Introduction
This advice document is intended to assist you, Seth, in understanding the legal position of a company promoter. You have been approached by Frank and Evans to act as the promoter for a company they wish to form. This document will explain who a promoter is in the eyes of the law, the legal duties you would owe to the new company, and the potential consequences if those duties are breached. The law in this area is not contained within a single statute but has been developed over many years through case law. Therefore, this advice will refer to several key legal cases to illustrate the principles involved.
(i) Who is a Promoter?
The first point to clarify is the definition of a promoter. There is no precise statutory definition of a ‘promoter’ in the Companies Act 2006. The legal meaning comes from descriptions given by judges in various cases. The classic judicial description was provided in the case of Twycross v Grant (1877). Here, Cockburn CJ stated that a promoter is "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" (Cockburn CJ quoted in Lipton, Herzberg and Welsh, 2017).
This definition is very broad. It captures anyone who is actively involved in the formation of the company. The specific tasks a promoter might undertake include:
- Negotiating preliminary agreements on behalf of the proposed company.
- Arranging for the company’s constitution (the memorandum and articles of association) to be drafted and registered with Companies House.
- Appointing the first directors of the company.
- Raising capital for the company.
Essentially, a promoter is anyone who acts as the driving force behind the creation of a company. You do not need a formal title of 'promoter' to be considered one in law; your actions are what matter.
However, it is important to note that not everyone involved in the company's formation will be classed as a promoter. Professionals, like solicitors or accountants, who are paid to provide their professional services are not normally considered promoters. For example, if Frank and Evans instructed a solicitor simply to draft the company documents and file them, that solicitor would not be a promoter.
A useful case study is Whaley Bridge Calico Printing Co v Green and Smith (1879). In this case, Smith helped Green to acquire a business and then form a company to buy that business. Smith was paid by Green for his services. The court had to decide if Smith was a promoter. Bowen J held that while someone who simply acts in a professional capacity is not a promoter, a person who goes beyond that role and takes an active part in the formation and in raising capital for the business can be a promoter. In this instance, because Smith was involved in the plan to set up the company to buy the business, he was found to be a promoter. Therefore, if your role for Frank and Evans goes beyond simple advice and involves taking active steps to ‘set the company going’, you will almost certainly be considered a promoter.
(ii) The Duties Owed by a Promoter to the Company
Once it is established that you are a promoter, the law imposes very strict duties on you. As a promoter, you are in a fiduciary relationship with the company you are forming. A fiduciary relationship is one of trust and confidence, where one party (the fiduciary) must act in the best interests of the other (the principal). In this situation, you (the promoter) are the fiduciary, and the company is the principal. This means you must not abuse your position of trust. The main duties that arise from this relationship are:
- A duty not to make a secret profit.
- A duty to disclose any personal interest in transactions with the company.
The duty not to make a secret profit is fundamental. As a promoter, you cannot profit from your position without the company’s knowledge and consent. A key case study for this is Gluckstein v Barnes [1900] AC 240. In this case, a group of promoters bought a property (a music hall called Olympia) for £140,000. They then sold it to the company they had just formed for £180,000, making a £40,000 profit. In the company’s prospectus, they disclosed the profit of £40,000 but failed to disclose an additional profit of £20,000 they had made from buying out the debts on the property at a discount. The company later went into liquidation, and the liquidator sued to recover this secret £20,000 profit. The House of Lords held that the promoters had breached their duty. The partial disclosure they made was not sufficient; they had a duty to make full disclosure of all profits made. They were therefore ordered to pay the secret profit back to the company. This shows that if you make any profit from a transaction with the company, it must be fully and frankly disclosed.
This leads to the second main duty: the duty of disclosure. If you have any personal interest in a contract with the company, you must disclose it. This most commonly occurs where a promoter sells his own property to the company. Mere disclosure is not enough; it must be made to an independent board of directors who can make an impartial decision on behalf of the company. If there is no independent board, a full disclosure must be made to all of the company’s shareholders, or in the company prospectus to potential shareholders.
The case study of Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218 illustrates this perfectly. A syndicate, led by the French banker Erlanger, bought the lease of an island said to contain phosphate mines for £55,000. They then formed a company and sold the lease to it for £110,000, doubling their money. The board of directors of the new company was made up of members of the syndicate or their nominees, so it was not independent. The prospectus inviting the public to buy shares did not disclose the profit the promoters had made. When new, independent directors were appointed, they discovered the facts and sued the promoters. The House of Lords held that the promoters had breached their fiduciary duty by failing to make full disclosure to an independent board.
(iii) The Remedies Available Against the Promoter
If you, as a promoter, breach any of your fiduciary duties, the company has several legal remedies it can pursue against you. The main remedies are rescission of contract, recovery of secret profit, and damages.
#### Rescission of the Contract
If you sell your own property to the company without making full disclosure, the company is entitled to rescind the contract. Rescission means the contract is cancelled, and the parties are put back into the position they were in before the contract was made. So, the company would return the property to you, and you would have to return the purchase price to the company.
The case study for this remedy is again Erlanger v New Sombrero Phosphate Co (1878). In that case, the House of Lords ordered the contract for the sale of the island to be rescinded. The company gave the mine back, and Erlanger’s syndicate had to return the £110,000. It is important to note that this remedy may be lost in certain circumstances, for instance, if the company waits too long after discovering the breach before taking action, or if it is impossible to restore the parties to their original positions (for example, if the property has been significantly changed or sold on to an innocent third party).
#### Recovery of Secret Profit (Account of Profits)
Where a promoter has made a secret profit, the company can choose to affirm the contract but sue the promoter to recover the profit. This means the company keeps the property but forces the promoter to hand over the money they made illegitimately. This remedy is equitable, and its purpose is not to punish the promoter, but to prevent them from being unjustly enriched by their breach of trust.
The case study here is Gluckstein v Barnes [1900]. As discussed above, the promoters were forced to account for the secret profit of £20,000 they had made on the transaction. This remedy is available even if the company has not suffered any loss; the simple fact that the promoter has profited from a breach of duty is enough.
#### Damages
The company can also sue a promoter for damages. This can be for deceit if the promoter has made a fraudulent misrepresentation, or for negligence if the promoter has failed to exercise reasonable skill and care. If damages are awarded, the promoter must pay financial compensation to the company for the loss it has suffered.
A suitable case study is Re Leeds and Hanley Theatres of Varieties Ltd [1902] 2 Ch 809. The promoters sold property to the company for a price higher than they paid for it, without disclosing their interest. The court held that they were liable to pay damages to the company. The amount of damages was calculated as the profit the promoters had made. This shows that the measure of damages is often the same as the amount of a secret profit.
Conclusion
In advising you, Seth, it is crucial to understand that the role of a promoter carries significant legal responsibilities. You will be in a fiduciary relationship with the company you help to form, which requires you to act with the utmost good faith. You must not make any secret profits from your dealings with the company, and you must fully disclose any personal interest you have in any contracts made with it. This disclosure must be made to either an independent board of directors or to the company's shareholders. Failure to comply with these duties could lead to the company taking legal action against you to rescind contracts, recover any secret profits you have made, or claim damages for any loss it has suffered. Provided you act transparently and always prioritise the company's interests over your own, you will be fulfilling your legal obligations as a promoter.
References
Dignam, A. and Lowry, J. (2020) Company Law. 11th edn. Oxford: Oxford University Press.
Erlanger v New Sombrero Phosphate Co (1878) 3 App Cas 1218.
Gluckstein v Barnes [1900] AC 240.
Lipton, P., Herzberg, A. and Welsh, M. (2017) Understanding Company Law. 19th edn. Pyrmont: Thomson Reuters.
Re Leeds and Hanley Theatres of Varieties Ltd [1902] 2 Ch 809.
Twycross v Grant (1877) 2 CPD 469.
Whaley Bridge Calico Printing Co v Green and Smith (1879) 5 QBD 109.
