Promoters and pre-incorporation contracts

Question 1

In determining what recourse Harry and Ian may have in relation to the CPK property, one should examine the relevant facts and authorities. In terms of law, it is well established that, when a promoter sets up a company he may not profit from this position without full disclosure and consent from independent directors or initial shareholders. This was established in the case of Erlanger v New Sombrero Phosphate Co where it was held that because the promoters had not appointed independent directors, the contract can be rescinded. It is not difficult to understand the court's reasoning; if the promoters appoint directors that were related to them, the directors may be influenced by the promoters and thereby not acting for the best interest of the company. Therefore for the interest of the company, the promoters must sought permission or provide disclosure to the shareholders.

As to the question of what actually is needed to be disclosed, one may refer to Gluckstein v Barnes. In this case, the promoters disclosed some of the profits they have obtained in a prospectus, but withheld some other profits; it was held that the promoters were responsible to make good to the company what they had obtained and withstand from the shareholders.

Moving onto the facts, it is known that Allan, Bob and Daniel wanted to make a profit, therefore bought the commercial property and incorporated the company; what is also known is that the directors, vendor, and buyer are all influenced by Allan, Bob and Daniel in one way or another. But there are a few crucial factors left unknown, and must be addressed to realise the recourse, if any that is available to Harry and Ian; namely was any prospectus issued to the shareholders; and if so, did the shareholders know about the existence of Allan, Bob and Daniel and their relationships with the directors?

As Harry and Ian seem suspicious about the price paid for CPK, for the purpose of analysis, it is assumed that Harry and Ian do not know about Allan Bob and Daniel, and no prospectus was ever released. As stated earlier, profiting from promotion of a company is not strictly prohibited, but a prospectus must be released to the directors, and if the directors are influenced by the promoters, the disclosure must be released to the initial shareholders. In terms of the vendor, unlike the case of Re Leeds and Hanley Theatres of Varieties Ltdwhere the vendors stated that they have full confidence in the company, do not have much part in the present case. In short, the promoters have breached their duties and made secret profits without disclosure. But what remedies are available to Harry and Ian?

For the type of remedy that is to be provided, the crucial question is whether the property was acquired before or after promotion has started. There are two remedies that are available in this situation, first the company may seek to rescind the contract with the promoter. A second possible remedy is to recover the profit from promoter rather than to rescind the contract. The question here is whether the contract has been affirmed? Affirmation of contract requires full understanding of the circumstances, which is clearly not the present case. Remedy would therefore likely to be a rescission of the contract.

Question 2

To answer the question as to whether LawInfo can enforce the lease, one must look at both the common law and the statutory provisions. In common law, it is well established by Kelner v Baxter that a pre-incorporated company may not enter into a contract, and those who sign as the company is not sufficient as to bringing the contract into force. However, in Newborne v Sensisolid Parker J said that had the person who signed the contract acted as an agent of the company, and if there was no company, he can prove that he was in fact the principal, then the contract may be in force. Unfortunately though, the presented facts do not have enough information to determine whether Harry signed as an agent or as the company. Considering that he signed as director, he may have signed using the company's name and thereby not acting as an agent of the company nor did he intend to act as the principal.

This is, however not conclusive, as one must consider the statutory provisions, or more specifically the Companies Ordinance s32. According to this section, the person who purports to make a contract on behalf of the company are personally liable, but more importantly he is entitled to enforce the contract. According to this provision then, Harry may enforce the contract as principal rather than as the director of the company. However, the lessor may rely on the judgment of Cotronic Ltd v. Dezonie & Or that the section does not apply as Harry thought the company was already incorporated. However, a further read into the judgment, the judges' rejection provision 36(4) of the Companies Act 1985 was because the original company was formed long before. This is therefore not applicable in the present case. One may also argue that the proposed company had not been incorporated at all, and Harry and Ian had no choice but to change its name to LawInfo. In Oshkosh B ‘Gosh Inc v Dan Marbel Inc Ltd, it was held that the company, although with a change of name, was liable for carrying out the contract that its agent has signed. This case again has no bearing on the present matters. Indeed the company has changed its name, however according to section 32(a), it is the agent who may enforce the contract, therefore regardless of the name changes or even if the company does not come into existence, the contract is still executable by Harry himself.

One may raise the defence of mistake, according to Parker J in Re Leeds and Hanley Theatres of Varieties Ltd, that had the lessor realised that it was in fact Harry who wanted to contract and not the company, the lessor would not have granted lease at all. This may have been a proper defence, however according to the facts, the lessor wants to repudiate based on the fact that he could obtain a much higher rental and not because of Harry`s personal execution of the lease. Furthermore Harry has already executed the lease and the facts state the the lessor is belated in seeking to repudiate. The repudiation may lead to much hardship for Harry and his company, and therefore by equity, the court may rule in favour of Harry. The short answer to LawInfo's question would be, LawInfo may not enforce the contract, but on the strength of Harry as the principal, he may enforce the contract.