Erlanger v. New Sombrero Phosphate Co. (1878)

Promoters are not mentioned in any incorporation form and hold no office. Erlanger is the decision that fixes their legal position anyway: they are in a fiduciary position towards the company they are forming, and the duty is discharged not by good intentions but by machinery — by giving the company independent directors who can decide for it. Every later statement of a promoter's duty in India traces back to this case, and the Companies Act's definition of a promoter in s. 2(69) presupposes it.

The case also teaches, better than any other, that a defence to rescission may succeed on delay where it fails on the merits. The House was unanimous on breach and had to work hard on laches.

Sombrero was a small island in the West Indies, about a mile and a quarter long, containing deposits of phosphate of lime. It belonged to the Crown, and a lease of it was made for twenty-one years from March 1865 at a rent of £1000. The lease was assigned to the Old Sombrero Co., which paid £100,000 for it, taking it subject to a mortgage of £12,400. That company was wound up by the Court of Chancery, and in 1871 the lease came to be sold in the winding up.

The appellants, with a solicitor named Thomas Westall, thought well of the speculation and formed a syndicate to buy the lease. On 30 August 1871 the syndicate agreed to buy it from the official liquidator for £55,000, the contract being made in Westall's name on behalf of his principals.

Shortly before 20 September the syndicate determined to form a joint-stock company and sell the island to it for £110,000 — twice what they had agreed to pay. The company was registered on 21 September 1871. The syndicate prepared the memorandum, the articles and the prospectus. The memorandum stated the object as the purchasing, leasing and working of mines or quarries of phosphate of lime in the island of Sombrero.

The sale contract was dated 20 September 1871, between John Marsh Evans as seller and Francis Pavy as purchaser, for £110,000 — £80,000 in cash and £30,000 in fully paid-up shares. Evans was a trustee or agent for Baron Erlanger and the other syndicate members; Pavy's name was introduced as a matter of form to represent the company about to be created. The contract was provisional, subject to the formation of the company and its adoption of the contract.

The board. Article 65 required not less than four nor more than seven directors and named five first directors. Article 82 empowered the directors, without further authority from the members, to adopt and carry into effect the contract of 20 September. The five were:

| Director | Position | |---|---| | M. Drouyn de Lhuys | Asked to act because his position would help sell phosphate on the continent; assented "trusting entirely to Baron Erlanger"; made no independent inquiry | | E. B. Eastwick | Had applied to Erlanger personally to join, and had gone to Canada | | Rear-Admiral R. J. Macdonald | Came in "with a foregone conclusion that everything his friend Erlanger had done was right", and under such a bias could afford no protection | | John Marsh Evans | The agent of the syndicate — and the vendor named in the contract | | Sir Thomas Dakin | Disinterested, embarked his own money, but made no inquiry although he knew that those getting up the company were the vendors of the lease |

The memorandum was signed by Evans and six others, "all of whom were nominees of the syndicate, and none of whom was in a condition to afford disinterested protection to the interests of the company."

On 29 September 1871, a meeting of directors attended by Dakin, Macdonald, Evans and Westall ratified the purchase without inquiry into facts and figures. Shareholders came forward; in November the price was paid. In February 1872 the first shareholders' meeting was held; in June a committee of shareholders was appointed to investigate the purchase; counsel's advice was taken; the committee reported; and on 24 December 1872 the company filed its bill to rescind.

Malins V.C. dismissed the bill. The Court of Appeal reversed him. The defendants appealed to the House of Lords.

1. Were the promoters trustees for the company, so that they could take no profit at all on the resale?
2. If not, were they under some other duty, and did they break it?
3. Had the company lost its remedy by delay or acquiescence?

Appeal dismissed with costs; the decree of the Court of Appeal rescinding the contract was affirmed.

On the first issue the House agreed with the courts below against the company: the syndicate were not trustees. As Lord Blackburn put it, "the syndicate never constituted themselves trustees, but intended to sell and did sell this property to the new company", and Lord Gordon held that the property when purchased "belonged absolutely to the members of the syndicate, who were entitled to deal with it in any way they thought proper." The cases forbidding a trustee to profit from the property of his cestui que trust therefore had no application.

On the second issue the House was unanimous the other way. On the third it held that there had been no laches.

Promoters stand in a fiduciary position towards the company they are forming, though not as trustees. Where they sell their own property to the company, they must provide it with a board of directors who know that the property is the promoters' and who are competent and impartial judges of whether the purchase should be made, and they must disclose all material facts of the transaction. They need not disclose the price they themselves paid, but they must not be guilty of unfair concealment of facts that in common fairness ought to be disclosed. If the company is given no opportunity of exercising an independent judgment through independent directors, the contract may be rescinded and the purchase price returned.

Lord Cairns on the promoter's position

The passage to learn is Lord Cairns's, and it is built out of the promoter's own power over the company's birth:

They stand, in my opinion, undoubtedly in a fiduciary position. They have had in their hands the creation and moulding of the company; they have the power of defining how, and when, and in what shape, and under what supervision it shall start into existence and commence to act as a trading corporation.

The duty follows from that power. If the promoters intend that the company shall, as soon as it starts into life, buy their own property, then "it is in my opinion incumbent upon the promoters to take care that in forming the company they provide it with an executive", that is, a board who both know the property is the promoters' and are "competent and impartial judges whether the purchase ought or ought not to be made."

He then states the limit, which is the sentence that saves ordinary commercial promotion: "I do not say that the owner of property may not promote and form a joint-stock company and then sell his property to it, but I do say that, if he does, he is bound to take care that he sells it to the company through the medium of a board of directors who can and do exercise an independent and intelligent judgment on the transaction".

Applied to the facts, the promoters had themselves fixed the proper strength of the board at four to seven, and had named five. Of those five, one was never expected to take any part, one was in Canada, one was the vendor's own agent, one came in with a foregone conclusion, and the fifth made no inquiry. The board Lord Cairns's rule required simply did not exist.

What must be disclosed, and what need not

The rule is asymmetric and is often misstated. A vendor "need not do what was at one time asserted by this bill, namely, disclose what he has paid in effecting his own anterior purchase before asking an enhanced price"; but he "must not be guilty of any conduct which amounts to unfair concealment on his part of the real facts of the case, which ought in common fairness to be disclosed". So the £55,000 purchase price was not, of itself, a fact the syndicate was bound to reveal. What was fatal was the absence of anybody on the company's side to whom disclosure could meaningfully be made.

Lord Blackburn placed the case among three familiar equitable categories: vendor and purchaser; partner and co-partner, where one partner owes uberrima fides; and the case of an agent for a purchaser who receives a gratuity from the vendor, where the negotiation can be impeached and set aside.

Delay, laches and acquiescence

This is where the defendants came closest to winning, and it is examinable in its own right.

Lord Blackburn treated the company as free of laches down to 23 October; the bill was filed on 24 December. Given the magnitude of the case, the information that had to be gathered, and the shareholders' committee's attempt at a compromise, he found no laches in that interval. He added the warning that governs mining and speculative property: if there were "the slightest indication of wavering and indecision whether or not the remedy should be taken until they saw how the thing would turn out, that might be a very different matter."

Lord Selborne stated the two requirements of acquiescence: "first, that there should have been sufficient knowledge of the facts on which the equity depended, and, secondly (when a contract was sought to be rescinded), that there should have been substantial freedom of choice and action, independent of the original influence under which the voidable contract was made." He also noted that the company had done nothing to the injury of the property since taking it over, so restitution remained possible.

Lord Gordon put the burden where it belongs: "The onus lay on the appellants of showing that there had been such laches on the part of the company as to deprive it of the right to set aside the contract", and they had failed to discharge it.