Chapter 5 Promoters and Preincorporation Cont.doc

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DR. MD. ABDUL JALIL, COMPANY LAW, CHAPTER FIVE, 2013

CHAPTER FIVE

PROMOTERS AND PRE-INCORPORATION CONTRACT

PROMOTERS

Before registration of a company few people undertake the initiative to prepare

necessary documents and do other necessary works in order to register the

company. Those people are known as promoters of the company. Promoters do

necessary works for the formation of the company. When the company has been

registered, sometimes the promoters become the first directors of the company

or they might find new directors for the company. In Twycross v. Grant,

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apromoter has been defined 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.

So, the person who is involved in the setting up of a new company is known as

promoter. Promoter may include a person who enters into contracts with

outsiders on behalf of the company before its incorporation. 2 A person who is a

party to the preparation of the prospectus of a company is also known as

promoter.3

The term promoter has been defined precisely neither in the Companies Act1965 (Malaysia) nor by the court. The term promoter is not only used for the

purpose of incorporation of a company. It can be used for initiating any other

projects. The term promoter encompasses a wide range of persons including

the person who undertakes for the formation of a business company. This was

observed by Gopal Sri Ram JCA in Tengku Abdullah Ibni Sultan Abu Bakar &

Others v. Mohd Latif bin Shah Mohd & Others,4 when he accepted the

definition given by the counsel that: A promoter is one who starts off a venture

any venture not solely for himself, but for others, but of whom he may be

one.

DUTIES OF PROMOTERS

The promoters make a close and friendly relation with the proposed company as

they work to incorporate the company. Therefore, the proposed company

shareholders and the outsiders view them very close to the company. Such close

1 [1877]2 CPD 469.2 See R. Rachagan, J. Pascoe and A. Joshi,Principles of Company Law in Malaysia, KualaLumpur: Malayan Law Journal, 2002.3 Section 4 of Companies Act 1965.4 [1996] 2 MLJ 265.

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relation with the company is known as fiduciary relation. Because of this

fiduciary relation the promoters must be trustworthy to the company and the

outsiders. Their relation with the proposed company is like trustees. They arenot allowed to do anything with the company that may breach their trust and

fiduciary duty to the company.

So, the promoters have fiduciary duty towards the company and the fiduciary

duty will be breached if the promoters make secret profit using the company for

their personal interest. Therefore, they should avoid making secret profit from

any transaction with relation to the proposed company. If they make any secret

profit while acting as promoters they should fully disclose the amount of secret

profit made. In Fairview Schools Bhd v. Indrani a/p Rajaratnam & Others,5

Mahadev Shankar JCA, in his judgment on be half of the Court of Appeal stated

that:

Promoters have a legal duty not to make any secret profit out of the

promotion of the company without the companys consent and also to

disclose to the company any interest the promoters have in any

transaction proposed to be entered into by the company.

The duty to disclose secret profit may be discharged if the promoters disclose

the incidence:

i) in the memorandum, articles or prospectus of the company;

ii) to an independent board of directors; or

iii) to the existing and intended members of the company.

The duty to disclose the secret profit or any interest secured by the promoters

must be made to the independent board of directors. If the board of directors of

the company after incorporation is not an independent board, then the disclosure

would not be effectively discharged by the promoters. If the promoters or some

of the promoters are in the board of directors, the board would not be

considered as an independent board of directors. When the board is not an

independent board, the disclosure should be made to the members of thecompany. And the disclosure of interest of promoters must be full disclosure. If

part of the profit is disclosed and a part of it not disclosed, then the disclosure

would not be considered as full disclosure.

In Erlanger v. New Sombrero Phosphate Co6, the court held that all the

transactions from which the promoters secure any benefit from the promotion of

the company must be properly disclosed.

5 [1998] 1 MLJ 110.6 [1877] 2 CPD 469.

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The disclosure of the benefit received by the promoters out of promotion must

be full, frank and explicit. All material facts related to the benefit received mustbe disclosed. A disclosure of profit by the promoters which is half truth or

partial truth can be defective and may not have legal effect.7

HOW THE PROMOTERS MAY BREACH THE FIDUCIARY DUTY

Promoters have fiduciary relation with the company. Fiduciary relation means

very close relation in which the company relies very much on the promoters as

its well-wishers. Therefore, the promoters duty is to act bona fide for the

interest of the company and avoid being involved in conflict of interests with

the company.

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The fiduciary duty is breached if i) the promoters make secret profits out of

contracts with the company; ii) the promoters do not disclose the secret profit

made out of promotion and keeps the money with them as opposed to their

fiduciary duty; iii) the promoters refuses to deliver the secret profit when asked

by the company; iv) the promoters act in conflict of interests with the company;

v) during promotion the promoters buy property with the intention of selling it

to the company at a profit; vi) the promoters disclose confidential information

of the proposed company without authorization; vii) the promoters do not avoid

taking up a contract or opportunity that in equity belongs to the company.

In Fairview Schools Bhd. v. Indrani a/p Rajaratnam & Others 9, Mahadev

Shankar JCA, on be half of the Court of Appeal observed that:

If a promoter acquires any property for the inchoate company after the

commencement of the promotion, he is presumed to do so as the trustee

of the company, so that he must hand it over to the company at the price

he gave for it, unless he discloses not merely the profit he proposes to

make but also informs the company of its right to call for the property at

its cost price.

Hence, it will amount to breach of fiduciary duty by the promoters if they buy

certain property for the proposed company and later sell it to the company with

profit and the profit is not disclosed to the company. In fact, when the

promoters secure any benefit or acquire any property on behalf of the inchoate

company, they receive it as trustees of the company and they should return the

benefit or property to the company without being asked to return as mentioned

by the Mahadev Shanker, Judge in the Court of Appeal, Malaysia.

7 Chan and Koh, op. cit., at p. 198. See also the decision in Gluckstein v. Barnes [1900] AC 240.(House of Lords)8 S. Rachangan et al, op. cit., at p. 152.9 [1998] 1 MLJ 110.

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PERSONS WHO ARE PROHIBITED TO BECOME PROMOTERS

Some people are prohibited to be promoters of a new company. 10 Those people

are:

a) If a person has been convicted of an offence in connection with the

promotion, formation or management of a corporation;

b) If a person has been convicted of an offence involving fraud or

dishonesty punishable on conviction with imprisonment for three

months or more; or

c) If a person has been convicted of an offence under sections 132, 132A

or 303 of Companies Act 1965.

The above persons are not entitled to be appointed as promoters and cannot

work as promoters unless they have obtained leave of High Court to work as

promoters. The conviction of offence mentioned above might be in Malaysia or

abroad.

The period of prohibition is five years within which time the above mentioned

persons are not entitled to be promoters. The five years prohibition period will

run from the date of the conviction or if imprisonment is imposed, from the date

of the persons release from the prison. If the provisions of sections 130, 132,

132A and 303 of the Companies Act are violated, the person will be liable for a

penalty of five years imprisonment or a fine of RM100,000 or both.

REMEDIES AGAINST PROMOTERS FOR BREACHING FIDUCIARY

DUTY

When the promoters breach their fiduciary duty to the company by making

secret profit out of the promotion, they would be liable to the company to

account for the secret profit made by them. The promoters need to fully and

properly disclose all the benefits they have gained out of the promotion. If they

fail to fully and properly disclose the financial benefits they have gained, the

company as a separate legal personality can claim certain remedies against the

promoters.

The promoters are jointly and severally liable to the company for the secret

profit they made out of promotion. If a promoter pays personally all the secret

profit made, he may seek to claim proper contribution from the co-promoters.11

However, court may disregard his claim for contribution from other co-

promoters for policy consideration. The company may claim the following

remedies from the promoters for breaching fiduciary duty.

10 See section 130, 132, 132A and 303 of the Companies Act 1965.11 S. Rachangan et al, op. cit, at p. 155.

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i) Rescission of the contract;

ii) Recovery of the secret profit;

iii) Damages for breach of fiduciary duty.

The company can enforce any of the above remedies against the promoters for

making secret profit out of promotion. These remedies have been explained

briefly below by the help of decided cases.

Rescission of the Contract

When the promoters have made secret profit by making some contract with

other companies or people on be half of the company or by selling certain goods

to the company before or after its incorporation, they are obliged undercompany law to fully disclose and return the profit to the company after its

incorporation. If the promoters fail to do so, the company can exercise its power

to rescind the contract made by the promoters to sell something to the company.

The reason for rescission of the contract is that the promoters have been

personally benefited out of promotion but the company has not been benefited

or the company has suffered loss.

The exercise of power for rescission of contract was successfully done in

Erlanger v. The New Sombrero Phosphate Co.12. In this case a syndicate

purchased a lease of an island in the West Indies. The island contained deposits

of phosphate of lime. Mr. Erlanger was the chief in the syndicate. The syndicatepurchased the lease of island for 55,000. Subsequently a company was formed

by the syndicate and it sold the island to the new company for 110,000 through

a nominee. As a result the syndicate earned 55,000 secret profit. The articles of

the company empowered the directors to adopt the purchase of the lease, which

was ultimately done. A prospectus was issued by the company giving a very

favorable account of the scheme and many people bought shares. The real

circumstances of the purchase were not disclosed to the shareholders despite

being questioned by the shareholders. Later an investigation committee was

formed to investigate the incidence and it recommended the removal of the

original directors and appointment of a new board of directors. The new board

of directors was appointed and it rescinded the purchase contract and claimed

for repayment of the money and shares which had passed to the syndicate. The

House of Lords held that the purchase contract could be rescinded.

Rescission of contract is an equitable remedy. The company can exercise this

right through an independent board of directors. However, if the company

ratifies the contract, the right to rescind the contract will be lost. 13Inordinate or

12 [1878] 3 Appeal Cases 1218; [1874-80] All ER 271. (decided by the House of Lords).13 Chan & Koh onMalaysian Company Law: Principles and Practice, Kuala Lumpur:Thomson, Sweet & Maxwell Asia, Second edition, 2006, at p. 203.

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undue delay on the part of the company to rescind the contract may also prevent

it from obtaining such remedy.14The right to rescind the contract is lost if:

a) after being informed of the secret profit the company ratifies the

contract;

b) the company shows no interest to rescind the contract and as a result

inordinate or undue delay has been caused to exercise the remedy;

c) restitutio integrum is impossible;

d) an innocent third party has meanwhile acquired rights to the property.

Restitutio integrum means to restore the parties to their original position. The

right to rescind the contract is lost when it is not possible to restore the partiesto their original position. For example, a company has substantially altered the

conditions of a property obtained through purchase from the promoters. The

company may not rescind this contract on the ground of undisclosed secret

profit made by the promoters as it would not be possible to put the promoters in

their pre-contract position as the property has undergone substantial change in

the hands of the company.15

Recovery of the secret profit

The company after incorporation can recover the secret profit made on the

ground of breach of fiduciary duty and principle of trust. Under the principle oftrust law when promoters receive profit out of promotion they hold it as trustees

for the company and bound to return to the company. Recovery of secret profit

is an alternative remedy which is usually claimed when the company does not

rescind the contract. In Gluckstein v. Barnes16, it was held by the court that the

company could recover the secret profit even though it chose not to rescind the

contract.

In Gluckstein v. Barnes17 a company was able to recover the sum of 20,000 as

secret profit which was not fully disclosed by the promoters. In this case a

syndicate consisted of four persons bought a property known as Olympia for

140,000 from a liquidator. Then it sold the property to a company which itpromoted for 180,000 by making 40,000 profit. The syndicate also made

another 20,000 profit by buying securities on the property at a discount. A

prospectus was issued by the company to the public to raise capital. In this

prospectus the promoters disclosed 40,000 profit but another 20,000 profit

14 SeeLagunas Nitrate Co. v. Lagunas Syndicate [1899] 2 Ch 392. (decided by Court of Appeal)15 See S. Rachagan, J. Pascoe and A. Joshi, Principles of Company Law in Malaysia, KualaLumpur: Malayan Law Journal, 2002.16 [1900] AC 240. (House of Lords)17 [1900] AC 240. (House of Lords)

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was not disclosed. The company went into liquidation within four years of its

incorporation. The liquidator sued the syndicate to recover 20,000 undisclosed

profit. House of Lords held that the disclosure of secret profit was not full andallowed the liquidator to recover 20,000 undisclosed profit from the syndicate.

When a co-promoter was promised by another co-promoter to pay an amount of

secret profit but it was not paid, the money is kept by the promisor as trustee for

the company. In Whaley Bridge Calico Printing Co. v. Green & Smith18, Green

in association with Smith bought certain calico printing works and premises for

the sum of 15,000. Later the plaintiff company was incorporated and the

printing works and premises were sold to it for 20,000. Green promised to pay

3000 secret profit to Smith which in fact was not paid. The issue was whether

the company could recover the money form Green. The court held that Green

held the money as trustee for the company and therefore bound to pay back themoney to the company. So, the company was entitled to recover the secret profit

from Green.

When the promoters disclosed the profit made by them out of promotion of the

company and later the independent board of directors ratified the contract

without claiming the profits, whether the company later can claim the profit or

not is an issue. In some case it was decided that a promoter may not effectively

relieve himself of his liability in respect of his breach of fiduciary duty by

inserting a clause in the articles whereby the company and the subscribers agree

to waive their rights against him.19 Besides, on the ground of breach of fiduciary

duty and on trust principle secret profit can be recovered by the company fromthe promoters even if the pre-incorporation contract has been affirmed

afterwards. This opinion is supported by the observation of Bowen J. in Whaley

Bridge Calico Printing Co. v. Green & Smith20, where he observed that:

As soon as Smith and Green formed the company and nominated its

board, it became their duty, in my opinion, to inform the company of

this private arrangement between them. Thereupon the company might

either, at its option, decline the proposed purchase or accept it, claming

the benefit of Smiths bargain, or might, if they thought it reasonable,

sanction the agreement and allow Smith to retain the profit himself. The

company cannot be worse off because the existence of this contract wasconcealed from them.21

However, in Tracy v. Mandalay Pty Ltd22 it was decided that if the contract

from which the promoters secure profit is ratified properly by an independent

18 [1879]5 QBD 109.19 Gluckstein v. Barnes [1900] AC 240 at 255 (House of Lords); Omnium Electric Plaaces Ltd.

V. Baines [1914] 1 Ch 332 at 347 (Court of Appeal).20 [1879]5 QBD 109.21 Ibid., at p. 112-113.22 [1953] 88 CLR 215.

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board of directors after its incorporation, the company loses the right to rescind

the contract and to recover the secret profit later. In this case, the promoters sold

a property to the company that was acquired prior to the commencement of thepromotion and the company elected not to rescind the contract but to proceed

with the contract with the promoter. The court held that the company was not

entitled to recover secret profit made by the promoters.

The decision in Tracy case has been different from Whaley Bridge case. It is

clear that the company was not entitled to recover the secret profit after the

contract was ratified by the independent board of directors. So, subsequent

ratification of the transaction by an independent board of director is an

important factor which will bar the company from recovering the secret profit if

the ratification clearly waved the right of recovery of the secret profit. If the

board of directors is not independent, the decision will be a contrary one.Another reason behind such decision might be that the promoters acquired

property before the commencement of their work as promoters and later sold

the property to the company while acting as promoters for the company.

The issue is whether the promoter will be liable for breach of fiduciary duty for

making secret profit by selling the property to the company which he acquired

before the commencement of the promotion work. If the answer is yes, then the

promoter cannot keep the profit legally with him and the company after

incorporation may opt to recover the secret profit. However, if the independent

board of directors after incorporation expressly resolved that the company will

not claim the secret profit from the promoters, then the company will lose theright to recover the secret profit afterwards.

Damages for breach of fiduciary duty

The fiduciary duty of the promoters may be breached if they make profit out of

contracts with the company and they did not disclose to the company the secret

profit they made. Such a non-disclosure of the promoters personal interest will

amount to fraud with the company. The fiduciary duty may also be breached if

the promoters acted negligently whereby the company suffered loss. In these

circumstances, the company may sue the promoters for damages in addition to

the rescission of contract.

If the non-disclosure of secret profit amounts to a fraudulent act, the company

may obtain damages from the promoters and also can rescind the contract. To

claim damages, the company must prove that it has suffered loss due to the

fraudulent or negligent transaction. However, when the transaction has been

rescinded, the company may not be able to prove loss and in that case it may not

claim damages. In Re Leeds and Handley Theatres of Varieties Ltd23, the court

held that the promoters had fraudulently omitted to disclose a profit made by

23 [1902] 2 Ch 809.

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them on the sale of a property to the company. Therefore, the company was

entitled to claim damages from the promoters and the appropriate measure of

damages was the promoters profit on the sale. In this case the damagesawarded by courts amounts to recovery of secret profit made by the promoters.

LIABILITY OF PROMOTER UNDER SECTION 130 OF COMPANIES

ACT 1965

Section 130 of the Companies Act 1965 provides that if a person is convicted of

any offence in connection with the promotion, formation or management of a

corporation, he shall be disqualified automatically from being a director or

promoter for five years from the date of conviction or from the date of release

from jail if he was imprisoned.24 However, the person can be appointed for such

position if he has obtained the leave of court.

If a person is convicted on indictment of an offence in connection with the

promotion of a company might be disqualified by the court to become a director

in the company.25

PRE-INCORPORATION CONTRACTS

Pre-incorporation contract is the contract which is made on behalf of a proposed

company before its incorporation with the Registrar of Companies under the

Companies Act 1965 (Malaysia). Pre-incorporation contracts are made by the

promoters when they sell certain goods or real property to the company or

outsiders sell certain goods or real property to the company and the negotiation

is done by the promoters on behalf of the company. Pre-incorporation contracts

suffer from lack of legal enforceability. As a result outsiders who make business

contract with the company before incorporation are seriously affected. The legal

position of pre-incorporation contracts in English common law is different from

Malaysian company law.

LEGAL STATUS OF PRE-INCORPORATION CONTRACTS IN

ENGLISH COMMON LAW

In English common law pre-incorporation contracts are not recognized. It is

considered as invalid and unenforceable by law. Pre-incorporation contracts are

not recognized and held invalid in English common law because a company

legally cannot make any contract before its incorporation. Before incorporation,

a company does not achieve the status of separate legal personality and

therefore it cannot make any contract. Hence, outsiders also cannot legally

make any binding contract with the company before its incorporation.

24 S. Rachangan et al, op. cit., at p. 156.25Re Leeds and Handley Theatres of Varieties Ltd[1902] 2 Ch 809. See also, Samser KamarLatiff, Company Law of Malaysia, Kuala Lumpur, 2000, at p. 20.

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In Newborne v. Sensolid (Great Britain) Ltd.26, the court held that a company

cannot make valid contract before its incorporation and also a person cannot

make legally binding contracts in the name of a company in anticipation of itsbeing incorporated.

Pre-incorporation contracts cannot be legally enforced as it is invalid. As a

result outsiders who make contracts with the proposed company before its

incorporation and sell certain goods or real property cannot enforce the contract

against the company. In that situation outsiders also cannot sue the company to

recover the selling price.

In English common law, the company cannot ratify the pre-incorporation

contract27. The reasons are firstly: the ratification has retrospective effect and

the contract is regarded as being made at the time it was entered into by theagent when the company was not in existence.28 Before incorporation the

company had no legal existence. So, it could not make a valid contract. The

contract was invalid and after incorporation it cannot ratify the previous invalid

contract. Secondly, under the principle of agency law a company also cannot

ratify pre-incorporation contract. Under the principle of agency law there should

have agent and principal relation between the promoters and the proposed

company. At that time the principal was not in existence. Therefore, it could not

appoint any agent to work on its behalf. For these reasons in English common

law pre-incorporation contracts are invalid and it cannot be ratified by the

company after its incorporation.

Another negative effect of English common law is that outsiders also cannot sue

the promoters personally to get back the selling price or claim damages for

breach of contract.29 InBlack v. Smallwood30, the court held that the person who

purported to make the pre-incorporation contract was also not personally bound

by the contract. Because, promoters cannot be appointed as agents by the non-

existent company. Hence, they are not personally liable for the pre-

incorporation contracts although the promoters usually negotiate with outsiders

on behalf of the pre-incorporation company to buy goods or property.

In the above case, Black had entered into a contract for the sale of a land to

Western Suburbs Holding Pty Ltd. which was not incorporated when thecontract was made, although Black believed that it had been incorporated and

that Smallwood and Cooper were its directors. The contract shows that

Smallwood and Cooper signed the contract as directors of the company. From

the contract it seems that Black intended to make contract with the company

and not with Smallwood and Cooper who purported to make the contract on

26 [1954] 1 QB 45.27Kelner v. Baxter(1866) LR 2 CP 174.28Ibid.29Black v. Smallwood(1966) 117 CLR 52.30 Ibid.

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behalf of the company. Hence, Smallwood and Cooper did not act as principals

while making the contract. They made the contract on be half of the pre-

incorporation company. Therefore, they were not personally liable for thecontract. This is an Australian case. The High Court of Australia held that a

non-existent company was incapable of having agents and consequently neither

the company nor the signatories (Smallwood and Cooper) were liable for the

contract.

In Kelner v. Baxter31, three persons made a contract to purchase goods on

behalf of the proposed Gravesend Royal Alexander Hotel Company from a

third party. The goods were supplied and the company used the goods in its

business after its incorporation. The price of the goods was not paid. The issue

was whether the seller could recover the price. The court held that the seller

could not recover the price of the goods supplied as the company could notmake a valid contract with him before its incorporation. A non-existent

company could not make a contract. As the contract was invalid, the supplier of

the goods could not recover the price.

In exceptional circumstances, promoters or other persons who contract on

behalf of the company to buy certain things from outsiders might be personally

bound for the contract and might be liable for breach of the contract, for

example, when the promoters make the contract as principals or intended to

make the contract as principals.32

Under English common law the negative effects of a pre-incorporation contractcan be overcome by making a fresh contract by the company after its

incorporation on same terms as the pre-incorporation contract. The company

becomes bound by such a fresh contract. Such fresh contracts are known as

novation33.

THE EFFECT OF PRE-INCORPORATION CONTRACT IN ENGLISH

COMMON LAW

Under common law the company is not bound by a contract made before its

incorporation. As a result, the other contracting party cannot enforce the

contract against the company. Because of this negative effect of the commonlaw, pre-incorporation contracts cause difficulties for the other contracting

party.34

There are serious negative effects of pre-incorporation contracts in English

common law. The outsiders who make pre-incorporation contracts in good faith

with the company through the promoters, fall in a very bad situation as they

31 (1866) LR 2 CP 174.32Kelner v. Baxter(1866) LR 2 CP 174.33 Shanthy Rachangan et al, op. cit., at p. 158; Chan & Koh, op. cit., at p. 207.34 Shanthy Rachangan et al, op. cit, at p. 158.

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cannot enforce the contract and the company also cannot ratify it after its

incorporation. As a result, outsiders who supplied certain goods to the company

cannot claim the price of the goods. Promoters also not personally bound by thepre-incorporation contract and outsiders who made the contract with the

company cannot sue the promoters for personal liability for breach of the

contract. So, English common law has put outsiders on a risky position where

they make contracts with the pre-incorporation company.

LEGAL STATUS OF PRE-INCORPORATION CONTRACTS IN

MALAYSIA

Under the Companies Act 1965 (Malaysia) pre-incorporation contract can be

ratified by the company after its incorporation.35When a contract is ratified by

the company, the company becomes bound by the contract and it can receive thebenefit of the contract. After ratification it will be presumed that the contract

existed at the date when it was first made. Section 35(1) of the Companies Act

1965 (Malaysia) provides to this regard that:

Any contract or other transaction purporting to be entered into by a

company prior to its formation or by any person on behalf of a company

prior to its formation may be ratified by the company after its formation

and thereupon the company shall become bound by and entitled to the

benefit thereof as if it had been in existence at the date of the contract or

other transaction and had been a party thereto.

Section 35(1) of the Companies Act 1965 (Malaysia) has not accepted the

English common law position on the status of pre-incorporation contracts. In

common law, pre-incorporation contracts cannot be ratified and it is void. The

outsiders could not enforce the contract against the company and as a result they

could not get back the price of the goods supplied to the company36.

The above section in the Companies Act 1965 (Malaysia) is very significant. It

states that by ratification of the pre-incorporation contact, the company becomes

bound by the contract. This section provides retrospective effect of the

ratification stating that the ratification of the contract will be assumed as if it

was made at the date of the contract before incorporation and the company wasa party thereto. Such provision in the Act in fact makes the ratification of the

contract effective from the date of its first formation guaranteeing all the rights

and benefits of the contract to both the company and outsiders. Thus, the

outsiders are fully protected by section 35(1).

Under Malaysian company law pre-incorporation contracts can be ratified and

validated even if the terms in the ratification are a bit different from the pre-

incorporation contract or additional conditions are added in the ratification. In

35 Section 35 (1) of the Companies Act 1965 (Malaysia).36Kelner v. Baxter(1866) LR 2 CP 174.

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Cosmic Insurance Corporation v. Khoo Chiang Poh37, The Privy Council held

that the pre-incorporation letter of appointment of the respondent as managing

director which was later ratified by a resolution of the company after itsincorporation validated and affirmed the previous appointment although the

terms in the ratification of appointment as the managing director was a bit in

different terms.

This is a Singapore case38 and the facts are: Mr. Khoo Ching Poh was appointed

as the managing director of the company before its incorporation. The pre-

incorporation appointment letter reads: Mr. Khoo Ching Poh shall be the

managing director for life unless he resigns, dies, or commits an offence under

the Companies Act or is prohibited to become a director under the Companies

Act for any offence. The ratification of the appointment slightly modified the

terms in the previous appointment letter which reads: Resolved that Mr. KhooChing Poh will be appointed managing director and will hold office for life in

accordance to the articles and memorandum of association and is responsible to

the Board of Directors.

In this case the Privy Council on appeal observed that the important matter was

the ratification of the pre-incorporation appointment for the position of

managing director which was duly done and validated. The ratification of

appointment slightly modified the previous terms was not material and the

modification of terms in the ratified appointment letter did not affect or

invalidate the appointment of the defendant for the position of managing

director. The court held that the ratification was duly done.

In Ahmad bin Salleh & Others v. Rawang Hills Resort Sdn Bhd39, James

Foong J. observed that: Ratification can be combined with other matters in a

resolution, but so long as its expression of ratification is clear, as in this case,

the process of ratification is completed by such an act.

In the above case the first sale and purchase agreement was executed on 12

April 1991 by one Chan Wah Long for and on behalf of the company Rawang

Hills Resort Sdn Bhd. At that time, Rawang Hills Resort Sdn Bhd was not yet

incorporated. The company was later incorporated and its directors passed a

resolution to ratify the previous sale and purchase contract. The resolution read:That the company does hereby affirm and ratify the purchase of the benefits

and rights to the sale and purchase agreement for the acquisition of the 186

acres of land being Lot 3514, Mukim Rawang, made up to 12 April 1991.

James Foong J. in the court held that the defendant companys directors passed

the resolution to ratify the previous sale and purchase of land contract which

was effective ratification of the pre-incorporation contract. The court observed:

37 (1981) 1 MLJ 61.38 This case was related to section 41 of the Companies Act (Singapore) which was inpari

materia with section 35 of the Companies Act (Malaysia).39 [1995] 3 MLJ 211.

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From the evidence as tendered, it cannot be denied that when the first

sale and purchase agreement was executed the defendants were not in

existence, but this does not prevent the defendants from ratifying suchan agreement under section 35 of the Companies Act 1965 This

court is of the opinion that the following words, that the company do

hereby affirm and ratify the purchase of the benefits and rights to the

sale and purchase agreement for the acquisition of the 186 acres being

Lot 3514, Mukim Rawang, made up to 12 April 1991 found in the first

part of this resolution, is sufficiently clear for the defendant to ratify the

said agreement.

Section 35(2) also allows outsiders to sue the person(s) who purported to

execute the pre-incorporation contract on behalf of the company if the company

after incorporation fails to ratify the contract. In that case the person whopurported to make and execute the contract on behalf of the company will be

personally liable to fulfill the contract or to pay compensation for breach of the

contract. However, if the pre-incorporation contract expressly excluded the

personal liability of the person or persons who purported to make the contract

on behalf of the company will not be personally liable for non-execution of the

pre-incorporation contract.

EFFECT OF PRE-INCORPORATION CONTRACTS UNDER

MALAYSIAN COMPANY LAW

Malaysian company law has put outsiders in a safe position when they makecontracts with a company in good faith. Under Malaysian company law, pre-

incorporation contracts are probably invalid but it can be validated by

ratification under section 35(1) of the Companies Act 1965 (Malaysia). When

the pre-incorporation contract is validated by ratification, it is binding on the

company and the outsiders who made pre-incorporation contracts with the

company. Hence, we can say that section 35(1) of the Companies Act 1965

(Malaysia) has put an innocent outsider in a far more satisfactory position than

under the common law of England.40

Section 35 of Companies Act (Malaysia) is very significant as it allows

outsiders to enforce pre-incorporation contracts after its incorporation byrequesting the board of directors to ratify the contracts. After ratification the

company undertakes the obligation to fulfill the terms of the contract and by

ratification it is assumed that the contract was in fact made at the date before its

incorporation by validating retrospective enforcement of the pre-incorporation

contract which is not possible under the common law of England. The common

law of England totally prohibits ratification and retrospective enforcement of

the pre-incorporation contract.

40 Samser K. Latif, supra, at p. 22.

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SAMPLE QUESTIONS

1. Who are promoters? Explain the duties of promoters.

2. Explain how a promoter may breach his fiduciary duty to the proposed

company. Explain the remedies available against the promoters for

breach of fiduciary duty.

3. A syndicate of four persons have been appointed to promote a garments

company Quality Garments Pvt. Ltd (QA Ltd.). Before incorporation

of the company it bought few cartons of garments from Famous

Garments Pvt Ltd (FA Ltd.) for RM 90,000. The promoters negotiated

for the contract on behalf of the company before its incorporation. Now

answer the following questions:

i) QA Ltd. Refuses to pay the price to FA Ltd. Advise FA Ltd. About

its legal rights against QA Ltd. in English common law and in

Malaysian company law.

ii) QA Ltd. is interested to ratify the pre-incorporation contract with FA

Ltd. Advise QA Ltd. about ratification of contract law under English

common law and Malaysian company law.

iii) Suppose QA Ltd. refuses to ratify and fulfill the contract. Can FA

Ltd. sue the promoters personally for the price? Explain your answer

referring to English common law and Malaysian company law.

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Documents

Chapter 5 Promoters and Preincorporation Cont.doc