Opinion ID: 1923357
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Heading Rank: 1

Heading: Duty of promoters. We first inquire, what is the basic duty of promoters toward a corporation and prospective stockholders?

Text: The general duty of a promoter was stated thus in The Telegraph v. Loetscher, 127 Iowa 383, 387-88, 101 N.W. 773, 774 (1904): The promoter is in the situation akin to that of agent or trustee of the company, and his dealings with it must be open and fair. Says Morawetz in his work on Corporations, section 546: If persons start a company, and induce others to subscribe for shares, for the purpose of selling property to the company when organized, they must faithfully disclose all facts relating to the property which would influence those who form the company in deciding upon the judiciousness of the purchase. If the promoters are guilty of any misrepresentation of facts or suppression of the truth in relation to the character and value of the property, or their personal interest in the proposed sale, the company will be entitled to set aside the transaction, or recover any compensation for any loss which it has suffered. The principle is not different from that involved when several persons are engaged in a joint enterprise for their mutual benefit. Each has the right to demand and expect from his associates good faith in all that relates to their common interest, and no one will be permitted to take to himself a secret and separate advantage to the prejudice of the others. The court subsequently stated in Hinkley v. Sac Oil & Pipe Line Co., 132 Iowa 396, 402-03, 107 N.W. 629, 632 (1906): As promoters these men stood in a fiduciary relation to the company to be organized, and those who should subscribe for its stock. As such they were bound to act in good faith and to deal with them in perfect candor. The principle upon which courts of equity proceed in these cases is a very familiar one. The promoter of a company, like its directors, is deemed to sustain towards the members of the company the relation of a trustee toward his cestui que trust. This being so he will not be permitted to speculate out of that relation, or to derive any secret advantages from it. He is bound to disclose to them fully all material facts touching his relation to them, including the amount he is to get for his services as promoter. Thompson on Corporations, section 457. Likewise the court said more recently in Des Moines Bank & Trust Co. v. George M. Bechtel & Co., 243 Iowa 1007, 1081, 51 N.W.2d 174, 216 (1952): As we have noted, the promoters, officers and directors of a corporation are the agents of and act for it, and indirectly for its stockholders, and they are the trustees or quasi trustees, at least, of the property of the corporation for the company and its stockholders. They occupy a fiduciary relation to the corporation on which relation the stockholders may rely. The corporate entity and the stockholders, in particular, may presume that these trustees will perform their duties with the diligence, honesty and the utmost good faith, inherent and implicit in their functions. They are not required to be ever on their guard and watchful lest those trustees misapply, destroy, embezzle, steal the corporate assets, or defraud them. See also 18 Am.Jur.2d Corporations §§ 109-112 (1965); 18 C.J.S. Corporations § 120 (1939). As a result of the fiduciary duty of promoters, stockholders whose trust has been betrayed may have relief when promoters issue themselves stock without giving full value. Hinkley, 132 Iowa at 411, 107 N.W. at 635; see 18 Am.Jur.2d Corporations § 256, at 779, § 268, at 791 (1965) (stockholders who do not participate in the distribution of stock issued for an insufficient or illegal consideration, or consent thereto or acquiesce therein, may object to such issuance by a suit for cancellation, or otherwise); 18 C.J.S. Corporations § 245, at 691, § 246, at 696 (1939). II. The Craigs' acts. The understanding of the Craigs and the minority stockholders was that the corporation would have $100,000 capital, of which the minority stockholders would provide $48,000 and the Craigs would provide $52,000, and that the Craigs would borrow if necessary to obtain their shares. In addition, a statute intervenes at this point. The corporation was formed under chapter 496A of the Code. Section 496A.22 provides in part: No certificate shall be issued for any share until such share is fully paid. Section 496A.18 provides: The consideration for the issuance of shares may be paid, in whole or in part, in money, in other property, tangible or intangible, or in labor or services actually performed for the corporation. When payment of the consideration for which shares are to be issued shall have been received by the corporation, such shares shall be deemed to be fully paid and nonassessable. Neither promissory notes of the subscriber nor future services shall constitute payment or part payment, for shares of a corporation. In the absence of fraud in the transaction the judgment of the board of directors or the shareholders, as the case may be, as to the value of the consideration received for shares shall be conclusive. This section changes the Iowa valuation requirement from the true value to the good faith rule. C. Cosson, Comment, Iowa Code Ann. § 496A.18 (West 1962); see H. Henn, Corporations § 167, at 307 (2d ed. 1970); 18 Am.Jur.2d Corporations § 262 (1965); 18 C.J.S. Corporations § 239 (1939). It also eliminates the prior requirement of Executive Council valuation, thus taking the calculated risk of possible abuse. C. Cosson, Iowa Business Corporation Act, 28A Iowa Code Ann. 1, 22-24, 34-35 (West 1962). The Craigs did not comply with the parties' understanding or with the statute. They paid the corporation only $3000 in money. They purported to pay the remaining $49,000 in two ways. One was by assigning the lease to the corporation. But the lease is not shown to have had any value in excess of the rent reserved, even considering the clause for finishing the building. No attempt was made to show that the amount of rent to be paid was a bargain for the tenant. See Watson v. Lewis, 272 N.W.2d 459, 463 (Iowa 1978). Actually, the substantial rent was one of the factors that drove the business to the wall; the landlord's notice to quit actually precipitated the liquidation. A sound argument cannot be constructed that the landlord's commitment to finish the store building for occupancy by the tenant, by the device of paying the contractor through the tenant, constituted a contribution of equity capital to the corporation. Landlords frequently remodel or complete demised premises for tenants. This is not a gift to the tenant or a payment for stock issued by a corporate tenant. The expectation is that the landlord will recover its investment in rent, or perhaps partially in the improvements themselves on termination of the lease, plus a return on its money. The landlord's funds to remodel or finish a building for a tenant do not provide a corporate tenant with uncommitted funds for capital; in the present situation the corporation needed about $100,000 to get started, in addition to the store premises; the landlord's provision of money to complete the store premises would provide none of this $100,000. The landlord here invested in its own property, not in the corporation. That the landlord routed its money through the tenant to the contractor, rather than directly to the contractor, does not change the result. The money the landlord expended for original construction of the building was not a contribution of capital to the corporation; the situation is no different with the money the landlord expended for finishing off the premises for occupancy. Moreover, no attempt was made here to show that the finishing itself, paid for with the landlord's funds, became the tenant's property. On the contrary, the list of corporate assets at time of liquidation shows no such property owned by the corporation. Its assets consisted of merchandise, fixtures, and equipment, such as clothing, hangers, racks, tables, cash registers, and file cabinets. The landlord's finishing of its own building for occupancy did not fulfill the Craigs' obligation to provide the corporation with capital of $49,000. Neither did the second way the Craigs purported to pay for their stock actually accomplish that endthe Bank's loan to the corporation of $49,000. Had that loan been to the Craigs, and had the Craigs then paid the corporation $49,000, they would have paid for their stock. But the corporation actually paid for its own stock it issued to the Craigs. The corporation was the primary obligor which would repay the note; the Craigs' guaranty of the note did not mean that they paid $49,000. See Hinkley, 132 Iowa at 404-05, 107 N.W. at 632 (Nor does the fact that they guarantied the company's notes relieve them. They proposed that the company should repay and the guaranty was in no manner the payment of the shares issued to them.). The acts of the Craigs in obtaining 49,000 of their 52,000 shares by assigning the lease and by causing the corporation to borrow from the Bank were in violation of both their understanding with the minority stockholders that they would contribute $52,000 in capital and section 496A.22 of the Code prohibiting issuance of certificates until the shares are fully paid. True, section 496A.18 ordinarily makes the judgment of the directors conclusive on the value of the consideration paid for stock, but the Craigs violated another statute. They engaged in self-dealing without compliance with the provisions of section 496A.34 of the Code. They were on both sides of the transaction; they were the promoters and prospective stockholders acquiring the stock and the directors and officers issuing it on behalf of the corporation.