This article covers frequently asked questions based on promoter, functions of promoter, duties of promoter, liabilities of promoter, etc.
a) Who is a Promoter?
According to 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.
b) What could be the consequences if promoter fails to make full disclosure of profit, secret profit, etc.?
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.
c) What are Pre-incorporation Contracts?
Contracts those are entered into by promoters with parties to acquire some property or right for and on behalf of a company yet to be formed are called as ‘pre-incorporation contracts’ or ‘preliminary contracts’.
Brief Explanation of Concepts:
a) Promoter:
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.
According to 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.
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 and to perform feasibility studies
- To collect required number of persons to form a company
- To take decisions on following matters like location of registered office, share capital, approval of name company, appointment of professionals, etc.
- Preparation of documents
Duties of Promoter:
- To disclose secret profits
- Duty of disclosure of interest
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.
b) Liabilities of Promoters:
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.
Liability of Promoter Under 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.
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.
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.
c) Pre-incorporation contract:
No contract is there if one of the parties to the contract is not in existence at the time of entering into the contract. Before incorporation, company do not have any legal existence, and if the ‘association of persons’ enters into an agreement in the name of company before incorporation; the agreement would be void ab initio. But before a company commences a business, it has to enter into several contracts and incur several initial expenses.
Contracts that are entered into by promoters with parties to acquire some property or right for and on behalf of a company yet to be formed are called as ‘pre-incorporation contracts’ or preliminary contracts. Since the corporation has not been formed yet, it cannot be a party to the agreement. If the corporation is not formed or if it fails to adopt the agreement, the promoters can be held personally liable for any breach of the agreement.
Responsibility of A Company Towards Pre-incorporation Contracts:
- The company, when it comes into existence, is not bound by any contract made on its behalf before its incorporation. A solicitor or lawyer, or chartered accountant who on the request of promoters, prepared a company’s documents and spent time and money in getting it registered, could not recover his charges from the company.
- The other party to the contract is also not bound. The company cannot ratify a pre-incorporation contract and hold the other party liable.
- The agents who contract for a proposed company may sometimes incur personal liability.
In Kelner v Baxter (1866) LR 2 CP 174 case, where the promoter of a new hotel on behalf of the unformed company accepted an offer of Mr. Kelner to sell wine. He supplied wine to the company. But subsequently the company failed to pay Mr. Kelner, and he brought the action against promoters. The Court held that the principal-agent relationship cannot be in existence before incorporation, and if the company was not in existence, the principal of an agent cannot be in existence. The company cannot take the liability of pre-incorporation contracts through adoption or ratification; because a stranger cannot ratify or adopt the contract and the company was a stranger because it was not in existence at the time of formation of the contract. So, the Court held that the promoters are personally liable for the pre-incorporation contract because they are the consenting party to the contract.
Detailed Explanation:
a) What is meant by Promoter? Explain in brief the position of promoter relating to his rights, duties and liabilities in a Company.
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.
According to 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.
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 Promoters:
- 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.
- 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.
- 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: Promoter should select 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.
- To Appoint Professionals: Promoter has to do appointments of the brokers or underwriters for the capital issue, if necessary, the bankers, the auditors and the legal advisers
- To Prepare Necessary Documents: In this stage, the promoter has to get documents like Memorandum of Association, Articles of Association, etc. 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: A promoter is not forbidden to make a profit but to make secret profits. He has to disclose secret profit to other members. 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.
- 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.
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 Promoters:
- Liability of Promoter Under 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.
- 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.
- 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.
Conclusion:
A number of persons come together to exploit some business opportunity and incorporate a company to achieve it are called promoters. 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. Promoter is important link in incorporation of company. A promoter has different rightsd, duties, and liabilities.