Position of Promoter in India: Critical analysis

By Sumit Kumar Suman, CNLU

Editor’s Note: For the purpose of formation of a company there must be a process and that involves several stages. the first stage in the process is the promotion. At this stage the idea of carrying on a business is conceived by a person called promoters. For the incorporation of company various formalities are required to be carried out. The promoters perform these function and bring the company into existence. A promoter conceptualizes the idea of a company and the purpose of its formation.

CONCEPT OF PROMOTER:

            Before look upon the term ‘Promoter‘ we have to know first of all the meaning of the term ‘Promotion’. So, the ‘Promotion’ is a term of wide import denoting the preliminary steps taken for the purpose of registration and flotation of the company. And the persons who assume the task of promotion are called ‘Promoters’. A promoter may be individual, syndicate, association, partner or company.[i] It is the Promoter who undertakes does and goes through all the necessary & incidental requirements keeping in view the object of proposed company in order to bringing to existence as such incorporated company.

            1.1.  Meaning:

So far as meaning of promoter is concerned, it means A person who involves in the promotion the company. A promoter is a person who does all necessary preliminary work, incidental to the formation or promotion of the company. To be a promoter one need not necessarily be associated with the initial formation of the company; one who subsequently helps to arrange floating of its capital will equally be regarded as a promoter.[ii]

            1.2. Definition:

The expression ‘promoter’ has not been defined under the Companies Act, although the term is used expressly in Sections 2(69), 35, 39, 40, 300, and 317 of the New Company Act, 2013. Even in English law, no general statutory definition of ‘Promoter’ is available.

As per Section 2(69) of the Act, 2013 defines the term ‘Promoter’, it means a person-

(a).   who has been named as such in a prospectus or is identified by the company in the annual return to in Section 92, or

(b).  who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or

(c).    in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act:

            Provided that nothing in sub-clause (c) shall apply to a person who is acting merely in a professional capacity;[iii]

So, in other words we can defines the expression ‘promoter’ to mean a promoter who has a party to the preparation of prospectus or of a portion thereof containing the untrue statement, but does not include any person by reason of his acting in a professional capacity in procuring the formation of the company.[iv]

Certain attempts has been made by the Judiciary to define the term ‘promoter’. Cockburn C.J., in the case of Twycross v. Grant[v], described a ‘Promoter’ as “one who undertakes to form a company with reference to a given project, and to set it going, and who takes the necessary steps to accomplish that purpose”.

In USA, securities Exchange Commission Rule 405(a) defines a promoter as a person who, acting alone or in conjunction with other persons directly or indirectly takes the initiative in founding or organizing the business enterprise.[vi]

            1.3. Types of Promoter:

“A promoter is the one who envisages an idea for setting up a particular business at a given place and carries out a variety of formalities required for starting a business.” A promoter is the one who envisages an idea for setting up a particular business at a given place and carries out a variety of formalities required for starting a business. A promoter may be an individual, a firm, an association of persons or a company.

The promoters may be professional, occasional, financial or managing promoters. Professional promoters handover the company to the shareholders when the company starts. Unfortunately, such promoters are very scarce in the developing countries.

They have played an important role in many countries and helped the business community to a great extent. In U.K. Issue house, in U.S. Investment Bank and in Germany, Joint Stock Banks have played the role of promoters very significantly.[vii]

Occasional promoters are those whose main interest is the floating of companies. They are not in promotion work on regular basis but take up promotion of some companies and then go to their earlier profession. For example, engineers, lawyers etc. may float some companies.

Financial promoters do the task of promoting the financial institutions. They generally take up this work when financial environment is favorable at the time. Managing promoters played a significant role in promoting new companies and then got their managing agency rights.

A promoter is neither an agent nor a trustee of the company as it is a non-entity before incorporation. Some legal cases have tried to spell out the standing of promoters.[viii]

FUNCTIONS OF PROMOTER

            A promoter plays a very important role in the formation of a company. A promoter may be an individual, an association or a company. In their capacity as promoters, they perform the following functions in order to incorporate a company and to set it going. To originate the scheme for formation of the company:

  • Promoters are generally the first persons who conceive the idea of business.
  • They carry out the necessary investigation to find out whether the formation of a company is possible and profitable.
  • Thereafter they organize the resources to convert the idea into a reality by forming a company;[ix] or in other words we can say that it is the promoter –
  • who settles the name of the company thereby ascertain the name will be acceptable by the registered of the office;
  • who settles the content or details as to the Articles of the companies; (here, articles implies Articles of association & Memorandum of association),
  • who nominates the directors, bankers, auditors and etc.;
  • who decides the place where registered office (head office) have to be situated;
  • who prepare the Memorandum of Association, Prospectus and other necessary documents and file them for incorporation.[x]

In this sense, the promoters are the originators of the plan for the formation of a company. To secure the cooperation of the required number of persons willing to associate themselves with the project: The promoters, in accordance with whether they want to incorporate a private or public company, try to secure the co-operation of persons needed to from the company. Minimum number of members required to from a public company is seven and that for a private company the minimum number is two. Depending upon the form chosen, the promoters may decide upon the number of primary members.

To seek and obtain the consent of the persons willing to act as first directors of the company: The company has a system of representative management and is managed by individuals appointed as directors. The first directors of the company are, however, generally appointed by the promoters. The promoters seek the consent of some individual whom they seem appropriate so that they agree to be the first directors of the proposed company. To settle about the name of the company: The promoters have to seek the permission of the Registrar of companies for selecting the name of the company.[x]

PRE-CONTRACTUAL AND POST CONTRACTUAL OBLIGATIONS WITH RESPECT TO: STATUS, DUTIES & LIABILITIES.

                 Legal status of promoter is concerned it is undefined. So, legal status of promoter has not been determined and specified by the statute. His position is incapable of being defined. He cannot considered as an agent, an employee and trustee of the companies. The status of the promoter is generally terminated when the board of directors has been formed and the board starts governing the company. Chronologically, the first persons who control or influence the company, and it they who take the necessary steps to incorporate it, to provide it with share and loan capital and acquire the business or property which it,  to provide it with share and loan capital and acquire the business or property which it is to manage. When these things are done, they handover the control of the company to its directors, who are often themselves under a different name.[xii]

            Duties:

The early companies Acts contained no provisions regarding the liabilities or duties of promoters, and even today legislation is largely silent on the subject, merely imposing liability for untrue statement in listing particulars or prospectuses to which they are parties.[xiii]

There are some duties or liabilities with respect to Promoter has been also provides by the statute: The promoters have certain basic duties towards the company formed :-

  • As we know that Promoters have been described to be in a fiduciary relationship (i.e., relationship of trust and confidence) with the company. This relationship of trust and confidence requires the promoter to make a full disclosure of all material facts relating to the formation of the company.[xiv] He must not make any secret profit out of the promotion of the company. Secret profit is made by entering into a transaction on his own behalf and then sell to concerned property to the company at a profit without making disclosure of the profit to the company or its members. The promoter can make profits in his dealings with the company provided he discloses these profits to the company and its members. What is not permitted is making secret profits i.e. making profits without disclosing them to the company and its members.
  • He must make full disclosure to the company of all relevant facts including to any profit made by him in transaction with the company.[xv]

            Liabilities of promoter:

A promoter can be compelled by the company to hand over any secret profit which he has made without full disclosure to the company. The company can also sue for the rescission of the contract of sale by the promoter where the promoter has not disclosed his interest therein.

A promoter is subject to the following liabilities under the various provisions of the Companies Act:

  • Section 56 lays down matters to be stated and reports to be set out in the prospectus. He may be held liable for the non-compliance of the provisions of this section.
  • Under Section 62, a promoter is liable for any untrue statement in the prospectus to a person who has subscribed for any shares or debentures on the faith of the prospectus. Such a person may sue the promoter for compensation for any loss or damage sustained by him.
  • Besides civil liability, the promoters are criminally liable under Section 63 for the issue of prospectus containing untrue statements. Section 68 imposes severe penalty on promoters who make untrue and deceptive statements in a prospectus with a view to obtaining capital.
  • A promoter may be liable to public examination like any other director or officer of the company if the court so directs on a liquidators report alleging fraud in the promotion or formation of the company.
  • A company may proceed against a promoter on action for deceit or breach of duty under Section 543, where the promoter has misapplied or retained any property of the company or is guilty of misfeasance or breach of trust in relation to the company.[xvi]

So, promoter is liable to the original allottee of shares for mis-statements contained in the prospectus. It is clear that his liability does not extend to subsequent alloottees. He may also be imprisonment for a term which may extent to 2 years or may be punished with fine up to Rs. 50,000 for such untrue statements in the prospectus[xvii]  

POSITION OF PROMOTER IN INDIA IN RELATION TO COMPANY.

Position of the promoter is fiduciary concerning the company which being the promotes his position is quasi legal. A promoter is neither a trustee nor an agent of the company which he promotes because there is no trust or principal in existence at the time of his efforts. But certain fiduciary duties, like an agent, have been imposed on him under the Companies Act. As such he is said to be in & fiduciary position (a position full of trust and confidence) towards the company and the original allottee of shares. Consequently, a promoter must make full disclosure of the relevant facts, including any profit made.

He must not make any secret profits out of the transactions he makes on behalf of the company. It is to be observed that it is not the profit made by the promoter which the law forbids, but the non-disclosure of it. If full disclosure is made to an independent Board of Directors or to the shareholders as a body (and not to a selected few), the profit is permissible. A promoter vendor cannot evade his liability of disclosure of profits by disclosing to a Board of Directors who is mere nominees of his own, or in his pay.

A good illustration on the point is to be found in Gluckstein vs. Barnes.[xviii] In this case, a syndicate of persons was formed to purchase the Olympia Company and to promote and register a company to which the Olympia property was to be resold. At that time the Olympia Company was in a bad shape. The syndicate first bought the debentures of the Olympia Company at a discount. Then they brought the Company for £ 1,40,000. Out of this money, provided by them, the debentures were repaid in full and a profit of £ 20,000 was made thereon. They promoted a new company and sold Olympia to it for £ 1,80,000.

The profit of 40,000 was revealed in the, prospectus, but not the profit of £ 20,000. It was held that the profit of £ 20,000 was a secret profit made by the syndicate as promoters of the company, and they were bound to pay it to the company which was at that time in liquidation. On behalf of the syndicate it was argued that they had in fact made a proper disclosure, but it was turned down on the plea that disclosure made by them in the capacity of vendors to themselves in the capacity of directors of the purchasing company was not sufficient. The disclosure ought to be to an independent Board or to all shareholders by means of a prospectus.[xix]

            4.1. Prior to incorporation of the company:

Sometimes, contracts are made on behalf of a company even before it is duly incorporated. But no contract can be bind a company even before it becomes capable of contracting by incorporations.[xx] So, a pre-incorporation contract is a contract entered into by a company before it is incorporated, which is obviously not possible. Ratification of a pre-incorporation contract is not possible since ratification acts retrospectively. A person cannot entered into a contract on behalf of a company before the company incorporated or born or came into existence. However, it may be necessary to bind an outsider with a contract before the company is incorporated. Hence, the need for pre-incorporation contract.[xxi]

The true legal position in respect of pre-incorporation contracts may be discussed under the following two heads:-

  • Position before 1963 (i.e., before passing of Specific Relief Act, 1963), and
  • Position since 1963.

Position before 1963:

  1. A pre-incorporation contract never binds a company since a person (legal or juristic cannot contract before his or its existence and a company before incorporation has no legal existence. Another reason is that promoters are proverbially profuse in their promises and if the corporation were to be bound by them, it would be subject to many unknown, unjust and heavy obligations).[xxii]
  2. Even where there is a request purported to enforce such a contract, the company cannot be found because ratification is not possible as the ostensible principal did not exist at the time the contract was made.[xxiii] In re English and colonial Produce Company case[xxiv], a solicitor was engaged to prepare the necessary documents and obtain the registration of a company. He paid the registration fee and incurred the certain expenses incidental to registration. It was held in this case that the company was not liable or bound to pay for his services and expenses.
  • The company is also not entitled to sue on a pre-incorporation contract. As it was held in the case of Natal land and Colonisation Company v. Pauline Colliery Syndicate[xxv] that the syndicate was not entitled to its claim as it was not in existence when the contract was made and a company cannot obtain the benefit of a pre-incorporation contract in the suit of specific performance. So, fact of this case was that the a ‘N’ company contracted with ‘A’, the nominee of the syndicate company which was not even incorporated, to grant a lease of certain coal mining rights for three years. After the syndicate was registered, it claimed the contracted lease which the company ‘N’ refused.

Position since 1963 (i.e., after passing of the specific relief Act, 1963):   

Until the passing of the Specific Relief Act, 1963, in India the promoters found it very difficult to carry out the work of incorporation. Since contracts prior to incorporation were void and also could not be ratified, people hesitated to either supply any goods or services for the cause of incorporation. Promoter also felt shy of accepting personal responsibility. The Specific Relief Act, 1963 came as a relief to the promoters.

The specific relief Act provides under the following sections:

Section 15(h) and 19(e) of the Specific Relief Act provides as follows:

  1. The contract should have been entered into by the promoter for the purpose of the company.
  2. The terms of incorporation should warrant should warrant such contract.
  3. The company should accept the contract after incorporation.
  4. Such acceptance should be communicated to the other party to the contract.[xxvi]

So, preliminary contract enforced by the promoter at the prior to incorporation of the company will be treated as contract between two individuals who are in existence. Thus, the company do have no inherent right concerning ratification of those contract unless company acquiring the power as to the ratification by its memorandum as the subject-matter of contract is not contrary to the object of the company. Hence, the third party cannot sue the company, if any breach of contract has been taken place where such contract entered prior to the incorporation even they for the benefit of the company.

So, question is here that the what is the position of the promoter in relation to preliminary contracts? Or in other words we can say that if the company does not execute a fresh contract incorporation and the contract is not one warranted for the purposes of incorporation of the company, what will be the legal position of the promoter who brings about such a contract? It was observed in the case of Phonogram Limited v. Lane,[xxvii] that although a contract made before a company’s incorporation cannot bind the company, it is not wholly devoid of legal effect, even if all the persons who negotiated the contract are attempting to incorporate a Pop group had obtained financial assistance from a recording company. He was held personally liable to refund the amount on his project failing to materialize.

So, Promoters shall be liable to pay damages for failure to perform the promises made in the name of company and this shall be so, even where the contract expressly provides that only the company’s paid up capital shall be answerable for performance as it was also held in the case of Scot. v. Lord Ebury.[xxviii]

            4.2. After incorporation of the company:

After company came into existence, a company can ratify or adopt the contract, and this would bound the company and not the promoter. under the Specific Relief Act 1963, section 15(h) and 19(e) promoter can shift his right and responsibility to the company, if it is warranted by the terms of incorporation.[xxix] If we look on the point of remuneration for promoter concerns, then it is clear that generally the promoter is not entitled for any kind of remuneration, salary and in any manner. However, once the company is incorporated & members of the company is improved then he may be compensated in terms of lump-sum amount. Nothing is entitled to obtained as a legal right he only be compensate on the ground of equity. If the allotment of share is taken place for promoter then automatically promoter becomes a member of the company.

         4.3. Comparison between Indian and other country’s laws regarding promoter’s liability for pre-incorporation contract:

Although under the English Common Law, the American law and the Indian Law recognize the rule that promoter is personally liable for pre-incorporation contract, American Laws and Indian laws are much more innovative and effective to solve the problem of Pre-incorporation Contract. Whereas the English Courts still follow the principle of Kelner v. Baxter. Although in UK, Contracts (Rights of Third Parties) Act 1999 brought some relief, but it is not as broad as the American and Indian Laws are.

Under English Common Law, the ratification or adoption, after the incorporation, did not release the promoter from liability of pre-incorporation contract. Whereas in American Court recognize that if the after the incorporation company can ratify or adopt the contract, and this would bound the company and not the promoter. Indian Law the rule of Kelner v. Baxter is applicable but under the Specific Relief Act 1963, section 15(h) and 19(e) promoter can shift his right and responsibility to the company, if it is warranted by the terms of incorporation. The principle of novation of pre-incorporation contract is applicable in above three counties, the reason behind is that, the novation replace the old contract with the new contract, so there is not problem of non-existence of company. Now after the Contracts (Rights of Third Parties) Act 1999, English laws may also allow company to become the part of pre-incorporation contract, when it acquire its legal existence.[xxx]

CONCLUSION

 In conclusion, it may be said that the word ‘Promoter’ is used in common parlance to denote any individual, syndicate, association, partnership or a company which takes all the necessary steps to create and set it going. The Promoter originated the scheme for the formation of the company; gets together the subscribers to the memorandum; gets memorandum and prepared articles, executed and registered; finds the bankers, brokers and legal advisors; located the first directors, settle the terms of preliminary contracts with vender and agreement with underwriters and makes arrangements for preparation, advertisement and circulation of the prospectus and arrangement of the capital. So, Promoters act as a molding format for the company and gives it a shape which can exist in the world although they cannot take anything in this regard.

Formatted on 19th February 2019.

Reference

[i]  A.K. Majumdar, Dr. G.K. Kapoor, ‘Taxman’s Company Law’, 16th ed., New Delhi: Taxman Publications Pvt. Ltd., 2013, Pg. 67.

[ii]  Lagunas Nitrate Company v. Lagunas Syndicate [1899] 2Ch. 392 (P. 392, P. 428, C.A.), ibid, P. 68.

[iii] Section 2(69) Companies Act, 2013

[iv] supra note 1

[v] 1872 2 C.P.D. 469 page 541 C.A. as quoted in Taxmann’s A.K. Majumdar, & G.K. Kapoor, p.67.

[vi] supra note 1

[vii] Infra.

[viii] Author – DeeKay, Tags – FinanceEconomy, as quoted at: http://dailyojo.com/articles/kinds-of-promoters-in-business.html at: 2:45 PM. on 17th oct. 2014.

[ix] By Rahul Pandey, ‘Promoters of company’, New law college BVP, 5th July 2012, as quoted at: http://www.legalindia.in/promoters-of-company/ at 3:25 PM. on 17th oct. 2014.

[x] Meaning Of Company Promoters And  Their Functions, as quoted at: http://accountlearning.blogspot.in/2011/04/company-promoters-and-their-functions.html at: 3:39 PM, on 17th oct.2014.

[xi] Supra note 9.

[xii] Supra note 1, p. 69.

[xiii] FSMA 2000, s.90(see para. 25-31). But note s.90(8)nwhich makes it clear that in respect of the duty of disclosure a promoter is in no worse position than any other person responsible the propspectus. as quoted in Gower and Davies, ‘Principles of Modern Company Law’, 18th ed. London; Thomson, Sweet & Maxwell, South Asian Edition, 2008, p.107.

[xiv] Supra note 1, p. 69-70.

[xv] promotion and formation of co.,  as quoted at: http;//www.legalserviceindia.com/company%20law/com_1.htm.

[xvi] Sections 56, 62, 63, 68, and 543 of the Companies Act, 1956.

[xvii] Sections 34 & 35 of Companies Act, 2013 and 62 & 63 of 1956.

[xviii] [1900] A.C. 240.

[xix] Supra note 9.

[xx] Supra note 1, p.71.

[xxi] Infra note 25.

[xxii] Parker v. Modern Woodman 181 All. 214, 234., as quoted in Taxmann’s Company Law, p.71-72

[xxiii] Kelner v. Baxter [1866] 15 LT 213. (supra note 1, p.72).

[xxiv] [1906] 2Ch. 435 CA.

[xxv] [1904] AC 120.

[xxvi] K.S. Anantharaman, ‘Lectures on Company Law & Competition Act (including Secretarial Practice)’, Tenth ed., Nagpur, LexisNexis Butterworths Wadhwa; 2005, p.49.

[xxvii] [1982] QB 938.

[xxviii] [1867] LR 2CP255.

[xxix] Infra note 30.

[xxx] Pre-incorporation contracts and the promoter, as quoted at: http://www.lawteacher.net/contract-law/essays/pre-incorporation-contracts-and-the-promoter.php , at 7:00PM, on 18th oct. 2014.

3 Replies to “Position of Promoter in India: Critical analysis”

  1. Dear Sir,
    I have started my proprietary concern ‘Jurista Publications’ e-law journal for publishing the citations of Hon’ble High Courts and Hon’ble Supreme Court of India on online in the name of ‘jurista’. I’m seeking company promoters for promotion of my proprietary concern. If you have details about the Indian company promoters please inform. Thanking You.

  2. the sections mentioned are all wrong . you are here to teach public at large. section provided is not as per the companies act 2013. please check and replace them

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