COMPANY LAW 2014-2015

LECTURE 5
Dr Jingchen Zhao
Senior Lecturer in Corporate Law
LL.B LL.M PhD

Reading
Textbook:
Len Sealy and Sarah Worthington, Cases and Materials in

Company Law, 10th ed., OUP, 2013 Chapter 3

Paul Davies and Sarah Worthington, Gower & Davies'
Principles of Modern Company Law, 9th ed., Sweet and
Maxwell, 2012 Chapter 5
Alan Dignam and John Lowry Company Law (Core Text
Series), 8th ed., OUP, 2014 Chapter 4

Activities Prior to Incorporation

Contracts negotiated with suppliers, distributors,

manufacturers;
Employees hired;
Premises obtained for operations (leases signed);
Bank accounts and credit facilities obtained;
Documents drafted for purposes of incorporation
(proposed constitutions);
Finance obtained from equity investors (i.e. prospective
shareholders) often by means of impressive documents
(prospectuses).

The issue arises

Is whether the promoter is personal liable on entering into

contract for company before it is formally registered

Promotion Process
Effecting the registration of the company with Companies

House
Negotiating pre-incorporation contract on behalf of the
recognised company
Finding the initial directors and shareholders

What is a Promoter?
Twycross v Grant (1877) 2 CPD 469: [a person who]

undertakes to form a company with reference to a given

project, and to set it going and takes the necessary
steps to accomplish that purpose. (per Cockburn CJ)
Whaley Bridge Calico Printing Co v Green and Smith
(1879) 5 QBD 109: Mr Justice Bowen found that 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. (per Bowen
J)

19th Century Problem of Fraudsters

Selling to the future company his own property at a

grossly inflated price

Promoters as Fiduciaries
Promoter is not the agent of the future company (Kelner v

Baxter 1866)
Promoter is not the trustee of the future company (Re Leeds
and Hanley)
Under to act for or on behalf of another in some particular
matter or matters
Erlanger v New Sombrero Phosphate Co. (1878) 3 App Cas
1218:
[Company 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 under what
supervision it shall start into existence and begin to act as a
trading corporation Cairns L J

Duty of Fiduciary
The fiduciary must act solely in the interests of his

principal: the fiduciary must act to secure his principals

best interests, and must not allow his own self-interests,
or the interests of others, to govern his behaviour in any
way that would conflict with the principals best interests.
Fiduciary law is thus the origin in modern society of the
legal notion of conflict of interests (Penner, The Law of
Trusts (2012))

Erlanger v New Sombrero Phosphate Co. (1878) 3

App Cas 1218
I invite your lordships to draw two conclusions. First, that the

company never had an opportunity of exercising, through

independent directors, a fair and independent judgment upon the
subject of this purchase; and, secondly, that this result was brought
about by the conduct and contrivance of the vendors themselves ...
Placed in [a)]position of unfair advantage over the company which
they were about to create, they were, as it seems to me, bound
according to the principles constantly acted upon in the Courts of
Equity, if they wished to make a valid contract of sale to the company,
to nominate independent directors and fully disclose the material
facts. The obligation rests upon them to show they have not made
use of the position which they occupied to benefit themselves; but I
find no proof in the case that they have discharged that obligation.
(Lord Penzance)

Disclosure
In the absence of an independent board of directors the

disclosure duty will be discharged if full disclosure of tall

material facts is made to the original shareholders.
Yes (Saloman v Saloman 1897)
No (Gluckstein v Barnes 1900) if the original
shareholders are not truly independent and scheme as a
whole is designed to defraud the investing public

Reduced Relevance of Prospectus Liability

(a) private companies are no longer permitted to solicit

investment from/offer shares to the public (see s755 CA

2006);
Prohibition of offering securities (shares and debenture)
(b) public companies are subject to strict regulation on the
contents of prospectuses (listing particulars) they issue,
which must comply with regulations and stock exchange
requirements.
Companies Act PART 43 Chapter 5
Financial Services and Markets Act 2000 isseud by the
Financial Services Authority. (Prudential Regulation
Authority and Financial Conduct Authority)

Pre-Incorporation contracts
However another issue relevant to the question of

promoters arises in relation to pre-incorporation contracts

these are the genuine contracts entered into by
promoters in advance of the formal incorporation of the
company. Under contract law, the company cannot be a
party to the contract as it does not yet exist (see Rover
International Ltd v Cannon Film Sales Ltd (No.3) [1987]
BCLC 540)
Doctrine of privity will prevent rights and liability being
conferred or imposed on company (Klelner v Baxter 1866)

A Question of Agency?
Kelner v Baxter (1866) LR 2 CP 174
I agree that if [the hotel] had been an existing company at this

time, the persons who signed the agreement would have signed
as agents of the company. But as there was no company in
existence at the time, the agreement would be wholly inoperative
unless it were held to be binding on the defendants personally ...
and a stranger cannot by subsequent ratification relieve [them]
from that responsibility. When the company came afterwards into
existence, it was a totally new creature, having rights and
obligations from that time, but no rights or obligations by reason of
anything which might have been done before ... there must be two
parties to a contract; and the rights and obligations which it
creates cannot be transferred by one of them to a third person who
was not in a condition to be bound by it at the time it was made.

Common Law
English law attempts to distinguish two situations:
(a) the intention is that third party contracts with promoter, in

anticipation of the formation of the company, in which case promoter

is normally liable (as agent for non-existent principal) as in Kelner
(b) the intention is that third party contracts with company, but,

company being non-existent, no contract is created. Promoter singed

the contract merely to confirm the signature of the company; See
Newborne v Sensolid (GB) Ltd [1954] 1 QB 45: sale to S of 200
cases of spam; market fell and S refused to take delivery; when
sued, S pleaded that when contract was made, N had not been
incorporated and neither N nor promoter could enforce it. Court
agreed because contract supposed to be with non-existent company.

Statutory Intervention
Article 7 First Company Law Directive (68/151 OJ 1968(I))

which was given effect by s36C(1), CA 1985 which is now

s 51(1), CA 2006:
a contract which purports to be made by or on behalf of a

company 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.

Phonogram Ltd v Lane [1981] 3 WLR 736

company to be formed to run pop group (Cheap Mean

and Nasty); the group obtained finance from P; the

company was not formed and the group never played; P
sued L to recover moneys as L had negotiated on behalf
of company to be formed. Held: L personally liable.
Lords Denning and Shaw decided that the phrase subject
to any agreement to the contrary means that in order for
a promoter to avoid personal liability the contract must
expressly provide for his or her exclusion.

Objective of S.51
The objective of s. 51 is to protect third parties

who contracted in the belief that they were

dealing with registered companies by making preincorporation contracts legally enforceable as
personal contracts with promoters unless the
personal liability of the latter has been
unequivocally excluded.