Duty for Promoters towards Corporation - Case Study Example

Explain the duties owed by promoters towards any company that they form, and also the remedies, which are available for breach of those duties. Statute do not provide for definition of the term promoters. It is primarily in nineteenth century, the term promoter is more clearly described by the courts. In Twycross v Grant1 the court has given a more clear description to the term Promoter. Twycross v Grant1: Divisional court and court of appeal in this case while deciding the liability of Promoters under section 38 of the Companies Act, 1867, described 'promoter' as a person who i) undertakes to form a company with reference to given project ii) sets the company going, iii) takes the necessary steps to accomplish the purpose. Duties owed by promoters towards any company that they form: The courts have developed tremendous case law on the duties owed by promoters towards any company they form. This old aged case law has become disused for the reason that drastic changes have taken place in securities marketing, which is the prime segment in formation of a new company. In the changing conditions for forming a new company and listing the company in stock exchange for trading its share it has become statutory to show the track record of the trading. To fulfill such conditions promoters are required enter into contracts on behalf of the company. "A promoter stands in a fiduciary relationship towards his company. A contract made between him and the company is voidable at the company's option unless he has disclosed all material facts relating to the contract to an independent board, and the company has freely agreed to the terms." [L.S.Sealy, Cases and Materials in Company Law, 2001 (p.35)] Promoters hold fiduciary relationship towards the company that they form. This fiduciary relationship is the development equity law. Equity law imposes on persons holding in fiduciary relationship a duty of care to protect the interest of such company, and its stakeholders such as shareholders. The law imposes a duty on them to disclose all the material facts of contracts they make to an independent board, and the company accords free acknowledgment of the terms of contract, else such contract is voidable at the option of the company. In such condition promoters are liable for breach of such contract but not the company. Duties of promoters is elaborately described by the court in Erlanger V New Sombreno Phosphate Co2 case. Erlanger V New Sombreno Phosphate Co2: In this case a syndicate led by Erlanger, a banker formed a company. The syndicate acquired an island for producing phosphate for a lease of 55,000 for the company, which they intended to form, prior to incorporation the new company. The promoters nominated three directors of the newly formed company among them one director was independent of the syndicate and remaining two directors are mere puppets of Erlanger. The promoters have sold the lease of the island for 110,000 at double the price they have acquired. The board of directors ratified the transaction without making any enquiry into the transaction and this transaction was undisclosed. Public have subscribed for shares. Later the phosphate shipment failed. The shareholders have removed the directors nominated by the promoters and new directors were appointed. The new board of directors has brought the proceeding before the court. The Court has laid down what position the promoters to be placed and what duties they owe to with reference to the company, which they proposed to form. The court said (a) The promoters stand in a fiduciary position, (b) the creation and moulding of the company is in their hands, (c) they are vested with powers of defining (i) how the company starts its existence (ii) when it starts (iii) in what shape it starts (iv) under what supervision it shall start and act as trading corporation. (d) Promoters shall take care while forming the company that they provide board of directors who (i) are aware of the fact that the property, which the company is asked to purchase is of the promoters (ii) are impartial and competent judges while making the transactions (e) promoters while exercising the powers they must be at most truthful, good faith and careful to the protection of future shareholders e) when promoter sell his property to the company he shall take care that the sale is made through the board of directors who are intellegent and independent in taking the decision. Remedies, which are available for breach of the duties of promoters: Whaley Bridge Calico printing Co V GraGreen3 The remedies available for breach of the duties of promoters are of wide range. 1. Restitution of Benefits: The promoter cannot make secret profits. He is required to act as a trustee of the company. In case he makes any secret profits in breach of his duties company may initiate proceeding to restitute the benefits/profits fraudulently received by the promoters. 2. To sue the parties to the secret bargaining: The Company may sue the parties to the secret bargaining under an action of deceit. 3. Damages: The Company can claim damages from the promoters for the breach of their duties. 4. Rescission of contract of sale: Remedy of rescission of contract executed by the promoter on behalf of the company prior to incorporation is available to the company if the promoter has failed to make appropriate disclosure of his interest at the instant of sale, this remedy ceases once the company elects to affirm the contract. 5. Compensation: Compensation can be claimed from the promoters for their breach of their duties with regard to listing of shares and making proper declarations in prospects on which public rely and subscribe for shares. Advise on the Bertram's position and that of his company: In the given case Bertram is the promoter of Bertico Ltd. He has entered into a contract with Crafts and company for purchase of computers. The contract was entered prior to incorporation of Bertico Ltd. This contract comes within the ambit of pre incorporation contracts under Section 36 C of Companies Act 1985, which is discussed below. Pre-incorporation contracts: "A company has no legal existence before it is incorporated. It is incapable of entering into contract itself, and equally incapable of acting through an agent. A person who purports to make a contract on behalf of a proposed company may do so in a way which renders him personally liable at common law." [L.S.Sealy, Cases and Materials in Company Law, 2001 (p.26)] In common law the company gets its legal existence only after it is incorporated. When there is no legal existence it cannot enter into any contract. Any contracts entered into on behalf of the company by either its agents or promoters, the company is not legal bound, the law permits its agents to enter into a contract on behalf of the proposed company but as far as liability is concerned the persons who sign the contract are personally liable but no the company. This is legal position is reiterated by the court of common pleas in Kelner v Baxter4 Case. Kelner v Baxter4: In this case Kelner entered into a contract of sale wine with Baxter and other who were the promoters of proposed company, Gravesend Royal Alexandra Hotel Company, Limited. Kelner performed his part of contract and supplied the wine. The promoters formed the company. Before making the payment to Kelner in terms of the contracted entered into by then promoters the company has failed. Kelner sued the promoters for recovery of the amount. The court held that the promoters are held liable personally. While dealing with this case the court said that when the company is not in existence at the time of signing a contract it can not be a party to that contract, hence it is not bound by that contract, and the agreement is inoperative against the company even after incorporation, but that contract is operative against the person who sign the contract and he is personally liable. The court further said that the company is a stranger to that contract and cannot relieve the person who signed the contract from his liability even by its subsequent ratification. S 36 C of Company Act 1985 provides that "where a contract purports to be made by a company, or by a person as agent for a company, at a time when the company has not been formed, then, subject to any agreement to the contrary, the contract shall have effect as a contract entered into by the person purporting to act for the company or as agent for it, and he shall be personally liable on the contract accordingly" Phonogram V Lane 5: In this case, the promoter has entered into an agreement on behalf of the company prior to its incorporation regarding finance. He has given an undertaking for the repayment of money and signed for and on behalf of the company. Claimant sued the promoter for breach of contract. Promoter contended that he has signed for and on behalf of the company, hence he is not personally liable. Court held that promoters are liable, since there is no express agreement that the man who was signing was not to be liable. [L.S.Sealy, Cases and Materials in Company Law, 2001 (p.30)] The ratio laid down in Kelner Vs. Baxter is reiterated in this case. The court held that the protection to the personal liability of the agent who signs on behalf of the company will be saved provided an express provision is made in the contract to that effect. Under these circumstances, and the legal position discussed if the company decides to avoid the contract, the Bertram is personally held liable as a promoter of the company for breach of the contract. Though the contract is later ratified by the board of directors it may not save Bertram in view of the court's findings in Erlanger V New Sombreno Phosphate Co. In this case house of lords said that when promoter sell his property to the company he shall take care that the sale is made through the board of directors who are intellegent and independent in taking the decision. In the present case, the board of directors consists of Bertam and his wife. It cannot be said that the decision to ratify the contract was of independent from the point of view of the company since board of director and the promoter are one and the same. However Bertram can take a stand that the company is a separate legal entity. Though he and his wife are board of directors he is deferent from that of the company as decided in Salomon v Salomon6. The company has separate legal entity. The company under its separate legal entity has ratified the contract. The company has not only ratified the contract but it also accepted the modification of the contract through its secretary. The law provides that the company secretary is competent to enter into contract with regard to the subject matter connected with administration, as decided in Panorama Development V Fabric Furnishing7. Panorama Development V Fabric Furnishing: In this case Bayne, a company secretary entered into a contract of hiring cars for staff without any authority from board of directors. The court held that the contract is binding on the company since hiring of cares was usual to the office of the company secretary. In the present case the company secretary has accepted to the modification of the contract by accepting the alternative printers in place of the printer as originally contracted for. Hence Betram's liability may be protected under this plea. Foot Notes: 1. Twycross v Grant, (1877 2) CPD 469 2. Erlanger V New Sombreno Phosphate Co (1878)3 App Cas 1218 (house of lords)]: 3. Whaley Bridge Calico printing Co V GraGreen (1879) 5 QBD 109 4. Kelner v Baxter (1866) LR 2 CP 174 5. Phonogram V Lane (1982) QB 938 6. Salomon v Salomon (1897) 7. Panorama Development V Fabric Furnishing (1971). Sources: 1. L.S. Sealy, Cases and Materials in Company Law, 2001, 7th Edition. 2. Douglas Armour, Company Secretary's Hand book, 2003, 4th Edition. 3. ACCA, Approved Tex for the professional qualification, 2005 4. John Ellison, Jim Bedingfield, Tom Harrison, Business Law, 1997, 4the Edition. 5. Ewan Macintyre, Business Law A Novel Approach, 1997 6. http://www.lexis.com/research/retrieve/frames_m=39ff5a8f1bd6c2957311c499671100a4&docnum=59&_fmtstr=FULL&_startdoc=51&wchp=dGLbVtb-zSkAz&_md5=3a3dd7f4d16775614ba4ddb0db7db513 7. http://www.lexisnexis.com.au/cui/uni-login/default.htmlogin.aspuni=sth9ac&source=UK;ALLCAS 8. http://caselaw.lp.findlaw.com/scripts/getcase.plcourt=us&vol=210&invol=206 9. http://www.ilex-tutorial.ac.uk/Assets/File/Text%20Samples/Sample%20-%20Company%20and%20Partnership%20Law%20-%202006.pdf Read More