Liabilities on Promoter | Company Law - CLAT PG PDF Download

Liabilities of Promoters under the Companies Act

Promoters can face various legal responsibilities under the Companies Act. Here’s a breakdown of these liabilities:

Contents of Prospectus (Section 26)

• Promoters must ensure that all required information is included in the prospectus. Failure to comply can lead to legal consequences.

Untrue Statements in Prospectus (Sections 34 and 35)

• If a prospectus contains false information, promoters can be held accountable by individuals who rely on it to purchase shares or debentures.
• However, the promoter's liability is limited to the original buyer of the shares and does not extend to later purchasers.

Examination of Promoter (Section 300)

• Promoters can be subject to scrutiny like any director or officer of the company if a court, based on a liquidator's report, suspects fraud in the company's promotion or formation.

Action for Deceit or Breach of Duty (Section 340)

• Companies can take legal action against promoters for misusing or improperly keeping company property, or for misconduct like misfeasance or breach of trust.

Case Law: Prabir Kumar Misra v. Ramani Ramaswamy

• The Madras High Court ruled that a promoter can be held liable even if they are not a signatory to the Memorandum/Articles of Association, a shareholder, or a director of the company.
• A promoter's civil liability to the company and third parties is based on their actions and contracts made during the pre-incorporation phase as an agent or trustee of the company.

What are Pre-Incorporation Contracts?

• Pre-incorporation contracts are agreements made by promoters on behalf of a company that is not yet legally formed.
• These contracts are necessary for setting up the company and ensuring its operations from the start.

Key Features of Pre-Incorporation Contracts

• Bilateral Nature: Involves two parties, but also benefits the future company.
• Legal Existence: The company cannot be a party to the contract because it does not legally exist at that time.
• Promoter's Role: The promoter acts on behalf of the prospective company, even though the company is not yet formed.

Historical Context in India

• Before the Specific Relief Act 1963, India followed the English Common Law regarding pre-incorporation contracts.
• Under common law, the promoter was solely liable for the contract because the company did not exist yet.

Specific Relief Act, 1963

• Introduced changes to make pre-incorporation contracts valid.
• Section 15(h): Allows specific performance of a contract when promoters enter into a contract for the future company.

Understanding the Concept

• Pre-incorporation Contracts: These are agreements made by the promoter on behalf of a company that is not yet legally formed.
• Nature: While it appears to be a bilateral contract between the promoter and the third party, it also benefits the future company.
• Legal Existence: The reason the company cannot be held liable is that it does not legally exist at the time of the contract.
• Historical Context: Before the Specific Relief Act 1963, the promoter was solely responsible for pre-incorporation contracts in India, similar to English Common Law.
• Specific Relief Act 1963: This Act made provisions for pre-incorporation contracts valid, allowing specific performance under certain conditions, such as when promoters enter into contracts for the future company.

Key Sections of the Specific Relief Act, 1963

• Section 15(h): This section allows specific performance of a contract when promoters enter into a contract for the purposes of the company before its incorporation.
• Parties Involved: Any party to the contract, or their representative, can seek specific performance, except in cases where personal qualities of a party are crucial to the contract.
• Promoter's Authority: The promoter has the authority to enter into contracts on behalf of the future company, ensuring that such contracts align with the terms of incorporation.

Enforcement of Specific Performance Against Companies

Introduction to Specific Performance

• Specific performance is a legal remedy that compels a party to fulfill their obligations under a contract.
• Section 19 (e) of the Specific Relief Act 1963 allows for the enforcement of specific performance against a company when certain conditions are met.

Contracts by Promoters Before Incorporation

Promoters can enter into contracts on behalf of a company that is yet to be formed. These contracts can be enforced against the company once it is incorporated, provided they align with the terms of incorporation.

Case Study: Weavers Mills Ltd. v. Balkies Ammal

• Context: The Madras High Court case where promoters agreed to purchase properties for a company before its incorporation.
• Outcome: After incorporation, the company took possession and made improvements on the properties. The court ruled that the company's title to the property was valid despite the absence of a formal conveyance from the promoters.

Promoters' Liability in Pre-Incorporation Contracts

• Generally, promoters are personally liable for contracts made before the incorporation of a company.
• If a company does not ratify or adopt a pre-incorporation contract under the Specific Relief Act, the common law principle applies, making the promoter liable for breach of contract.

Case Study: Kelner v. Baxter

• Context: A case where a promoter, on behalf of a yet-to-be-formed company, accepted an offer to purchase wine.
• Outcome: When the company failed to fulfill its obligations, the promoter was held liable. The court emphasized that a principal-agent relationship cannot exist before incorporation, and a company cannot ratify or adopt a pre-incorporation contract because it was not in existence at that time.

Case Study: Newbome v. Sensolid (Great Britain) Ltd.

• Context: A scenario where an unformed company entered into a contract, and the other party refused to perform.
• Outcome: The court clarified that a company cannot take action for a pre-incorporation contract because it did not exist at the time of the contract. If a promoter signs the contract, they may be personally liable, but if a director of the unformed company signs, the contract is unenforceable.

Application in Indian Law

• In the case of Seth Sobhag Mai Lodha v. Edward Mill Co. Ltd., the Rajasthan High Court followed the common law approach regarding pre-incorporation contract liability.
• Criticism: A. Ramaiya criticized this case for not considering the Specific Relief Act.

Shifting Liability under Specific Relief Act 1963

• Promoters can shift liability for pre-incorporation contracts to the company under the Specific Relief Act 1963 or through novation under contract law.
• In the case of Howard v. Patent Ivory Manufacturing, the English Court recognized the novation of a contract.

Conclusion on Promoters' Liability

• Promoters are personally liable for pre-incorporation contracts because the company does not exist at the time of contract formation.
• Once the company comes into existence, it cannot be held liable for pre-incorporation contracts. However, under Section 15(h) and 19(e) of the Specific Relief Act 1963, the company can assume the rights and liabilities of the promoter.
• Promoters' personal liability for pre-incorporation contracts is recognized in American Law, English Law, and Indian Law.