Tutorial Questions ABBL3144 Corporate Law & Governance

TUNKU ABDUL RAHMAN COLLEGE

DIPLOMA IN BUSINESS STUDIES

CORPORATE LAW & GOVERNANCE

Tutorial 3

1. Jack and Jill had approached Garfield to be the promoter of the company that they
intend to form. Garfield had agreed to be the promoter, but he is uncertain as to who
a promoter is and the function of a promoter. Garfield seeks your assistance.
Advise Garfield on the following matters:

a. Who is a ‘promoter’? (Define with reference to case laws)

b. What are the duties owed by a promoter to the company?
c. The remedies available against the promoter who has acted in breach of his duty.

Answer:
a. ‘Promoter’ is a term used to describe such person who forms the company. He is
the person who registers the company and makes business preparations for the
pre-incorporated company.

A promoter is defined in Twycross v Grant (1877) 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’.

Thus, the promoter would be the person who undertakes the formation of a
company by carrying out the procedures necessary for incorporation. Such a
person is termed as ‘an active promoter’.

A passive promoter is a person who is not actively involved in its formation but
contributed to the initial working capital of the company. He would also be deemed
as a promoter.

The legal significance and importance of determining whether a person is a

promoter is because promoters owe certain fiduciary duties to the company. It is
necessary to determine the promoter for the purpose of ascertaining whether he
has breached his duty to the company.

*fiduciary relationship = relationship based on trust

b. A promoter has the following fiduciary duties:

i. Duty to act bona fide. Promoter must act in good faith for the best interest of
the company as a whole.
ii. Duty not to make secret profit at the expense of the pre-incorporated
company. – Fairview School Bhd. v Indrani Rajaratnam & Ors.
iii. Duty to make full and complete disclosure to an independent board of
directors of any personal advantage he has obtained whilst carrying out his
work as promoter. Partial disclosure will not be sufficient. – Erlanger v New
Sombrero and Gluckstein v Barnes.
iv. Duty not to disclose confidential information of the company.
 v. Duty to avoid conflict of interest with that of the company. Promoter must
avoid taking up a contract or opportunity which in equity belongs to the
company.
c. Remedies available against the promoter who breached his duty:

i. Rescission. A rescission is the cancellation of a contract. Company can

rescind the contract entered by the promoter. This is possible if:
• Company has not affirmed the contract after discovering the breach
by the promoter.
• Third parties have not acquired rights under the contract.
• Company does not delay in taking an action in court for breach of
duties.
ii. Recovery of secret profit from the promoter.
iii. Damages. Company may claim compensation for damages due to the
breach of duty by the promoters.

2. Compare and contrast between ordinary shares and preference shares.

Answer:
Ordinary shares
The dividend is paid after the payment of
all liabilities.
Cannot be converted.
They have a right to an equal share in the
distribution of the surplus assets of the
company.
Ordinary shares carry voting rights.
Not entitled to cumulative dividend.
Equity shares are the ordinary shares of
the
company representing the ownership of
the shareholder in the company.
Preference shares
Priority in payment of dividend over
ordinary shareholders.
Can be converted to ordinary shares.
Cannot participate in the distribution of the
surplus assets of the company.
Preference shares have limited voting
rights.
Entitled to cumulative dividend.
Preference shares are the shares that
carries preferential rights on the matters of
payment of dividend and repayment of
capital.
3. Describe and explain the concept of variation of class rights. Explain how class
rights can be varied by a company.

Answer:
• S. 89(1) CA 2016 – for the purpose of the CA 2016, shares are in the same class
if the right attached to the shares are identical in all respects.
• Class right are special rights that are given only to the shareholders within the same
class. Example: rights to fixed dividend, voting rights, cumulative dividends for
preference shares etc.
• A variation of class rights occurs when there is a change or cancellation to the legal
rights attached to the class of shares.

• Section 91(1) CA 2016 states the rights attached to shares in a class of shares in
a company may be varied only:
o in accordance with the constitution for the variation of those rights; or
o if there are no such provisions, with the consent of shareholders in that class
given in accordance with this section.

• Under S91(2), the consent of the shareholders required for the purposes of this
section shall be:
o a written consent representing not less than 75% of the total voting rights of
the shareholders in the class; or
o a special resolution passed by shareholders in the class sanctioning the
variation.

• S92(1) states if the rights attached to shares in any class of shares in a company
are varied, the company shall give written notice of the variation to each
shareholder in that class within 14 days from the date on which the variation is
made.

• S92(2) provides if the company and every officer who contravene this section
commit an offence and shall, on conviction, be liable to a fine not exceeding five
hundred thousand ringgit.

• S93(1) states if the rights attached to shares in any class of shares in a company
are varied, the shareholders representing at least ten percent of the total voting
rights in the class may apply to the Court to have the variation disallowed.
4. Explain the difference between share capital and loan capital.

Answer:
Share Capital Loan Capital

Company issue shares to shareholder. Company acquires capital from debt

This is called share capital. financing. This is called loan capital.

Shareholder is a proprietor or owner of The one lending is a lender or creditor

the company. of the company.

Subject to the Constitution of company, Entitled to fixed rate of interest as

entitled to distribution (if declared). agreed in the debenture agreement.

Distribution to shareholders only out of Interest must be paid irrespective of

profits of the company available if the whether the company makes profit or
company is solvent. (able to pay for its not.
debts)

If after authorization but before Failure of the company to pay entitles

distribution is made, the directors cease the debenture holder to sue for
to be satisfied that the company will be payment.
solvent immediately thereafter, the
directors must take all steps to prevent
distribution.

Distribution paid are not tax deductible. Interest paid to lender is tax deductible
Thus, distribution is paid from profits after from the company’s income. This
tax is paid. reduces the companies’ taxable
income.

Shareholders have voting rights. Creditors have no voting rights.

Shareholder entitled to notices of general Not entitled to notice of meeting.

meeting.

Shareholder can attend general meeting Cannot attend general meeting nor
and get involved in the management of participate in the management of the
the company. company.

In liquidation, shareholder is the last to In liquidation, creditor stand in priority

receive payment. to receive payment.

Shareholders are entitled to many Enjoy limited statutory protection.

statutory protections.
5. What is a pre incorporation contract what is the position of these type of contracts
in Malaysia with reference to S 65(1) and S 65(2) of the Companies Act.

Answer:
Pre-incorporation contract is a contract entered into before incorporation. The case of
Kelner v Baxter provides the English common law position that pre incorporation contract
is void and cannot be ratified.

However, under Malaysian law, our position is different from the English common law
and pre-incorporation contract is valid. It may be ratified by the company after
incorporation. The following are the main rules relating to pre-incorporation contract in
Companies Act 2016.

• S.65(1) CA 2016 – A promoter may be personally liable for the contract if it is not
ratified by the company.
• S.65(2) CA 2016 – The company may ratify the contract entered by the promoter
after its incorporation and the company shall be liable for the contract.

*Ratification is up to the company. It may choose not to ratify, and promoter could be
personally liable.

6. Briefly explain four methods of how a company can raise capital.

Answer:
Generally, incorporated companies raise capital either by share capital or by loan
capital.

It is the duty of the company managers to review and decide the most appropriate
capital structure for the company. The company managers will have to balance the
most appropriate ratio of debt to equity, the relative cost involved for each type of
capital and the length of term of the respective capital.

This generally depends on the level of risk the company management is willing to
take. This is because if there is a drop in the company income of a company with
high debts, it may not only result in loss of profits and consequently investors’
confidence but may even lead to insolvency.

The following are 4 main methods of raising capital:

(i). Direct invitation to the public through a prospectus

The company will issue its securities directly to members of the public who
have applied in response to its prospectus.
*Prospectus is any notice, advertisement or documents inviting applications or
offers to subscribe for or purchase securities.

(ii). Indirect invitation through an offer for sale

Public is invited to buy a block of shares which have already been issued.
There are two methods or scenarios:
 1st method – where the private company seeks to "go public", a portion of
the shares held by the existing shareholders may be offered for purchase to
members of the public.

2nd method - company may allot shares to an issuing house which then will
offer them for sale to the public.

(iii). Private placement/ private invitation through placing

Placing is an arrangement where a financial institution helps the company

to find a number of its clients to whom securities may be issued in larger
quantities than what individual members of the public generally would
subscribe. The placement is often made with a slight discount to the current
market price of the shares.

The financial institution merely acts as an agent and is paid a brokerage fee
for its services. Private placements speed up the wholesale distribution of
shares. It is considered a cost-effective way for small businesses to raise
capital.

(iv). Restricted invitation through a rights issue

A rights issue is an offer to the existing members in proportion to their

shareholdings at the time of offer. It is usually priced at a slight discount to
the current market price. Existing shareholders may purchase shares if they
maintain the existing percentage of shareholding.

7. Describe a provisional contract under the Companies Act 2016.

Answer:
S.190(5) CA 2016 – A provisional contract made by a public company before the date on
which it is entitled to commence business shall not be binding on the company until the
date the company commence business.

The date when a public company having a share capital can commence its business is
referred to in S.190(3) CA 2016 as the date when a statutory declaration is lodged by the
secretary or one of the directors of the company to the Registrar verifying that S.190(1) or
S.190(2) have been complied with.

In other words, provisional contracts are contracts entered into by a public company
limited by shares which is not yet entitled to commence business. The company will be
liable for the provisional contract after compliance with S.190(1) and S.190(2) CA 2016.
8.
(a) Define a prospectus.
(b) State the information required to be provided in the prospectus according to the
Securities Commission in its guidelines issued in May 2003.
(c) What are the types of liabilities involved when an untrue statement is made in the
prospectus?

Answer:
a) Definition of prospectus:

• A prospectus is a disclosure-based document.

• A prospectus, in finance, is a disclosure document that describes a financial
security for potential buyers.
• It commonly provides investors with material information about mutual
funds, stocks, bonds, and other investments, such as a description of the
company's business, financial statements, biographies of officers and
directors, detailed information about their compensation, any litigation that
is taking place, a list of material properties and any other material
information.
• The purpose of the prospectus is to help would be investors decide whether
or not to invest in the company.

b) Among the information required by the prospectus guidelines:

• Purpose of the public offering

• Terms and conditions of the public offering
• Details of pricing of the public securities
• Information in relation to assets and liabilities
• Financial position, profit and losses and prospects of the issuers

c) Types of liabilities for false or misleading statements in prospectus:

Criminal liability:
• S246(3) CMSA 2007 deals with criminal liability.
• It will be a criminal offence to make untrue statement or omit material
information in the prospectus.
• Maximum fine RM 3milion, up to 10 years of imprisonment or both.

Civil liability:
• S249 CMSA 2007 deals with civil liability.
• Civil liability is being responsible for actions and practices that could
damage others.
• A person who makes the untrue statement/omits material information in the
prospectus can be ordered to pay.
• Compensation must be paid to an investor who suffered loss as a result of
having relied on that incorrect statement/information.
*Additional questions and answers

Breach of promoter’s duty.

In September 2016, Kamala was asked by a few friends to help set up a company. She was
also asked to look for a suitable piece of land to be used to build a factory for the company
which was to be incorporated.

Kamala purchased a piece of land in Banting at the price of RM300,000 in October 2016 and
the land was registered in Kamala’s husband’s name. With the help of Kamala, the company
was incorporated in January 2017 as a private company. Kamala became one of the
shareholders of the company. In February 2017, Kamala arranged for the sale of the land in
Banting to the company. The agreed price was RM600,000.

Recently, at the EGM some of the other shareholders demanded that the contract for the
sale of the land by Kamala to the company be set aside. Alternatively, the shareholders have
called for the return of the difference between the price when the land was originally
acquired and the price when the land was sold to the company.

Discuss the legal consequences of this matter.

Answer:
Issue:
Whether Kamala has breached her duties as promoter and if so, what are the remedies available
to the company?

Breach of promoter’s duties:

A promoter is defined in Twycross v Grant as ‘one who undertakes to form company with reference
to a given project and who takes the necessary steps to accomplish that purpose’. Therefore,
Kamala is a promoter as she is the one involved in the formation of the company and in searching
a land for the company to build a factory on. As promoter, she owes the company some fiduciary
duties.

The duties are:

• Promoters are under an obligation to act bona fide or in the company’s best interest.
• Promoters must avoid conflict of interest with the company.
• Promoters must make full and complete disclosure to an independent board of director of
any personal advantage gained as stated in Erlanger v New Sombraro Phosphate Co.
(1878) and Gluckstein v Barnes.
• Promoters must not make secret profit at the expense of the company as stated in Fairview
School Bhd. v Indrani Rajaratnam & Ors.
• Promoters must not disclose confidential information.

Application:
• Kamala has breached her duties as a promoter as follows:
• Kamala bought the land in her personal capacity for RM300k and registered the land under
her husband’s name knowing that the company wanted the land. This is a conflict of
interest and not a bona fide action in the best interest of the company.
• She later sold the land to the company for RM600k without proper disclosure and made a
secret profit of RM300k at the expense of the company.
• Therefore, the company can seek remedies from her.

Remedies:
• The company may rescind the contract for the purchase of the land, and if that is not
practical;
• The company may recover the secret profit of RM300k made by Kamala.
Pre-incorporation contract.

Polly, a promoter and subsequently director of Cempaka Sdn. Bhd, a newly formed printing
company, entered into 2 contracts with A and B respectively in December 2015. The contract
with A was for the lease of a two-story shophouse which is now being used as the principal
place of business by Cempaka Sdn. Bhd.

The contract with B was to purchase printing machines. A and B believed that Cempaka Sdn
Bhd was already incorporated in December 2015 but in actual fact, Cempaka Sdn Bhd was
only incorporated in March 2016. Cempaka Sdn Bhd has refused to pay B for the printing
machines despite B’s repeated demands but has agreed to pay A for the rental for the
shophouse.

Answer:
Issue:
The issue is whether A and B can respectively claim for their contracts made with Polly
before the incorporation of the company, and from whom the claim can be made.

The law applicable is as follows:

i. S.65(2) CA 2016 states any contract entered into by promoter may be
ratified by the company after its formation.
ii. Thus, if the company ratifies, then the company is bound by the
contract as if the company had been in existence at the date of the
contract.
iii. S.65(1) CA 2016 provides, unless the company ratify the contract, the
promoter shall be personally bound.
iv. This means, if the company does not ratify under S.65(2), then the
promoter will be personally bound under S.65(1).

In A’s case:
• In A’s case, the company has agreed to pay for the lease for the shophouse despite
the contract entered into is a pre-incorporation.
• This would mean that the company has ratified the contract under S.65(2).
• Therefore, the company will be bound to pay the rental.

In B’s case:
• In B’s case, the contract entered with Polly for the printing machines in Dec 2015 was
a pre-incorporation contract.
• Since the company has refused to pay despite repeated demands, this means that the
company has not ratified the contract for the printing machines.
• Under S.65(1) CA 2016, where the company refuse to ratify the contract, then the
promoter, Polly will be personally liable. Polly must pay for the printing machines.