Corporations Law In Principle - ( Chapter 8 Promoters and Pre-registration Contracts ) PDF

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CHAPTER 8

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Promoters and Pre-registration Contracts Useful Websites ..................................................................... 221 Recent Developments ............................................................ 221 Aim ......................................................................................... 221 Related Topics ....................................................................... 222 Principles ............................................................................... 222 Promoters and their duties ............................................................. 222 Remedies for breach of promoters’ duties .......................................... 224 Pre-registration contracts .............................................................. 226 Mentor: Test your Knowledge ............................................... 230 Practice Questions ................................................................. 230 Problem for Discussion .......................................................... 230 Guide to Problem Solving ...................................................... 231

Useful Websites ...................................................................................................................................... (See http://legal.thomsonreuters.com.au/browse/mentor/corplawhub.asp for websites on the Topic of Promoters and Pre-registration Contracts.)

Recent Developments ...................................................................................................................................... B J McAdam Pty Ltd v Jax Tyres Pty Ltd (No 3) [2012] FCA 1438 Rafferty v Madgwicks [2012] FCAFC 37

Aim ...................................................................................................................................... At the end of this topic you should:

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Further Reading ..................................................................... 233

• understand what is meant by the word “promoter” in different contexts; • know the duties of promoters to the company being formed and the company's remedies for breach of those duties; and • understand why pre-registration contracts are regulated by the Corporations Act.

Jeswynn, Y., Lidia, X., Yogaratnam, J., Xynas, L., & O'Connell, A. (2016). Corporations law : In principle. ProQuest Ebook Central http://ebookcentral.proquest.com Created from vu on 2020-12-09 19:25:13.

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Related Topics ...................................................................................................................................... Chapter 14 Members' Rights and Remedies; Chapter 21 Fundraising

PRINCIPLES This Topic deals with problems associated with the formation of companies. Promoters (the people who are involved in setting up a company) may take advantage of their position through contracts or arrangements to benefit themselves. Therefore, the law imposes duties on them to disclose their interests. Other problems may arise where contracts have been entered into (purportedly) on behalf of a company, but before that company has legally been formed – that is, prior to its registration. The law has to resolve the questions of validity and enforceability of such contracts because one party (the not-yet-registered company) is not in existence at the time of contracting and, indeed, may never come into existence. [8.10]

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Corporations (Aboriginal and Torres Strait Islander) Act 2006 (Cth) (CATSI Act)

There are no specific provisions in the CATSI Act dealing with promoters' liability and pre-registration contracts. However Part 2-5—Effects of Registration, Part 3-5—Corporations powers and how they are exercised, and Part 4-4—Protection of members' interest are relevant, amongst other provisions.

Promoters and their duties Who are promoters? .......................................................................................................................................................................

In general terms, promoters are the people who establish the company. The Corporations Act 2001 (Cth) (Corporations Act) does not define “promoter” so it is necessary to rely on the principles established by case law: see, for example, Tracy v Mandalay Pty Ltd (1953) 88 CLR 215, Twycross v Grant (1877) 2 CPD 469 and, Aequitas Ltd v AEFC Leasing Pty Ltd (2001) 19 ACLC 1,006. The principles established in the cases above provide for the following points: [8.20]

• both the people who actively participate in starting the company, and those who actively participate in raising equity for the company after it has been registered but before an independent board has been appointed, will be promoters (Aequitas Ltd v AEFC Leasing Pty Ltd (2001) 19 ACLC 1,006);

Jeswynn, Y., Lidia, X., Yogaratnam, J., Xynas, L., & O'Connell, A. (2016). Corporations law : In principle. ProQuest Ebook Central http://ebookcentral.proquest.com Created from vu on 2020-12-09 19:25:13.

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• people who take only a passive role in forming the company may still be promoters if they know of the plans and have agreed to share in the profits (Tracy v Mandalay Pty Ltd (1953) 88 CLR 215; Aequitas Ltd v AEFC Leasing Pty Ltd (2001) 19 ACLC 1,006); • those acting merely in a professional capacity to register the company on behalf of a promoter are not themselves promoters – for example, solicitors and accountants who do the “paper work” but take no further part in the business plans; and • companies may be promoters: Parra Wirra Gold & Bismuth Mining Syndicate No Liability v Mather (1934) 51 CLR 582. What are the duties of promoters? .......................................................................................................................................................................

Promoters automatically stand in a “fiduciary relationship” with the company being formed: Aequitas Ltd v AEFC Leasing Pty Ltd (2001) 19 ACLC 1,006. A fiduciary relationship arises in situations where one party (the “principal”) is entitled to expect that the “fiduciary” will act in the principal's best interests, putting the interests of the principal ahead of their own or any other party's interests. Other examples of fiduciary relationships are trusteebeneficiary and director-company: see Chapters 11, 12 and 13. This duty to serve another's interest brings with it:

[8.30]

• the need to keep the principal fully informed. Thus, a strict duty is imposed on a fiduciary not to make secret profits. For example, it would be easy for the promoters to sell their own assets, such as land, to the company at an inflated price. Promoters are subject to an equitable duty to disclose any interest they have in any contract with the company, and any interest from which they may make a profit. Once all the information is available, it is up to the potential investors to decide whether to invest. People are free to make their own bad bargains as long as they are given all the facts. To whom must promoters make disclosure? .......................................................................................................................................................................

The leading cases on promoters' duties of disclosure are Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218 and Gluckstein v Barnes [1900] AC 240 (House of Lords). From these cases it is clear that promoters must make full disclosure to an independent board of directors. However this can be impracticable in certain situations, such as in the case of small proprietary companies like Salomon's. In Salomon v Salomon & Co Ltd [8.40]

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• the obligation to avoid any potential for personal gain by the fiduciary; and

Jeswynn, Y., Lidia, X., Yogaratnam, J., Xynas, L., & O'Connell, A. (2016). Corporations law : In principle. ProQuest Ebook Central http://ebookcentral.proquest.com Created from vu on 2020-12-09 19:25:13.

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[1897] AC 22 no-one doubted that the business had been sold at an over-valuation but, as all the shareholders (that is, Salomon's family) knew about it and acquiesced to the deal, there was no breach of duty. Hence, an alternative to making full disclosure to an independent board of directors is to make full disclosure to the existing or potential members as a whole: see Aequitas Ltd v AEFC Leasing Pty Ltd (2001) 19 ACLC 1,006. If the option of disclosure by the second method is open to promoters it will be found: • in the constitution; • in a disclosure document (where the provisions in Ch 6D apply because “outside” investors are being approached; or • in another format, provided all those who are, or who become, members are aware of the effect of the promoters' transactions. Partial disclosure, or disclosure to just a few associates, is insufficient. It must be full and explicit, either to an independent board of directors or to all the existing or potential members of the company.

Remedies for breach of promoters’ duties General law .......................................................................................................................................................................

The main remedy available is rescission, by which the company gets its money back and the asset is returned to the promoter: Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218. Rescission is only available if:

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[8.50]

• the company has not affirmed the contract (that is, taken up any benefit under the contract) – for example, if the contract was to purchase land and building works have not started on the land; • the parties can be restored to their original positions (that is, restitution is possible) – for example, it is not possible if the goods have already been used by the company; and • there has been no undue delay and no innocent third party has acquired any interest in the property. If the company elects not to rescind the contract, it cannot recover the secret profit made by the promoter unless the undisclosed profit can be construed as separate from the contract price: Tracy v Mandalay Pty Ltd (1953) 88 CLR 215; Aequitas Ltd v AEFC Leasing Pty Ltd (2001) 19 ACLC 1,006. For example, in Gluckstein v Barnes [1900] AC 240 the undisclosed £20,000 profit arose by way of discount on the mortgage over the property which was purchased from the vendor by the promoters. As this profit was separate from the (disclosed) profit made by the promoters on the sale of the property by them to the company, the court ordered that it be disgorged even though the company had not rescinded the purchase.

Jeswynn, Y., Lidia, X., Yogaratnam, J., Xynas, L., & O'Connell, A. (2016). Corporations law : In principle. ProQuest Ebook Central http://ebookcentral.proquest.com Created from vu on 2020-12-09 19:25:13.

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Where there has been a fraudulent misrepresentation by the promoters, the remedy is the same as in contract; that is, the contract can be rescinded and damages claimed as well: Re Leeds and Hanley Theatres of Varieties Ltd (No 1) [1902] 2 Ch 809. In certain circumstances where the promoter has acted for personal gain instead of for the company, the court may order that property acquired by the promoter and/or any profits made by the promoter on the sale of the property to the company, be held in trust on behalf of the company. Notes

1.

A breach of duty by a promoter is a wrong done to the subsequently registered company. It is the company which must sue. If the promoters are in control of the company, the members may be able to bring a statutory derivative action on the company's behalf under Pt 2F.1A.

2.

Even though the general law duties of promoters are similar to the general law duties of directors (because they both stand in a fiduciary relationship with the company), these promoters' duties shouldn't be confused with the statutory duties of directors and other officers under Pt 2D.1: see Chapters 11, 12 and 13. A promoter is not, at the time of the potential breach, an “officer” of the company within the definition contained in s 9. Once the company is registered, a person who “promoted” its formation may act as an “officer” (whether formally appointed as a “director” or not: s 9), but it is only from that time onwards that the duties imposed by Pt 2D.1 apply.

Statute .......................................................................................................................................................................

Promoters can be liable for untrue statements or non-disclosures in prospectuses or other disclosure documents under s 728. Investors who suffer loss through reliance upon the prospectus can seek compensation: s 729. In certain circumstances, promoters of failed companies may also be liable to liquidators under s 588FH. The definition of “related entity” (s 9) includes a promoter. Promoters of companies that list with the ASX are subject to Ch 9 of the ASX Listing Rules which places restrictions on the transfer of shares issued to them before the company was listed. Any promotion and set-up expenses incurred before registration can be paid out of the company's assets: s 122. [8.70]

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[8.60]

Jeswynn, Y., Lidia, X., Yogaratnam, J., Xynas, L., & O'Connell, A. (2016). Corporations law : In principle. ProQuest Ebook Central http://ebookcentral.proquest.com Created from vu on 2020-12-09 19:25:13.

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[8.80] Figure 8.1: Summary – timeline of promoters’ duties ....................................................................................................

Pre-registration contracts Context .......................................................................................................................................................................

Pre-registration contracts (formerly called “pre-incorporation” contracts) are contracts entered into by a person on behalf of a company that is yet to be registered under s 119. (These people are usually promoters but may not always be: Bay v Illawarra Stationery Supplies (1986) 4 ACLC 429.) Pre-registration contracts are now fairly uncommon. People will usually acquire a “shelf” company and this means that although the company has not traded before (that is, it is on the “shelf”), it is already registered. It can, therefore, immediately enter into contracts in its own right (that is, as a separate entity). Furthermore, as registration is a much more immediate procedure with online access, this results in fewer occasions when a contract will be entered before registration has occurred.

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[8.90]

[8.100] Figure 8.2: Example 1 ....................................................................................................

However, if the company is not yet registered, there will be a problem with contracts purportedly entered into on its behalf or for its benefit. There is

Jeswynn, Y., Lidia, X., Yogaratnam, J., Xynas, L., & O'Connell, A. (2016). Corporations law : In principle. ProQuest Ebook Central http://ebookcentral.proquest.com Created from vu on 2020-12-09 19:25:13.

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no separate legal entity in existence and, therefore, there is no capacity to enter into contracts at all. The key dates to check are the date of company registration and the date of the contract. [8.110] Figure 8.3: Example 2 ....................................................................................................

Statutory intervention .......................................................................................................................................................................

In order to overcome difficulties that existed with the general law relating to enforcement of contracts made on behalf of yet-to-be-formed companies, ss 131 – 133 were enacted. These sections replace the general law (on pre-registration contracts) (s 133) and set out the rights and liabilities of the contracting parties: see Aztech Science Pty Ltd v Atlanta Aerospace (Woy Woy) Pty Ltd (2004) 51 ACSR 147 where Barrett J explains the effect and operation of s 131. These sections allow the company to ratify any purported contract entered into while it was not in existence, that is, prior to its registration: s 119. Ratification can be oral, written or by conduct and has the effect of creating a binding contract on the terms of the original purported contract. Note s 131(1) – (2):

SECTION 131(1)-(2) Contracts before registration (1)

If a person enters into, or purports to enter into, a contract on behalf of, or for the benefit of, a company before it is registered, the company becomes bound by the contract and entitled to its benefit if the company, or a company that is reasonably identifiable

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[8.120]

with it, is registered and ratifies the contract: (a)

within the time agreed to by the parties to the contract; or

(b)

if there is no agreed time – within a reasonable time after the contract is entered into.

Jeswynn, Y., Lidia, X., Yogaratnam, J., Xynas, L., & O'Connell, A. (2016). Corporations law : In principle. ProQuest Ebook Central http://ebookcentral.proquest.com Created from vu on 2020-12-09 19:25:13.

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(2)

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The person is liable to pay damages to each other party to the pre-registration contract if the company is not registered, or the company is registered but does not ratify the contract or enter into a substitute for it: (a)

within the time agreed to by the parties to the contract; or

(b)

if there is no agreed time – within a reasonable time after the contract is entered into.

The amount that the person is liable to pay to a party is the amount the company would be liable to pay to the party if the company had ratified the contract and then did not perform it at all.

Effect of ratification

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....................................................................................................................................................................... [8.130] If the company ratifies the contract within the requisite period, each party has the normal rights under contract law to sue for breach – the company “becomes bound by the contract and entitled to its benefit”: s 131(1). Ratification of a contract is the act of adopting the contr...