Promoters and pre-incorporation contracts
Chapter 3
Promoters and pre-incorporation contracts
Chapter Contents
3.3 Remedies for breach of promoters’ duties
3.4 Payment for the promoters’ services
3.5 Pre-incorporation contracts
Somebody has to set up the company and, in order to set up a company, there have to be promoters. The promoters will purchase property from which the company is going to operate and undertake the preliminary steps to set the company up. They will thus be acting before the company has been formed.
In Victorian Britain, there used to be professional company promoters. These promoters were often dishonest and acted fraudulently. The Anglo-Bengalee Disinterested Loan and Life Assurance Company, mercilessly lampooned by Dickens in Martin Chuzzlewit, is typical of the sort of situation that arose. Indeed Albert Grant, who features in some of the prominent late Victorian cases concerning company promotion, is assumed to be the inspiration for the villain Augustus Melmotte in Trollope’s The Way We Live Now.
A code of rules therefore developed to ensure that promoters acted with integrity in setting up the company.
There are few statutory rules in this area and indeed no satisfactory statutory definition of a promoter. Section 67 of the Companies Act 1985 formerly defined a promoter in s 67(3) as a person who is ‘a party to the preparation of the prospectus or a portion of it’.
In the absence of any precise definition in statute, resort must be had to judicial statements relating to promotion. As Gross notes in ‘Who is a company promoter?’ [1970] 86 LQR 493, the term ‘promoter’ is ill defined by companies legislation. The usual dictum referred to in defining a promoter is that of Cockburn CJ in Twycross v Grant (1877) 2 CPD 469, where he said that a promoter is ‘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’. This definition is clearly somewhat general. In Whaley Bridge Calico Printing Co v Green (1880) 5 QBD 109, Bowen J said:
The term promoter is a term not of law, but of business, usefully summing up in a single word a number of business operations familiar to the commercial world by which a company is generally brought into existence.
The old, Victorian rogue promoters responsible for finding directors to manage a company and for drafting prospectuses to raise capital from the public are largely a thing of the past. Most companies are promoted as private companies by those who will subsequently be managing the business. Rules are still necessary to protect those investing in the business and to protect creditors.
A company promoter owes fiduciary duties to the company that he is setting up. Fiduciary duties are basically duties of good faith and integrity. Most obviously, where a promoter is selling property to a company, he must ensure that he discloses any profit that he is making on the deal. The disclosure may be made to all of the shareholders, actual and potential, as was the case for example in Salomon v A Salomon & Co Ltd (1897). Disclosure to the shareholders was also the method employed successfully in Lagunas Nitrate Company v Lagunas Syndicate [1899] 2 Ch 392. Alternatively, the disclosure may be made to the company’s directors. However, in such an instance the disclosure can only be effective if it is to an independent board of directors. In Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218, a syndicate had purchased a lease of a Caribbean island called Sombrero. The syndicate was selling the island to a company that had been formed for the purpose.
The syndicate owed promotional duties in relation to the sale. They disclosed the profit that was being made in selling the island to the company to the board of directors. There were five directors; two were abroad at the material time, two were associated with the syndicate and the fifth was the Lord Mayor of London who was too busy to give proper attention to the affairs of the company. It was held in the circumstances that this was not a full disclosure to an independent board of directors. The company was able to rescind the contract.
When a promoter discloses a profit that he is making upon a deal, he must take care to ensure that he is disclosing the entire profit that he is making from the arrangement. In certain cases, there may well be some collateral profit as well as the direct profit from the sale. It was thus in Gluckstein v Barnes [1900] AC 240, where a syndicate had purchased the exhibition hall, Olympia. The syndicate disclosed the profit that it was making in re-selling the hall to the company but failed to disclose a profit that it was making in relation to certain mortgages over the hall which it had purchased at a discount. This meant that, when the syndicate purchased the hall, there was a further reduction of £20,000 since the price of the purchase also included an amount to be set off against debts which were now owed to the syndicate. Lord MacNaghten said:
They issued a prospectus representing that they had agreed to purchase the property for a sum largely in excess of the amount which they had, in fact, to pay. On the faith of this prospectus, they collected subscriptions from a confiding and credulous public. And then comes the last act. Secretly, and therefore dishonestly, they put into their own pockets the difference between the real and the pretended price.
The case clearly represents a breach of promoters’ duties and the promoter in question, Gluckstein, was ordered to repay his share of the secret profit.
Particular problems may arise where a promoter has acquired property before the promotion began. In such a situation, where the promoter then sells the property to the company without fully disclosing the profit that is being made upon the transaction, there is a difficulty in awarding an appropriate remedy. If the company were to seek an account of profits in such a case, the question would arise as to what portion of profits properly belongs to the pre-promotion period and so would be rightfully the property of the promoter, and what part of the profit could be said to belong to the post-promotion period and so belong to the company. In such cases, therefore, the view of the courts is that it is not possible to sue for an account of profits but merely for rescission of the contract, always assuming that the right to rescission has not been lost. See Re Cape Breton Co, Cavendish-Bentinck v Fenn (1887) 12 App Cas 652 and Ladywell Mining Co v Brookes (1887) 35 ChD 400. These decisions have been criticised notably by Xuereb in ‘Secret profit – Re Cape Breton Company revisited’ (1987) 5 CLD 9 on the basis that some apportionment of the profit could be made by the court.
3.3 Remedies for breach of promoters’ duties
Promoters owe fiduciary duties to the company which they are promoting. The duty is akin to the duty owed to the unborn child as no company is yet in existence. However, there is a range of remedies that will be available against a promoter who has breached his duty and failed to disclose the extent of the profit that he is making where he has sold property to the company. A possible remedy is for rescission of the contract of the sale between the promoter and the company. The usual bars to rescission will apply. Thus, rescission is not available where there has been affirmation, where it is impossible to restore the parties to their pre-contractual positions or where third party rights have intervened.