Promoters & Their Legal Position | Business Studies (BST) Class 11 - Commerce PDF Download

A. Promoters

Definition of the Word Promoter

Section 2 (69) of the Companies Act, 2013 defines the term ‘promoter’ as under:-

“Promoter” means a person—

• 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
• who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or
• 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.

By virtue of above definition, 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. However, 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.

Further, according to SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, “promoter” includes:

1. the person or persons who are in control of the issuer;
2. the person or persons who are instrumental in the formulation of a plan or programme pursuant to which specified securities are offered to public;
3. the person or persons named in the offer document as promoters.

Is a director/officer/employee of the issuer a promoter? 

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. As per section 2 (27), control” shall include the right to appoint majority of the directors or to control the management or policy decisions exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of their shareholding or management rights or shareholders agreements or voting agreements or in any other manner.

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.

Certain attempts have also been made by the judiciary to define the term 'promoter'

Case Law

It was held in Twycross v. Grant, (1877) 2. C.P.D. 469 that 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".

In Whaley Bridge Calico Printing Co. v. Green (1880) 5 Q.B.D. 109, Bowen, L.J. held that the term "promoter" is a term not of law but of business usually summing up in a single word a number of business operations familiar to the commercial world by which a company is generally brought into existence".

company. Any person who becomes a director, places shares or negotiates preliminary agreements, may be covered by this term. Who constitutes a promoter in a particular case , has to be seen in the light of a clear legislative definition provided under section 2(69) the Companies Act, 2013. A company may have several promoters. A promoter may be a natural person or a company.

It is clear from the foregoing that the word "promoter" is used in common parlance to denote any individual, corporate, syndicate, association or partnership which has taken all the necessary steps to create and mould a company and set it going. The promoter originates the scheme for the formation of a company; gets together the subscribers to the memorandum, gets the Memorandum and Articles prepared, executed and registered, finds the bankers, brokers and legal advisers, finds the first directors, settles the terms of preliminary contracts with vendors and agreement with underwriters, and makes arrangement for preparation, advertisement and circulation of the prospectus and placement of the capital. But a person who merely acts in a professional capacity on behalf of the promoter, such as a solicitor who draws up an agreement or articles, an accountant or valuer who prepares figures or valuation on behalf of a promoter, and who is paid for the same, is not a promoter.

Promoters' Contract — Ratification Thereof

As regards ratification of promoters’ contracts, the view taken in Kelner v. Baxter LR (1886) 2 CP 174 was that the company could not ratify contract made by a promoter before its incorporation. Specific performance of a contract may be enforced against a company in respect of contracts entered into by promoters on behalf of the company, if such a contract is warranted by the terms of incorporation and the company has accepted the contract and communicated the acceptance to the other party. (Section 15 of the Specific Relief Act, 1963). Section 19 of the same Act provides that the other party can also enforce the contract if the company has adopted it after incorporation and the contract is within the terms of incorporation.

As long as the company does not ratify, as required by the Specific Relief Act, 1963 the position remains the same as under the common law.

Case Law

In D.R. Patil v. A.S. Dimilov AIR 1961 MP 4 AT 5, it was held that a promoter is personally liable to third parties upon all contracts made on behalf of the intended company, until with their consent, the company takes over this liability.

If the promoter commits a breach of duties, the company can either rescind the contract or can compel him to account for any secret profits that he has made.

Legal Position of a Promoter

While the accurate description of a promoter may be difficult, his legal position is quite clear. A promoter is neither an agent of, nor a trustee for, the company because it is not in existence. But he occupies a fiduciary position in relation to the company and therefore requires to make full disclosure of the relevant facts, including any profit made by him as held by Lord Cairns in Erlanger v. New Sombrero Phosphate Co. (39 LT 269).

Case Law

Lindley L.J. in Lydney and Wigpool Iron Ore Co. v. Bird, (1866) 33 Ch. D. 85, described the position of a promoter as follows:

"Although not an agent for the company, nor a trustee for it before its formation, the old familiar principles of law of agency and of trusteeship have been extended and very properly extended to meet such cases. It is well settled that a promoter of a company is accountable to it for all money secretly obtained by him from it just as the relationship of the principal and agent or the trustee and cestui que trust had really existed between him and the company when the money was obtained".

Similarly, it was observed in Lagunas Nitrate Co. v. Lagunas Syndicate, (1899) 2 Ch. 392 that "promoters" stand in a fiduciary relation to the company they promote and to those persons whom they induce to become shareholders in it".

The promoters undoubtedly stand in a fiduciary position. They have in their hands the creation and moulding of the company. They have the power of defining how and when and in what shape and under whose supervision it shall come into existence and begin to act [As per Lord Cairns in Erlanger v. New Sombrero Phosphate Co., (1873) 3 App. Case 1218-1236].

In a series of similar cases under the English Law it has been held that the promoters, being in a fiduciary position, may not make, either directly or indirectly, any profit at the expense of the company and that if he does make a profit in disregard of this rule, the company can compel him to account for it.

The promoters can be compelled to surrender the secret profits [Emma Silver Mining Co. v. Grant, (1879) 11 Ch. D. and Erlanger v. New Sombrero Phosphate Co, (supra)].

Duties of a Promoter

The Companies Act, 2013, contains some provisions regarding the duties of promoters. The fiduciary duties of a promoter includes:

(a) 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]

The above provision is based on the principle that a promoter cannot make either directly or indirectly,

any profit at the expense of the company he promotes, without the knowledge and consent of the company and that if he does so, in disregard of this rule, the company can compel him to account for it. In relation to disclosure it may be noted that part disclosure will also attract the same consequences. A promoter is not forbidden to make profit but he is barred from making any secret profit. 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 principal's consent.

Case Law

In Gluckstein v. Barnes, (1900) A.C. 240 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.

(b) A promoter is not allowed to derive a profit from the sale of his own property to the company unless all material facts are disclosed. If a promoter contracts to sell his own property to the company without making a full disclosure, the company may either repudiate the sale or affirm the contract and recover the profit made out of it by the promoter. Either way the dishonest promoter is deprived of his advantage.

Case Law

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.

In case, therefore, the promoter wishes to sell his own property to the company, he should either disclose the fact:

• to an independent Board of directors; or
• in the articles of association of the company; or
• in the prospectus; or
• to the existing and intended shareholders directly.

In addition to disclosing secret profits, a promoter has the duty to disclose to the company any interest he has in a transaction entered into by him.

(c) As per section 13(8), a company, which has raised money from public through prospectus and still has any unutilised amount out of the money so raised, shall not change its objects for which it raised the money through prospectus unless a special resolution is passed by the company and the dissenting shareholders shall be given an opportunity to exit by the promoters and shareholders having control in accordance with regulations to be specified by the Securities and Exchange Board.

(d) As per section 27(2), the dissenting shareholders being those shareholders who have not agreed to the proposal to vary the terms of contracts or objects referred to in the prospectus, shall be given an exit offer by promoters or controlling shareholders at such exit price, and in such manner and conditions as may be specified by the Securities and Exchange Board by making regulations in this behalf.

(e) As per section 167(3), where all the directors of a company vacate their offices under any of the disqualifications specified in sub-section (1), the promoter or, in his absence, the Central Government shall appoint the required number of directors who shall hold office till the directors are appointed by the company in the general meeting.

(f) As per section 168(3), where all the directors of a company resign from their offices, or vacate their offices under section 167, the promoter or, in his absence, the Central Government shall appoint the required number of directors who shall hold office till the directors are appointed by the company in general meeting.

(g) As per section 284(1)* , the promoters, directors, officers and employees, who are or have been in employment of the company or acting or associated with the company shall extend full cooperation to the Company Liquidator in discharge of his functions and duties during winding up by the Tribunal.

Promoter’s 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.

Termination of Promoters' Duties

It is a general opinion that a promoter completes his duty the moment the company, that he promotes, is incorporated or when the Board of directors is appointed. But, in reality it continues until the company has acquired the property for which it was formed to manage and has raised its initial share capital, [Lagunas Nitrate Co. v. Lagunas Syndicate Ltd. (Supra)] and the Board takes over the management of the affairs of the company from the promoters.

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.

1. 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.

2. 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:

• 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.
• 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.
• 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—

• rescind the contract and if he has made a profit on some ancillary transaction that may also be recovered; or
• retain the property, paying no more for it than what the promoter has paid, depriving him of his profit; or
• 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.

Liabilities of Promoters

A promoter is subject to the following liabilities under the various provisions of the Companies Act, 2013:-

1. Incorporation of company by furnishing false information:- 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.

2. 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.

3. Civil Liability for misstatements in prospectus:- A promoter is liable for any misleading statement in the prospectus to a person who has subscribed for any securities of the company on the faith of the prospectus. By virtue of section 35(1), where a person has subscribed for securities of a company acting on any statement included, or the inclusion or omission of any matter, in the prospectus which is misleading and has sustained any loss or damage as a consequence thereof, the company and certain persons as mentioned in the said section, including a promoter of the company shall, without prejudice to any punishment to which any person may be liable under section 36, be liable to pay compensation to every person who has sustained such loss or damage. No promoter shall be liable under this section, if he proves

• that the prospectus was issued without his knowledge or consent, and that on becoming aware of its issue, he forthwith gave a reasonable public notice that it was issued without his knowledge or consent.

4. Punishment for fraudulently inducing persons to invest money:- As per section 36, any person who, either knowingly or recklessly makes any statement, promise or forecast which is false, deceptive or misleading, or deliberately conceals any material facts, to induce another person to enter into, or to offer to enter into, (a) any agreement for, or with a view to, acquiring, disposing of, subscribing for, or underwriting securities; or (b) any agreement, the purpose or the pretended purpose of which is to secure a profit to any of the parties from the yield of securities or by reference to fluctuations in the value of securities; or (c) any agreement for, or with a view to obtaining credit facilities from any bank or financial institution, shall be liable for punishment for fraud under section 447.

5. Contravention of provisions relating to private placement: If a company makes an offer or accepts monies in contravention of the provisions of private placement as stated in section 42, the company, its promoters and directors shall be liable for a penalty which may extend to the amount involved in the offer or invitation or two crore rupees, whichever is higher, and the company shall also refund all monies to subscribers within a period of thirty days of the order imposing the penalty. [Section 42(10)]

6. Liability during Revival and Rehabilitation of companies (Yet to be notified)

1. As per section 257(3), the interim administrator may direct any promoter, director or any key managerial personnel to attend any meeting of the committee of creditors and to furnish such information as may be considered necessary by the interim administrator.
2. As per 266 (2), if the Tribunal is satisfied on the basis of the information and evidence in its possession with respect to any person who is or was a director or an officer or other employee of the sick company, that such person by himself or along with others had diverted the funds or other property of such company for any purpose other than the purposes of the company or had managed the affairs of the company in a manner highly detrimental to the interests of the company, the Tribunal shall, by order, direct the public financial institutions, scheduled banks and State level institutions not to provide, for a maximum period of ten years from the date of the order, any financial assistance to such person or any firm of which such person is a partner or any company or other body corporate of which such person is a director, by whatever name called, or to disqualify the said director, promoter, manager from being appointed as a director in any company registered under this Act for a maximum period of six years.

7. Failure to cooperate with Company Liquidator during winding up: As per section 284 (2), where any promoter, without reasonable cause, fails to cooperate with the Company Liquidator during winding up, he shall be punishable with imprisonment which may extend to six months or with fine which may extend to fifty thousand rupees, or with both. (Yet to be notified) 

8. A promoter may be liable to public examination like any other director or officer of the company if the Tribunal so directs on a Company Liquidator's report alleging fraud in the promotion or formation business or conduct of affairs of the company since its formation [Section 300(1)]. (Yet to be notified)

9. A company may proceed against a promoter on action for deceit or breach of duty under Section 340* , where the promoter has misapplied or retained any money or property of the company or is guilty of misfeasance or breach of trust in relation to the company.

10. 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:

• that the statement or omission was immaterial; or
• 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.

The following are some of the remedies available to the subscriber who is deceived by any misleading statement or the inclusion or omission of any matter in the prospectus:—

1. As per section 37, a suit may be filed or any other action may be taken under section 34 or section 35 or section 36 by any person, group of persons or any association of persons affected by any misleading statement or the inclusion or omission of any matter in the prospectus.
2. He may take proceedings to repudiate the contract and require repayment of his money with interest.
3. He may, in respect of any misleading statement or the inclusion or omission of any matter in the prospectus, bring an action against the directors and promoters for the recovery of compensation.
4. He may, bring an action for damages against the directors and other persons responsible for failure to disclose matters in a prospectus.
5. He may, in respect of any misleading statement or the inclusion or omission of any matter in the prospectus, bring an action against directors or those who are responsible for the prospectus.

In addition to directors and promoters the liability under the section also attaches to person who have authorised the issue of the prospectus. However, the words cannot reasonably be held to apply to such persons as bankers, brokers, accountants, solicitors and engineers who merely consent to their names appearing as such in the prospectus.

Misrepresentation of facts: A promoter will be responsible for any misstatement as to an existing fact. A calculation of future profits is not a statement of fact [Bentley v. Black, (1893) 9 TLR 580 (CA)]. But a misstatement as to purposes for which the money to be raised and is to be applied is a misrepresentation of a present fact. [Edgington v. Fitzmaurice, (1885) 29 Ch D 459: (1991-5) All ER Rep 59 (CA)]

Misstatements of Names of directors: If a director's name is misstated in the prospectus, it is an important misrepresentation and the promoter can be held to be liable, [Metropolitan Coal Consumer's Association Ltd., Karberg's case, (1892) 3 Ch 1 (CA)].

Representation true only at time of issue: 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. 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. [Brownliey v. Campbell, (1880) 5 App. Cas 925; Rajagopala Iyer v. The South Indian Rubber Works, AIR 1942 Mad 656; (1942) 12 Com Cases 203].

Rights of Promoters

Right to receive preliminary Expenses

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. [Re. English & Colonial Produce Company (1906) 2 Ch. 435 CA].

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.

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.