Law and You > Corporate Laws > Companies Act, 2013 > The Promoter of a Company
A number of persons come together to exploit some business opportunity and incorporate a company to achieve it are called promoters. A company comes into existence generally by a process referred to as incorporation. Once a company has been legally incorporated, it becomes a distinct entity from those who invest their capital and labour to run the company. Such an incorporated company may be a company. A promoter can be an individual, a corporate, a syndicate, an association or a partnership which has taken all the necessary steps to create and mould a company and set it going.
Usually, the first step to form a company is the process known as ‘promotion’ where a person persuades others to contribute capital to a proposed company before it is incorporated. Such a person is called the promoter of the company. Promoters also can enter into a contract on behalf of a company before or after it has been granted a certificate of incorporation, and arrange share issues in the name of the company.
In Bosher v. Richmond Land Co., Va 455:16 SE 360 case, the term Promoter has been defined as: “A Promoter is 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 subscription, and sets in motion the machinery which leads to the formation itself.”
Section 2 (69) of the Companies Act, 2013
“Promoter” means a person—
(a) who has been named as such in a prospectus or is identified by the company in the annual return referred 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 sub-clause (c) shall not apply to a person who is acting merely in a professional capacity.
According to the sub-clause (c) of Section 2(69) of the Company Act, a persons in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act are also treated as promoters and if a person is merely acting in a professional capacity i.e. giving only professional advice to the Board of directors, he shall not be treated as a promoter
SEBI Guidelines:
According to SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, “promoter” includes:
(i) the person or persons who are in control of the issuer;
(ii) the person or persons who are instrumental in the formulation of a plan or programme pursuant to which specified securities are offered to public;
(iii) the person or persons named in the offer document as promoters.
A director/officer/employee who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise is considered as a promoter. However, a director or officer or employee of the issuer or a person, if acting as such merely in his professional capacity, shall not be deemed as a promoter. But a person may be a promoter even if he has undertaken a lesser active role in the formation of a company.
In Twycross v. Grant, 1872 2 C.P.D. 469 case, the Court 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 Lagunas Nitrate Co. v. Lagunas Syndicate [1889] 2 Ch. 392 (p. 428, C.A.) case, the Court observed: “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.”
Functions of Promoter:
To Identify a Business Opportunity
The promoter first identifies a potential business opportunity in form of the production of a new product or service, substitute to existing product or service with a better alternative or updated features or any other such opportunity having investment potential.
To Perform Feasibility Studies
Once the business opportunity is identified, the promoter analyzes and investigate the feasibility of the opportunity. First technical feasibility is carried out. Whether technology and the raw material is available to execute the project. Whether it is available locally or it requires importing. Then financial feasibility is done. Whether necessary finance is available and how fast can it be raised? The last step is economic feasibility study, which includes checking profitability of the project on various parameters. If the project is not able to give the required profit, it is unviable.
To Collect Required Number of Persons to form a Company:
Next step of the promoter is to collect the requisite number of persons (i.e. seven in case of a public company and two in case of a private company) who can sign the ‘Memorandum of Association’ and ‘Articles of Association’ of the company and also agree to act as the first directors of the company. Usually, the signatories of the memorandum are the first Directors of the Company. However, the written consent of the persons signing the memorandum is required to act as Directors and to take up the qualification shares in the company.
To Take Decisions on Following Matters:
In this stage the decision regarding the name of the company. the location of its registered office, the amount and form of its share capital, the brokers or underwriters for the capital issue, if necessary, the bankers, the auditors and the legal advisers are taken.
To Get Name Approved:
Next step after a feasibility study of the project, and a decision of a launch a company is made then, the next step is to select a name for the company and get it registered with the registrar of companies of the state in which the registered office of the company is to be situated. An application with three names, in the order of their priority, is filed with the registrar to get the name approved.
To Appoint Professionals:
Appointments of the brokers or underwriters for the capital issue, if necessary, the bankers, the auditors and the legal advisers are important because they help promoters in the preparation of necessary documents that are required to be filed with the Registrar of Companies.
To Prepare Necessary Documents:
The documents to be submitted to Registrar of Companies for getting the company registered are Memorandum of Association, Articles of Association, consent of Directors and statutory declaration. In this stage, the promoter has to get these documents prepared and printed with the help of professionals.
Other Functions:
Other functions include to settles the terms of preliminary contracts with vendors and agreement with underwriters; to make arrangement for preparation, advertisement and circulation of the prospectus and placement of the capital; to arrange for the registration of the company and obtain the certificate of incorporation; to defray preliminary expenses; to arrange the minimum subscription.
Duties of Promoter:
Duty to Disclose Secret Profits:
As per section 102(4), where as a result of the non-disclosure or insufficient disclosure in any explanatory statement annexed to the notice of a general meeting , by a promoter, director, manager, if any, or other key managerial personnel, any benefit accrues to such promoter, director, manager or other key managerial personnel or their relatives, either directly or indirectly, the promoter, director, manager or other key managerial personnel, as the case may be, shall hold such benefit in trust for the company, and shall, without prejudice to any other action being taken against him under this Act or under any other law for the time being in force, be liable to compensate the company to the extent of the benefit received by him.
In the case of default in complying with above provisions, every promoter, director, manager or other key managerial personnel who is in default shall be punishable with fine which may extend to 50,000 rupees or five times the amount of benefit accruing to the promoter, director, manager or other key managerial personnel or any of his relatives, whichever is more. [Sub-section (5) of Section 102]
Thus, A promoter is not forbidden to make a profit but to make secret profits. He may make a profit out of promotion with the consent of the company, in the same way as an agent may retain a profit obtained through his agency with his principle’s consent. For example, one of the promoters owns a good property in a business hub. He had purchased in for rupees twenty lakhs 10 years back. He asks his friend to pretend as the owner of the property and get it sold in a pre-incorporation contract to the company being incorporated at rupees 40 lakhs. This is the secret profit made by the promoter. If the promoter directly offers his property to the company and convinces other promoters that it worths rupees forty lakhs now and if they accept to buy at that price, then it is a profit by the promoter with the consent of other promoters.
If the company comes to know about the secret profit made by the promoter, the company can rescind such a pre-incorporation contract after its incorporation. If a promoter makes a secret profit or does not disclose any profit made, the company has a remedy against him. The company can recover the secret profit also.
In Gluckstein v. Barnes, (1900) A.C. 240 case, it was held that where a promoter makes some profits in connection with a transaction to which company is a party and does not make full disclosure of his profits; the company has the right to affirm the contracts and promoter should handover his profits to the company.
In Erlanger v. New Sombrero Phosphate Co., (1878) 3 A.C. 1218, a syndicate of which E was the head purchased an island containing mines of phosphate for £ 5,000. E then formed a company to buy this island. A contract was made between X a nominee of the syndicate and the company for its purchase at £ 1,10,000. The details of the sale were not disclosed to the shareholders or to the independent Board of directors. The company now sought to rescind the contract of sale. It was held that as there had been no disclosure by the promoters of the profit they were making, the company was entitled to rescind the contract.
Duty of Disclosure of Interest:
A promoter must disclose to the company any interest he has in a transaction entered into by it. He should also give the particulars of his interests in other firms or bodies corporate.
Duties under the Indian Contract Act:
Promoters’ duties cannot depend on a contract because at the time the promotion begins, the company is not incorporated, and so cannot contract with its promoters.
The promoter’s duties must be the same as that of a person acting on behalf of another individual without a contract of employment. If he does make any misrepresentation in a prospectus he may be held guilty of fraud under Section 17 of the Indian Contract Act, 1872 and would be held liable for damages.
Remedies Available to the Company against the Promoter:
If a promoter makes a secret profit or does not disclose it, the company has got a remedy against him. This varies according to the circumstances, which can be divided into two possible situations.
- Where the promoter was not in a fiduciary position when he acquired the property which he is selling to the company, but only when he sold it to the company. If a person acquires property or has had it before he takes any active steps in the promotion of a company and sells it to the company at a profit, he is entitled to retain that profit. Here the promoter, as in Salomon’s case, has had the property for a period of time. He can hardly be said to be in a fiduciary relation to the company. As long as he makes a full disclosure of the fact that the property is his and he is the real vendor, he may sell it to the company at a profit. If, however, he fails to disclose this fact the company is entitled either to rescind the contract or claim damages for breach of duty of disclosure.
- Where the promoter was in fiduciary position when he acquired the property and when he sold it to the company. This may happen in any of the following circumstances:
(a) Where the promoter bought property with a view to sell it to the company which he intends to promote, he occupies fiduciary position vis-a-vis the company. He must disclose all the facts to the company.
(b) Where the promoter resells property to the company at an increased price, the property which he purchased after he has commenced to act in the capacity of a promoter, he cannot retain the profit which he has not disclosed to the company.
(c) Where a person is a promoter for acquiring the property for the company, the rules of agency will apply, so that any profit he makes will belong to the company.
3. Where, the promoter bought the property with a view to sell it to the company he promotes, the company may either—
(a) rescind the contract and if he has made a profit on some ancillary transaction that may also be recovered; or
(b) retain the property, paying no more for it than what the promoter has paid, depriving him of his profit; or
(c) where the above remedies would be inappropriate, such as when the property has been altered so as to render recession impossible and the promoter has already received his inflated price, the company may sue him for misfeasance (breach of duty to disclose). The measure of damages will be the difference between the market value of the property and the contract price.
Termination of Duties of Promoter:
Promoter’s duties continue until the company has acquired the property or business which it was formed to manage and has raised its initial share capital and the Board of directors has taken over the management of the company’s affairs from the promoters.
Liabilities of Promoter:
In Prabir Kumar Misra v. Ramani Ramaswamy [2010] 104 SCL 174 case, the Court held that to fix liability on a promoter, it is not necessary that he should be either a signatory to the Memorandum/Articles of Association or a shareholder or a director of the company. Promoter’s civil liability to the company and also to third parties remain in respect of his conduct and contract entered into by him during the pre-incorporation stage as agent or trustee of the company.
Liability to Furnish True Information at Incorporation:
As per section 7(6), where, at any time after the incorporation of a company, it is proved that the company has been got incorporated by furnishing any false or incorrect information or representation or by suppressing any material fact or information in any of the documents or declaration filed or made for incorporating such company, or by any fraudulent action, the promoters, the persons named as the first directors of the company and the persons making declaration shall be liable for fraud under section 447.
Liabilities Regarding Matters to be Stated in Prspectus:
Section 26 of the Act lays down matters to be stated and reports to be set out in the prospectus. The promoter(s) may be held liable for the non-compliance of the provisions of this Section. Further, as per section 26(1)(a)(xiv) prescribed disclosures about sources of promoter’s contribution has to be made in prospectus.
Civil Liability for Misstatement in Prospectus:
Section 35 holds the promoter liable to pay compensation to every person who subscribes for any share or debentures on the faith of the prospectus for any loss or damage sustained by reason of any untrue statement included in it. The liability of the promoters will be unlimited in such a case. The Act amounts to fraud and is punishable under Section 447 of the Act. Section 447 of the Act lays down that any person who is found to be guilty of fraud shall be punishable with imprisonment for a term which shall not be less than six months but which may extend to ten years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud: Provided that where the fraud in question involves public interest, the term of imprisonment shall not be less than three years.
Criminal Liability for Misstatement in Prospectus:
Besides civil liability, the promoters are criminally liable under Section 34 for the issue of prospectus containing untrue or misleading statements in form or context in which it is included or where any inclusion or omission of any matter is likely to mislead. Section 447 imposes severe punishment for fraud on promoters who make untrue or misleading statements in prospectus with a view to obtaining capital. The punishment prescribed is imprisonment for a term which shall not be less than six months but which may extend to ten years and also a fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud. Further, where the fraud in question involves public interest, the term of imprisonment shall not be less than three years. A promoter can, however, escape the punishment if he proves:
(i) that the statement or omission was immaterial; or
(ii) that he had reasonable grounds to believe, and did, up to the time of the issue of prospectus, believe that statement was true or the inclusion or omission was necessary.
In Bentley v. Black, (1893) 9 TLR 580 (CA) case, the Court held that a promoter will be responsible for any misstatement as to an existing fact. Court also held that a calculation of future profits is not a statement of fact.
In Edgington v. Fitzmaurice, (1885) 29 Ch D 459: (1991-5) All ER Rep 59 (CA) case, a misstatement as to purposes for which the money to be raised and is to be applied is a misrepresentation of a present fact.
In Metropolitan Coal Consumer’s Association Ltd., Karberg’s case, (1892) 3 Ch 1 (CA) case, the Court held that if a director’s name is misstated in the prospectus, it is an important misrepresentation and the promoter can be held to be liable.
Sometimes representations which were true when the prospectus was issued, become false before the allotment is made. In such cases, the fact ought to be communicated to the applicant otherwise the applicant will not be able to rescind the contract.
In Rajagopala Iyer v. The South Indian Rubber Works, AIR 1942 Mad 656 case, the Madras High Court held that a promoter/director who knows that a statement has become false is under a duty to disclose the truth and if he abstains, he may be guilty of fraud.
Liability of Promoters in Respect of Allotment of Shares:
When company issues prospectus, all the money received by it from the applicants for the shares is to be kept deposited in a scheduled bank. If entire amount payable on applications for shares in respect of minimum subscription amount as stated in the prospectus has not been received by the company within the prescribed period, all money received by it from the applicants is to be returned to such applicants in the stipulated period.
Default to this becomes punishable under S. 39 with fine which may extend to rupees 1 lakh or rupees 1000 for each day of default, whichever is less.
Liability U/s 447 of the Companies Act,2013:
Without prejudice to any liability including repayment of any debt under this Act or any other law for the time being in force, any person who is found to be guilty of fraud, shall be punishable with imprisonment for a term which shall not be less than six months but which may extend to ten years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud :
Provided that where the fraud in question involves public interest, the term of imprisonment shall not be less than three years.
Liabilities of Promoter at the Time of Winding Up:
In the course of winding up of the company on order of Tribunal, on an application made by the official liquidator, the court may make a promoter liable for misfeasance or breach of trust. (Section 300). Further, where fraud has been alleged by the liquidator against a promoter, the court may order for his public examination.
Rights of Promoter:
Right to receive Preliminary Expenses:
The promoters are entitled to receive all the expenses incurred for in setting up and registering the company, from Board of Directors. The articles will have provision for payment of preliminary expenses to the promoters. The company may pay the expenses to the promoters even after its formation, but such payments should not be Ultra Vires the articles of the company. The Articles may have provision regarding payment of fixed sum to the promoters.
In Re. English & Colonial Produce Company (1906) 2 Ch. 435 CA case, the Court held that a promoter has no legal right to claim promotional expenses for his services unless there is a valid contract. Without such a contract he is not even entitled to recover his preliminary expenses.
Right to Recover Proportionate Amount from the Co-Promoters:
The promoters are held jointly and severally liable for the secret profits made by them in the formation of a company. Therefore if the entire amount of secret profits is paid to the company by a single promoter, he is entitled to recover the proportionate amount from co-promoters. Likewise, if the entire liability arising out of mis-statement in the prospectus is borne by one of the promoters; he is entitled to recover proportionately from the co-promoters.
Types of Promoters:
Professional Promoters:
These persons take up promotion as a part of their occupation. There are persons who specialize in company promotion, including its incorporation and flotation. They float new companies and dispose of them off when the companies are well established and come to a position of making profits.
Occasional Promoters:
They are already engaged in some other business. They are not engaged in promotion work on a regular basis. Whenever they find some good opportunities, they take up the promotion of some company and once it is over they go to their original profession. They may even decide to retain the companies with them by managing their affairs. Generally engineers, lawyers etc. act as professional promoters.
Entrepreneur Promoters:
They are both promoters and entrepreneurs. They conceive the idea of a new business unit, do the groundwork to establish it and may subsequently become a part of the management.
Financier Promoters:
Some financial institutions, like investment banks or industrial banks, may take up the promotion of a company with a view to finding opportunities for investment.
Institutional promoters.
The institutions set up by the government such as the Industrial Finance Corporation of India. They are known as institutional promoters.
Legal Position of Promoters:
A promoter is a person who brings a Company into existence. As such, a promoter occupied an important position in formation of the Company. The legal position of the Promoter is that he is neither an agent nor a trustee of the proposed Company, But he occupied a very fiduciary position in the Company. For this fiduciary position, the promoter can’t make either directly or indirectly any profit at the expenses of the Company he promotes.
Remuneration of the Promoter:
A promoter has no legal right to claim proportional expenses or his service unless, there is a valid contract. With such contract, the promoter is not entitled to claim any expenses even his preliminary expenses. When a promoter makes a proper disclosure, he may expect to be rewarded for his effort. Therefore when the Company is registered, it may pay or agree to pay.
some remuneration for the service he rendered. Practically, a promoter is remunerated in the following ways:
- He may sell his own property to the Company for cash or against fully paid shares in the Company at an over valuation after making full disclosure to an independent Board of Directors or to the intending shareholders.
- He may be given an option to buy further shares in the Company at par.
- He may take commission on share sold.
- He may take a grant of some shares in the Company.
- He may be paid a lump-sum by the Company. Whatever the remuneration may be, it should be disclosed in the prospectus fully.
Conclusion:
In conclusion, promoters play a crucial role in the formation and development of a company under the Companies Act, 2013. They are responsible for conceptualizing the business idea, undertaking pre-incorporation activities, and ensuring the company comes into existence. Promoters are individuals or entities who take the initiative to form a company, organize its resources, and carry out legal formalities. They identify the business opportunity, secure funding, and prepare foundational documents like the Memorandum of Association (MOA) and Articles of Association (AOA).
Although promoters are not trustees or agents of the company before its incorporation, they hold a fiduciary position and must act in the best interests of the company they are forming. They are responsible for accurate disclosures and transparency during the incorporation process. Promoters have fiduciary duties toward the company and its prospective shareholders, including avoiding conflicts of interest, acting in good faith, and disclosing any personal profits from company transactions. They can be held liable for any misrepresentation or fraud during the pre-incorporation phase. Promoters may be reimbursed for expenses incurred during the company’s incorporation and may also be compensated through shares or other benefits, as specified in agreements. Any contracts entered into by the promoter on behalf of the company before its incorporation are not binding unless the company adopts them after incorporation.
Promoters are integral to the creation and successful launch of a company, but their actions and decisions are closely regulated under the Companies Act, 2013, to safeguard the interests of the company and its stakeholders.