Relevant to LW-LSO
The Companies Act (CA) 2011 defines a ‘promoter’ to mean any person who applies for incorporation of a company.
The definition of ‘promoter’ in CA 2011 raises two issues.
Pre-incorporation contract are defined under the CA 2011 as a contract:
(a) purporting to be made by a company before its incorporation, or
(b) made by a person on behalf of a company before and in contemplation of its incorporation.
Until the company is incorporated it cannot contract or do any other act. Nor, once incorporated, can it become liable on, or entitled under, contracts purported to have been made on its behalf prior to incorporation because ratification is not possible when the ostensible principal did not exist at the time the original contract was made.
However if promoters are arranging for the company to take over someone else’s business, the seller and the promoter would wish to have a binding contract, which would provide that the personal liability of the promoters would cease once the company is incorporated. The seller and the company will provide this in their contract specifically.
Promoters frequently enter into contract with lawyers and accountants for incorporation of the company. They may also enter into contracts with third parties ostensibly for the company before it has been incorporated. Thus, pre-incorporation contracts are often made on behalf of a company. A company may be liable on a pre-incorporation contract made on its behalf in two ways:
(a) under section 10 CA 2011 Act, or
(b) under the common-law rules relating to contracts on behalf of a third party.
The benefit of section 10 CA 2011 may only be claimed when a promoter with the Registrar of the Companies has first reserved the name of the company before entering into a pre-incorporation contract. The company must be incorporated, apparently with the same name, and registration documents must be submitted to the Registrar within 14 days of the reservation of the name. If this is not done, the pre-incorporation contract becomes null and void and the promoter would not be able to benefit from the provisions of section 10. However, third parties will not be affected by the invalidity of the pre-incorporation contract and can recover their losses. (Reg. 6, CA 2011).
Under section 10 CA 2011, a company, after incorporation, may ratify a contract made in its name or on its behalf prior to its incorporation within such period as is specified in the contract. If no period is specified, the company may ratify it within a reasonable time after its incorporation. Normally, it is the directors of a company after incorporation that would ratify the pre-incorporation contracts. This can be inferred from the model articles, which provide that the directors shall manage the business of the company. These are very broad powers and should include the power to pay all expenses incurred in promoting and registering the company and entering into contracts on behalf of their company.
Section 10 also takes care of a situation where a promoter enters into a pre-incorporation contract in the name or on behalf of the company, which the company does not ratify.
Unless a contrary intention is expressed in the contract, a promoter while entering into a pre-incorporation contract impliedly warrants that the company:
(a) will be incorporated within the period specified in the contract, or if no period is specified, within a reasonable time after the making of the contract; and
(b) it will ratify the contract within such period specified in the contract, or if no period is specified, within a reasonable time after the incorporation of the company.
For breach of this implied warranty, the company is liable to pay damages to any person suffering a loss. The court would assume that the pre-incorporation contract was ratified and then cancelled by the company. The amount of damages that may be recovered would be for losses incurred as a result of the company not performing its obligations under the pre-incorporation contract.
In addition, if a company does not ratify a pre-incorporation contract after its incorporation, a party to that contract may approach the court for an order:
(a) that any property, movable or immovable, acquired by the company under the contract be returned to that party (usually the seller)
(b) for any other relief in relation to that property, or
(c) specific performance, whether in whole or in part, by validating the contract.
The court may grant any other additional relief as well, if it considers just and equitable to do so. Section 10 CA 2011 also covers a situation when a company after ratifying a pre-incorporation contract breaches it. In such a case, the court shall, on its own motion, or on the application of the company or any party to the proceedings, make such order for the payment of damages or other relief, as the court considers just and equitable. Such other relief may be in addition to, or in substitution for, any order, which may be made against the company, or a person by whom the contract was made (usually a promoter).
Last, if a company, after its incorporation, instead of ratifying a pre-incorporation contract chooses to enter into a contract on the same terms as the pre-incorporation contract, the liability of the company, the promoter or any person including the liability to pay damages under a court order comes to an end.
The aim of section 10 CA 2011 is to increase security of transactions for the third parties by avoiding the consequences of a contract that occur because a company before its incorporation is a nullity. The protection is provided by giving the third party an enforceable contractual obligation against the incorporated company. The implied warranty of the promoter can be taken advantage of unless a contrary intention of the third party to forego the protection is expressed in the contract.
If a promoter enters into a pre-incorporation contract on behalf of a yet-to-be incorporated company and the company chooses not to adopt or ratify the contract, then is the promoter personally liable? Section 10 CA 2011 does not deal with that situation. That is largely left to the common law.
At the common law, a company cannot adopt or ratify a contract entered into prior to its incorporation by a person who professed to act as its agent on behalf of a non-existent principal. (See Kelner v. Baxter .
However, under the Roman-Dutch common law a company can adopt a contract made for its benefit by a person acting as a principal (stipulatio alteri) and such a contract is binding on a company. In short, if a promoter signed the contract as an agent on behalf of the proposed company, the promoter is personally liable under the common law. However, if the promoter signed the contract as a principal (stipulans) for the benefit of a company, the promoter may not be personally liable provided certain conditions are met. The object of the agreement must be to secure some advantage for the unformed company. The benefit may carry with it some corresponding obligation. In that case, a company cannot take the benefit without the corresponding obligation. If a company accepted the benefit then it must notify the promisor. On such notification, the contract is binding on both the parties: the company and the promisor.
However, a company may not be entitled to sue on a pre-incorporation contract under the common law when someone acting as an agent on behalf of the proposed company made the contract.
The Companies Act 2011 is largely silent on the subject, merely imposing liability for untrue statements in prospectus. The duties of a promoter, thus, are to be found in the common law, not in the Companies Act.
The courts were alive to the possibilities of abuse that were inherent in the promoter’s position and in order to protect the investors laid it down that a promoter stands in a fiduciary position towards the company they promote. These duties, which to some extent, track the fiduciary duties of directors, have not been restated in the Companies Act 2011, as the directors duties have been, and that is why they remain regulated by the common law.
It is not unusual for promoters to sell their own property to the company they are promoting at a profit to themselves. This is permissible provided they provide the company with a board of directors, who are aware that the property the company is buying is the property of the promoters, and further that such board of directors can and do exercise an independent and intelligent judgment on the transaction.
Therefore, an exception to the rule had to be made. It was decided in Salomon v Salomon & Co, that disclosure to the entire membership would be equally effective.
Gower explains that the present position of law is that disclosure must be made to the company either by making it to an entirely independent board or to the existing and potential members as a whole. If the first method is employed the promoter will be under no further liability to the company. If the second method is adopted the veil of incorporation is in effect ignored and disclosure must be made in the prospectus, articles, or otherwise, so that those who are or become members, as a result of the transaction in which the promoter was acting as such, have full information regarding it. A partial or incomplete disclosure will not do; the disclosure must be explicit. A promoter cannot effectively contract out of his duties by inserting a clause in the articles whereby the company and the subscribers agree to waive their rights.
Written by a member of the Corporate and Business Law examining team