Erlanger v. New Sombrero Phosphate Co.(1874-80) All ER Rep. 271

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Case Summary

Full Case Details

The position of promoters vis-à-vis the company which they are promoting is not that of
trustees to a cestui que trust, but they are in a fiduciary position towards the company.
Consequently, where the promoters of a company sell property to the company the burden is
on them of showing that they have not taken any unfair advantage resulting from their
relations with the company. It is their duty to nominate independent directors of the company
who are capable of acting impartially in defence of the company’s interests and will be
competent and impartial judges whether or not the purchase ought to be made. Furthermore,
they must disclose to the company all the material facts relating to the transaction. They need
not disclose what they paid for the property which they are selling to the company, but they
must not be guilty of any conduct which amounts to unfair concealment of the real facts of the
case which ought in common fairness to be disclosed to a person seeking to purchase or
entering into a treaty with them for that purpose. Where a company is not given by the
promoters an opportunity of exercising, through independent directors, a fair and independent
judgment on the subject of the purchase by the company of property from the promoters, the
court may order the contract to be rescinded and the purchase price to be returned.
Appeal by the defendants in the action from a decision of the Court of Appeal (SIR
GEORGE JESSEL, M.R., JAMES and BAGGALLAY, LL.J.), reversing a decree of MALINS, V.C.,
on a bill filed by the respondent company to rescind a contract for the purchase of a small
island in the West Indies called “Sombrero”, on the ground that all the circumstances
attending the transaction had not been disclosed by the vendors, a “syndicate” of which the
appellants were members, who had purchased the lease of the island, with the assent of the
Court of Chancery, from the liquidator of a former company, and had re-sold it to the present
company.
The plaintiff in the action in the Chancery Division was the New Sombrero Phosphate Co.
Sombrero was a small island in the West Indies, about a mile and a quarter long, in which
were deposits or beds of phosphate of lime. It belonged to the Crown, and a lease was made
of it for twenty-one years from March 1865, at a rent of £1000. This lease was assigned, in
the first instance, to a company called the Old Sombrero Co., who paid £100,000 for it, taking
it subject to a mortgage of £12,400. This company was wound-up by the Court of Chancery,
and in 1871, in the winding-up, the lease of the island came to be sold. The appellants, along
with one Thomas Westall, a solicitor, thought well of the speculation, and wished to buy the
lease, and for this purpose they formed a syndicate. On August 30, 1871, the members of the
syndicate agreed to buy the lease from the official liquidator, for £55,000, the contract being
made in the name of Westall on behalf of his principals. Shortly before Sept. 20, 1871, the
syndicate determined to form a joint-stock company, which was registered on Sept. 21, and to
sell the island to the company for £110,000. They took the necessary steps for this purpose,
preparing the memorandum of association, and the articles, and also the prospectus which was
to be issued. The memorandum of association stated that the object of the company was the

purchasing, leasing, and working of mines or quarries of phosphate of lime in the island of
Sombrero. The articles stated that the number of directors should from time to time be
determined by a general meeting, and that till any other number was determined there should
be not less than four nor more than seven directors. Two directors should be a quorum for the
transaction of business; and among the acts which the directors were empowered to do were
the adoption and carrying into effect the contract for the assignment to the company of the
island of Sombrero, dated the same day as the articles, namely, September 20, 1871. By this
contract John Marsh Evans agreed to sell, and Francis Pavy agreed to purchase, the lease of
the island and the property on it for £110,000, £80,000 to be paid in cash and £30,000 in fully
paid-up shares of the new company. Evans was a trustee or agent for Baron Erlanger and
other members of the syndicate, and Pavy was a person whose name was introduced into the
contract as a matter of form, to represent the company about to be created in case it should
adopt the contract. The contract was, on the fact of it, a provisional one, subject to the
formation of the company and the adoption of the contract by it. In the whole of this
proceeding up to this time the syndicate, or the house of Erlanger, as representing the
syndicate, were the promoters of the company.
The memorandum of association of the company was signed by Evans and six other
persons, 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. Mr. Westall prepared the
articles of association. By art. 65:
“The number of directors shall from time to time be determined by the company in
general meeting; until any other number is so determined, there shall not be less than
four directors nor more than seven. The first directors shall be His Excellency
Monsicur Drouyn de Lhuys, E.B. Eastwick, Esq., the Right Hon. Thomas Dakin,
John Marsh Evans, Esq., and Rear-Admiral R. John Macdonald.”
By art. 82:
“In their management of the business of the company the directors may, without any
further power or authority from the members, do the following things, viz., first, they
may adopt and carry into effect the contract for the assignment to the company,
bearing even date herewith, of the island of Sombrero, in the West Indies, and the
factory, buildings, and works thereon, for the residue of a term of twenty-one years
from Mar. 16, 1865, subject to the provisions contained in the lease thereof.”
With regard to the five persons named as the first directors, M. de Lhuys was requested
by Erlanger to act as director, and he assented. It was not pretended that he made, or was
expected to make, any independent inquiry on behalf of the company. He was asked to be a
director because from his position he would be influential in promoting the sale of phosphate
on the continent; and he assented, trusting entirely to Baron Erlanger. His appointment,
therefore, afforded no protection to the company. Mr. Eastwick had applied to Erlanger
personally to be allowed to join the company, but had gone to Canada. Admiral Macdonald
was stated by LORD BLACKBURN to have “evidently come into the company with a foregone
conclusion that everything his friend Erlanger had done was right, and under such a bias he
could afford no protection to the company.” Evans was the agent of the syndicate. The

company could not, therefore, have any protection unless from Sir Thomas Dakin. He was
quite disinterested and he embarked his own money in the company, but before lending his
name as director he made no inquiry although he was aware that those getting up the company
were the vendors of the lease.
On Sept. 29, 1871, there was a meeting of directors, attended by Sir Thomas Dakin,
Admiral Macdonald, Evans, and Mr. Westall, the solicitor to the syndicate. These directors,
without inquiry into facts and figures, ratified on behalf of the company, the proposed
purchase of the island. A considerable number of shareholders came forward, and in
November the purchase price of the island was paid. In February, 1872, the first meeting of
shareholders took place, and in June of that year a committee of shareholders was appointed
to investigate the matter of the purchase. The advice of counsel was taken, the committee
reported, and on Dec. 24, 1872, the company filed the bill in the present action.
LORD CAIRNS, L.C. – It is now necessary that I should state to your Lordships in what
position I understand the promoters to be placed with reference to the company which they
proposed to form. 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. If they are doing all this in order that the company
may, as soon as it starts into life, become, through its managing directors, the purchaser of the
property of themselves, the promoters, 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 to say, with a
board of directors who shall both be aware that the property which they are asked to buy is the
property of the promoters, and shall be competent and impartial judges whether the purchase
ought or ought not to be made. 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, and are
not left under the belief that the property belongs, not to the promoter, but to some other
person.
If this is the position and duty of a promoter, I ask your Lordships in the next place to
consider how far that duty was discharged by the promoters in the present case. The company
was formed to purchase mines in the island of Sombrero, and the directors were armed
specifically with the power of adopting the contract of Sept. 20, 1871. The promoters, in
framing the constitution of the company, have themselves given us what they considered to be
the proper measure of strength of a board of directors who were to be entrusted with the
execution of this power. They were to be not less than four nor more than seven, and in point
of fact five names were given as the first directors. They were at once to enter upon business,
and the first duty they would have to perform would be to consider whether the contract
should be adopted or not. How far then were they in a position to perform this duty? The first
name was that of Monsieur Drouyn de Lhuys. It is not pretended that the idea was ever
entertained by the promoters that he either would or could take any part in the first great act of
the directors, the adoption of the contract, or that he could attend any meeting for the purpose.
Of the second director named, Mr. Eastwick, the same may be said. He was absent at a

distance from England, and did not take his seat at the board till the end of December, 1871.
The third director, Evans, was himself the vendor, and whether he was vendor as being
beneficially interested in the property or as trustee for the syndicate, is, in my opinion,
immaterial. There remained two directors only, Sir Thomas Dakin and Admiral Macdonald,
and of these I will speak when I come to the first meeting of the directors.
The company was registered on Sept. 21, 1871, and the first meeting of directors took
place on the 29th of that month. There were present of the directors Sir Thomas Dakin,
Admiral Macdonald, and Evans. There was also present Mr. Westall, who had been appointed
and was acting as solicitor for the company, but was himself one of the syndicate, although it
is said that on the syndicate he merely represented certain other names not disclosed, and had
himself no interest beyond the promise of a payment of £500. At this meeting a prospectus
was produced, ready for issue to the public, stating that the contract for purchase had been
made by the directors; and the first resolution proposed and carried, almost as a matter of
course, was that the contract should be approved and confirmed. Neither Sir Thomas Dakin
nor Admiral Macdonald have given evidence in the case, and it is difficult to say positively
what they knew or what they inquired about that which they were professing to buy.
The conclusion at which I have arrived, from such materials as are before your Lordships,
is that both Sir Thomas Dakin and Admiral Macdonald treated from the first the adoption of
the contract as a foregone conclusion. But whether this was so or not, it was the duty of the
promoters to take care that the contract for the purchase of their property was submitted to the
intelligent consideration of a competent number of independent directors; and I cannot but
regard a meeting at which two of the principal directors did not and could not attend – at
which one who did attend, and take part in the deliberations, was at once a person buying and
selling – where the legal adviser present and assisting was virtually another vendor, and where
the two remaining directors are not shown to have had the means of exercising, or to have
exercised, any intelligent judgment on the subject – as little else than a mockery and a
delusion. I have said nothing as to the provision that two directors should be a quorum. That
is a provision, which, in my opinion, could not be held to remedy defects such as I have
pointed out as going to the entire constitution of the board.
I cannot, therefore, entertain any doubt that, if within a proper time after the completion
of this purchase a bill had been filed by the company, impeaching it on the grounds that I
have stated, the purchase must have been set aside. The part of the case which, however, has
given me the most anxiety is the question whether, having regard to what was made known at
the time that the company was formed, and to what became known, and to what also might
further have become known, shortly after it was formed, and having regard further to the very
peculiar nature of the property which had been purchased, and to the impossibility of
restoring the parties to their original position, relief can or ought now, consistently with the
principles of equity, to be given to those who seek to impeach the contract. On this question I
entertain considerable doubt, or more than doubt. Under these circumstances, looking to the
very peculiar nature of the property and the utter impossibility of restoring the property, and
the commercial undertaking connected with it, to the vendors in the state in which it was
when the company took possession of it, and looking to the amount of notice which the
company had by the prospectus, and to the knowledge which they might have obtained by

pursuing the inquiries which the prospectus ought to have suggested, I am of opinion that it
would be contrary to the principles of equity to give to the company the relief which at an
earlier period they might have obtained.
LORD HATHERLEY – After the view which has been so clearly expressed by my noble and
learned friend, I certainly feel diffidence in coming to a conclusion contrary to that which he
has adopted. In the present contention between the appellants and the company there were
three several heads argued as to some of which every judge who has heard the case has been
agreed.
In the first place, the company endeavoured to set aside this contract on the ground of the
persons who sold the property having filled a fiduciary position as actual trustees for the
company which was formed, and being disentitled to participate in any profit which could be
made in the sale in consequence of that trusteeship. The court below, as well as all your
Lordships, have been of opinion that they were in no such sense as that trustees for the
company, but that the syndicate, which was formed for the original purchase of the mines,
which they did purchase under arrangements made in the winding-up of the old company,
were entitled to hold that purchase as a syndicate and to deal with it as they thought proper.
Consequently, any authority derived from those cases which insist that no profit can be
derived by a trustee out of that which is the property of his cestui que trust has no application
to the present case, inasmuch as the syndicate never constituted themselves trustees, but
intended to sell and did sell this property to the new company or association which was about
to be formed, and for the purpose of making sale they desired that the company should be
formed, and took an interest in its formation. Secondly, it was urged in this case, and upon
this point also the courts were agreed, that although the purchase so made was not liable to be
interfered with on the ground that I have stated, as being a purchase made by persons who
were trustees for the company, nevertheless it was liable, if due steps were taken at the proper
time, to be impeached upon other grounds disclosed by the bill and sustained by the evidence.
On that point my noble and learned friend who has just addressed the House has concurred in
the view unanimously taken by the learned judges in the courts below, and I believe your
Lordships are also unanimous on the point. The circumstances of this particular case are such
that, if there was no delay and no laches in asserting the remedy, the remedy which the
company seeks was open to them.
The question is, therefore, reduced to this point of delay, and, in considering it, I think it
very important to see what the exact position of the parties was at the moment when the
contract was entered into by the company. The courts of equity have at all times carefully
abstained from attempting a nice definition of imposition with reference to the rights which
the practice of such imposition may confer upon the parties injured by it. It is notorious that
every mode that can well be conceived of dealing with contracts which ought not to be
maintained in consequence of some deception which vitiates them has from time to time
before the consideration of the courts of equity, and there is scarcely any one which can be set
on foot that is not struck at by the general doctrines of the courts of equity, although the
precise circumstances of the case may have never yet come before the court. There are three
particular classes of cases of what the court terms fraud, which may be pointed to as having

some analogy with or some bearing upon the present case. The first is as between vendor and
purchaser; the next is as between partner and co-partner; and the third is the case in which an
agent for a purchaser receives a gratuity from a vendor. As to the first of these, 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 from him to whom he
seeks to sell the property; 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 to a person seeking to purchase or entering into a treaty with him for that purpose.
As regards partners there is no doubt that one partner is bound to exercise uberrima fides with
regard to any transactions in which the partners may be engaged in common. There is another
class of cases well known in courts of equity which has some bearing upon the case before us,
and that is where a person, acting as agent for a purchaser, receives a gratuity of some
description from the intending vendor. In that case, again, the courts interfere, and say that a
negotiation carried on between the agent for the purchaser, and the vendor as principal, in
which the agent for the purchaser receives benefits or advantages of any kind from the
intending vendor, is one which can be impeached, and which would be set aside in a court of
equity.
We have the company quite right, as appears to me, down to Oct. 23 with regard to the
question of laches. The bill was filed on Dec. 24. I confess, that being so, considering the
magnitude of the case and the difficulties there would be in the way of any rapid progress, the
quantity of information that had to be obtained, and the action of the [shareholders]
committee in endeavouring to bring about a compromise, I do not see in that interval between
Oct. 23 and Dec. 24, filled up as it was in a great degree, although not wholly, with
communications with Baron Erlanger, that amount of laches which would induce your
Lordships to say that the right which, as every court and every judge before whom the case
has come agrees, once clearly existed, was waived and lost in consequence of the neglect of
the company to take steps in due time to free themselves from the contract. No doubt the case
of a mine is one which we must look into with very great accuracy; and if once we saw the
slightest appearance of malafides, if we saw 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. But although it is true that things were prosperous
in February, that was not brought home to the minds of all the shareholders who were not
present at that meeting. At the next meeting the appointment takes place of the committee of
shareholders, obviously for the purpose of seeing what can be done to free themselves from
the contract. Negotiations take place immediately after that, because the committee were
recommended to see what could be done by negotiation; and after the failure of the
negotiation there is no long or unreasonable time until the filing of the bill. I am satisfied that
in this case the appeal ought to fail, and should be dismissed with costs.
LORD O’HAGAN – The original purchase of the island of Sombrero was perfectly legitimate,
and it was not less so because the object of the purchasers was to sell it again, and to sell it by
forming a company which might afford them a profit on the transaction. The law permitted
them to take that course and provided the machinery by which the transfer of their interests

might be equitably and beneficially effected for themselves and those with whom they meant
to deal. But the privilege given to them for promoting such a company for such an object
involved obligations of a very serious kind. It required, in its exercise, the utmost good faith,
the completest truthfulness, and a careful regard to the protection of the future shareholders.
The power to nominate a directorate is manifestly capable of great abuse, with very evil
consequences to multitudes of people who have little capacity to guard themselves. It should
be watched with jealousy, and restrained from employment in such a way as to mislead the
ignorant, the unwise, or the unwary. In all such cases the directorate nominated by the
promoters should stand between them and the public, with such independence or intelligence
that they may be expected to deal fairly, impartially, and with adequate knowledge, in the
affairs submitted to their control. If they have not those qualities, they are unworthy of trust;
they are the betrayers and not the guardians of the company they govern, and their acts should
not receive the sanction of a court of justice.
For reasons given by my noble and learned friends, I think that the promoters in this case
failed to remember the exigencies of their fiduciary position when they appointed directors
who were in no way independent of themselves, and who did not sustain the interests of the
company with ordinary care and intelligence. he majority seem to me to have represented
simply the great financier to whom they owed their appointments. They were not independent
directors dealing for the shareholders, with a single regard to their security and advantage.
The value of the island was judicially ascertained to be £55,000; and a few days after,
circumstances remaining wholly unchanged, a contract for the sale of it at £110,000 was
ratified by three of the five directors, two of them being Mr. Evans and Admiral Macdonald,
assisted by their solicitor, who was a member of the syndicate. Apparently, there was no
inquiry as to the enormous advance in the price beyond that which the Vice-Chancellor had
accepted, no consideration of the state of the property, and no intelligent estimate of its
capabilities and prospects. If the directors were nominated merely to ratify any terms the
promoters might dictate, they discharged their functions; if it was their duty, as it certainly
was, to protect the shareholders, they never seem to have thought of doing it. Their conduct
was precisely that which might have been anticipated from the character of their selection,
and taking that conduct and character together, I concur in the unanimous opinion of your
Lordships that such a transaction cannot be allowed to stand.
The promoters who so forgot their duty to the company they formed as to give it a
directorate without independence of position, or vigilance and caution in caring for its
interests, which were accordingly subordinated to their own, misused their power, and must
take the consequences. This does not necessarily imply the imputation of evil purpose or
conscious fraud, and I make no such inputation. The fiduciary obligation may be violated,
though there may be no intention to do injustice. If the protection proper and needful for a
person standing at disadvantage in relation to his guardian, or his solicitor, or a company so
largely in the power of the promoters, be withheld, the guardian, the solicitor, or the promoter
cannot sustain a transaction equitably invalidated by the want of it, merely because he is not
impeachable with indirect or improper motives.
If for any of the reasons which have been given the purchase would have been set aside
by a court of equity if a bill had been filed immediately after it was made, the remaining

question is whether the respondents by their laches or acquiescence have deprived themselves
of a right to a rescission? I cannot think so. No doubt there is force in the arguments which
have been urged as to the peculiar nature of the property, the shortness of the lease, the
deterioration of the value, and the consequent difficulty of replacing the parties on either side
in status quo ante. But, notwithstanding, I have seen no sufficient reason to hold that the lapse
of fourteen months before the suit was instituted, under the peculiar circumstances of the case,
disentitled the respondents to seek relief. I am of opinion that the decree should be affirmed
and the appeal dismissed with costs.
LORD SELBORNE – By such an adoption of such a contract the company could not be bound
in equity if, when the material facts became known to the shareholders, they sought to be
relieved from it within a reasonable time; nor could the nature of the property (a lease of
minerals for years, of speculative value) make any difference in this respect. It was the act of
the vendors to put their property, being of that character, in such a position; and, unless some
equity arises against the company from some conduct or omission of their own, the vendors
must take the consequences of that act. The company were put into possession of the property
as a going concern; they took over the manager, and all the other agents whom they found
upon it, and did not alter or interfere with the course of management until they found that the
manager was not doing his duty properly, when they promptly did what was right, and
appointed a new, and a fit, person to succeed him. There has, therefore, been nothing done, or
left undone, to the injury of the property, since it came into the company’s hands, which can
now stand in the way of the company’s right to relief, unless they have precluded themselves
from it by acquiescence, and the relief given by the decree is such as, under these
circumstances, is proper and usual, and is granted upon the usual equitable conditions.
With respect to the question of acquiescence, HIS LORDSHIP said, two things were
generally necessary – 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. On consideration of the evidence he
could not impute any acquiescence, which would make it inequitable to rescind the contract.
The decision of the Court of Appeal in Chancery was correct, and ought to be affirmed.
LORD GORDON – I have no doubt that the syndicate, which was formed for the purchase of
the interest of the Old Sombrero Co. in the island in question, and by which the rights of the
old company were purchased, acquired the property for its own behalf, and not in trust for the
company which was afterwards formed. 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. Having acquired the property, they resolved to form a company for the working of
the produce of the island, and to make over their purchase to that company. They became
promoters of the company, and prepared the necessary documents for its formation, and
issued a prospectus to the public with the view of inducing the public to take up its shares. In
doing this the syndicate changed the position it originally held, and put itself in a fiduciary
relation to the company which it was engaged in forming. It thus became incumbent on the

promoters, not only to make a full disclosure of the position they as owners of the property
which they proposed to sell to the company held in regard to that property, but also to make
arrangements, by the appointment of competent officials and otherwise, for enabling the
company to form an independent judgment as to the propriety of purchasing the property of
the promoter, and of the value of that property, and the price to be paid for it. I agree with
your Lordships in thinking that the promoters failed in their duty in this respect, and that the
company was not put in a position for forming an intelligent and independent judgment as to
the contract between the promoters and the company, and that if the contract had been
challenged by the company in proper time it might have been set aside.
The only questions of difficulty in this case are whether the contract has been challenged
in due time or whether there has been such laches on the part of the company so as to prevent
their now demanding the rescission of the contract, and whether the terms on which the Court
of Appeal has set aside the contract are fair and equitable. After very careful consideration, I
am of opinion that the company has not lost its right of challenge. 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. I think that the appellants have failed to show
that there has been such laches on the part of the company. Therefore, I am of opinion that the
judgment appealed against is right, and should be affirmed.