Promoter of a Company: Legal Position

    Company is a legal entity that is voluntarily associated with a group of persons to employ in and operate a business. Lord Justice Lindley defines, Company is a body corporate formed by an association of several people to contribute money or money’s worth to common stock and employ it in some trade or business and who share the profit/loss arising there-from [1]. Promoters act as a key person in the promotion stage, which is the first stage for incorporation of a company. The promoter performs all the necessary precursory works for the formation and promotion of the company. Thus the promoters formulate a notion for setting up a particular business and carry out the different formalities required for starting a business. 

    MEANING

    A promoter is a person who brings out an idea to carry a specific business. He is the one who starts or helps in starting a business for a company and develops the scheme of business through promotions. He stays connected to the business and to the activities that are performed by the Company. He continues to discharge his duties in all spheres of activities/fields until the complete governance, management, and affairs of the company are taken by the board of directors.

    DEFINITION

    The judges found certain issues while defining the term ‘Promoter’ since the scope of this term is not a term of art, nor a term of law, but of business.

    • Justice Cockburn defines, “A promoter is 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.”[2]
    • In the case of Bosher v. Richmond Land Co [3], the term promoter was referred to as “A person who brings about the incorporation and organization of a corporation. He brings together the persons who become interested in the enterprise, aids in procuring subscriptions, and sets in motion the machinery which leads to the formation itself.”
    • Section 2(69) of The Companies Act, 2013 defines the term “promoter” as

    – A person who has been named in the prospectus or is identified by the company in the annual return referred to in section 92.

    – A person who has control over the affairs of the company, directly or indirectly whether as a shareholder, director.

    – A person in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to the act. [4]. 

    • Regulation 2(1)(za) of Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009 elaborates Promoters as follows:

    – A person or persons who are in controller of the issuer.

    – A person or persons who perform a significant role in the formulation of a plan or programme by following specified securities that are offered to the public.

    – A person or persons named in the offer document as promoters.[5]

    FUNCTIONS  

    The following functions are entrusted to a promoter, which are to be performed for and on behalf of the Company:

    • Discovering opportunities to start and employ in some business,
    • To formulate an idea for setting up and engaging in a particular business,
    • Obtaining funds for the operation of a business,
    • To enter into preliminary contracts with the trader, salesperson, etc.,
    • Gaining a required number of persons for the incorporation of the company,
    • To get the Memorandum of Association (MOA) and Articles of Association (AOA) signed by the members of the Company,
    • To make arrangements for promotion and
    • Finally obtaining the certificate of incorporation. 

    Further, in the case of Twycross v. Grant [6], the Court cleared the doubts and held that the defendants were the promoters of the Company based on the functions performed by them. Thus, certain important functions of the promoter were explained in this landmark case, they are:

    • The promoter begins the scheme for the formation of a company,
    • Gets together the subscribers to the memorandum,
    • Gets the memorandum and articles prepared, executed, and registered,
    • Determines the name, location of register office of the Company,
    • Decides the bankers, brokers, and legal advisers of the Company,
    • Determines the first directors and to qualify them,
    • Settles the terms of preliminary contracts with vendors,
    • Arranges for printing and advertisement for promotion,
    • Circulation of the prospectus and placement of the capital.

    The Court further added that the function of promoter ends as soon as they hand over the complete governance of the Company to the Board of Directors.

    LEGAL POSITION OF PROMOTERS

    The position of a promoter in relation to Company has been ruled out in the case of Erlanger v. New Sombrero Phosphate Co [7], here Lord Cairns has opined that the position of “Promoters of a company stands undoubtedly in a fiduciary position. They are vested with the power of creation and molding of the company. They have the power to decide how and when, and under what supervision the company shall start into existence and begin to act as a trading corporation”. The business of promotion gives a much-privileged position to promoters. Thus the Court had fixed them with the responsibility of a fiduciary agent. Hence a promoter does not enjoy any legal status. They are neither a trustee nor an agent of a Company. Moreover, the Company was not entitled as a separate legal entity before incorporation.

    https://legalreadings.com/the-extent-of-powers-of-the-supreme-court-of-india/

    As per section 2(69) of the Companies Act, 2013 a person who acts merely in a professional capacity is not a promoter. Thus a solicitor, who prepares the primary documents of the proposed company on behalf of the promoter, will not be regarded as a promoter. Simultaneously, a valuer or an accountant who helps for the promotion within his professional capacity is not a promoter. But a person may become a promoter only when he helps in the formation of the company by doing any activities outside the scope of his professional duty. In Re Great Wheal Polgooth Co Ltd, [8], it was stated that a solicitor who is a professional advisor for mere consultation of legal work will not be regarded as a promoter of that company.  

    DUTIES

    The duties performed by the promoters are as follows:

    • Duty to disclose secret profits – As he stands in a fiduciary position. A promoter is prohibited to make any secret profits whether directly or indirectly. If such secret profits are found to be made out of promotion then the duty of the promoter is to disclose the same to the company.
    • Duty to disclose all material facts/interests – All the financial information must be clearly reported without any failure. Or else such failure may lead to termination of the contract/sale made by the promoters of the company with the vendors. Then the company can retrieve the profits made from the contract/sale by the promoters. Hence, it is an important duty of the promoter to disclose the material facts.
    • Duty to do good to the company which he obtained as a trustee – It is the duty of the promoter to do good to the company by helping the company from the sources which he had obtained as a trustee for the welfare and development of the company.
    • Duty to disclose any private arrangements – In addition to secret profits and interests is also a duty of the promoter to report and disclose all the profits obtained from promotion through private arrangements.
    • Duty against future allottees – Since a promoter has only fiduciary relation with the company. Therefore he has only a fiduciary relationship with the future allottees of shares of the company.

    RIGHTS

    Certain rights that are guaranteed to promoters are listed as follows:

    • Right of indemnity – This right is also known as a right to recover a proportionate amount from the co-promoters. When there is more than one person as promoters of a company, one amongst them can claim against another promoter for the damages and compensation paid by him. Besides, the promoters are jointly and severally liable for making any secret profits or printing and circulation of any misstatements/false-statements in the prospectus.
    • Right to receive preliminary expenses – This right is not a contractual right and the preliminary expenses are provided based on the discretion of the directors. However, the promoter is authorized to receive preliminary expenses accompanied by a receipt or voucher that are incurred during the process of promotion and incorporation of the company.
    • Right to receive remuneration for services – Basically, promoters are entitled to claim remuneration for the services provided by them for the Company. The remuneration provided by the director is also based on his discretion and thus the promoter doesn’t have any contractual right to sue the company. In some circumstances, the Articles of Association itself provide a specific amount that must be given to promoters by the directors as remuneration for the services done by them for the incorporation of the company. In Re English and Colonial Procedure [9], a lawyer was engaged in preparation and incurred some expenses for registration of the Company. The Court held that the company is not bound to provide remuneration for the services provided by him as a promoter but he is permitted for a sum of rational remuneration specified under Articles of Association of the company.

    LIABILITIES

    A promoter must always conform towards all works done by him in a good faith and for the better management of a company. He has certain liabilities accompanied by all the activities performed by him for the formation of the company. Here the burden of proof is completely on the promoters in order to relieve him from all the liabilities. General liabilities of promoters are as follows:

    • Promoters can be made liable for non-compliance of all matters to be stated in prospectus as expressly specified under s. 26 of the Companies Act, 2013.
    • A promoter has civil liability for any false/misstatements found in the prospectus issued by a Company under s. 35 and penalized under s. 447 of the Companies Act, 2013.
    • Promoters are personally liable for all the contracts entered by them on behalf of the company until the liability is transferred to the company once it is registered as a separate legal entity. 
    • During wounding up of a company a promoter can be made liable under s. 543 of the Companies Act, 2013 when found guilty for an act of misfeasance (by wrongful exercise of lawful authority) or for breach of trust.  

    In Prabir Kumar Mishra v. Ramani Ramaswamy [10], it was held that to make a promoter liable it is not mandatory that he should be neither signatory to the Memorandum and Article of Association nor director of a company. It’s based on the promoter’s civil liability towards the company and the third party remains in the matter of his conduct and contract entered by him during the pre-incorporation stage as a trustee or an agent.

    Further, promoters are personally liable for the status of Preliminary Contracts where the company is excluded from the liability. Preliminary contracts are also known as pre-incorporation contracts. It is also one of the legal processes used in the formation of a company. Before the incorporation of a company, promoters enter into several contracts on behalf of the company yet to be incorporated with other parties for the purchase of certain goods or properties to start the business. Hence, the contracts which are entered before the incorporation of the company by the promoters are known as Preliminary or pre-incorporation contracts.

    In Kelner v. Baxter [11], the Court held that the promoter was personally liable since he signed the contract by accepting the offer made by plaintiff Mr. Kelner before the incorporation of a company, and eventually the company couldn’t pay the plaintiff for the goods offered. The Court further cleared that there was no principal-agent relationship between the company and the plaintiff since the company was not in existence at the time of signing the contract. Moreover, the company was a non-entity during the preliminary contract being a stranger it cannot ratify the contract to take the liability on its own. Thus the company is excluded from the liability of pre-incorporation contracts.

    Later the provision under s. 15(h) of the Specific Relief Act, 1963 digressed the common law principle by allowing the company to ratify or adopt the pre-incorporation contract with the essential condition of such preliminary contracts should be warranted by terms of incorporation. On the other hand s. 19(e) of the Specific Relief Act, 1963 reduces the liability of promoters by permitting the other party to a preliminary contract can sue the company only when the terms of incorporation are warranted and by adopting the contract by the company.

    But in the case of novation of contract, the company is made liable and the promoter is excluded from his liability. Since the new contract/terms of the contract have been substituted by the pre-incorporation contract thus the liability of the promoter ends in the novation of the contract. In Re Howard v. Patent Ivory Manufacturing Co [12], it was decided that the promoter is relieved from his personal liability since the terms of the original agreement were substituted with a new one by the parties to the pre-incorporation contract.

    CONCLUSION

    Promotion is the crucial stage under the stages for the incorporation of a company since all the primary functions for incorporation are done in order to ensure the leveled functioning of the Company without any drawbacks. Therefore a promoter is an important person who strives hard for the formation and registration of a company. He is the one who develops a notion of starting a business and engaging in it. He performs an essential role that is indispensable in the incorporation of a corporate body or company. A promoter is the starter of the company and business. He develops a better circumstance for the company by obtaining all the requisites that a company should possess. 

    References:

    [1] What Is Company, available at http://www.legalserviceindia.com/legal/article-1293-what-is-company.html (last visited on November 24, 2020).

    [2] Avatar Singh, COMPANY LAW, 135, (EBC Publishing (P) Ltd., Lucknow, 17th edition.).

    [3] 89 Va 455: 16 SE 360.

    [4] The Companies Act, 2013, s. 2(69).

    [5] Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2009, Regulation 2(1) (za).

    [6] (1877) LR 2 CPD 469.

    [7] (1878) LR 3 AC 1218.

    [8] (1883) 53 LJ Ch 42.

    [9] (1906) 2 Ch 435.

    [10] (2010) 104 SCL 174.

    [11] (1886) LR 2 CP 174.

    [12] (1888) 38 Ch D 156.

    BY- HARI HARAN. V | SCHOOL OF EXCELLENCE IN LAW , PERUNGUDI

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