Unit 3 Company Promotion

3.1 PROMOTION

A company comes into existence when a number of persons come together with a view to
exploit some business opportunity. These persons are called promoters.

3.2 PROMOTER / PROMOTERS

Before a company can be formed, there must be some persons who have an intention to
form a company and who take the necessary steps to carry that intention into operation.
Such persons are called promoters. There is no statutory definition of the word “promoter”
under the Companies Act 2017 and it has also not been clearly defined by case law. The
term “promoter” according to Bowen L. J. in Whaley Bridge Calico Printing Co v Green
(1880) “is a term not of law but of business…”

Therefore, a promoter may be defined as a person who undertakes to act in good faith to
form a company by taking the necessary steps of company formation who may be a
professional or in certain instances a shareholder of the company. Bowen simply put it as
“one who generally brings a company into existence”.

Twycross v Grant (1877)2 C.P.D. 469

Held
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”. Per Cockburn, C.J

As the promoter is in a fiduciary relationship with the company they are promoting, this
places them in a relationship of trust and confidence to the shareholders and potential
shareholders.

Erlanger v New Sombrero Phosphate Co. (1878)3 App. Cas. 1218 HL

Held
That, “the promoters stand, in my opinion, .......... undoubtedly in a fiduciary position. They
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………..” per Lord Cairns

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Therefore, a promoter may in simpler terms be said to be an individual who helps to create
or creates a company.

However, the term promoter does not include those who act merely in professional
capacity acting on the instructions of a promoter such as a solicitor or an accountant.

3.3 DUTIES OF PROMOTERS

As there is a possibility of abuse of authority inherent in the position of being a company

promoter, the courts have drawn up a number of duties:
(i) Preparation of the memorandum and articles of association of the proposed
company.
(ii) The appointments of first directors.
(iii) Preparation of the prospectus.
(iv) Negotiating preliminary contracts.
(v) Paying the preliminary expenses.

Although a promoter is not strictly speaking a trustee or agent of the company he

promotes, his position is similar in nature to that of the two. The old principals of law on a
trustee or agent’s duties have been extended to promoters:

(i) Duty of Disclosure

A promoter must never derive gain from a sale of his own property to the company which
he promotes unless all material facts are disclosed. Where a promoter fails to disclose the
fact of the sale of his own property, the company can either repudiate the contract or affirm
it and recover any profit gained from the transaction.

Erlanger v New Sombrero Phosphate Co. (1878)3 App. Cas. 1218 HL.

Held
That, the promoter’s duty was to ensure that the company had an independent board of
directors and to make full disclosure to it.

However, disclosure to the members would be equally effective.

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Lagunas Nitrate Co. v Lagunas Syndicate [1899]2 Ch. 392

Held
That, “after Salomon’s case, I think it impossible to hold that it is the duty of the promoters
of a company to provide it with an independent board of directors if the real truth is
disclosed to those who are induced by the promoter to join the company”. Per Lindley M.R.

This then means that only the obligation of full disclosure to the members or where the
intention is to float off the company to the public, then to potential members in a
prospectus.

Gluckstein v Barnes [1900] A.C. 240, HL.

Held
That, the promoter’s disclosure must be explicit and not impartial or incomplete.

(ii) Duty to Account

The promoter must not directly or indirectly make a secret profit at the company’s expense
without its knowledge (see Gluckstein v Barnes above) The law does not necessarily
forbid the making of a profit, but the non-disclosure of the fact.

Therefore, where a promoter acquires any property or profit in the process of promotion,
then he is required to hand it over to the company as he is presumed to have been acting
as a trustee for the benefit of the company on its formation and must hand over such
property to the company at the price at which he acquired it unless he discloses the
amount of profit which he proposes to make. A promoter can make a profit but the profit
must not be a secret profit. Only after making full disclosure to the members and with their
consent could the promoter retain any profits or property acquired during the process of
promotion.

Cook v Deeks [1916] 1 AC 554, [1916] UKPC 10 (N.B. A Canadian Case)

Deeks and Hinds were the directors of the Toronto Construction Company. They
negotiated a lucrative construction contract with the Canadian Pacific Railway. During the
negotiations, they decided to enter into the contract personally, on their own selves and
incorporated a new company, the Dominion Construction Company to carry out the work.
The contract appeared to be taken over by this company, by whom the work was carried
out and the profits made. A shareholder in the Toronto Construction Company brought an
action against the directors and the Dominion Construction Company.

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 Held
That, Deeks and Hinds were guilty of a breach of duty in the course they took to secure
the contract, and were to be regarded as holding it for the benefit of the Toronto
Construction Company. That “while entrusted with the conduct of the affairs of the
company, they deliberately designed to exclude, and used their influence and position to
exclude, the company whose interest it was their first duty to protect”.

Therefore, “men who assume the complete control of a company’s business must
remember that they are not at liberty to sacrifice the interests which they are bound to
protect, and, while ostensibly acting for the company, divert in their own favour business
which should properly belong to the company they represent”.

(iii) The promoter must not make any unreasonable use of his position.

(iv) The promoter has an obligation not only to be honest with the company or its
shareholders, but must also to be careful towards them as well. The standard of care as
regards professional promoters is expected to be higher than that of lay promoters.

Therefore, as a promoter is in a fiduciary relationship with the company, he has the legal
duty to disclose to the company any profits which he makes from the promotion. If he
makes a profit but does not disclose it, he must account to the company for it as follows:-

(i) Where the promoter purchased the property before he began to act as promoter,
his non-disclosure of the fact that the property was his own would entitle the
company to repudiate the contract of sale and restore the original position, that is,
return the property to the promoter and recover the purchase price.

For example, if a person acquired some piece of land before he began to act as a
promoter with the intention of using it for farming but changed his mind after starting
to act as such and sold the land to a company he was promoting without disclosing
his interest, then company after incorporation may:
(a) Rescind the contract.
(b) Keep the land in which case it cannot recover the profit which the promoter
made.

(ii) Where the promoter purchased the property after he began to act as a promoter,
the company may:
(a) Rescind the contract.

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 (b) Keep the property and recover the secret profit made by the promoter. In
this case, it is deemed that the promoter had an intention of reselling it to the
company and the promoter’s position would be regarded as “an agent” and
the company’s rights at common law would be the same as those of the
principal.

Erlanger v New Sombrero Phosphate Co. (1878)3 App. Cas. 1218 HL.

Held
That, …… “I do not say that the owner of a company may not promote and form a joint
stock company and then still sell his property to it, but I do say that if he does, he is bound
to take care that he sells it to the company through the medium of a board of directors who
can and do exercise independent and intelligent judgment on the transaction”. Per Lord
Cairns

It should be noted that a promoter cannot contract out of his duties by inserting a clause in
the articles whereby the company on formation and the members (subscribers) agree to
waive their rights.

4.4 REMEDIES FOR BREACH OF PROMOTER’S DUTIES

(i) The company after its formation can bring an action for rescission (to rescind) of
any contract with the promoter. (Erlanger v New Sombrero Phosphate Co)

(ii) The company after its formation can bring an action for the recovery of any secret
profit which the promoter made.

(iii) The company after its formation can bring an action in restitution for the promoter to
account to the company for any profit he has made. (Gluckstein v Barnes)

(iv) The company after its formation can bring an action for damages for failure to
disclose which a breach of fiduciary duty is. (Re Leeds & Hanley Theatre of
Varieties)

3.5 REMUNERATION OF PROMOTERS

A company cannot enter into a contract before incorporation and therefore, a promoter has
no legal claim or right against the company he promotes for fees and expenses for
services rendered in its formation. A promoter is not entitled as of right to receive any
remuneration or payment from the company for the services of promoting the company

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unless there is a valid contract to pay between him and the company after its formation.
Without such a contract, a promoter is not even entitled to any indemnification on the
preliminary expenses incurred by him prior to incorporation.

This is so because:

(i) The company did not ask him to promote it. There was no contract between the
promoter and the company which would entitle him to sue for his expenses or
professional fees.

(ii) The company could not after its incorporation enter into a contract to pay him for his
services during the promotion as no consideration to support such a contract would
be furnished by him. This would be “past consideration”.

Erlanger v New Sombrero Phosphate Co. Ltd (1878) LR 3 App Cas 1218, All ER 271

A syndicate, of which Erlanger was the head, purchased an island containing mines of
phosphate for £55,000. Erlanger then formed a company, the New Sombrero Phosphate
Co. to buy this island. 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. The details of the
sale were not disclosed to the shareholders or independent Board of Directors.
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.

Held
That promoters of a company stand in a fiduciary relationship to investors and as there
had been no disclosure by the promoters of the profit they were making, the company was
entitled to rescind the contract.

Therefore, the promoters are at the mercy of the directors to recover any preliminary
expenses and registration fees.

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However, the Companies Act 2017 section 86 empowers the directors to pay promoters all
expenses incurred in promoting and forming the company although the power given to
directors confers no legal rights on the promoter. This situation has led Professor Joseph
Gross (“Who is a Company Promoter?” (1970) 86 LQR 493 at 498) to state that the
promoter is the “illegitimate child of the law – actively known, and formally ignored”.

3.6 PRE-INCORPORATION CONTRACTS

A pre-incorporation contract is an agreement which is entered into, usually by a promoter,
on behalf of a company at a time when the company’s formation has not been completed
by its registration.

Pre-incorporation contracts may relate to property which the promoters wish to purchase
for the company or they may be made with persons whose know-how is vital to the
success of the company. The promoters may perhaps have arranged for the company to
take over an existing business, and therefore need to make a contract with the vendor for
its sale or purchase.

Before its incorporation, a company has no capacity to contract and therefore, a contract
entered into by promoters on behalf of a proposed company is void in so far as the
company is concerned. The promoters cannot be agents for a principal which has not yet
come into existence. Therefore, it cannot be held liable or be entitled to contracts
purporting to be made on its behalf before incorporation.

Kelner v Baxter (1866) L.R. 2 C.P. 174

The promoters of a hotel company entered into a contract on its behalf for the purchase of
wine. When the company formally came into existence it ratified the contract. The wine
was consumed but before payment was made the company went into liquidation. The
promoters, as agents, were sued on the contract. They argued that liability under the
contract had passed, by ratification, to the company.

Held
That as the company did not exist at the time of the agreement it would be wholly
inoperative unless it was binding on the promoters personally and a stranger cannot by
subsequent ratification relieve them from that responsibility.

In such cases the company cannot sue or be sued on it as it has no legal existence until it
is incorporated.

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It therefore follows:

(i) That when the company is registered, it is not bound by pre-incorporation contracts
eventhough it had taken the benefit.

(ii) That the company when registered cannot ratify the agreement. The company was
not a principal with contractual capacity at the time when the contract was made. A
contract can be ratified only when it is made by an agent for a principal who is in
existence and who is competent to contract at the time when the contract is made.

Natal Land Co. Ltd vs. Pauline Colliery Syndicate Ltd (1904)

Natal Land Co. Ltd agreed with Mrs. Carrey an agent of a syndicate before its
incorporation that Natal Land Co. Ltd would grant a mining lease to the syndicate. The
syndicate was incorporated as Pauline Colliery. Pauline Company discovered coal
whereupon Natal Land Co. Ltd refused to grant the lease.

Held
That there was no binding contract between Natal Land Co. Ltd and Pauline Company as
the latter was not in existence when the contract was signed.

If the company were allowed to ratify the contract, it would mean that it contracted on the
date the contract was formed. This in effect would mean that the company contracted
before it was formed. If the company wishes to revive the abortive contract it must make a
fresh offer and if the offer is accepted by the other party, a contract will come into
existence from the moment of acceptance.

(iii) That if the agent undertook any liability under the agreement he would be
personally liable notwithstanding that he is described in the agreement as an agent and
that the company may have attempted to ratify the agreement.

Kelner v Baxter (1866)

An agreement was made between Kelner and Baxter. Baxter was acting on behalf of the
proposed hotel company. Wine supplied under the contract was used by the company
which had “ratified” the agreement after incorporation. The company went into liquidation
before paying the debt.

Held
That Baxter was personally liable and no ratification could release him from his liability.

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This means that any contracts entered into by or on behalf of the company before its
incorporation are mere “gentlemen’s agreements” and the promoters enter into such
contracts on the undertaking of personal liability. The company cannot ratify or adopt such
contracts after its formation unless it enters into a post-incorporation agreement on similar
terms and hence the liability on the promoter ceases.

However, the Companies Act 2017 section 20(3) provides that a company may, not later
than fifteen months after its incorporation adopt the pre-incorporation contract by an
ordinary resolution, and on the adoption:

(a) The company shall be bound by the contract and entitled to the benefits of the
contract as if the company had been incorporated at the date of the contract and had
been a party to it.

(b) The person who purported to act in the name or on behalf of the company shall
cease to be bound by the contract or entitled to the benefits of it.

The aim of this provision is to secure transactions of third parties by avoiding the
consequences of the contract with the company being a nullity.

3.7 EFFECT OF PRE-INCORPORATION CONTRACTS ON THE PROMOTER

(i) UNDER THE COMPANIES ACT

The Companies Act 2017 section 20(1) and 20(2) provides that where a person purports to
enter into a contract, whether evidenced in writing or not, in the name or on behalf of an
entity before it is incorporated, the person shall be bound by the contract and is entitled to
the benefits arising from such a contract.

However, the Companies Act 2017 section (20)4 provides that this section shall not apply
if the relevant contract expressly provides that the person who purported to act in the
name or on behalf of the company before it was incorporated shall not be bound by the
contract nor entitled to the benefits in it.

(ii) AT COMMON LAW

(i) If the third party knew the company was not yet in existence, he could make the
purported agent liable on the contract. (Kelner v Baxter).

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(ii) That if the agent undertook any liability under the agreement he would be
personally liable notwithstanding that he is described in the agreement as an agent
and that the company may have attempted to ratify the agreement.

Kelner v Baxter (1866)

An agreement was made between Kelner & Baxter. Baxter was acting on behalf of the
proposed hotel company. Wine supplied under the contract was used by the company
which had “ratified” the agreement after incorporation. The company went into liquidation
before paying the debt.

Held
That Baxter was personally liable and no ratification could release him from his liability.

3.8 LIMITATION OF LIABILITY ON THE PROMOTER

(i) A promoter could agree with third party that promoter’s liability will end when the
company, once formed, enters new contract on same terms. In this regard, the Companies
Act 2017 section 20 (5) provides that a promoter shall not be bound by the contract nor be
entitled to its benefits if the pre-incorporation contract he entered into in the name or behalf
of the company before its incorporation expressly provides for it.

Phonogram Ltd v Lane [1982] QB 938

A rock group intended to perform under the name "Cheap Mean and Nasty" and to form a
company for the purpose to be called "Fragile Management Ltd". Mr Lane accepted a
cheque from Phonogram for £6,000, signing his name "for and on behalf of Fragile
Management Ltd". The money was to be used to finance production of an album and was
repayable if this was not achieved. When the album was not produced, Phonogram sought
to recover the money from Lane, the company having not been in existence at the time the
contract was made. Lane argued that his signature "for and on behalf of" the company
amounted to an agreement that he was not to be personally liable on it.

Held
This was not sufficient to exclude the operation of the section, which would be given full
effect unless there was a clear and express exclusion of personal liability. Lane was thus
liable to repay the money.

(ii) A promoter can avoid personal liability if the company, after incorporation, and the
third party substitutes the original pre-incorporation contract with a new contract on similar

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terms. This substitution (Novation) of the promoter by the conduct of the parties may
relieve the promoter from any liability on the original contract.

(iii) A promoter can also avoid personal liability on a contract where he signs the
agreement merely to confirm the signature of the company because in so doing he has not
held himself out as either agent or principal. The signature and the contractual document
will be a complete nullity because the company was not in existence

Newborne v. Sensolid (Great Britain) Ltd. [1953] 1 All E.R. 708

Newborne had entered into a contract with Sensolid Ltd. to supply tinned ham to Sensolid
Ltd. The price of tinned ham fell and Sensolid Ltd. refused to take further deliveries of
tinned ham from Newborne. The contract had been signed by Leopold Newborne
underneath the words Leopold Newborne (London) Ltd which company was not
incorporated. Later, Leopold Newborne (London) Ltd. was incorporated and it brought an
action against Sensolid Ltd. That action was dismissed because Leopold Newborne
(London) Ltd. had not been incorporated at the time the contract was entered into. Leopold
Newborne then sued Sensolid Ltd. in his own name seeking to enforce the pre-
incorporation contract on the basis that he was a party to the contract himself. The
argument was made on the basis of Kelner v. Baxter saying that if the contract was not
with Leopold Newborne (London) Ltd. then it must have been with the person who signed
on behalf of the company, namely, Leopold Newborne.

Held
That given the way in which the contract was signed by Leopold Newborne, it was
intended to be a contract with the company and only the company. In other words, given
the way in which it was signed it indicated that it was not intended that Leopold Newborne
be a party to the contract himself. Thus Leopold Newborne could not enforce the contract
in his own name.

3.9 PROMOTER SELLING PERSONAL PROPERTY TO A COMPANY

A promoter who wishes to sell his own property to the company must make a full
disclosure of his interest in the transaction. The disclosure may be made:
(i) To an independent Board of Directors.
(ii) In the Articles of Association.
(iii) In the prospectus.
(iv) To the shareholders.

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In this regard, Lord Cairns observed that, “I do not say that an owner of property may not
promote and form a joint stock company and then sell his property to it but I do say that if
he does, he is bond to take care that he sells it to the company through the medium of
board of directors who can exercise an independent and intelligent judgment on the
transaction”.

3.10 DISQUALIFICATION OF PROMOTERS

The Companies Act 2017 section 363 disqualifies a person who has been convicted of an
indictable offence in connection with the promotion, formation or management of a
company, fraud or a breach of professional secrecy from directly or indirectly taking part in
the promotion or formation of a company for three years following the conviction or the
judgment without first obtaining leave of the Court which may be given on such terms and
conditions as the Court considers appropriate.

3.11 TERMS OF PRE-INCORPORATION CONTRACTS INCLUDED IN THE

COMPANY’S ARTICLES

The Companies Act 2017, section 26 (1) provides that the articles shall have the effect of a
contract between the company and each member and amongst the members, and hence
can only bind the company and its members. Therefore, terms of pre-incorporation
contracts included in the company’s articles will only bind the directors and shareholders.

Eley v Positive Government Life Assurance Co Ltd (1876) 1 Ex D 88

The articles provided that Eley was to be appointed as the company's solicitor and that he
should not be removed from office except for misconduct. He was to be paid all usual fees
and charges. Eley was employed as solicitor and he subsequently acquired shares and
became a member of the company some time after its incorporation. When the directors
ceased to employ him and used another solicitor, he sued for breach of contract.

Held
That the plaintiff was not a party to the contract and that was a matter between the
directors and shareholders. The articles did not create any contract between the company
and Eley in his capacity as solicitor.

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