Company Law Assignment: Analysis of Promoter's Duties and Liabilities

This assignment analyzes the duties and liabilities of company promoters under the Corporations Act 2001, examining scenarios involving pre-incorporation contracts, breaches of fiduciary duty, and strategic decisions like share allotments to prevent hostile takeovers. The assignment addresses the personal liability of promoters in pre-incorporation contracts, particularly focusing on the implications for Tom and the milkman, and whether Tom can avoid his liability. It also explores Dick's breach of fiduciary duties by selling furniture to the company at a profit and the associated remedies, as well as Harry's failure to disclose his directorship in another company. Furthermore, the assignment assesses the legality of allotting shares to a third party to counter a takeover bid, considering the strategic options available to the company and the potential impact on shareholder value. The analysis draws on relevant case law and legislation to provide a comprehensive understanding of the legal principles involved.

Company Law Assignment
The general rule binding the promoters is that of a fiduciary relationship with the company as well as with the
third parties, including vendors, and customers. Therefore it is imperative that the promoter must act in the bona
fide interests of the company and not in their own personal interests. This assignment analyzes these aspects of
the duties and liabilities of the promoters in the light of the Corporations Act, 2001 where in the roles of Tom,
Dick and Harry have been elucidated in relation to the liability of the company towards the milk man. Secondly,
whether the Dick’s action in selling the office furniture is justified and whether the company is justified in
allotment of 10,000 shares to a third party to stop a takeover bid from Carol Ltd.
In relation to the pre-incorporation contract between Tom and the Milkman
In this situation involving Tom and the milkman, Tom had promised him that the incorporated company would
take over the liabilities. Tom appears to have acted on behalf of the company by entering into a pre-registration
contract which is not yet in existence, and which under the common law is an invalid contract. Tom is
personally liable under s 131(2) to pay the liabilities1 and damages to the Milkman arising out of a pre-
registration contract within a reasonable amount or the timeframe agreed to. The Corporations Act imposes
liability on the person to compensate the third party for the loss suffered because the registered company does
not ratify the contract, or fails to perform its obligations under the ratified contract. The company cannot be held
liable following the popular rule established in Kelnar v Baxter 2which states that since the principal-agent
relationship cannot be in existence before incorporation, the company cannot take liability of the pre-
incorporation contract through adoption or ratification.
The remedy is however available both to the supplier, third party as well as the promoter who is representing the
interests of the company. Under the provisions of s 131(2), a person is liable to pay damages to other party for
pre-registration contract occurs if the company is not registered or the company does not ratify the contract or
enter into a substitute of it. 3It can be noted here that despite the formation of company, the bill remains unpaid,
for which the milkman can bring about an action for breach making Tom liable. I would therefore advise Tom
may avoid his liability under s132 (1) of the Act if he obtains a consent from other promoters to release him
from a personal liability arising therein. If in an occasion where the company fails to ratify the contract, it will
make Tom personally liable for the pre-registration contract. Secondly, he can also avoid personal liability by
agreeing with the Milkman that a substitute contract will be entered into, in place of pre-registration contract
with the registered company.
Dick’s action of selling the furniture to the Company at a profit
One of the fiduciary duties of the promoter of the company necessitates that he is acting honestly and with
reasonable skill, care and diligence as well as not making any profit at the expense of the company. By selling
the furniture to the company at a profit of $ 4,000, Dick has breached the fiduciary duties without exercising
reasonable skill, care and diligence. It is the duty of a promoter to act in a bona fide and honest manner and not
derive any secret benefit in his dealings with the company. This inherent duty lays down a rule for every
promoter not to make secret profit out of the company, as well as to disclose all the profits whether direct or
indirect. In Gluckstein v Barnes, 4one of the promoters had failed to disclose the profit that he had made from
buying up a mortgage at a discount. The Court held the promoter liable to disgorge that portion of indirect profit
back to the company. Breach of this duty can make the promoter liable to disgorge the profit back to the
company or rescind the contract with the promoter. 5
Some of the liabilities include: returning that profit to the company where in his capacity as a promoter, Dick
has made secret profit of $4,000, the right to repudiate or ratify the contract of sale or claim the profit made by
1 Wayne Courtney, Failed Pre-registration Contracts and the Statutory Remedy (2007) 25 C& SLJ 226
2 Kelnar v Baxter(1866) LR 2 CP 174
3 Harris, J. Hargovan, A. Adams, M. Australian Corporate Law LexisNexis Butterworths 3rd edition,2011
4 Gluckstein v Barnes [1900] AC 240
5 Nicholas Bourne, Essential Company Law (1st edn, Cavendish 2000)

the promoter. 6 The Company on the other hand can either opt to rescind the contract or recover the secret profit
made by the promoter. Serious repercussions may also follow under the Company Directors Disqualification
Act, 1986 7where the promoter may be disqualified from acting in his capacity on behalf of the company. Since
the present case is not of an extreme nature, it calls for a full and honest disclosure by Dick regarding the secret
profit that he has realized out of selling of furniture. It is therefore pertinent that Dick makes full disclosure to
the other co-promoters regarding the true value of the furniture, or alternatively, disgorges the profit back to the
company.
Role of Harry as the director of Feather Ltd
As discussed above, the situation of Harry is similar to the one faced by Dick. He being the promoter of the
company should have disclosed that he is also the director of Feather Ltd. One of the essential duties imposed
on the promoter of the company is that he is under a fiduciary relationship with the company and must act in the
bona fide interests of the company and not in his personal interest. Disclosure of material facts including the
nature and extent of any interest in transaction, is vital not only towards the co-promoters, but as well as towards
the shareholders. Although, there is nothing in the law which prevents Harry from continuing his position as the
director of Feather Ltd., he not disclosing to other promoters has led to the breach of the cardinal principle.
Now that it has already been discovered by the other promoters, it is vital that Harry shares all the material facts
and information to the others. As far as the present contract is concerned, rescinding the present contract is an
option for Marks and Spencer’s. Breach of fiduciary duties as a result of deceit, misrepresentation is also
actionable under statutory law where the company’s remedies include rescission or retention of property at the
contract price. 8This is so in light of the fact that the contract made by a promoter with a company will be
voidable at the option of the company for want of sufficient disclosure.9The contract may be set aside and the
money paid if any; can be recovered. Harry on the other hand, can make full disclosure as to the profit made; if
any, and opt to make good the loss to Marks and Spencer’s in doing so. The liability also entails that he make all
necessary disclosures regarding his interest, its extent and nature in Feather Ltd.
Allotment of 10,000 shares to third party by the promoters of Marks and Spencers
Tom Dick and Harry allot 10,000 shares to a third party fearing a takeover bid from Carol Ltd. In this case of
hostile takeover bid, Tom, Dick and Harry are resisting the takeover of their company, and refusing to sell the
company to Carol Ltd., for the reason that the board works to maintain its control over the company. In such a
situation, Marks and Spencers has several options such as finding an alternative bidder that could be less
threatening than the potential buyer, viz., Carol Ltd., in the present case. The right strategy for the company is to
function effectively, draw up a management plan so that the stock price illustrates the real value of the company
and the potential for growth. This can in future prevent occasions of hostile takeover. By building the real value
and maximizing the share holder value, take over can prove to be positive for the company in future.
Currently, the company has diluted its stake by allotting shares to a third party, who is also called the White
knight. 10Since the management sees no threat in doing so and unless repugnant to the clauses of the articles of
association, such dilution of stake is not wrong and can be called as a strategic move to avoid hostile take
overbids. Opting to allot shares to friendly hands, where hostile takeovers seems imminent, the target companies
often seek out to sell the substantial stocks to such investor. It is however, unclear here as to whether the articles
prevent such dilution of stake. However, it is a positive response to avoid the takeover bid from Carol Ltd.
6 Dr. Ashok Sharma, Company Law (1st edn, VK Enterprises 2010).
7 Ibid 5
8 Tracy v Mandalay Pty Ltd (1953) 88 CLR 215
9 Erlanger v New Sombrero Phosphate (1878) 3 App Cas 1218
10 (govt.nz, 2010) <http://www.takeovers.govt.nz/assets/Assets-2/CON-hostile-takeovers-dec10.pdf> accessed
30 December 2016.

Bibliography
Bourne N, Essential Company Law (1st edn)
Courtney, Wayne, Failed Pre-Registration Contracts and the Statutory Remedy (November 30, 2010). Company
and Securities Law Journal, Vol. 25, No. 4, pp. 226-245, 2007; Sydney Law School Research Paper No. 10/134.
Erlanger v New Sombrero Phosphate (1878) 3 App Cas 1218
Gluckstein v Barnes [1900] AC 240
(govt.nz, 2010) <http://www.takeovers.govt.nz/assets/Assets-2/CON-hostile-takeovers-dec10.pdf> accessed
30 December 2016
Harris, J. Hargovan, A. Adams, M. Australian Corporate Law LexisNexis Butterworths 3rd edition, 2011
Kelnar v Baxter(1866) LR 2 CP 174
Sharma D, Company Law (1st edn, VK Enterprises 2010)
Tracy v Mandalay Pty Ltd (1953) 88 CLR 215