PROMOTERS KKG

TOPIC 3 – PROMOTERS

A promoter is a person who does the necessary preliminary work incidental to the formation of a comp
directors who are often the promoters themselves, under a different name.

LEARNING OBJECTIVES

At the end of this lesson the leaner should be able to:

Define of promoters
Describe the functions of promoters.
Describe legal status of a promoter
Describe fiduciary position of a promoter
Describe duty of promoter as regards prospectus
Explain remuneration of promoters
Describe pre – incorporation or preliminary contracts
Explain position of promoters as regards pre – incorporation contracts
Explain ratification of a pre-incorporation contract

A promoter is the person who conceives the idea of forming a company and who undertakes,
does and goes through all the formalities and incidental preliminaries of incorporating a
company. Promoter help to incorporate a company, provide it with a share and loan capital and
acquire business or properly which it is to manage.

Chronologically, the first persons who control a company’s affairs are its promoters. It is they
who conceive the idea of forming the company, with reference to a given object and then to set
it going. It is they, who take the necessary steps to incorporate the company, provide it with
share and loan capital and acquire the business or property which it is to manage. When these
things have been done, they hand over the control of the company to its directors who are often
the promoters themselves, under a different name.

Lord Blackburn has beautifully stated that “it is a short and convenient way of designating those
who set in motion the machinery by which the Act enables them to create and incorporate
company.

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Justice Cockburn defines a promoter as, “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”

So long as the work of formation continues, those who carry on that work retain the character of
promoters. However, if the board of directors is formed and it undertakes the remaining work of
company formation, the promoters‟ function comes to an end.

Not everybody connected with the formation of a company can be called a promoter. Thus the
professional adviser, legal as well as others, are not promoters. Similarly, when those engaged
in starting a new enterprise, consult an expert to advise them of the full facts with regard to the
proposed enterprise and its future prospectus (e.g values, surveyors, engineers e.t.c) they cannot
be called promoters.

S. 45 (5) of the Companies Act [Cap 486] Law of Kenya does not include a person acting in a
professional capacity within the meaning of a promoter e.g a lawyer. Whether a person is or is
not a promoter is a question of fact depending upon the role performed by him in the formation
of the company. A person who does not play a prominent role may also be a promoter if he has
so acted. But if the person is merely employed in professional or technical capacity such as a
lawyer (for preparing the Memorandum and Articles of Association of the proposed company)
accountants, valuers or business consultant he will not be a promoter.

Section 45(5) (a) provides that a promoter means a person who has a party to the preparation of
the prospectus, but does not include any person acting in a professional capacity for persons
engaged in the formation of the company. But if any such person acts beyond the scope of his
professional duty and helps in any way in the formation of a company or in preparations for the
management of its affairs, he will become a promoter A registered company may also act as a
promoter.

Functions of Promoters

The promoters of a company decide its name and ascertain that it will be accepted by the
Registrar of Companies. They settle the details of the company’s Memorandum and Articles the
nomination of the directors of the company, bankers, the secretary and the registered office of
the company. They arrange for the printing of the Memorandum and Articles, the registration of
the company, the issue of prospectus; where a public issue is necessary. They are in fact
responsible for bringing the company into existence for the object which they have in view.

Legal Status of a Promoter

As to the exact legal status of a promoter, the statutory provisions are silent. His legal status is
incapable of precise statement, but Lindley L. J described his position in Lydney & Wigpool
Iron Ore Co. s. Bird [1866] 33 ch.d as follows.

“Although not an agent for the company, nor a trustee for it before its formation the old familiar
principle of the law of agency and of trusteeship have been extended and very popularly
extended to meet such cases”

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PROMOTERS KKG
Thus it appears that a promoter is neither an agent nor a trustee of the company under
incorporation but certain fiduciary duties have been imposed on him under the Companies Act.
He is not an agent because there is no principal born by that time and he is not a trustee because
there is no “cestui que trust” i.e beneficiary in existence. Hence he occupies the peculiar
position of a quasi trustee.

Fiduciary position of a promoter

A promoter stands in a fiduciary relation (requiring confidence or trust) to the company which
he promotes. In E – langer Vs New Sombero Phosphate Co (1878) 3 A. C. 1218, Lord Cairns
observed in this regard:

“In equity the promoters of a company stand in a fiduciary relation to it and those persons
whom they induce to become shareholders in it, and cannot in equity bind the company by any
contract with themselves as promoters without fully disclosing to the company all material facts
which the company ought to know”

The fiduciary position of a promoter may be summed up as follows.

1. Not to make any profit at the expense of the company:

The promoter must not make, either directly or indirectly any profit at the expense of the
company which he is promoting. If any secret profit is made in notation of this rule, the
company may on discovering it compel him to account for and surrender it, such profit . If he
sells to the company, stock or shares of his own at prices in excess of their market value, he
may be liable in damages for the excess of the price received by him over the market value.

2. To give benefit of negotiation to the company:

The promoter must, when once he has begun to act in the promotion of the company, give to the
company the benefit of any negotiations or contracts into which he enters in respect of the
company. Thus, where he purchases some property for the company, he cannot rightfully sell
that property to the company at a price higher than he gave for it. If he does so, the company
may on discovering it, rescind the contract and recover the purchase price.

In Erlanger Vs New Sombrero Phosphate Co. (1878) 3 A. C. 1218, a syndicate, of which E was
the head, purchased an island said to contain valuable minerals. E, as promoter, sold the island
to a company newly formed for the purpose of buying it. A contract was entered into between
X, a nominee of the syndicate, and the company for purchase at double the price actually paid
by E. It was held that as there had been no disclosure by the promoters, of the profit they were
making, the company was entitled to rescind the contract and to recover the purchase money
from E and the other members of the syndicate.

When a promoter sells or wishes to sell his own property to the company, he should either see
that there is a Board of independent persons appointed as directors of the new company or
disclose his interest in the property to the intended members or to the public by means of a
prospectus. He must also make a full disclosure of profits he is making in that deal.

3. To make a full disclosure of interest or profit:

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PROMOTERS KKG

If the promoter fails to make a full disclosure of all the relevant facts, including any profit and
his personal interest in a transaction with the company, the company may sue him for damages
for breach of his fiduciary duty and recover from him any secret profit.

It is important to note that it is not the profit by the promoter which the law forbids, but the
non–disclosure of it and if disclosure is made, the profit is permissible

The disclosure must be made to an independent Board of Directors. Where there is no

independent Board, disclosure must be made to the intended shareholders as a whole.

The measure of damages is the actual loss suffered by the company as a result of the transaction
in question.

st
On 1 February 1873, five persons bought a mine for £ 5,000 for cash with a view to selling to a
th
company to be formed. On 4 April, 1878 they entered into a provision contract with the
trustees of the intended company for the sale of the mine for £ 18,000. Subsequently when the
company was registered it adopted
th
the contract of 4 April, and four of the vendors were appointed the directors of the company.
st
On coming to know of contract of 1 February which was not disclosed to the company, the
company sued the vendors to recover that profit of £13,000. It was held that the vendors were
not promoters when they bought the mine and they were therefore under no fiduciary duty to
disclose their interest and account for the profit they had made.

Thus, a person who is not the agent nor the trustee of a company, nor in a fiduciary relationship
to the company can, when he buys he buys property sell the same to the company at a profit
without disclosing the same.

4. Not to make unfair use of position:

The promoter must not make an unfair or unreasonable use of his position and must take care to
avoid anything which has the appearance of undue influence or fraud.
Note:

Persons, who are acting in a purely professional capacity who have been instructed by a promoter,
for example, a lawyer or accountant, do not become promoters themselves.36 Although, if they go
Duty of promoter
beyond this and,as
forregards prospectus
example, agree to become a director or secretary of the company, they will be
held to have become promoters.
The promoter must see, in connection with the prospectus if any is issued or a statement in
lieu of prospectus, that the prospectus:

i) Contains the necessary particulars

ii) Does not contain any untrue or misleading statements or does not omit any material facts.

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PROMOTERS KKG

iii) Section 39 of the Act states that a prospectus issued by or on behalf of a company or
in relation to an intended company shall be dated; and that date unless the contrary
is proved, is taken as the date of publication of the prospectus.

iv) Section 40 provides that every prospectus issued by or on behalf of a company or on

behalf of any person who is or has been engaged or is interested in the formation of
the company shall state the matters specified in part one of the third schedule.

It is important to note when a company issues a prospect, this does not constitute an offer
made by the company to members of the public for the company’s shares. It is a mere
invitation to treat. However, is must be truthful in its content since the promoters can be
held liable for any misstatement in the prospectus. If the promoters fail to do this then
following consequences may ensue:

a) Allotment of shares may be set aside in the case of a fraudulent or innocent

misrepresentation.

b) They may be sued for damages.

c) They may be sued for compensation for misrepresentation.

d) They may be sued for damages by shareholders who have suffered by reason of their non
– compliance with the statutory requirements as to the contents of the prospectus, and

e) They may become liable to criminal proceedings.

The Companies Act itself provides for both civil and criminal liability for any untrue
statement contained in the prospectus.

For civil liability, S 45 (1) provides as follows:

S. 45(1) “Subject to the provision of this section, where a prospectus invites persons to
subscribe for shares or debentures of a company, the following persons shall be liable to
pay compensation to all person who subscribe for any shares or debentures on the faith of
the prospectus for the loss or damage they may have sustained by reason of any untrue
statement included therein, that is to say:

a) Every person who is a director of the company at the time of the issue of the prospectus.

b) Every person who has authorized himself to be named and is named in the prospectus as a
director or as having agreed to become a director either immediately or after an interval of
time.

c) Every person being a promoter of the company and

d) Every person who has authorized issue of a prospectus

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PROMOTERS KKG
However, if the consent of a person is required for the issue of a prospectus which
consent he has given, he shall not by reason of his having given consent be liable under
this subsection as a person who has authorized the issue of the prospectus except in
respect of an untrue statement purporting to be made by him as an expert. S 45 (2) of the
Act provides possible defense to persons who would otherwise be liable under subsection
(1) of section 45.

Such person shall not be liable if he proves:

a) That, having consented to become a director of the company, he withdrew his

consent before the issue of the prospectus, and that it was issued without his
authority or consent or

b) That the prospectus was issued without his knowledge or consent, and that on becoming
aware of its issue, he forthwith gave reasonable pubic notice that it was issued without
his knowledge or consent or,

c) That, after the issue of the prospectus and before allotment there under he, on becoming
aware of any untrue statement therein withdrew his consent thereto and gave reasonable
public notice of the withdrawal and of the reason thereof or

d) That:
As regards every untrue statement not purporting to be made on the authority of an
expert or of a public official document or statement, he had reasonable ground to
believe, and did up to the time of the allotment of the shares or debentures, as the
case may be, believe, that the statement was true, and

As regards every untrue statement purporting to be a statement by an expert or contained in

what purports to be a copy of or extract from a report or valuation of an expert, it fairly
represented the statement, or was a correct and fair copy of or extract from the report or
valuation, and he had reasonable ground to believe and did up to the time of issue of the
prospectus believe that the person making the statement was competent to make it and that
person had given the consent required by section 42 to the issue of the prospectus and has
not withdrawn that consent before delivery of a copy of the prospectus for registration or to
the defendant‟s knowledge before allotment thereundrer and

As regards every untrue statement purporting to be a statement made by an official

person or contained in what purports to be a copy of an extract from a public official
document or copy of or extract from the document.

Note:

Where a promoter is in breach of his duty to the company and is making an undisclosed profit from
the sale
Untrue of an asset
statement to prospectus
in the the company, maythealso
remedies
attract available
criminal to the company
liability are46a (1)
under S. rescission
of of the
thecontract,
Act .Theinsaid
which case provides
section the profitaswill usually evaporate (but the company will still be able to
follows:
recover any profit made as an ancillary to the main transaction), or a recovery of the profit from the
promoter. 6
PROMOTERS KKG

“Where a prospectus is issued after the commencement of this Act, includes any untrue
statement, any person who authorized the issue of the prospectus shall be guilty of an
offence and liable to imprisonment for a term not exceeding two years, or to a fine not
exceeding ten thousand shillings or to both such fine and imprisonment, unless he proves
either that the statement was immaterial or that he had reasonable ground to believe and did
up to the time of the issue of the prospectus, believe that the statement was true”

It is important to note that S. 46 (1) prescribes the criminal sanctions only in respect of
willful untrue statement made in the prospectus and not otherwise.

Remuneration of promoters

A promoter has no right to get compensation from the company for his services in
promoting the company unless there is a contract to that effect. If there is no such
contract, he is not entitled to get any compensation in respect of any payment made by
him in connection with the formation of the company.

In Clintons Claim (1908) 2ch. 515, a syndicate which promoted a company incurred
certain expenses in respect of fees and stamp duty incidental to the formation of the
company. The company was later wound up. It was held that the syndicate was not entitled
to recover the expenses incurred by it. In practice a promoter takes remuneration for his
services in one of the following ways:

a) He may sell his own property at a profit to the company for cash or fully paid shares provided
he makes a disclosure to this effect.

b) He may be given an option to buy a certain number of shares in the company at par.

c) He may take a commission on the shares sold.

d) He may be paid a lumpsum by the company

Article 80 of table A usually gives the directors power to pay all expenses incurred in promoting
and registering the company but this gives the promoter no right to sue for payment as it only
confers discretion upon the directors. However it is common practice that promoters are usually
the first directors and no difficulty is likely to arise for receiving their expenses.

Pre – incorporation or preliminary contracts

The promoters of a company usually enter into contracts to acquire some property or right for
the company which is yet to be incorporated. Such contracts are called pre – incorporation or
preliminary contracts. The promoters generally enter into such contracts as agents for the
company about to be formed. The legal position is that two consenting parties are necessary to a
contract whereas the company before incorporation is a non – entity. In Kelner Vs Baxter
(1866) LR 2, Kelner agreed to sell a hotel to Baxter who was acting agent for a company which
was about to be formed. It was held that Baxter was personally liable on the contract as the
company was not in existence at the time of contracting and therefore, could not ratify the
contract after its incorporation. The promoter cannot, therefore act as agent for a company

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PROMOTERS KKG
which has not yet come into existence. As such the company is not liable for the act of the
promoters done before its incorporation.

A pre-incorporation contract permitted to be made by a company which does not exist is

an annullity. As such the company, when it comes into existence can neither sue nor be
sued on that contract.

In Newborne vs. Sensolid (Great Braitain) Ltd (1954) I Q B 45, New borne a director, entered
into a contract in the name of a company before its incorporation. He signed his name
underneath the name of the yet be formed company. It was not contract.

Position of promoters as regards pre – incorporation contracts

Company not bound by pre-incorporation contract. A company, when it comes into existence is
not bound by a pre-incorporation contract even where it takes

the benefit of the contract entered into on its behalf.

English Colonial Produce Co. Ltd Re (1906) 2 ch. 435: A solicitor prepared the Memorandum
and Articles of Association of a company and paid the necessary fees and other incidental
expenses to obtain the registration of the company. He did this on the instructions of certain
persons who later become directors of the company. It was held that the company was not liable
to pay the solicitor‟s costs although it had taken the benefit of his work.

5. The company cannot enforce pre-incorporation contract. A company cannot, after

incorporation enforce the contract made before its incorporation. The leading case on this point
is Natal Land Colonisation Co. Ltd vs. Pauline Colliery Development Syndicate Ltd AC 120. In
this case the N company agreed with an agent of the P Syndicate. The syndicate was registered
and discovered a seam of coal. The company refused to grant the lease. It was held that there
was no binding contract between the company and the syndicate.

6. Promoter personally liable. The promoters remain personally liable on a contract made on behalf
of a company not yet in existence. Such a contract is deemed to have been entered into personally
by the promoters and they are liable to pay damages for failure to perform the promises made in the
company’s name even

though the contract expressly provides that only company’s shall be answerable for
performance.

Ratification of a Pre-Incorporation Contract

A company cannot ratify a contract entered into by the promoters on its behalf before its
incorporation. Therefore, it cannot by adoption or ratification obtain the benefit of the contract
purported to have been made on its behalf before it came into existence as ratification by the
company when formed is legally impossible. The doctrine of ratification only applies if an agent
contracts for a principal who is in contract at the time of the contract by the agent.

Where a contract is made on behalf of a company known to both the parties to be non – existent,
the contract is deemed to have been entered into personally by the promoters. The company can,

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PROMOTERS KKG
if it desires, enter into a new contract, after its incorporation with the other party. The contract
may be on the pre – incorporation contract made by the promoters. But the adoption of the pre –
incorporation contract made by the company will not create a contract between the company
and the other parties even though the adoption of the contract is made as one of the objects of
the company in its Memorandum or Articles.

In such a case, it is safer for the promoters acting on behalf of the company about to be
formed to provide in the contract that:

7. If the company makes a fresh contract in terms of the pre-incorporation contract, the
liability of the promoters shall come to an end, and

8. If the company does not make a fresh contract within a limited time, either of other
parties may rescind the contract.

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PROMOTERS KKG

Activity

Describe the functions of promoters.

Describe legal status of a promoter
Describe fiduciary position of a promoter
Describe duty of promoter as regards prospectus
Explain remuneration of promoters
Describe pre – incorporation or preliminary contracts
Explain position of promoters as regards pre – incorporation contracts

Explain ratification of a pre-incorporation contract

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