Lecture 3 – Formation of a Company
Recommended Reading
Grier N, Company Law (5th edn, W Green 2020) – Chapters 3 and 4
Optional:
Black (ed), Business Law in Scotland, 4th ed, 2019, Chapter 16 specifically sections 16-01 to 16-14
Palmer’s Company Law, Chapter 2 on Westlaw.
Podcast 1: Promoters and Pre-Incorporation Contracts
In this first lecture podcast, we will consider:
▪ who are the promoters of companies and what do they do?
▪ the duties of promoters
▪ what happens if promoters make contracts in the name of the company before it has
been formed (pre-incorporation contracts) - and how to avoid doing this in practice!
Who is a promoter?
A promoter is someone who sets up a company, carries out the preliminary activities relating to
company formation.
Cockburn CJ in Twycross v Grant (1877) 2 CPD 469
“A promoter, I apprehend, is one who undertakes to form a company with reference to a given
project and to set it going, and who undertakes the necessary steps to accomplish that purpose...and
so long as the work of formation continues, those who carry on that work must, I think, retain the
character of promoters. Of course, if a governing body, in the shape of directors, has once been
formed, and they take what remains to be done in the way of forming the company into their own
hands, the functions of the promoter are at an end."
He's talking about these aspects, retaining the character of promoters. Once a company is being
formed in the shape of the managers, the directors, they then take on the role of the promoter, and
the functions of the promoter, according to the judge, is at an end. the role of the promoter or
someone who is at at the stage even before the company is formed.
Whaley Bridge Calico Printing v Green (1880) 5 QBD 109, per Bowen J who said:
"The term promoter is a term not of law, but of business, usefully summing up in a single word a
number of business operations familiar to the commercial world by which a company is generally
brought into existence.”
The promoter is someone who does stuff to get a company formed and up and running.
,Many of the difficulties that arose with promoters and their activities happened at the end of the 19th
century when the ability to set up companies was established. And then it was many unscrupulous
individuals who sought to take advantage of this new corporate form. The idea of a company and the
benefits of separate legal personality of companies from their members, their shareholders and their
managers, their directors, and also the protection of limited liability.
Why was this? It was to potential investors into scam operations principally. So this is why we've had
some case law developing the concept of the promoter since then.
What is the Role of the Promoter?
▪ Incorporate the business;
▪ Find investors;
▪ Take all other steps necessary to start the business (premises, employees, licences etc)
▪ Historical issues arising with promoters not so prevalent today: off-the-shelf companies can
be formed quickly (off-the-shelf companies is one way in which we can kind of get round or
bypass the problem of using a promoter).
▪ However, two issues worth reviewing further: pre-incorporation contracts and fiduciary
duties.
Promoters’ Duties
Promoters owe the following duties to the company:
(1) Not to make a secret profit - The promoter must disclose any profit he stands to make from the
promotion of the company to either:
▪ An independent board of directors, or
▪ Existing or intended shareholders
(2) Reasonable skill and care.
Payment of Promoters
▪ A promoter is not an agent during the period before the company has been formed – as the
company (principal) does not exist - and so the company cannot contract to pay the promoter
for work done in that period.
▪ However, the articles of association often provide for payment for this work after the
company is formed.
, Remedies for breach of promoters’ duty
▪ Accounting to company for secret profit
Gluckstein v Barnes [1900] AC 240
A syndicate bought a property and intended to sell it to a company that they were forming, so the
company had not yet come into existence. They nominally bought it for £140,000, but they got it at a
discount at £120,000 so they saved £20,000. They then sold it to the newly formed company, which
they had become directors for, at £180,000. Thus, they had made a profit. The prospectus issued to
the public disclosed a profit of £40,000, but not the £20,000 discount. The company later failed and
the liquidator claimed repayments of that £20,000 discount.
The House of Lords upheld the liquidators claim, they had to account for the secret profit.
▪ Rescission of contract between company and promoter
Erlanger v New Sombrero Phosphate Co (1878) 3 App. Cas.1218
The syndicate was headed by Erlanger, who acquired the lease of an island in the Caribbean for
£55,000. The lease holder was a nominee of the syndicate, and the syndicate later incorporated the
company New Sombrero Phosphate Co, so the company was then later incorporated. At a meeting of
the syndicate, some of them who were members of the syndicate group that existed before, it was
agreed that the company would buy the lease from the nominee. The company issued a perspective
which did not mention that anyone other than the nominee had any interest in this.
It was held that there had been no disclosure by the promoters of the profit they were making
meaning the company could rescind the contract and recover the price from Erlanger and the other
members of the syndicate. So recission was appropriate in that case because it made the situation
that much more clear in terms of that wasn't so much a secret profit, but it was just not literally that
the contract was not going to necessarily disclose the profits that they were making.
▪ Damages
Re Leeds & Hanley Theatre of Varieties [1902] 2 Ch 809
The promoters of a company purchased property for the purposes of selling it to the company when
it was formed. When the company was being formed and a prospectus was being drawn up to invite
public to buy shares in the company, there was no mention that the promoter was the seller of the
property to the company. The company went into liquidation and the liquidator asked the court to
make the promoter account for the profit that they had obtained on reselling the property to the
company.
The court held that the promoter was in a fiduciary position towards persons who were invited to take
up shares to pay to invest in the company. It was the promoters duty to disclose to those persons the
fact that they were the real sellers of the property to the company. This made the company
prospectus, the document that was created by the promoter, a fraudulent one, and that was their
breach of duty that this nondisclosure by the promoters were liable in damages to the company and
that the true measure of damages in Leeds was the profits that the promoters had obtained upon the
purchase of the property and the resale of it to the company. In that case, damages was an appropriate
remedy.
