ACCA F4 - Corp and Business Law (ENG)

Part D The formation and constitution of business organisations  13: Company formation 197

A promoter may make a profit as a result of their position.

(a) A legitimate profit is made by a promoter who acquires interest in property before promoting a

company and then makes a profit when they sell the property to the promoted company, provided

they disclose it.

(b) A wrongful profit is made by a promoter who enters into and makes a profit personally in a

contract as a promoter. They are in breach of fiduciary duty.

A promoter of a public company makes their disclosure of legitimate profit through listing particulars or

a prospectus. If they make proper disclosure of a legitimate profit, they may retain it.

1.1.1 Remedy for breach of promoter's fiduciary duty

If the promoter does not make a proper disclosure of legitimate profits or if they make wrongful profits the

primary remedy of the company is to rescind the contract and recover its money: Erlanger v New

Sombrero Phosphate Co 1878.

However sometimes it is too late to rescind because the property can no longer be returned or the

company prefers to keep it. In such a case the company can only recover from the promoter their

wrongful profit, unless some special circumstances dictate otherwise.

Where shares are sold under a prospectus offer, promoters have a statutory liability to compensate any

person who acquires securities to which the prospectus relates and suffered loss as a result of any untrue

or misleading statement, or omission. Statutory and listing regulations together with rigorous

investigation by merchant banks have greatly lessened the problem of the dishonest promoter.

2 Pre-incorporation expenses and contracts

A promoter has no automatic right to be reimbursed pre-incorporation expenses by the company,

though this can be expressly agreed.

2.1 Pre-incorporation expenses

A promoter usually incurs expenses in preparations, such as drafting legal documents, made before the

company is formed. They have no automatic right to recover these 'pre-incorporation expenses' from

the company. However they can generally arrange that the first directors, of whom they may be one, agree

that the company shall pay the bills or refund to them their expenditure. They could also include a special

article in the company's constitution containing an indemnity for the promoter.

2.2 Pre-incorporation contracts

Pre-incorporation contracts cannot be ratified by the company. A new contract on the same terms must be

expressly created.

A pre-incorporation contract is a contract purported to be made by a company or its agent at a time

before the company has been formed.

In agency law a principal may ratify a contract made by an agent retrospectively. However, a company can

never ratify a contract made on its behalf before it was incorporated. This is because it did not exist

when the pre-incorporation contract was made so one of the conditions for ratification fails.

A company may enter into a new contract on similar terms after it has been incorporated (novation).

However there must be sufficient evidence that the company has made a new contract. Mere recognition

of the pre-incorporation contract by performing it or accepting benefits under it is not the same as making

a new contract.

Key term

FAST FORWARD

FAST FORWARD