OCTOBER 2008 PART B Q2

The first issue is whether the agreement entered by Jambu amount to a pre-
incorporation contract and if so, whether it is ratified.

Pre-Incorporation contracts is a contracts made before a company is
incorporated. Whereas, promoter is a person involved with the preparations and other
procedures to incorporate a company and other procedures carried out before company
is formed.
The general rule under Common Law is that a company is not bound by a
contract made before it is incorporated. Such contract is void as Company has no
capacity to contract until it is incorporated. In addition, under the Law of Agency, an
agent cannot be created by a principal that is not yet in existence and thus would not
have authority to act for such principal.
This is illustrated in the case of Kelner v Baxter
1
where in this case, Gravesend
Royal Alexandra Hotel Co. Ltd was in the process of being formed. There were few
persons purportedly acting on behalf of the Gravesend entered into a contract for the
purchase of wine from Plaintiff. The wine was delivered to the Company after its
formation but before Plaintiff was paid the Company went into liquidation. The court held
that the company was not bound to the contract that had been signed by the promoters
before its incorporation. The promoters were made personally liable on the contract.
In another case of Phonogram v Lane
2
, in this case, Fragile Management Ltd.
was in the process of being formed. DF contracted with PF for a loan of 12,000 to
finance a pop group called Cheap, Mean & Nasty. DF was required to sign and return a
copy for and on behalf of Fragile Management Ltd. The Co. was never formed and the
group never performed. The Court held that the DF was personally liable to repay the
money advanced.

1
(1866) LR 2 CP 174

2
[1982] QB 938

However, this Common Law position creates problems for third parties who may
not be aware whether the company has been incorporated or not. The above problems
were overcome when the legislation was enacted in the form of Section 35(1) and
Section 35(2) of the Companies Act 1965
3
.
Section 35(1) provide that where a contract is supposed to be made by a
company or by a person as agent at the time when the company has not yet been
incorporated, the company may ratify the contract. Ratification may be expressed or
implied. Example of an express ratification is in the situation where Company passes a
resolution adopting a contract. On the other hand, implied ratification is when the
company does some act affirming the contract. The effect of ratification is that it is
binding as if it had been entered into by the company at the time of the contract.
Subsequently, third parties can take action against the company if it ratifies the contract
after it is incorporated.
If the company does not ratify, Section 35(2) provide that third parties can take
action against the persons who entered into the contract on behalf of the co. before its
incorporation and such they can also enforce the contract. However, the contract must
have been entered into by the company or by any person on the companys behalf
before incorporation. In addition, there must be no express agreement to the contrary
such as in situation where third party promises to make only the company liable and not
any other party.
This is illustrated in the case of Cosmic Insurance Corporation Ltd. v Khoo
Chiang Poh
4
, where in this case, Khoo was offered the post of MD 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. After
some disagreement, the co. wanted to remove Khoo. The issue that was raised was, as
to whether the first letter amounted to a pre-incorporation contract, and if so, whether it
was ratified. The Privy Council held the letter amounted to a pre-incorporation
agreement and that the resolution passed after incorporation amounted to ratification.

3
Companies Act 1965
4
[1981]1 MLJ 61
Applying the law to this problem, on 20
th
July 2007, Jambu, on behalf of Jambu
Air Sdn Bhd had entered into a contract with Shasha to purchase land which they both
co-own at twice the market value. Contract made by Jambu and Shasha is a pre-
incorporated contract as the contract was made before the incorporation of Jambu Air
Sdn Bhd. By virtue of Section 35(1) of Companies Act 1965, the pre-incorporation
contract will bind Jambu Air Sdn Bhd if Jambu Air Sdn Bhd ratifies the contract either by
expressly or impliedly. As illustrated in the case of Cosmic Insurance Corporation Ltd. v
Khoo Chiang Poh [1981] 1 MLJ 61, if Jambu Air Sdn Bhd passes any resolution or use
the purchased land, it will be considered as ratification. However, if Jambu Air Sdn Bhd
did not ratify the contract, Section 35(2) of Companies Act will come into force and the
promoter will be personally liable. By virtue of Section 35(2), Shasha can take action
against Jambu as he is the person on the companys behalf before incorporation.












The next issue is whether Jambu has breached his fiduciary duty as a promoter
of JambuSdnBhd during the promotion of the company.
A promoter is a person who is involved in the formation of a company. A
promoter also is a person who enters into contracts on behalf of the company before the
company is incorporated. There is no precise definition under Companies Act.
Nevertheless, Section 4 of the Companies Act 1965
5
defines promoter as a person
who is a party to the preparation of the prospectus, but a person who is acting in his
professional capacity would not be regarded as a promoter. For instance, solicitors and
accountants who are employed in their professional capacity to incorporate are not
necessarily promoters; they merely act on the instructions of others to provide
assistance to register a company to conduct a business venture which they are paid for
it.
The term promoter can be explained in the case Twycross v Grant
6
where
Cockburn CJ defines promoter as a a person 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. Not only that, in Tengku Abdullah ibni Sultan Abu Bakar v
MohdLatiff bin Shah Mohd
7
, Gopal Sri Ram JCA said that, a promoter is one who
starts off a venture any venture solely for himself, but for others, of whom he may be
one.
Promoters are in a fiduciary position to the company which they are under the
obligation to act in good faith for the interest of the company. They owe a duty to
disclose everything with regard to their dealings with the company in order to avoid
conflict of interest. Any benefits they would receive pertaining to any dealings, must be
made known to the company or otherwise they will be considered as being in breach of
their fiduciary duties.

5
Companies Act 1965
6
(1887) 2 CPD 469
7
[1996] 2 MLJ 265
This can be supported in the case of Erlanger v New Sombrero Phosphate
Co
8
. In this case, a syndicate purchased an island for mining phosphates. A company
was formed to purchase the island from the syndicate. The directors of the company
have been nominated by the head of the syndicate at its first meeting. Then, the
company adopted the contract. Later, the company found out that the island was
actually worth greatly less than the purchase price the company had paid. The
promoters had made a profit causing loss to the company and its shareholders. The
case laid down the principle that a promoter who has an interest in a contract with the
company and who stands to make a profit because of his interest must disclose that
interest or profit to the company or otherwise the company can rescind the dealing and
make the promoter liable for the profit.
In Habib Abdul Rahman v Abdul Coder
9
, there was a company that was
promoted by Abdul Coder and another person. They bought a piece of land from
another company on behalf of the company. This land was then divided and offered for
sale to the public. However, Abdul Coder set up a partnership with three others and
they bought one lot and he did not disclose to the company he promoted that he had
interest in the purchase. The other shareholders sought to have the sale rescinded on
the grounds of his failure to disclose his interest. The court allowed the contract to be
rescinded on the fact that Abdul Coder did not disclose his interest when he bought the
land from the company he had promoted.
However, a promoter may not be liable for any secret profit that he gains from his
position if he makes a full disclosure to the independent board of directors and not to a
board that is subordinate to the promoter
10
, so that their judgment on the transaction
can be independent and rational. This is because an independent board of directors is
capable of making impartial and independent judgment of the transaction undertaken by
the promoters. In the event the company still wanted to complete the transaction after a
full disclosure has been made known to the independent board of directors, the
company would be held as agreed to allow the promoter to obtain any benefits that he

8
[1878] 3 App Cas 1218
9
(1808-1890) 4 Ky 193
10
[1990] AC 240
has received at the companys expense. However, the disclosure can also be made to
the shareholders, which may also include potential shareholders in the event it is not
possible to do so to the independent board of directors.
In the event that the promoter has breached his fiduciary duty against the
company, the company is left with several major remedies, which are rescission of
contract, recovery of secret profit and damages.
Rescission of a contract is the remedy that a company normally seek where the
promoter enters into a contract without disclosing his interest to the company
11
. Under
this remedy, the contract entered into by a company that was not aware of the truth due
to the promoters breach of fiduciary duty would be terminated. The promoter must
return any profits that he has gained to the company and the company also must return
the property back to the promoter. This is an equitable remedy by restoring the parties.
However, the contract made cannot be rescinded under several circumstances. Firstly,
the company did not rescind the contract promptly after being aware of the breach.
Secondly, the contract is affirmed by the company after knowing it. Thirdly, where the
parties involved cannot be restored to their original position due to the impossibility to
restore the subject matter of the contract and lastly, where an innocent third party has
acquired some interest in the property that cannot be defeated. This can be illustrated in
the case of Re Leeds & Hanley Theatres of Varieties Ltd
12
, where the court
disallowed rescission of the contract as the innocent parties have acquired interest to
the property.
On the other hand, recovery of secret profit is an alternative way to claim any
secret profit made by the promoter on the basis of trust principles. This means that a
company may elect not to rescind the contract but instead choose this way to make the
promoter liable for the profits he has made at the expense of the company. To recover
secret profit, the company must prove that there was failure on the part of the promoter
to disclose his interest and there was profit arose from the transaction within the
promotion period. In short, it is a useful alternative remedy in the event the company

11
Ibid
12
(1902) Ch 809
could not rescind the contract or where the company chooses to retain the contract
provided that the secret profit recoverable must be separated from the contract price. It
must be noted that, once the company opts for this remedy, it can no longer rescind the
contract. In the case of Fairview Schools Bhd v Indrani a/p Rajaratnam
13
, a promoter
acquired a property for her personal gain instead of for the company promoted during
the course of promotion. The court held that the company may obtain a constructive
trust order and require the promoter to hand it over at cost.
The last option for the remedies is damages. In the case of Re Leeds& Hanley
Theaters of Varieties Ltd
14
, in order to sue the promoter for damages, the company
must prove that it has suffered loss as a consequence of the promoters breach of duty.
In this case, the promoters were held liable for damages to the company and the
measure of the damages was the promoters secret profits.
In applying the law to the situation at hand, Jambu is a promoter of
JambuSdnBhd, a limited company he sets up wih Abu and Airy. Hence, he owes
fiduciary duty towards JambuSdnBhd as a promoter to disclose any profits or benefits
he would gain as a promoter to prevent any conflict of interest. In this situation, the
company intended to involve in housing development projects. Therefore, Jambu as the
promoter to the company was given the task to enter into a contract to purchase a land
to launch the project. However, without the companys knowledge, Jambu had entered
into a contract on behalf of the company in purchasing a land which he co-owns with
Shasha and the land was sold at twice the market value. Not only that, he also failed to
disclose his interest in the land he purchased on behalf ofJambuSdnBhd during the
companys first board of director meeting. He is said to make secret profit at the
expense of JambuSdnBhd when he is not allowed to do so as a fiduciary to the
company.Thus, this shows that he had breached his fiduciary duty as a promoter for
Jambu Air Sdn Bhd. This can be illustrated in the case of Erlanger v New Sombrero
Phosphate Co
15
.

13
(No 2) [1998] 1 MLJ 110
14
Ibid
15
Ibid
Therefore, the company could opt to rescind the contract by virtue of Habib Abdul
Rahman v Abdul Coder
16
case on the fact that Jambu failed to disclose his interest over
the contract when he had the chance to do so. However, due to the fact that the land
the company had bought was actually own by Abu and Shasha, assuming that Shasha
had no knowledge that Jambu was actually the promoter to the company to purchase
the land, the company therefore could not opt to rescind the contract because it will be
unfair to her as a third innocent party to the contract as she had acquired interest from
the property and that cannot be defeated.This is as illustrated in the case of Re Leeds &
Hanley Theatres of Varieties Ltd
17
.
However, as an alternative remedy, JambuSdnBhd may recover the secret profit
that Jambuhad made from his position as a promoter to the company. This is based on
the trust principle. The company may do so provided that the secret profit recoverable
must be separated from the actual contract price of the land. This can be seen in the
case of Fairview Schools Bhd v Indrani a/p Rajaratnam.
18

Not only that, as illustrated in the case of Re Leeds & Hanley Theaters of
Varieties Ltd
19
, Jambu Air SdnBhd may also sue Jambu for damages to pay the loss it
had suffered as consequence of Jambus breach of his fiduciary duty as a promoter to
the company. The measure of the damages could be the secret profits that he had
gained.
As a conclusion, Jambu had breached his fiduciary duty as a promoter to
JambuSdnBhd and the company may sue him for recovery of secret profits or damages
for the secret profits that he had gained out of the promotion of the company.




16
Ibid
17
Ibid
18
Ibid
19
Ibid
REFERENCE
1. Kelner v Baxter (1866) LR 2 CP 174
2. Phonogram v Lane [1982] QB 938
3. Cosmic Insurance Corporation Ltd. v Khoo Chiang Poh [1981]1 MLJ 61
4. Twycross v Grant (1887) 2 CPD 469
5. Tengku Abdullah ibni Sultan Abu Bakar v MohdLatiff bin Shah Mohd [1996]
2 MLJ 265
6. Erlanger v New Sombrero Phosphate Co [1878] 3 App Cas 1218
7. Habib Abdul Rahman v Abdul Coder (1808-1890) 4 Ky 193
8. Gluckstein v Barnes [1990] AC 240
9. Re Leeds & Hanley Theatres of Varieties Ltd (1902) Ch 809
10. Fairview Schools Bhd v Indrani a/p Rajaratnam (No 2) [1998] 1 MLJ 110
11. Companies Act 1995 (Act 125) : Regulations, Rules & Order. Malaysia :
International Law Book Series. (2013).
12. Rachagan, S., Pascoe, J., Joshi, A. (2010). Concise Principles of Company
Law in Malaysia : Promoters and Pre-incorporation Contracts. Malaysia :
Lexis Nexis.
















LAW 604
LAW OF ASSOCIATION I

ASSIGNMENT


LWBR03

AZARITH SOFIA BINTI AZIZ 2011403462
NURUL SAKINAH BT AMIR HAMZAH MAJU 2010970557
FARAH AMALINA AB GHANI 2011846642
SANDRA Y. FREDDY 2010957775


MDM MAZLINA MANGSOR
18 JUNE 2014