PROMOTERS AND PREINCORPORATION CONTRACTS
Prior to the decision in Twycross v Grant, there was no precise definition of the term “promoters”. The reasoning was that adopting a precise definition could make the company susceptible to fraud and this could leave adverse effect on so many people. However, in Twycross v Grant an attempt was made to give a precise definition. Cockburn CJ described a promoter as one who undertakes to form a company with reference to a given project and to set it going, and who takes the necessary steps to accomplish that purpose. However, the term promoter does not include those who act merely in professional capacity acting on the instructions of a promoter for example a solicitor or an accountant. In this case, it is obvious that Candy and Caramel are promoters by setting up the business and entering into pre-incorporation contract.
CAMA codified the common law description of a promoter in S. 61 CAMA. The section provides:
‘’Any person who undertakes to take part in forming a company with reference to a given project and to set it going and who takes the necessary steps to accomplish that purpose, or who, with regard to a proposed or newly formed company, undertakes a part in raising capital for it, shall prima facie be deemed a promoter of the company”
Provided that a person acting in a professional capacity for persons engaged in pro‐curing the formation of the company shall not thereby be deemed to be a promoter.’’
The underlined part above is the difference between the Twycross’ case and that in CAMA. Please note that a promoter is neither an agent nor a trustee but he is in a fiduciary relationship with the company. Also, the fact that a person meets the characteristics in S. 61 doesn’t automatically make him a promoter of the company; it is only prima facie evidence. But with regard to persons acting in a professional capacity as stated in the proviso, does it mean that a solicitor can’t be a promoter of that company where such solicitor also has shares in the company and still engages in the incorporation process? S. 61 must be applied in the circumstances of each case.
S. 62(1) CAMA merely restates the common law position that a promoter stands in a fiduciary relationship with the company and must observe good faith towards the company in any transaction with it or on its behalf. Where he fails to do so, he must compensate the company for any loss suffered by it. S. 62(2) provides that a promoter who acquired any property or information in circumstances in which it was his duty as a fiduciary to acquire it on behalf of the company shall account to the company for such property and for any profit which he may have made from the use of such property. S. 62(3) is to the effect that any contract between a promoter and the company can be rescinded unless the company ratifies the contract after full disclosure of all the relevant facts known to the promoter have been disclosed. There is no ratification where the same wrongdoers in the company vote for the transaction. Thus, there must be a genuine and independent ratification. S. 62(4) provides that where a director contravenes the provision of S. 62(1)-(3), no limitation period shall lie in his favour but the courts can relieve him if it is equitable to do so.
The rule in Foss v. Harbottle provides that individual shareholders have no cause of action in law for any wrongs done to the corporation and that if an action is to be brought in respect of such losses, it must be brought either by the corporation itself (through management) or by way of a derivative action. Thus, the general rule is that law does not permit a shareholder to bring an action on behalf of the company in which it holds shares and treats the company itself as the proper plaintiff. This derives from the fact that a company has separate legal personality. However, there exists four recognised exceptions to that rule: a. ultra vires and illegality: the directors of a company, or a shareholding majority may not use their control of the company to paper over actions which would be ultra vires the company, or illegal (See Smith v Croft) b. Actions requiring a special majority: if some special voting procedure would be necessary under the company's constitution or under the Companies Act, it would defeat both if that could be sidestepped by ordinary resolutions of a simple majority, and no redress for aggrieved minorities to be allowed c. Invasion of individual rights d. Frauds on the minority: fraud here means abuse of power whereby the directors or majority, who are in control of the company, secure a benefit at the expense of the company.
It is important to note that the rule in Foss v Harbottle has been codified in sections 299 and 300 CAMA. By virtue of S. 299 CAMA, where a wrong has been done to a company or where an irregularity has been committed in the course of the company’s affairs, it is only the company that can sue to remedy that wrong and ratify the irregular conduct. S. 300 of the Act provides exceptions: a. where the transaction is illegal or ultra vires b. doing ordinary resolution when the constitution says special resolution c. where the act complained of affects that of the applicant as a member d. fraud on the minority shareholders e. where a meeting cannot be conveyed on time to redress such wrong f. the directors have or are likely to derive a benefit from their breach or negligence.
In order to get the benefits of a ‘corporate personality', it is very necessary for ‘an association of persons' to become incorporated under the CAMA 1990. After the incorporation of association of persons the company comes in existence, and it can start its business operations as company only after that. The simple reason behind it is that before incorporation, a company has no legal existence before incorporation, and if the ‘association of persons' enters into an agreement in the name of company before incorporation; the agreement would be void ab initio.
It would be a matter of inconvenience that ‘an association of persons' cannot perform any official business operation in the name of company before its incorporation or the issue of certificate of commencement of business; they may have to make arrangement for office, place of work, worker, etc. In order to do away with these inconveniences, the promoter can enter into the agreements in the benefit of ‘association of persons' or prospective company; these agreements are known as pre-incorporation contracts.
Under the strict principles of contract law, the promoter is solely liable for the breach of contract. The reason behind is that the promoter is party who enters into the contract, and not the company. The rule of privity of contract keeps away the company from pre-incorporation contract. Thus, the company can’t be liable since it was not in legal existence at time of pre-incorporation contract. The case of Kelner v Baxter confirms this position. In Kelner v Baxter, the promoter on behalf of unformed company accepted an offer of Mr. Kelner to sell wine, subsequently the company failed to pay Mr. Kelner, and he brought the action against promoters. The court found that the principal-agent relationship cannot be in existence before incorporation, and if the company was not in existence, the principal of an agent cannot be in existence. The promoters were held personally liable for the pre-incorporation contract.
In pure common law sense, Pre-incorporation contract does not bind the company. However, the court in Newborne v Sensolid interpreted the finding in Kelner’s case in a different way and developed the principle further. In this case, a written contract purported to sell goods by a company described as Leopold Newborne (London) Ltd. The document was subscribed by the name of the company with Mr Leopold Newborne’s signature under it. At that time it had not been incorporated. Mr Newborne attempted to enforce the contract as one to which he was party. The court observed that before the incorporation the company cannot be in existence, and if it is not in existence, then the contract which the unformed company signed would also be not in existence. So company cannot bring an action for pre-incorporation contract, and also the promoter cannot bring the suit because they were not the party to contract. The rule was further explained by Lord Denning in Phonogram Limited v Lane where he found that if an unformed company enters into the contact, then it cannot bind the company, but the legal effect of contract does not entirely lack. And even in that situation the promoter or ‘representor’ is personally liable for the pre-incorporation contract.
The case of Edokpolo v Sem-Edo Wire Industries must be noted here. The Court of Appeal in that case affirmed the common law principles on a company’s non-liability for pre-incorporation contracts and the famous rule in Foss v Harbottle. Relying on Kelner v Baxter, the court held that the company after incorporation could not ratify a 1975 pre-incorporation agreement such that it became an agreement between it and any of the original parties thereto. It must be noted that the Court of Appeal in this case failed to distinguish between pre-incorporation contracts and shareholders’ pre-incorporation agreements. The case presented the latter and the court erred when it treated it as the former. On appeal to the Supreme Court……..
S. 72(1) CAMA makes it possible for a company to ratify a contract made before its incorporation. Once ratification is done, the company can sue and be sued on such contract. S. 72(2) states that before any such ratification by the company, the person purporting to act on behalf of the company will be personally liable for the contract except there is an express agreement to the contrary. Please note that the provision of S. 72 does not cover a situation where the promoters were contracting for themselves and not for the company.
On the provision of S. 72, see Trans-bridge v Survey International and Sparks Electronics v Ponmile. The former is to the effect that though a company may ratify a pre-incorporation contract, it can only do this with the consent of the other party.The key difference between the common law provision and that under CAMA as regards pre-incorporation of contracts is that common law did not allow ratification of such contracts but this is possible under the CAMA. This was noted in the case of SocieteGeneraleFavouriser… v SocieteGenerale Bank, where the court noted that a pre-incorporation contract can be ratified by a company after its incorporation and thereby binding the company and entitling it to the benefit thereof. It should however be noted that this case was instituted prior to the enactment of the CAMA 1990. Is there anything wrong with this? = I think so. In my view, the court should have applied the common law position. Also, I don’t think the SC was right in treating shareholder’s pre-incorporation agreements as pre-incorporation contracts.