This section is from the book "Business Finance", by William Henry Lough. Also available from Amazon: Business Finance, A Practical Study of Financial Management in Private Business Concerns.
Legally the promoter is in a somewhat anomalous situation inasmuch as he is acting as representative of an enterprise which is, perhaps, not yet formed, or which, even if incorporated, is wholly a product of his own. The promoter's actions and promises cannot legally bind the corporation, although the promoter, as an individual, may be called upon to see to it that arrangements concluded on behalf of the corporation are actually carried out. The promoter, furthermore, stands in a limited trust relationship to the corporation and to the holders of securities which he has sold. This trust relationship forbids him from making secret profits at the expense of the corporation. He may make reasonable open profits without objection; as for instance when he buys a given property which is essential to the corporation, at a known price, and transfers it to the corporation at a known higher price. But, in case he should buy this same property and transfer it to the corporation, making a profit for himself without making known this profit, then he would be guilty of a fraud against the purchasers of the corporation's securities.
Among innumerable cases that might be cited to illustrate this statement, the following description of a Florida land deal has been selected:
In April, 1911, five persons acting jointly as promoters of an enterprise, purchased 23,300 acres of land at $5.50 an acre - a total consideration of $128,150. On this contract they paid $5,000, the remainder to be paid at the rate of $2,500 per month. They then caused the incorporation of the "Southern Land Company" for $250,000, and entered into a contract with the new company under which they transferred the acreage above mentioned for $8 per acre. By further agreement, payments were made by the new corporation direct to the original vendor of the land, so that the five promoters were relieved of all further trouble and responsibility. Their profits were to come in the form of final payments to them after the payments to the original vendor had been completed. Later, legal difficulties between the original vendor and the Southern Land Company arose, which made necessary the giving of notes by the land company and readjustment of their relations. Thereupon the five promoters came forward with a proposition to the land company that they would transfer to the land company their contract to purchase the land at $5.50 per acre. In consideration for giving up the difference between $5.50 and $8 per acre, they would accept $30,000 full-paid stock in the Southern Land Company. Objection was made to the transaction on the ground that the promoters had no right to any profits whatsoever, inasmuch as they were acting, when they purchased the land, in a trust relationship to the corporation and to the later security holders. The prospectus of the Southern Land Company stated that the land had been purchased at $8 per acre, but did not state from whom it had been purchased nor what profits had been made on the purchase by the promoters of the corporation.
On the above statement of fact it seems there can be little question but that the promoters gave themselves profits to which they were not entitled. If the corporation had first been formed and an independent board of directors had been elected so that the promoters would then have had to deal with this board, it is probable that no legal question could have been raised as to any profits they might make. But in this instance they were dealing with a corporation which was completely in their own hands, and they appear clearly to have abused this relationship.