Topic 4

PRE-INCORPORATION CONTRACTS &

INCORPORATION OF COMPANY
 Learning Outcomes
At the end of this lecture, students should
able to:

• Explain the concept of promoters.

• Describe the principle of
pre-incorporation contract.
• Discuss the effects of incorporation.
• Explain the principle of lifting of the
corporate veil.
 Topic Outline

Promoters

Pre-Incorporation Contracts

Incorporation of A Company

Lifting of the Corporate Veil

 Introduction

• Every existing thing, it all has its own

beginning.
 Promoters
Twycross v Grant Tracey v Mandalay Pty Ltd

• A person who undertakes • The idea of exertion for

to form a company with the purpose of getting up
reference to a given and starting a company
project and to set it going, and also the idea of some
and who takes the duties towards the
necessary steps to company imposed by or
accomplish that purpose. arising from the position
which the so-called
promoter assumes
towards it.
• Those who cause a
company to be
incorporated and also
those who may later find
persons to act as its
directors, arrange for its
shares to be offered to
the public or sell assets
to it, provided always
that in these activities
they are GENERALLY
INVOLVED IN
LAUNCHING THE
COMPANY.
 Duties of Promoters

Fiduciary relationship
Duty to disclose to the company any
profit which he may secure

Independent board Existing or intended

of directors shareholders
• Erlanger v New Sombrero
Phosphate Co.
– Facts:
• The App. & ors. formed a syndicate to acquire a lease of an
island for the mining of phosphates. Members of the
syndicate formed a company to purchase the lease. The
comp. then sells its shares to public. After 8 months, the
public investors found out the fact that the syndicate had
bought the island at half the price the company had paid
for it. The Comp. sued for rescission based on
non-disclosure.
– Held:
• The contract should be void because the prospectus that
offered the company’s shares to the public did not disclose
the promoter’s profit.
 Remedies for Breach
Where a promoter fails to make a full and proper disclosure of
a profit madepromoter
•Where by him out
hasof the promotion
sold his own property
to the company,
without disclosing this
Rescission of contract – the company can
rescind the contract
and recover the
purchase price.
•It is not necessary
Recovery of secret that there need an
imputation of evil
profit purpose or conscious
fraud.

•A company may also

have a remedy in
Damages for breach damages against its
of fiduciary duty promoters for breach
of their fiduciaries
duties.
 Pre-Incorporation Contracts

•Contracts made before a company is incorporated.

•A company has no contractual capacity prior to incorporation - so contracts cannot
be made on its behalf.
•Before incorporation, company is not a separate entity and therefore it is incapable
of gaining contractual rights or incurring liabilities.
•The promoters are responsible for acting for the company.
• Kelner v Baxter
– Facts:
• The promoter in behalf of unformed company accepted an
offer of Mr. Kelner to sell wine, subsequently the company
failed to pay Mr. Kelner, and he brought the action against
promoters.
– Held:
• The company cannot take the liability of pre-incorporation
contract through adoption or ratification; because a
stranger cannot ratify or adopt the contract and company
was a stranger because it was not in existence at the time of
formation of contract. The promoters are personally liable
for the pre-incorporation contract because they are the
consenting party to the contract.
Position in Malaysia
Section 65(1)

•A contract or transaction that purports to be made by or on

behalf of a company at a time when the company has not
been formed has effect as a contract or transaction made
with the person purporting to act for the company or as agent
for it, and he is personally liable on the contract or
transaction accordingly.
Section 65(2)

•Notwithstanding subsection (1), a contract or transaction

referred to in that subsection may be ratified by the company
after its incorporation and the company shall be bound by
the contract or transaction as if the company had been in
existence at the date of the contract or transaction and had
been a party.
 t s id e r t o
l e t h e ou
To ena b
a c t e i t h er
The t h e c o ntr r it
enforce c o m pa n y a f t e
t h e it
against h e n
Effect is i n c o r p o r ate
co
d
n
w
t r a c t or
i f i e s t h e ho
rat w
of aga i n s t t h e pe r s
e
o
c
n
u
s
t e the
e d t oe x
r t the
Section purp
cont
o
r a c t o n be h a l f
a
o
n
f
y i f it
t e n t c o mp
65 non-exi s
does no
t.
 Once
pre-incorporatio
n contract is Ratification
ratified, the operates
company is retrospectively.
bound by the
contract.
The company
may choose not
to ratify.
The person who
purported to act
in the name or
on behalf of the
company shall be
personally
bound by the
contract.
• Cosmic Insurance Corporation Ltd. V Khoo Chiang
Poh.
– Facts:
• The App. Khoo was offered the post of managing Director for
life in a letter written by the promoters of the company. After
incorporation, a resolution was passed confirming the position
of Khoo but with a slight variation from the earlier letter.
– Issue:
• Whether the first letter amounted to a pre-incorporation
contract, and if so, whether it was ratified.
– Held:
• The letter amounted to a pre-incorporation contract and that
the resolution passed after incorporation amounted to
ratification.
 Separate Legal
Entity
A company incorporated
under this Act is A BODY
CORPORATE and shall:

(a) Have LEGAL PERSONALITY

SEPARATE from that of its
members; and
•Legal recognition

•Section 20 (b) CONTINUE IN EXISTENCE

until it is removed from
the register.
 r c i s in g all
b l e o f e xe
a l l b e c apa F A B O DY
sh T I O N SO L L
F U N C t h e F U
the a n d h a ve
R P O R A TE Y O N O R
CO
Y T O C ARR or
A P A C I T S I N E S S
C
E A N Y BU
A K
UNDERT ity including:
Section activ b e s u e d;
T o s u e and h o l d ,
21(1) (a) re , ow n ,
o a c q u i f a ny
(b ) T ispo s e o
o p o r d
devel e r t y ; a n d
prop i c h i t m ay
a n y a c t wh
) T o d o t e r into
(c e n
do or to ions.
transact
 Effects of Incorporation

Boot
1. manufacturin Incorporated
•Salomon v a company
Separate legal Salomon g business
entity
Sold the
business to
the company
To secure the Business
pay, a failed,
security was creditors
given argued over
Held: despite
(charge) the charge
Salomon
controlled
the company,
it was not his
agent or
trustee
•The decision confirms that a company upon its incorporation, is a SEPARATE LEGAL
ENTITY from its members.
•The creditors can look to only the company, and not its member for repayment.
•If a loan is secured, the MEMBER-CREDITOR HAS PRIORITY OVER THE PROCEEDS
from the secured assets.
 •Foss v Harbottle
•Facts: 2 shareholders in the
Victoria Park Company brought
2. •All legal action an action against the company’s
Can sue and be involving a directors and some other
sued company must persons.
be in its own •Held: The injury complained of
name. was an injury to the company. In
law, the company and its
members were not the same.
 Macaura v. Northern Assurance Co

•Mr Macaura, sold all timber for

share capital of a company.
3. •A company may •A policy insuring the timber was
Ability to own hold property in taken out in the name of Mr
property its own right, Macaura. A fire destroyed the
either movable timber on the estate. Mr Macaura
or immovable. then sought to claim under the
policy he had taken out.
•Held: The timber belonged to the
company and that Mr Macaura
even though he owned all the
shares in the company had no
insurable interest in the property of
the company.
 The same principle
applies to directors and
other company officials.
4. •All liabilities
Limited liability on incurred by the In general, they are not
members company are to responsible for debts
be borne by the
company itself incurred by the company
and not its
members. despite the fact that a
company is run by
directors and company
officials.
 After a company is
incorporated, it
continues to exist until
•The existence of a it is dissolved according
5.
Perpetual succession
company does not to the law or it is stuck
depend on the
existence of its off the register.
members.
Membership may
change or members may
die - the company
continues in existence
until wound up.
 Lifting of Corporate Veil

Open to abuse Harsh injustice

Separate Legal Entity

Those who are

responsible
Pull aside the may be held
persona and personally
look to see who liable for the
is behind acts or
purported acts
of the company
 Why???

Sham Fraud
•Jones v Lipman
•Facts: Lipman sold his land to Jones. He
however refused to fulfil his obligation. He
then formed a company and subsequently
sold the said land to said company.

•Held: The company was a sham, formed for

the purpose of defeating Jones’s claim over
the land. Thus, the court has lifted the veil of
the company and specific performance was
subsequently granted against Lipman and his
company.
 Summary
• Pre-incorporation contract causes TWO (2)
different effects depending on the company’s
rectification thereof.
• Once a company is incorporated, it has full
capacity as body corporate.
• However, the rule is balanced with the
principle of lifting corporate veil.