Erlanger v New sombrero Phosphate Co [1878] 2 App Cas 1218, HL

KEY POINTS

• Company promoters often hold a fiduciary position, which entails high trust and responsibility. In this role, they are bound by ethical and legal obligations to act in the best interests of the company they are promoting and its prospective shareholders.

• One critical aspect of this fiduciary duty is disclosing all material facts relevant to the company's prospects and financial health. Promoters must provide complete, accurate, and transparent information to potential investors, ensuring they can make informed decisions.

• Concealing material facts or providing misleading information breaches the promoter's fiduciary duty and undermines the securities market's integrity. Such actions can lead to legal consequences, including civil and criminal liabilities and regulatory penalties.

• These principles are fundamental to maintaining trust and integrity in financial markets, safeguarding shareholders' rights and investments, and upholding corporate governance principles. Promoters play a pivotal role in ensuring these principles are upheld, and investors can have confidence in the companies they choose to invest in.

FACTS

• A group of individuals purchased a property and later established a company to buy the same property from themselves, holding a fiduciary duty towards the company they were forming. They were obligated to provide the company with complete and truthful property information, especially details that could affect its acquisition decision.

• Led by an individual named E, this group, known as a "syndicate" or partnership, acquired an island supposedly containing valuable phosphate mines from an insolvent company's official liquidator. E orchestrated the purchase to create a company to manage the island and its mines. For this purpose, he nominated five individuals as prospective company directors.

• Two of these proposed directors were based abroad, and the other three had clear ties to E. Two directors received shares to qualify as directors through arrangements made by E. One appeared to act as E's business agent, while the other was a personal friend of E. The island's sale was seemingly made through a person with no genuine interest in the property, and it was presented as being sold to the director acting as E's business agent, who represented the purchase on behalf of the company.

• The two directors associated with E's arrangement and a third individual, D, who was entirely unaware of the initial purchase and subsequent sale, assumed director roles and accepted the island's purchase on behalf of the company. A prospectus was issued to attract shareholders, painting a positive picture of the scheme. Numerous investors bought shares in the company. During the first shareholders' meeting, D chaired the session. When asked about rumors concerning the island's purchase and pricing in the initial sale and resale to the company, D admitted his lack of knowledge but expressed faith in the scheme's merits.

• The actual circumstances of the sale and purchase were not disclosed to the shareholders. The shareholders at the meeting in February 1872 approved the island's purchase. In June 1872, during a general shareholders' meeting, the rumors surrounding the purchase became more pronounced, prompting the establishment of an investigative committee. Upon receiving the committee's report in August 1872, the original directors were ousted at a public meeting, and new directors were appointed with the authority to take action in the company's interest.

• The new directors engaged in discussions with the island's vendors, but these negotiations proved unfruitful. As a result, in December 1872, a lawsuit was filed to annul the contract.

JUDGEMENT

• After due deliberations and arguments, it was concluded that the contract could not sustain

COMMENTARY

• Company promoters carry a fiduciary responsibility, mandating transparency and diligence in safeguarding the company's and potential shareholders' interests by disclosing material facts that affect the company's well-being. Failing to do so can lead to legal consequences, compromising market integrity and resulting in civil, criminal, or regulatory liabilities. 

• These principles underpin trust and governance in financial markets, securing shareholders' rights and investments. In this specific instance, a group acquired an island with valuable phosphate mines through a company they formed. They appointed five directors, but a lack of disclosure marred the acquisition's integrity, leading to an investigation and, eventually, the contract's annulment in December 1872 due to its unsustainability.

ORIGINAL ANALYSIS

• Defendant purchased a lease on a mine and then nominally sold it to a new company he set up of which he was a director and all the other directors were people clearly under his control. He then sold shares in the company to the investors, prices being based on the price at which Defendant sold to his own company rather than the price at which he purchased.

• This was later discovered when the shareholders voted to sack all the directors and replace them with new ones, who sued Defendant to rescind the sale of the island to the company and thereby entitling the shareholders to get their money back.

• HL said the contract could be rescinded. 

Lord Penzance

• In fiduciary relationships such as trustee-trustor, principal-agent, father-son etc. the courts grant relief from “unfair advantage” and the party accused of being in the position of unfair advantage has the burden on him to show that he is not.

• On the question of whether the contract was affirmed by delay, the question is “whether there was such delay as fairly imports acquiescence”.

• In this case the total lack of knowledge or capability to discover the truth means no acquiescence. Inevitably there would be a delay between discovery of the truth and the bringing of an action, since a committee had to investigate and then a resolution had to be passed to sue Defendant. This is a reasonable delay.