Tutorial 1: Promoters and Pre-incorporation Contracts

1. What is the effect of a pre incorporated contract on the company.

Answer:
At times, promoters will have to enter a contract with a third party though the
company has yet to be registered.
A pre-incorporation contract is one which is purportedly made by or on
behalf of a company at a time when the company has not yet been
incorporated.
At common law such contracts were totally void. This was because until a
company was incorporated it has no capacity to contract.
A company could not ratify the contract after its incorporation
Kelner v Baxter (1886)
Baxter and two others agreed on behalf of a company yet to be formed to
purchase trade stock for its business. Later the company was formed and
accepted and used the trade stock, but failed to pay for the stock.
HELD: The company was not liable as it could not ratify a pre
incorporation contract with retrospective effect to a date before the
company existed. Baxter and friends were therefore unable to recover
their money.
Thus, in Kelner v Baxter, it was held that the pre-incorporation contract
was not binding on the company after its formation, and that the
promoters or persons acting on behalf of the company before the
formation were personally liable.
Further, no ratification could release them from such liability.

The United Kingdom subsequently introduced s36C Companies Act 1985,

which provides:
A contract which purports to be made by or on behalf of a company at a time
when the company has not been formed has effect, subject to any
agreement to the contrary, as one made with the person purporting to act
for the company or as agent for it, and he is personally liable on the contract
accordingly.
This rule may be avoided by any agreement to the contrary.
Phonogram Ltd v Lane [1981] confirmed that such a provision must be
expressly and unambiguously included in the agreement and will not be
implied. (Note: This case was decided under a prior enactment of s36C.)

2. Briefly explain the Malaysian position on pre-incorporated contracts.

Answer:
The Malaysian position is governed by section 35(1) and (2) of the
Companies Act 1965.
By virtue of section 35(1) of the Companies Act 1965, any contract or
other transaction purporting to be made by a company prior to its
formation may be ratified by the company after its formation.
After such ratification, the company shall become bound by and entitled
to the benefit thereof as if it had been in existence at the date of the
contract or other transaction, and as if it had been a party thereto.
By virtue of section 35(2) of the Companies Act 1965, prior to ratification
by the company, the person or persons who purported to act on behalf
of the company shall in the absence of express agreement to the
contrary be personally bound by the contract or other transaction and
entitled to the benefit thereof.
Thus, in Malaysia, a pre-incorporation contract can be ratified by the
company after its incorporation.
Once ratified, either party can sue the other party for breach upon the
contract as illustrated in Cosmic Insurance Co. Ltd. v Khoo Chiang Poh
(1981).

3. In the event of a secret profit made by a promoter of a company, what are the
remedies available to the company?
Answer:

Erlanger v New Sombrero Phosphate Co [1878].

Erlanger, the promoter, acquired on his own account but in the name of
another (a nominee) the lease of a phosphate mine in the West Indies
for 55,000. He then proceeded to sell the mining rights to the newly
formed company for 110,000.
The purchase was approved by the board of directors of the company,
who had been appointed by Erlanger and was either under his influence
or, as in the case of one of the directors, who was the Lord Mayor of
London, simply did not have time to give to the enterprise.
The prospectus that offered the companys shares to the public did not
disclose the promoters profit. When the original board of directors was
replaced, the new directors, on discovering the swindle, sued Erlanger
to have the contract for the sale of the mining rights rescinded.

It was held that the contract should be rescinded because the

profit made by Erlanger had not been properly disclosed (in this
case to an independent board) and therefore could not be kept by
him.

 This case illustrates the fiduciary nature of the promoters role, which
puts him very much in the same position of quasi-trusteeship as a
company director. A key feature of this status is that such a fiduciary
must not make a secret profit. The promoter can avoid contravening this
requirement in a number of ways.
By making a proper disclosure of any profit he has made (thus
removing any element of secrecy) to either an independent board of
directors or to the existing or prospective members of the company or
In the case of a public company, compliance with the rules on
prospectus disclosure is sufficient.

Gluckstein v Barnes (1900)

Promoters of a company had acquired a property intending its resale
through the sale of shares in the company. In doing so the original
directors made a substantial profit which they did not disclose (though
it was discoverable). The company became insolvent and investors
sought repayment of the hidden profit. Held: The action succeeded.

As promoters they were under a duty to make explicit

declarations of the profits already made.
So a promoter has to disclose any transaction entered, either by,
disclosing in Memorandum & Articles;
by communicating to an independent Board of Directors;
By communicating to the existing and intended members of
the company.
Failure to disclose, the company has options:
Company may rescind the contract (Erlanger v New
Sombrero Phosphate), and
In certain circumstances, company may be able to claim the
secret profit obtained by the promoter (Gluckstein v
Barnes),
Company may file suit for damages for the breach of
fiduciary duties (Re Leeds & Hanley Theater)
If the company elects to affirm the contract, company may have a
cause of action against promoters for:
deceit,
fraud
negligent misrepresentation
4. What are the roles played by a promoter before the formation of the
company?

 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.
(Setting up the company)
per Cockburn, C.J in Twycross v Grant (1877), a promoter is described 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.
This classic definition includes anyone who:
either takes the procedural steps necessary to form the company; or
sets up the companys business (involving entering into pre-incorporation
contracts);
but does not include those who act merely in a professional capacity
acting on the instructions of a promoter, for example a solicitor or an
accountant.
Promoters owe fiduciary duties towards the company, not to the individual
members of the company.

If the promoter is in breach of his fiduciary duties, it is the

company who may take legal action against the promoter.
A promoter owes fiduciary duties towards the company:
To act in good faith
To ensure that there is no conflict of interest
Refer to cases:
Erlanger v New Sombrero Phosphate Co (1878)
Gluckstein v Barnes (1900)
5. If there is a contract entered into before the formation of the company, can the
company choose not to honour the contract? Please state your answer with
the support of case law.
Answer:
At times, promoters will have to enter a contract with a third party though the
company has yet to be registered.
This has to be analysed from two viewpoints i.e. the position in the United
Kingdom and the Malaysian position.
A pre-incorporation contract is one which is purportedly made by or on behalf
of a company at a time when the company has not yet been incorporated.
At common law such contracts were totally void. This was because until a
company was incorporated it has no capacity to contract.
A company could not ratify the contract after its incorporation
Kelner v Baxter (1886)
Baxter and two others agreed on behalf of a company yet to be formed to
purchase trade stock for its business. Later the company was formed and
accepted and used the trade stock, but failed to pay for the stock.

HELD: The company was not liable as it could not ratify a pre incorporation
contract with retrospective effect to a date before the company existed.
Baxter and friends were therefore unable to recover their money.
Thus, in Kelner v Baxter, it was held that the pre-incorporation contract was
not binding on the company after its formation, and that the promoters or
persons acting on behalf of the company before the formation were
personally liable.
Further, no ratification could release them from such liability.

The United Kingdom subsequently introduced s36C Companies Act 1985,

which provides:
A contract which purports to be made by or on behalf of a company at a time
when the company has not been formed has effect, subject to any agreement
to the contrary, as one made with the person purporting to act for the
company or as agent for it, and he is personally liable on the contract
accordingly.
This rule may be avoided by any agreement to the contrary.
Phonogram Ltd v Lane [1981] confirmed that such a provision must be
expressly and unambiguously included in the agreement and will not be
implied. (Note: This case was decided under a prior enactment of s36C.)

6. In January 2009, Annie Apples and Betty Berry decided to form a company to
manufacture wine. In March 2009, Annie without telling Betty purchased a plot
of land, Grapefield at a properly conducted auction for a price of RM
375,000. This was actually more than 100% less than its true market value at
that time. Grapefield was then transferred to the sole name of Annie.
In August 2009, Annie approached Dave Glee and explained to him that she
was forming a wine manufacturing company. She entered into an agreement
with Dave to supply a hydraulic grape press machine for the sum of RM
50,000 which shall be payable within three months of delivery.
In December of 2009, Annie and Betty formed a company, Sloshed Sdn.
Bhd. and that company was duly incorporated in accordance with the
Companies Act 1965. They each held 500,000 RM1 fully paid up shares in
the newly formed company.
In January of 2010, Annie sold Grapefield for RM1.2 million (the actual
market value at that time) to Slosh Sdn. Bhd. Last week, they sold the
company to Sean Kayne who has now discovered all these facts. Sean has
been receiving phone calls from an irate Dave demanding payment.
Discuss.

In January 2009, Annie Apples and Betty Berry decided to form a

company to manufacture wine.

In January 2009, Annie Apples and Betty Berry decided to form a

company to manufacture wine.

When AA and BB decide to form a company, the issue is whether

this will amount to promotion of a company. The law provides
that 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. (Setting up the company).

As per Cockburn, C.J in Twycross v Grant (1877), a promoter is

described 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. This classic
definition includes anyone who:

Either takes the procedural steps necessary to form the

company; or sets up the companys business (involving entering
into pre-incorporation contracts); but does not include those who
act merely in a professional capacity acting on the instructions of
a promoter, for example a solicitor or an accountant.

In March 2009, Annie without telling Betty purchased a plot of land,

Grapefield at a properly conducted auction for a price of RM 375,000
and transferred to the sole name of Annie.

This action again do not amount to formation of a company, as

although there were actions taken, but the action was to transfer
the property to the sole name of Annie without the knowledge of
Betty. This may not amount to taking action to form a company
and a such AA in purchasing the land is not taking action to form
the company.

This was actually more than 100% less than its true market value at
that time. Grapefield was then transferred to the sole name of Annie.

Half- price from true value.

In August 2009, Annie approached Dave Glee and explained to him

that she was forming a wine manufacturing company. She entered into
an agreement with Dave to supply a hydraulic grape press machine for
the sum of RM 50,000 which shall be payable within three months of
delivery.

When Annie informs Dave of her intention and then enters into a
contract to purchase hydraulic grape press machine for RM
50,000 for the company. This fulfils the requirements that 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. (Setting up the company).

As per Cockburn, C.J in Twycross v Grant (1877), a promoter is

described 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.

This classic definition includes anyone who: Either takes the

procedural steps necessary to form the company; or sets up the
companys business (involving entering into pre-incorporation
contracts.

In December of 2009, Annie and Betty formed a company, Sloshed

Sdn. Bhd. and that company was duly incorporated in accordance with
the Companies Act 1965. They each held 500,000 RM1 fully paid up
shares in the newly formed company.

In December 2009, when Annie and Betty formed a company

Sloshed Sdn. Bhd., with 1,000,000 shares of RM 1 fully paid-up
this fulfill the requirement of section 4 (1) of the Companies Act
of formation of a limited company as a company limited by
shares or guarantees.

In January of 2010, Annie sold Grapefield for RM1.2 million (the

actual market value at that time) to Sloshed Sdn. Bhd.
The issue that is in contention would be whether Annie fulfilled her fiduciary
role as a promoter. In Erlanger v New Sombrero Phosphate Co [1878], it
was held that the contract should be rescinded because the profit made
by Erlanger had not been properly disclosed (in this case to an
independent board) and therefore could not be kept by him. A key
feature of this status is that such a fiduciary must not make a secret
profit. The promoter can avoid contravening this requirement in a
number of ways.
By making a proper disclosure of any profit he has made (thus
removing any element of secrecy) to either an independent board of
directors or to the existing or prospective members of the company or
In the case of a public company, compliance with the rules on
prospectus disclosure is sufficient. Gluckstein v Barnes (1900)
Promoters of a company had acquired a property intending its resale
through the sale of shares in the company. In doing so the original
directors made a substantial profit which they did not disclose (though
it was discoverable). The company became insolvent and investors
sought repayment of the hidden profit. Held: The action succeeded. As
promoters they were under a duty to make explicit declarations of the
profits already made.
So a promoter has to disclose any transaction entered, either by,
disclosing in Memorandum & Articles;
by communicating to an independent Board of Directors;

By communicating to the existing and intended members of the

company.

Failure to disclose, the company has options:

Company may rescind the contract (Erlanger v New Sombrero
Phosphate), and
In certain circumstances, company may be able to claim the
secret profit obtained by the promoter (Gluckstein v Barnes),
Company may file suit for damages for the breach of fiduciary
duties (Re Leeds & Hanley Theater)
If the company elects to affirm the contract, company may have a cause
of action against promoters for:
deceit,
fraud
negligent misrepresentation

Last week, they sold the company to Sean Kayne who has now
discovered all these facts. Sean has been receiving phone calls from
an irate Dave demanding payment.
Sean Kayne as the new member of the Board of Directors may have the
following options: Can use Erlanger, Gluckstein and Re Leeds to discuss: Failure to disclose, the company has options:

Company may rescind the contract with the former owner of the
company, namely AA and BB (Erlanger v New Sombrero
Phosphate), and in this case we were told that the company had
already been sold to Sean. Only if the nature of the company has
completely changed then Sean would not be able to rescind the
purchase of the company with AA and BB. Rescission means that
Sean would be placed back in a position before the contract was
made would only be possible if the nature of the company had
not changed. As the company had only recently changed hand
recession may be possible.

In certain circumstances, where the Sean cannot rescind the

contract the company may be able to claim the secret profit
obtained by the promoter (Gluckstein v Barnes), and failing
which,

The Company may file suit for damages for the breach of
fiduciary duties (Re Leeds & Hanley Theater)

If the company elects to affirm the contract, company may have a cause
of action against promoters for:

deceit,
fraud

negligent misrepresentation.

The machine supplied by Dave could have been used by the company in
which case the company must affirm the contract and pay Dave for the
amount owing and pursue to recover from the past Director, Annie.

If the company elects to affirm the contract, company may have a

cause of action against promoters for:
o
o
o

deceit,
fraud
negligent misrepresentation.