Promoters in Company Law – iPleaders

The article is written by Pramit Bhattacharya, Sujitha S, and updated by Danish Ur Rahman. In this article the authors talk about the role and position of a Promoter of a company. The blog post delves into the duties and liabilities of a promoter and also looks into the position of the promoter before the incorporation of the company and after the process of incorporation is complete, with reference to relevant case laws and legal provisions. 

It has been published by Rachit Garg.

Establishing a company is not a one-day task. Before a firm may take its ultimate form, it must complete many processes. Promoters play an important role right from the start of the process. The process of forming a corporation is extensive and involves several steps. The ‘promotion’ stage of the formation process is the first step. An individual or a group of people known as promoters comes up with the concept of starting a business at this stage. Various processes must be completed to incorporate a firm. The promoters carry out these functions and establish the firm. The term has been used frequently in Indian company matters. The Indian Companies Act, 1956 used it to fix liability on promoters, but did not define it and accepted their established position under the common law principle. Subsequently, the Indian Companies Act, 2013 defined the term for the first time. It is a common misconception that the promoters’ job continues until the business has purchased the property, raised initial money, and the board of directors has taken over control of the company’s activities. However, a review of the different provisions of the Companies Act of 2013 demonstrates that the promoters’ role cannot be overlooked even when the board of directors assumes control of the company’s business. This can be carried over to the period when the firm is operating as a going concern and even to the time when the company’s affairs are being wound up. 

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The definition of the phrase “promoter” has been defined in Section 2 (69)[1] of Companies Act, 2013. The term has been used specifically in Sections 35, 39, 40, 300 and 317 of the Act. Section 2 (69) of the Act states that promoter is a person whose name has been mentioned in the prospectus of the company or is identified in the annual returns of the company, or any person who has direct or indirect control over the affairs of the company, whether as a stakeholder or as a director, or on whose direction the Board of Directors act. In simple words, a promoter is a person who performs the various preliminary steps like making the prospectus of the company, floating the securities in the market, etc. but if a person is doing this in a professional capacity, he wouldn’t be considered a promoter.  In Bosher v. Richmond Land Co. (1892), the term Promoter has been defined 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.

Statutory definition – Section 2(69) of the Companies Act, 2013

The Companies Act, 2013 contains a statutory definition of the promoter which is also more or less in terms of functional categories: Promoter means a person  

  1. who has been named as such in a prospectus or is identified by the company in the annual return referred to in Section 92
  2. who has control over the affairs of the company, directly or indirectly, whether as a shareholder, director or otherwise; 
  3. in accordance with whose advice, directions or instructions the Board of directors of the company is accustomed to act. The proviso excludes persons acting in a professional capacity

As stated above, a promoter is the one who conceives the idea of formation of a company. An individual, an association of a person, a firm or a company, can act as a promoter. A promoter may be an occasional, professional, managing or financial promoter. A professional promoter is the one who hands over the reign of the company to the stakeholders when the company is up and running. Financial promoters are those promoters, who promote financial institutions or banks. Their main aim is to assess the financial situation of the market and form a company at the opportune moment. In the case of managing promoters, they not only help in the formation of the company but when the company is formed, they get managing agency rights in the company. Occasional promoters are those whose main work is to float the company and do all the preliminary work. Although they do not do the promotion work routinely, they may float a company and then go back to their original profession. 

Professional promoter

  • Professional promoters are people who are specialists in promoting new business ventures
  • Professional promoters initiate all the steps in establishing a new company; they have years of experience in promoting various businesses, and with that experience, they promote a company professionally.
  • Professional promoters have the promotion of companies as their occupation. Professional promoters are mostly not directly connected with any specific company because they have an occupation as promoters for various other companies. They are connected to a specific company only at the time of promotion. 
  • Once the professional promoters are done with the promotion of the company, they pass on the management of the company to their owners or shareholders, and then they move to another new business venture or another company to promote it.

Occasional promoter

  • Occasional promoters are not involved in the promotion work of a company on a regular basis, and they do not have promotion as their occupation. 
  • Unlike professional promoters, occasional promoters do not promote a series of companies from time to time; they promote only a limited number of companies that they wish to promote.
  • Since occasional promoters have their own occupation or profession apart from promoting a company and once the promotion work is done they hand over the management of the company to their owners or shareholders, they move back to their profession.
  • Normally, the occasional promoter has an interest in promoting a company or helping the company get into a floating stage. They like to bring a company into existence with their ideas. The occasional promoters can be lawyers, accountants, doctors or any other professionals; if they have an interest in promoting a company, they become occasional promoters.

Financial promoter

  • Certain financial institutions sometimes aid new business ventures by bringing them into existence, and they become their promoters and do the promotion of the company as a normal promoter would.
  • Most financial institutions provide financial assistance and financial guidance to upcoming businesses and help them launch their business ventures in the business world.
  • A company needs capital for its existence, and the promoter works in order to bring the company to existence. The financial promoter helps the company by funding its capital.
  • Financial promoters most often collaborate with new entrepreneurs who are willing to invest and persuade them to invest in new businesses, thus promoting new businesses by acquiring financial aid. 
  • Financial promoters provide the management and technical expertise needed for a company to come into existence.

Entrepreneurial promoter

  • The role of an entrepreneur is that of an initiator and a promoter. The entrepreneur is also a promoter, as he does all the initial work just like the promoter, like finding the correct members for the business, entering into contract in his name for the sake of the company, and bringing the business or the company into existence. 
  • Individuals who conceive ideas for business and take all the necessary steps required for the promotion of the company are called entrepreneurial promoters.
  • These types of promoters take necessary steps to set up a business unit to give it shape and they take  ultimate control and manage the company. Mostly,  the founder who does the promotion is the entrepreneurial promoter.
  • These types of promoters are those who work on the ground level for the promotion of the company. As they are mostly founders, they are liable for all the risks that occur during the promotion of the company.
  • The best examples of entrepreneurial promoters in India are the Tata, Birla and Reliance groups, where the founders did all the promotion of the company.

A promoter plays various functions in the formation of a company, from conceiving the idea to taking all the necessary steps to convert the idea into reality. Some of the functions of a promoter are-

  • One of the main functions of a promoter is to comprehend the idea of formation of the company
  • The promoter looks into the viability and feasibility of the idea that whether the formation of the company will be profitable and practicable or not.
  • After the idea has been conceived, the promoter collects and organizes the resources available to convert the idea into a reality.
  • The promoter decides the name of the Company and also settles the content regarding the Articles of Association and the Memorandum of Association of the Company.
  • The promoter is the one who decides where the head office of the company will be situated. The promoter also nominates people or associations for vital posts. For instance, the promoter may appoint the bankers, auditors and Directors of the company for the first time.
  • The promoter also prepares all the other necessary documents which are required to incorporate a company.
  • The promoter must undergo a detailed investigation, and after analyzing all the concepts related to the idea discovered, the promoter must think about the cost, profitability, production, demand of the product, supply of such product in the market, etc.
  • The promoter has to enter into a preliminary contract with the third parties on behalf of the company to collect all the resources necessary to form a company. The promoter makes contracts for the purchase of material, land, and machinery, and he also recruits staff for the initial functioning of the company.
  • The promoter decides who can be the signatories to both the MoA and AoA of the company. The signatories are those who become the directors of the company, and the promoter gets written consent from such signatories that they will act as the directors.
  • The promoter makes all the publicity for the company by way of advertisement and marketing strategies during the period of promotion of the company

Defining the legal status of a promoter can be a very tough job. He cannot be considered an employee, trustee or an agent of the company. The role of the promoter ceases to exist when the company is on the track and is handled by the Board and the Management.

The legal position of the promoter of a company is very complicated to understand. The legal position of the promoter is hard to fix, even though he does all the work to bring the company into existence. The legal position of the promoter is explained in detail below:

Promoter is not an agent

Criminal litigation

The company should be in existence in order to make the promoter an agent of the company,  and since the company is not registered during the promotion of the company, the promoter is not an agent, and he is not liable for the contracts entered personally by him on behalf of the company.

As the contract is held on behalf of the company, the company has to ratify it; if it does not have the power to ratify and the promoter still enters into a contract with third parties, then the promoter would be liable. Hence, the promoter would be individually liable and would not be liable as an agent of the company.

Promoter is not entitled to expenses incurred

The promoter works in his own capacity for the existence of the company, and he is not entitled to the expenses incurred from the promotion.

If the promoter has incurred expenses during the promotion of the company, the company has to reimburse the promoter for such expenses. Hence, the promoter is legally not entitled to any expenses incurred on behalf of the company during the promotion.

Promoter and his remuneration 

The company may remunerate the promoter, but it is not mandatory for the company to remunerate the promoter for the work he has done. The remuneration can be paid by paying the promoter a lump sum payment or commission for the work done by him during the promotion of the company.

Normally, if the promotion of the company is held by the owners or shareholders of the company, then the concept of remuneration is immaterial, but in terms of professional promoters, as discussed above, their remuneration is mandatory. Since the sole occupation of the professional promoters is to promote a company, they ought to be paid. The professional promoters get remuneration from various companies that they have promoted.

Allotment of shares or debentures to the promoters

The company may allow and allot shares or debentures to the promoters, or they can also give the option to purchase their security at a future date. If the shares are allotted to the promoters, then they become shareholders of the company, thus enjoying ownership of the company to some extent.

The Indian law prohibits companies from granting Employee Stock Option Plans (ESOPs) to promoters. This prohibition to grant ESOPs is provided in Regulation 2(1)(i) of the Securities and Exchange Board of India (Share Based Employee Benefit and Sweat Equity) Regulations, 2021 and in Rule 12 of the Companies (Issue of Share Capital and Debenture) Rules, 2014.

These rules and regulations are applicable to listed companies. The promoters are excluded from the definition of employees, and thus the granting of Employee Stock Options (ESOPs) is prohibited to them.

This restriction does not apply to the promoters of the startups registered with the Department of Promotion of Industry and Internal Trade. The Company Law Committee (CLC), through its 2016 Report, provided this exemption. The CLC recommended that startups be given permission to grant Employee Stock Options (ESOPs) to the promoters, as they might be working as employees or whole-time directors. The grant of ESOPs to the promoters would allow startups to compensate them adequately without the cash flows being impacted.

The promoters who form the company have certain basic duties towards the company. A promoter has a relationship of confidence and trust with the company, i.e., a fiduciary relationship. Keeping this fiduciary relationship in mind, the promoter is under the obligation to disclose all the material facts which relate to the formation of the company. The promoter is also under the obligation to not take any secret profit while carrying out the promoting activities like buying a property and then selling it to the company for profit, without making any disclosure. The promoter is not barred from making profits while dealing with various parties. The only condition is that he is under the duty to disclose such profits and not make any secret profits.

Fiduciary position of the promoter 

The fiduciary position of the promoter with regards to a company was first explained in the case of Erlanger v. New Sombrero Phosphate Co. (1878). Lord Cairns, in this case, stated that the promoters undoubtedly stand in a fiduciary position. The creation and molding of the company is in their hands. They have the power of defining when and how, in what shape and under whose supervision the company shall come into existence and begin to act as a business corporation.

Since the concept of promotion of a company gives a very advantageous position to the promoter in relation to the company proposed, the responsibility of a fiduciary position is fixed upon the promoter by the courts. The first and foremost duty of a promoter is that if he attains any form of profit through transactions with the company and obtains money from the shareholders, he must disclose all facts faithfully relating to such transactions. 

The fiduciary position of the promoter is explained in the below case of Erlanger v. New Sombrero Phosphate Co. (1878).

Facts of the case

A group of people headed by Erlanger bought an island that had phosphate mines for 55,000 euros. A company by the name of Phosphate Co. was then incorporated on the same island, and Erlanger was the promoter of the company. Erlanger named five persons as directors of the company, out of which two were abroad, and of the three others, two of them were entirely under Erlanger’s control. The three directors purchased the island from Erlanger for 1,10,000 euros, a prospectus was issued, and shares of the company were distributed. The shareholders adopted the purchase of the land at their first meeting, but the facts were not disclosed to them. The company failed, and the promoter was sued by the liquidator for a refund of the profit and disclosure of a conflict of interest.

Issue of the case

Whether the promoter will be sued for not disclosing the conflicting interest despite having a fiduciary relationship with the company?

Judgment of the case

The only contention on behalf of the promoter was that the company’s board of directors had knowledge of the facts of such a purchase of the island from Erlanger. The Court rejected this argument and held that if the promoter proposed to sell the island to the company, it is incumbent upon him to take care of and provide the company with a group of persons (directors) who have the information that the property that they are going to purchase is the promoter’s property. The group of persons must be competent and impartial as to whether the purchase had to be made or not. The Board of directors must be independent and impartial in such purchases. In this case, the island was bought by just three directors of the Board and out of whom two were entirely under Erlanger’s control. Hence, the promoter had control over the Board, and the disclosure of facts to the specific directors of the Board cannot be considered a disclosure of facts to the company. The promoter was held liable and was entitled to refund the profit.

Promoter must work with utmost care and due diligence

The promoter has the duty that he must work with utmost care and due diligence while performing the work of the company during its promotion. Since the promoter is empowered with so many powers and rights during the stage of the promotion of the company, he is expected to work with the utmost care and due diligence.

Liability regarding irregularities in the prospectus 

Section 26 describes what should be stated in the prospectus and what reports should be included. The promoter may be held accountable by the shareholders if this provision is not followed. 

Civil liability

Section 35 outlines the civil liabilities for any prospectus misstatements. Under this Section, a person who has subscribed for the company’s shares and debentures on the basis of the prospectus can hold the promoter accountable for any false statements in the prospectus. The promoter may be held liable for any loss or damage suffered by any person who subscribes for shares or debentures as a result of the false statements made in the prospectus. Specific provisions have also been provided under Section 62 regarding the reasons on which the promoter can avoid his liability. These remedies are available to anyone who can be held accountable for a prospectus misstatement.

Criminal liability

Section 34 deals with the criminal liabilities of drafting a prospectus that contains false claims. The promoters can be held criminally accountable, in addition to the civil liabilities described in the previous two examples, if the prospectus they released contains misstatements. The penalty is either a two-year prison sentence or a fine of up to 5000 rupees, or both. Unless he can show that the inaccurate statement was inconsequential or that he was justified in believing, on reasonable grounds, that the statement was truthful at the time of prospectus issuing, the promoter may be held criminally liable for misstatements.

Public examination of promoters 

Section 300 gives the court the authority to order a public investigation of all promoters found guilty of fraud in the promotion or establishment of a corporation. If the liquidator’s report indicates fraud in the promotion or establishment of the company during its winding up, the promoter, like every other director or officer of the company, can be held liable for public examination by the court.                                                                                                                                                                                               

Personal liability 

Promoters can be held personally liable for pre-incorporation contracts. 

  • A promoter has to mention the true facts in the prospectus of the company. If he does not do so, he may be held liable for it. The promoter will be liable for any untrue statement which has been made in the prospectus, and on the basis of that untrue statement any person has subscribed to the securities of the company. The person may sue the promoter if he has suffered any damage.
  • Apart from civil liability, the promoter may be held criminally liable also for mentioning any untrue statements in the prospectus. A severe penalty will also be imposed on him if he provides any untrue statement with the view of obtaining capital.
  • A promoter can be made liable to a public examination if there are any reports which allege fraud in the formation of the company or the promotion activities.
  • The company can also proceed against the promoter in case there is a breach of duty on the promoter’s part or he has misappropriated any property of the company or is guilty of breach of trust.

Prior to incorporation of the company

Promoters found it extremely difficult to carry out promotion activities before the Specific Relief Act was introduced in 1963. Before this Act was passed, pre-incorporation contracts of the company were held to be void. Such contracts also couldn’t be ratified. Therefore, people were very hesitant to supply resources for incorporation of the company without any definite contract. Promoters were also very apprehensive about taking personal liability. The introduction of the Specific Relief Act, 1963[4] made it easier for the promoters to carry out incorporation activities, as the promoters could now enter into pre-incorporation contracts with third-parties.

Section 15 (h) and 19 (e) states that;

  • The promoter should have entered into the contract for the purpose and benefit of the company
  • The terms provided in the incorporation agreement should warrant such contracts.
  • The contract should be ratified after the company, and it should be informed to the opposite party.

A contract made between the promoter on the behalf of the company and the third parties will still be considered as a contract between two individuals. The right to ratify a contract does not lie with the company inherently. The authority of ratifying a contract should be given to the company through its memorandum. So a company cannot be sued by the third party if the company does not ratify the contract, even if the contract was beneficial for the company.

In case the company does not have the authority to ratify the contract (because such authority has not been provided in the Articles), or the company does not ratify the contract, then the promoter will be personally liable.

After Incorporation of the company

After the company comes into existence, and in case it ratifies the contract entered into by the promoter, in such a case the contract will become binding on the company and not the promoter. Section 15(h)[5] and 19 (e)[6] also state that the promoter can transfer his rights and liabilities to the company, provided that such provision is present in the incorporation agreement. Although the promoter is not entitled to any kind of salary and remuneration. But the general trend is to compensate the promoter in lump-sum after the company has been set up. A promoter cannot be asked to be compensated as a legal right. If the promoter is compensated at all, the compensation given to him is on the basis of equity ad fairness. If any shares are being allotted to the promoter of the company, the promoter also becomes a member of the company automatically.

Right to indemnity

When more than one member acts as the company’s promoter, one promoter can sue the other for the compensation and damages he paid. Promoters are jointly and severally accountable for any false statements made in the prospectus, as well as for any hidden profits.

Right to recover genuine preliminary expenditures

A promoter is entitled to reimbursement for valid preliminary expenditures incurred in the establishment of the firm, such as advertising costs, solicitors’ fees, and surveyors’ fees. It is not a contractual entitlement to receive the preliminary expenses. It is up to the company’s board of directors to decide. Vouchers should be attached to the cost claim.

Right to remuneration

Unless there is a contract to the contrary, a promoter has no right to remuneration from the company. Although the company’s articles may provide for the directors to pay promoters a certain sum for their services, this does not provide the promoters with any contractual right to sue the company. This is just a power granted to the company’s directors. However, because the promoters are usually the directors, the promoters will earn their remuneration in practice.

Weaver Mills v. Balkies Ammal(1969)

The Madras High Court’s ruling in Weavers Mills Ltd. v. Balkies Ammal  [1969] broadened the applicability of Pre-incorporation contracts. In this instance, the promoters agreed to buy several properties for and on behalf of the firm that was being pushed. When the firm was formed, it took possession of the land and began to build facilities on it. It was held that the company’s title to the property could not be set aside even if the promoter had not conveyed the land to the firm after its incorporation.

Kelner v. Baxter (1866)

In Kelner v. Baxter (1866), the promoter accepted Mr. Kelner’s promise to sell wine on behalf of an unformed company; however, the corporation neglected to pay Mr. Kelner, and he sued the promoters. The principal-agent relationship cannot exist prior to incorporation, according to Erle CJ, and the principal of an agent cannot exist if the firm does not exist. He goes on to say that the company cannot assume obligation for a pre-incorporation contract by adoption or ratification because a stranger cannot ratify or accept a contract, and the company was a stranger because it did not exist at the time the contract was formed. As a result, he concluded that the promoters are personally accountable for the pre-incorporation contract because they consented to it.

Probir Kumar Misra v. Ramani Ramaswami (2009) 

The question of whether the signatures of the promoters in the Memorandum and Articles of Association were required in order to make them liable arose. The Madras High Court held that,  before the incorporation of the company, there is no need for the promoter to be either a signatory of the Memorandum or Articles of Association, or shareholder or the Director of the Company. The High Court of Madras further stated that the promoters are called “midwives” of the business, as coined by Henry in the Law of Corporations. It is the promoter who does all the major roles for the purpose of bringing the corporate person into existence, like proposing the objectives of the company, forming the original scheme, making arrangements to get the company registered, preparing a prospectus, Memorandum and Articles of Association, etc., which are crucial for the company to come into existence. Thus, the promoters can be held liable even though they may not be either signatories to the Memorandum or Articles of Association or a shareholder or the Director of the company, as they are so connected to the company and its incorporation. 

It can be said that a promoter can be an individual, a company, or an association of person which conceives the idea of formation of a company, undertake all the activities which are necessary for the company’s incorporation and brings about the actual existence of the company as a separate legal entity. The promoter nominates the directors, bankers and auditors of the company and also decide the contents of the Articles of the company. The promoter can be called as a molding block who gives basic shape to the company, and his role is of utmost important. The most important part while incorporating a company is the promotion of the company. It is in the time of promotion that all the vital steps to incorporate a company take place, and the promoters are the persons who do the promotion of a company. The promoter undoubtedly has a great influence on the promotion and incorporation of a company. 

1. Are Individuals alone eligible to become the promoters of a company?

It is not necessary that the individuals alone have to be the promoters of the company. An individual, an association of persons, a firm or a company—anyone can be a promoter of a company. Whoever helps the company in the early stages of incorporation and aids in bringing the company into existence can become its promoter.

2. What is the difference between the founder and promoter of the company?

There is a very thin-line difference between the founder of the company and the promoter of the company. The founder and the promoter both have the idea on which the company is to be started. Sometimes the founder may just have the idea, but he won’t do any required work for the promotion of the company. At that time, the founder may get help from the promoter to promote the company. The founder is responsible for the company’s success or failure throughout its lifetime, whereas the promoter is responsible for the company only during the process of promotion. A founder can also be a promoter. 

3. What is promoter holding?

The promoter holding is the percentage of shares of the company that is held by the promoter of such a company. Companies with high promoter holding stocks are often considered safer for investors to invest in. Since the promoter has knowledge of the company’s actual performance and its capabilities, if the promoter thinks that it is worth buying the shares, then there is a possibility that the company will perform well in the future.

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