not disclosed. However, a company may not be able to rescind the contract in several situations such as: It does not rescind the contract reasonably promptly after becoming aware of the promoter’s interest in the contract. After becoming aware of the promoter’s interest, it does something which indicates that it has affirmed the contract. Restituo in integrum is impossible. It is not possible to restore the parties to their original position. Where prior to the rescission of contract, an innocent party acquires some interest in the property. Restoration of the property in the same condition as when it was purchased or if a third party have acquired interest in it.

18. RECOVERY OF SECRET PROFITS AND CONSTRUCTIVE TRUST Where promoter makes secret profits at the expenses of the company promoted, the company can recover the secret profits unless the promoter has disclosed that profit to the company. Where a promoter, during the course of promotion, acquires property for his personal gain, the company may obtain a constructive trust order and require the promoter to hand it over at cost. See Gluckstein and Fairview’s case above.

19. DAMAGES In addition to the above, the company may also sue the promoter for damages if it suffers loss as a consequence of the promoter’s breach of duty – Re Leeds & Hanley Theater’s of Varieties Ltd

20. LIABILITY UNDER THE COMPANIES ACT 2016 Section 199(1) provides that where a person is convicted of any offence in connection with the promotion of a corporation, that person shall automatically be disqualified from being a promoter for five years, unless he obtains leave from court.

21. PRE- INCORPORATION CONTRACTS

22. DEFINITION OF PRE-INCORPORATION CONTRACTS Pre-incorporation contract simply is a contract purpotedly entered into on behalf of a company before its incorporation. It must be noted that before incorporation, a company has no contractual capacity

23. COMMON LAW POSITION Prior to its registration, a company as a legal entity does not exist. At this stage, neither the company can enter into contracts nor can it appoint any person to enter contract on its behalf. Therefore, at common law, a company is not bound to any contract made prior to its incorporation – Newborne v Sensolid (Great Britain) Ltd At common law, a company is also not capable to ratify any pre-incorporation contract – Kelner v Baxter A company could not enter into a contract before it was incorporated as it had no separate legal existence until its incorporation - Black v Smallwood

24. 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. Later the company was formed and accepted and used the trade stock, but failed to pay for the stock. HELD: 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. Further, no ratification could release them from such liability.

25. MALAYSIAN POSITION- SEC 65 A pre-incorporation contract is a binding contract on the company if the company ratifies after the incorporation. Prior to ratification, the person who purportedly sign the contract before incorporation, is personally liable to the contract. Sec 65(1) However, if the company ratifies after its incorporation, the company will be bound by the contract as if the contract was signed by the company.

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27. HOW RATIFICATION IS MADE? The Act is silent on how ratification of pre-incorporation contract should be made. It can be expressed or implied ratification. However, in Ahmad Bin Salleh v Rawang Hills Resort Sdn Bhd [1995] 3MLJ 211, it is suggested that a board resolution that has the effect confirming that the company has adopted the pre-incorporation contract will suffice. In Cosmic Insurance Corp v Khoo Chiang Poh [1981] 1 MLJ 61, the Privy Council held that implied ratification was also accepted. When the company fails to ratify the contract, the person who signed the contract will be personally liable.

28. COSMIC INSURANCE CORP V KHOO CHIANG POH [1981] 1 MLJ 61 Three things must exist : the allegedly contract or other transaction must purport to have been entered into by any person on behalf of a company before its formation: It is only after the first condition is satisfied, that the company may ratify the alleged contract or other transaction after its formation; and it is only if those conditions are satisfied that such a contract upon such ratification is ante-dated to the date when it was first purported to have been made. Specially Crafted by | TAQI’UDDIN HAMZAH ‹#›

29. POSITION UNDER THE NEW COMPANIES ACT 2016 Sec 65- a contract of transaction that purports to be made by or on behalf of a company has effect as a contract or transaction made with the person purporting to act for the company or as agent for it, and he is personally liable on the contract or transaction accordingly. Sec 65(2)- Notwithstanding subsection (1), a contract or transaction referred to in that subsection may be ratified by the company after its incorporation and the company shall be bound by the contract or transaction as if the company had been in existence at the date of the contract or transaction and had been a party to the contract or transaction.

30. NON-APPLICATION OF DOCTRINE OF CONSTRUCTIVE NOTICE Section 39 states that no person shall be deemed to have notice or knowledge of the contents of the Constitution or any other document relating to a company due to the fact : That the constitution or document has been registered by the Registrar; or That it is available for inspection at the registered office of the company, With the exception of document relating to instrument of charges.

31. CONCLUSION ‹#›