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Week 4 Notes- Promoters

Lecture notes by student, lecturer Kate McKnight

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Company law (ACC3024)

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Introduction

The Constitution of the Company - Promoters and Pre-Incorporation contracts

What we will cover today:

1. The constitution of a company

2. Memorandum

3. Articles of Association

4. S contract between members

5. Alteration of the Articles

6. Shareholder agreements

7. Promoters, and

8. Pre-incorporation contracts

The outcomes for today include:

Having successfully completed this session you should be able to:

1. Explain the content and effect of the memorandum of association

2. Describe the contents of the articles of association

3. Analyse the effect of a company’s constitutional documents

4. Explain how articles of association can be changed

5. Consider who will be regarded as a promoter and whether any definition of the term

“promoter” is possible or advisable.

6. Compare the fiduciary position of a promoter with those of a trustee and an agent

REMEMBER the material in this lecture will cover the next two tutorials.

1. The Constitution of a Company

 A Company’s constitution is defined under the Companies Act 2006 as including:

Remember that that in 2006 that this Act was the single biggest Act in British

history. The Company Law Steering Group took many years to bring about this

legislation.

◦ The company’s articles of association, and

◦ Any resolutions and agreements affecting a company’s constitution.

 Before 1st October 2009 the memorandum of association was an integral part of a

company’s constitution, but its constitutional significance has been greatly reduced

by the CA 2006. This has now lost its dominance and has been replaced by the

Articles of Association. Explain why things have changed.

2. The Memorandum of Association – now a one-page document. It was important for

the company name and objects clause.

 Company names

◦ The tort of passing off

 The objects clause

◦ Ashbury Railway Carriage & Iron Co v Riche [1875]

◦ Rolled Steel Products v British Steel [1985]

• The Companies Act 2006 – not implemented until 2009. Any company founded

before this would have had a Memorandum.

 Altering the Objects Clause

The Company name is of paramount importance as is the address – you have to establish

domicile [not residence] which is where all the legal documents can be signed. All

information and letters much contain the address on all company documents.

The domicile is a big issue for tax. [See next semester – TAX].

any resolution to which Chapter 3) of the 2006 Act) applies.

The memorandum is still required for registration under s of CA 2006, but its role is

significantly reduced. According to s the memo simply states the intention of the

subscribers to form a company, to set up in business and to be members of the company

on formation as well as to take at least one share each in the company.

For existing companies s(1) states that provisions within the memorandum which fall

outside those envisaged by the CA 2006 will be treated as provisions of the articles. Articles

are now the SENIOR DOCUMENT. [Still part of the company’s constitution as defined

by s.]

The objects clause was formerly one of the fundamental elements of a company’s

memorandum and it has now been relocated to the Articles. You will be expected to know

what has changed in the Companies’ Acts. You need to know the position both before and

after the CA 2006. In addition, s(1) CA 2006 provides that the objects of a company are

unrestricted unless the articles specifically restrict them.

This is a considerable step forward in the area of, previously many companies were wary

of the doctrine of ultra vires [beyond the power] and objects clauses were often long and

complicated. Often shareholders could refuse to allow a company to follow a different path

other than what was in the objects clause.

Prohibited names

 Just in case you think that the material we cover only applies to big multi-national

companies. See High court case – Hotel Cipriani – a restaurant on Lisburn Road

called itself Cipriani’s. They were sued by the Hotel Cipriani in Venice and New

York. The High Court agreed that they should not use the name. The owner had to

change the name as the trademark name was protected.

1. The Memorandum of Association

For a company limited by shares, the memorandum must contain the following:

(a) Name Clause

CA 2006 s. 58 & 59 - the name of a public limited company must end with the words "public limited company", the name of a private limited company must end with the word "Limited". Abbreviations may be used instead: "plc" or "Ltd".

It is an offence to carry on business under a name which uses these words or abbreviations when not entitled to do so - the penalty is a fine.

It is not possible to register a company name which includes the words "public limited company", "limited", "unlimited" or their abbreviations anywhere except at the end of the name.

There are also other restrictions on the use of names:

(i) Under s, a company cannot be registered under a name which is identical to a name already registered.

(ii) S. 53 A company cannot be registered under a name which is regarded as offensive or where the use of the name would constitute a criminal offence. The Registrar has already turned down the names ‘Hookers Ltd’ and ‘Lindi St Clair French Lessons Ltd’ when application was made for the registration of the business of a prostitute.(1981)

(iii) S. 54(1) A company cannot be registered under a name which suggests that the company is connected with the government or a local authority - or under any name including a word listed in the Company and Business Names Regulations 1981 - unless the Secretary of State gives permission for the name to be used.

(iv)S does not prevent the registration of a name very similar to that of another company - but if the similarity is deceptive and likely to lead to confusion, the established business may bring an action to restrain the new company from using the name. This is called a "passing-off" action.

The company can be restrained by injunction from doing so from the moment of incorporation. Where the offending business is a proposed company, an injunction can be obtained to prevent registration, if information is available in time. If an injunction is made against an existing company for passing off, it must either change its name of its business or wind-up.

The mere fact of using one’s own name in business will not necessarily prevent a successful passing- off claim by an organization already in business under that name.

To constitute the tort of passing off the business carried on by the offending concern must be the same as that of the claimant, or it must be likely that custom will come to the offending concern because the public will be deceived and associate it with the claimant.

Contrast the cases of

Ewing v Buttercup Margarine Company Ltd [1917]

Ewing who traded under the name Buttercup Dairy Company sued to restrain a newly registered company called Buttercup Margarine Company Ltd from using the name on the grounds that the general public might reasonably believe that there was a link between the two businesses. HELD: Ewing was successful.

and Aerators Ltd v Tollit [1902]

company because the agent who made it had no authority to do so. Keep in mind the two areas of company capacity and agent authority.

(i) The Ultra Vires Rule

If the company does something beyond the scope of its objects clause, this is said to be ultra vires (beyond the powers of the company).

Previously this was of great importance - transaction entered into beyond the company’s powers was void and could not be enforced by or against the company, and it could not be ratified. This was called the ultra vires rule.

The leading case was :-

Ashbury Railway Carriage and Iron Co v Riche [1985]

ARC’s objects clause stated that the company was “to build and supply railway stock”. The company made a contract to build a railway system in Belgium for R but did not perform. R sued and lost, since the company had no power to enter into a contract to build a railway system. R had not read the objects clause of ARC.

Tesco’s, ASDA and M&S all started off as very small shops – go into superstores now where you can buy clothes, food, electrical items, computers, phones, shares, credit cards, insurance etc. All these activities have developed from a small base over the years and the objects clause had to be changed.

3. Why does a company need Articles of Association and what happens if they don’t

have any?

 Every company formed in UK is required to have articles, without which a

company cannot legally be formed.

 This requirement applies whether the company is public or private and whether

limited by shares or by guarantee.

 Companies generally have freedom in drafting their articles although they are

subject to provisions contained in the Companies Acts.

 Companies limited by shares and formed before 1 October 2009 may have adopted

the standard articles prescribed in earlier legislation and known as ‘Table A’

articles. Now these are known as the MODEL ARTICLES.

 All companies incorporated on or after 1 October 2009 may adopt the standard

‘model articles’ prescribed in the current legislation.

 A new company will be formed on the basis of model articles if it has not registered

a set of its own articles and unless and until the model articles are excluded,

amended or modified.

Tip

 The Articles of Association regulate the internal management of a company and

provide rules by which the company operates.

4. The Membership Contract

The Articles of Association

The articles govern the internal management and organisation of the company. Historically known as Table

A but now called the model articles in CA 2006.

The articles were formerly secondary to the memorandum - if there was a conflict between the articles and the memorandum, the memorandum prevailed. Now under CA 2006 the role of the memorandum is reduced, and it does not form part of the company’s constitution, the Articles are dominant.

The most important function of the articles is to allocate the power of the company between the board and the general meeting. Articles deal with such matters as the appointment and powers of directors, general meetings of the company, the voting rights of the members, the transfer of shares, and dividends. In many ways the instruction book of the company. The articles provide the Board of directors with the power to run the company.

While private companies are no longer required to hold an AGM for public companies the AGM is designed to fulfil an important supervisory function. The GM is in effect the residual power organ that meets once a year to exercise its continued supervision over the board. The GM can elect and remove directors, issue shares and review the Directors pay package. It can alter the articles if 75% of the members by special resolution vote in favour of the resolution. Thus, in effect the members can alter the internal rules by which the company’s power is allocated.

 The legal effect of the Articles – know these cases – for this course you do need

cases:

You do not need to know judges’ opinions but remember something about the cases.

◦ Wood v Odessa Waterworks Co [1889]

◦ Hickman v Kent or Romney Marsh Sheepbreeders’ Assoc [1915]

◦ Rayfield v Hands [1958]

◦ Eley v Positive Government Security Life Assur. Co [1876]

Section 33(1) of the Companies Act 2006 makes it clear that a contract is created by the articles of association. S. 33 CA 2006 states that ‘the provision of a company’s constitution bind- ‘The company and its members to the same extent as if there were covenants on the part of the company and each member to observe those provisions’.

The phrase to watch out for is on the part of the company and each member previous legislation suggested that the articles bound only the members, in effect ignoring the fact that the company was a separate legal entity. However, the case of Hickman v Kent or Romney Marsh Sheepbreeders’ Assoc [1915] was authority for the assumption that articles were binding as between members and the company.

Company

Member Member

Hickman v Kent or Romney Sheep Breeders Association [1915] 1 Ch 881 Articles provided for disputes between a member and the company to be referred to arbitration. A member sued in court to enforce his rights as a member, including his right to have his sheep registered by the

company in its published flock book.

Held: The court stayed [HALTED] the court proceedings brought by the member as the member was bound by the articles to arbitrate the dispute and the company was entitled to enforce the arbitration clause in the articles against the member. They had to exhaust the arbitration process.

In Hickman , the rights the member was seeking to enforce were rights common to all members: they were ‘membership rights’. The company was permitted to enforce the arbitration clause in the articles because the dispute between the member and the company related to membership rights. The company cannot enforce provisions in the articles against a member if the provision relates to rights of the member in a different capacity, such as in his capacity as a director or solicitor

Despite the new statutory provisions, the case law in relation to the statutory contract remains of considerable use.

Does each member have a binding enforceable contract with each other? ◦ Wood v Odessa Waterworks Co (1889) 42 Ch D 636 Provisions in the articles of association governed the rights of the members in respect of the division of the profits of the company. A member, on behalf of himself and all other members, brought an action for an injunction to restrain the company from acting on an ordinary resolution supporting a board proposal that profits be used to give debenture bonds to members instead of dividends, on the ground that to do so contravened the articles of association of the company. Held: per Stirling J: ‘What I have to determine is, whether that which is proposed to be done is in accordance with the articles of association as they stand, and, in my judgment, it is not, and therefore the Plaintiff is entitled to an injunction so far as relates to the payment of dividends’.

Eley v Positive Government Security Life Assur. Co [1876]

Eley set up the company – he included an article which said he should be the solicitor. The company wanted to use another solicitor.

Articles required the company to employ Eley as its solicitor unless he had been guilty of misconduct. The company used a different solicitor and Eley sued the company for breach of contract arguing that the articles formed a contract between himself and the company. Eley was treated as suing in his capacity as an ‘outsider’, not as a member. Held: Eley could not rely on or enforce the articles which were ‘a matter between the directors and shareholders, and not between them and the plaintiff.’ The court also rejected the argument that the relevant article was evidence of an agreement between the company and Eley separate from the articles. He should have had a separate legal contract to set up as the Company’s solicitor. He lost.

A company's constitution binds, under s 33:

 Members to company

 Company to members

 Members to members - The company's constitution does not bind the company to

third parties.

 This principle applies only to rights and obligations which affect members in their

capacity as members.

Hickman v Kent or Romney Marsh Sheepbreeders Association 1915

relation to their holdings of the company's shares in its articles' and the directors

were bound by it.

Point to note:-

 The articles only create contractual rights/obligations in relation to rights as a

member.

◦ Rayfield v Hands [1960]

Articles provided that a shareholder wishing to sell his shares must offer them to those members who were directors, and those member/directors were required to buy the shares at a fair price. The member/directors refused to buy the shares and Mr Rayfield sued them to enforce the provision in the articles. Held: Mr Rayfield could enforce the article against the member/directors who were ordered to take the shares. Note that Vaisey J sounded a note of caution as to the range of application of this principle of direct enforcement by one member against another: ‘The conclusion to which I have come may not be of so general application as to extend to articles of association of every company, for it is, I think, material to remember that this private company is one of that class of companies which bears a close analogy to a partnership.’

Prior to Salmon and Salmon 1968 most businesses were partnerships. The Companies Acts enabled small businesses to set up to take advantage of limited liability. Many of these small companies were really ‘quasi partnerships’.

The s contract – individual shareholders can sue to enforce the constitution. It ensures

that all members and the company are bound to observe the constitution.

5. ALTERATION OF ARTICLES

 A company’s articles are not unalterable.

 With evolving business needs a company may want to change certain wording in

its current articles, add or remove wording or replace the articles with an entirely

new set better suited to the business at that time. Companies do evolve over time

especially companies like Tesco – they have changed their articles and objects

clause. Tesco share price is 215 today. Shared must be priced at the time they

are sold TO THE MINUTE.

See links to TESCO online – alteration of articles of association via ordinary and

special resolution.

ALTERATION OF ARTICLES

 Section 21(1) restates previous provisions [legislation] and permits a company to

alter its articles by special resolution.

 The common law rules relating to such alterations still apply.

 A special resolution (one requiring agreement of at least 75% of the shareholders)

to change a company’s articles can be passed in one of two ways:

◦ a written resolution signed by the shareholders; or

◦ a special resolution passed at a meeting of the shareholders.

The Constitution- The Articles of Association contd.

 The Articles and insider/outsider rights – see Textbook

◦ Salmon v Quin & Axtens Ltd [1909]

◦ Re New British Iron Co. ex parte Beckwith [1898]

◦ Read v Astoria Garage (Streatham) Ltd [1952]

The Articles and insider/outsider rights

Until Salomon , it was generally accepted that the company format was an inappropriate vehicle for small commercial enterprises. Rather such enterprises should adopt the partnership format. But Salomon changed all that, it encouraged the growth of small private companies, which over time evolved into the genre of ‘quasi-partnership’ companies which operate internally on a basis far closer to that of a partnership than a pure corporate structure e. management - control etc.

Today this type of company is widely acknowledged as being a fundamental part of company law. But over a hundred years ago the development of this type of company led to many problems.

One major problem was when there was a dispute over for example the expectation in a small company that a member would perhaps be a director. Additional clauses may have been required to be added to the Articles, there were methods by which a special meeting could be called, and the company’s constitution amended.

The purpose of the articles of association was to regulate the internal affairs of the company (to provide detailed instructions as to how the company is to work /function).

As the lifespan of a company could be several hundred years often the courts had to deal with the issue of whether or not they should permit such new clauses as being valid and if they should be enforced. Three relevant cases are

◦ Salmon v Quinn & Axtens Ltd [1909] ◦ Re New British Iron Co. ex parte Beckwith [1898]

Re New British Iron Company Limited ex parte Beckwith (1898) B was a director and a shareholder. The company failed to pay its directors, who sued for their salary (since they had contractual rights to it). However, they did not sue for a breach of the Articles, since there was no direct contract there. Their employment contract did not give an indication of how much they should be paid; the Articles gave a figure of £1000 per annum. The courts implied this sum into their employment contract.

◦ Read v Astoria Garage (Streatham) Ltd [1952]

member of the company, in effect enforced the rights in the articles given to a managing director. The managing director’s veto right was not common to all shareholders, thus Mr Salmon enforced an ‘outsider’ right. He enforced this ‘outsider’ right by bringing an action as a member to enforce the articles. Lord Wedderburn has argued that this case establishes that members can indirectly enforce outsider rights in the articles by suing as members to require the company not to depart from the contract in the articles

 The effect of the Contracts (Rights of Third Parties) Act 1999

The above Act does not apply to the statutory contract between a company and its

members in terms of the provisions in a company’s constitution as set out in s.

According to s6(2) of the Act it specifically excludes it application so as to prevent third

party rights from arising. Thus, the decision in Eley v Positive Government Security Life

Assurance Co. 1876 still stands and would not or could not be affected by the 1999 Act.

This case still stands.

See Video from Open Tuition – but do worry about case law

6. Shareholders' agreements.

 Sometimes supplement a company's constitution

 Shareholder agreements are concerned with the running of the company; in

particular they often contain terms by which the shareholders agree how they will

vote on various issues

 They offer more protection to the interests of shareholders than do the articles of

association. Individuals have a power of veto over any proposal which is contrary

to the terms of the agreement. This enables a minority shareholder to protect his

interests against unfavourable decisions of the majority. Look at minority

protection here.

Shareholder Agreements

 Often in private companies

◦ Russell v Northern Bank Development Corpn Ltd [1992]

◦ Euro Brokers Holdings Ltd v Monecor (London) Ltd [2003]

50% of businesses fail in the first year. A shareholder’s agreement can help as things can

be agreed in advance. Buy a template? You do need a bespoke agreement – you may have

multiple shareholders. This is a promotional video by a firm of London solicitors.

What are the advantages of shareholder agreements?

It gives certainty of enforcement and the courts have shown that they will respect such agreements.
A shareholder can identify who he wishes to contract with e. voting with other shareholders.

7. Promoters

 A company cannot form itself. The person who forms it is called a 'promoter'. A

promoter is an example of an agent.

 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: Twycross v Grant 1877. [Who or what is a promoter?]

 A person who acts merely in a professional capacity in company formation, such

as a solicitor or an accountant, is not on that account a promoter. They are just form

fillers or professional facilitators.

Promotion and Incorporation

The Promoter

Duties

Transfer of non- cash assets to Company

Payments to

Pre-Incorporation Contracts

The General law

Solutions to personal liability of promoter

prospective company members or to an independent board of directors. As

soon as you sell on you have a duty to disclose to this independent board.

Duties of promoters

 A promoter may make a profit as a result of their position.

◦ (a) A legitimate profit is made by a promoter who acquires interest in

property before promoting a company and then makes a profit when they

sell the property to the promoted company, provided they disclose it.

◦ (b) A wrongful profit is made by a promoter who enters into and makes a

profit personally in a contract as a promoter. They are in breach of fiduciary

duty.

 A promoter of a public company makes their disclosure of legitimate profit through

listing particulars or a prospectus. If they make proper disclosure of a legitimate

profit, they may retain it.

Remedy for breach of promoter's fiduciary duty

 If the promoter does not make a proper disclosure of legitimate profits or if they

make wrongful profits the primary remedy of the company is to rescind the contract

and recover its money: Erlanger v New Sombrero Phosphate Co 1878.

 Where shares are sold under a prospectus offer, promoters have a statutory liability

to compensate any person who acquires securities to which the prospectus relates

and suffered loss as a result of any untrue or misleading statement, or omission.

Promoters Promotion of a company is concerned with taking the steps necessary for incorporation. (a) Definition "Promoter" is not defined in the Companies Act. Some attempts at definition have been made by the courts: Twycross v Grant [1877] 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”.

Whaley Bridge Printing Co v Green

Whether someone is acting as promoter of a company is a question of fact rather than a question of law. “The term of promoter is not a term of law but of business usefully summing up in a single word a number of business operations familiar to the commercial world by which a company is generally brought into existence” Bowen J.

Hence, a promoter can be said to be any person involved in the planning, incorporation or initial running of a company, other than persons involved in a purely professional capacity. Accordingly, accountants, solicitors, etc., employed in their professional capacity to establish a company will not be promoters. The typical steps that a promoter would take include taking the procedural measures necessary to form a

company, inviting other persons to become directors and seeking out investors for a company.

(b) Duties of Promoters In the 19th century, it was common for promoters to sell their own property to a newly formed company at an inflated price, or to acquire assets for the company and receive a commission from the seller. In equity a promoter stands in a fiduciary relationship towards the company he is promoting but is not a trustee. The courts then began to impose a fiduciary duty on promoters similar to that imposed on agents. A promoter must disclose any profit or potential conflict of interest to either: (i) an independent board of directors, or (ii) existing or intended shareholders. (c) Remedies for Breach of Promoters Duty

(i) Where promoter has sold his own property to the company, without disclosing this - the company can rescind the contract and recover the purchase price: Erlanger v New Sombrero Phosphate Co The 19th century saw some notorious company flotations in which unscrupulous promoters benefited themselves at the expense of the investors, as illustrated by Erlanger v New Sombrero Phosphate Co [1878]. Erlanger, the promoter, acquired on his own account but in the name of another (a “nominee”) the lease of a phosphate mine in the West Indies for £55,000. He then proceeded to sell the mining rights to the newly formed company for £110,000. The purchase was approved by the board of directors of the company, who had been appointed by Erlanger and were either under his influence or, as in the case of one of the directors, who was the Lord Mayor of London, simply did not have time to give to the enterprise. The prospectus that offered the company’s shares to the public did not disclose the promoter’s profit. When the original board of directors was replaced, the new directors, on discovering the swindle, sued Erlanger to have the contract for the sale of the mining rights rescinded.

It was held that the contract should be rescinded because the profit made by Erlanger had not been properly disclosed (in this case to an independent board) and therefore could not be kept by him. This case illustrates the fiduciary nature of the promoter’s role, which puts him very much in the same position of quasi-trusteeship as a company director. A key feature of this status is that such a fiduciary must not make a secret profit. The promoter can avoid contravening this requirement in a number of ways.

Right of recission is lost if restitutio in integrum is not possible.

(ii)The promoter may have to account to the company for any profit he has made.

Gluckstein v Barnes So t he company may, however, elect to rescind the contract concerned (as was the case with Erlanger) or may, where the right to rescind is not available, ask the promoter to account for his profit (i. return it to the company), as another promoter was required to do in Gluckstein v Barnes [1900 ].

 Property purchased before acting as a promoter

(iii)The company may be able to sue the promoter for damages for breach of fiduciary duty.

Re Leeds & Hanley Theatre of Varieties The promoter sold property to the company at an overvaluation, damages were awarded against the promoter. But note that the amount of the damages was the same as the profit made by the promoter.

 Property purchased after starting to act as a promoter

 Rules of capital maintenance

(d) Payment to Promoters

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