PROJECT OF CORPORATE LAW

SUBJECT: CORPORATE LAW

A PROJECT ON THE TOPIC
ROLE OF PROMOTERS IN THE FORMATION OF COMPANY, THEIR
RIGHTS AND LIABILITIES

SUBMITTED BY:
MOHD SAKIB

B.A.LLB Semester 6th

Reg No GU17R0032

SUBMITTT
ED TO:-
Miss. ALQAMA MAM

(FACULTY OF LAW)
 PROJECT OF CORPORATE LAW

-: TABLE OF CONTENT:-

Introduction

Definition of Promoter

Position of Promoters In Establishing A Company

Functions of Promoters

Duties of Promoters

Liabilities of Promoters

Remedies to Company
Conclusion
Bibliography
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-: INTODUCTION:-
The promoter is a business term. It is used to describe the person or persons who initially take all
necessary steps to form a company with reference to a given object and set it going.
“According to L.H. Haney promotion may be defined as the process of organization and
planning the finance of a business enterprise under the corporate form”.
In the words of Justice cokburu, “A promoter is one who undertakes to form a company with
reference to a given object and sets it going and takes the necessary steps to accomplish that
purpose”
The term promoter has been defined under the section 2(69)1 of the Companies Act, 2013. As per
this section it refers to a person

a)Who has been named as such in the prospectus or is identified by the company in the annual
return .

b) Who has control over the affairs of the company, directly or indirectly whether as a
shareholder, director or any other position in the company .
c) Who advices, directs or instructs the board of directors of company (but does not include a
person who is acting merely in a professional capacity.

A promoters may be an individual, a firm or a company who performs all the preliminary duties
necessary to bring company into existence . He conceives the idea, develops it and finds and induces
others to join company. The promoters prepare the scheme for the formation of the company , find
and bring together the subscribers to the memorandum , prepare the memorandum and articles and
get it executed and registered , finds the bankers , brokers and legal advisers , finds the first directors
and makes arrangements for the advertisement and circulation of the prospectus and arranges the
capital.

-: Definition of Promoter:-
1
The Company Law Bare Act, 2013 (Section 2(69) page no 21, Universal Law publication)
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The term promoter was not defined in Companies Act, 1956 but was frequently used in various
section e.g. sections 56, 62, 69, 76, 478 & 519. In Whaley Bridge Co. v. Green, 2 Bowell LJ while
defining the term promotion held that ‘promotion’ is not a term of law but of business operations
familiar to the commercial world, by which a company is generally brought in to existence.
Promotion includes wide range of commercial activities which include many technical and non-
technical operations. Amongst the technical include project planning, feasibility study, looking for
technical cooperation and collaboration and locational studies. Non-technical activities include
assembling required number of signatories, obtaining advice on different legal requirements,
appointing key people like company lawyer who make documentation and enter into all types of pre-
incorporation contracts.”
SEBI3 (Substantial Acquisition of shares &Takeover) Regulation 1997 also mentions for promoters.
Securities Exchange Commission Rule of US 405 (a) 4 defines promoter as a “person who acting
alone or in conjunction with other persons directly or indirectly takes the initiative in founding or
organizing the business enterprise.”

Recently in the Companies Act 2013 the term was defined in section 2(69) in following way:
“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 nothing in sub-clause (c) shall apply to a person who is acting merely in a professional
capacity.

In this definition if a person’s name appears in the prospectus or annual return as promoters or when
he directly or indirectly control the affairs of company as a shareholder or director or he maintains
control over Board of Directors, he is promoter of that company. However the people who are
2
1897 QBD 111
3

4
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rendering services to the company in professional capacity shall not be promoters e.g. Company
Secretary, Lawyers, Merchant Banker, Lead Manager etc.

POSITION OF PROMOTORS IN ESTABLISHING A COMPANY:-

When an individual has an idea for a new business venture, he or she may set about interesting other
in the venture and persuade them to contribute capital to a company to be incorporated for the
purpose of carrying on the venture. The individual will then be described as “Promoter” of the
company.
Then the question arise that who really are promoters of a company, the most important work of a
promoters is in the formation of a company. The whole process of the formation of a company may
be divided into four stages (i) Promotion, (ii) Registration, (iii) Floatation and, (iv) Commencement
of business. Promotion is a term of wide import denoting the preliminary steps taken for the purpose
of the registration and floatation of the company. A promoter may be an individual, association,
partner or company.

The Job of promoter is not only limited towards, performing certain duties, but surely it extends
toward the incorporation of a company. It depends on the nature of the company which is to be
established, to arrange their respective persons. More evidence can be found in the Companies act
section 12 which states that “Any seven or more persons or where the company to be formed will be a
party company, any two or more persons, associated for any lawful purpose may, by subscribing their
names to a memorandum of association and otherwise complying with the requirements of this act in
respect of registration form an incorporated company with or without limited liability. Thus the
promoters have to get together at least seven persons in the case of public company and two persons
in case of private to subscribe to memorandum of association. Following are the functions of
promoter in an elaborate manner.

The Important Steps in the Process of Registration

Before proceedings to register a company, the promoters have to decide the following facets:
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What type of Company to float: The first thing the promoters must decide is the type of
company proposed to be made. Under the Companies act of 1956, Public companies and Private
companies are the ones which can be registered. The Companies Act places a great variety of
forms of companies at the disposal of businessmen. The requirements of business vary greatly:
some people wish to limit their liability, others, while trading as a corporation, wish to be liable
without limitation for the obligations which they have undertaken or the money entrusted to
them; some businesses are large, others small; in some instances the capital required for the
business is provided by the promoters; in others it is contemplated inviting the public to
contribute to the capital of the company; and in others again no initial capital is required;. The
aim of the Act is to make available a variety of forms of corporate organization so that company
promoters may choose the form most appropriate to the purposes which they pursue.

Preparation of Memorandum and Articles of Association5. As in the words of Pennington, the

memorandum of association is a document of great importance in relation to the proposed
economy. It contains the objects for which the company is formed and therefore identifies the
possible scope of its operations. A promoter’s job in under this segment comes which precedes
process of registration. Likewise, another important document namely the articles of association
which contains rules and regulations related to internal management of the company.

Vetting of Memorandums & Articles, Printing, Stamping and Signing of the same

Under this head, a promoter of company has to get the memorandum and articles of association
printed, vetted, stamped and signed. And these documents must be vetted either by Registrar of
company or Regional Director.

Preparation of other documents: Under this head, a promoter with a view to fulfill various
formalities that are required for incorporation of a company may execute a power of attorney in
favor of some professional like Chartered Secretary or Chartered Accountant.

5
Section 4 of the Companies Act defines the Memorandum of Association and Section 5 of the Companies Act
defines the Article of Association.
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Erlanger v. New Somrero phosphate co. Ltd6.

Cairns LJ said that, “The promoters undoubtedly stand in a fiduciary position. They have in their
hand the creation and moldings of the company. They have the power of defining how and when
and in what shape and under whose supervision it shall come in to existence and begin to act as a
trading corporation.

-: Functions of Promoters:-
A promoter has the most major role in the incorporation of a company from a mere business
idea. They perform the following functions to set it on a course of development:

 They are the first to get the idea of the business

 They find out where a profitable business venture can be shelved and then analyse the
situation in the market.
 After that, they organize the whole process of turning an idea into a reality by doing
the work of inception of a company.
 They also decide the name of the company which has to be accepted by the registrar
of companies and decide on where the registered office is to be situated.
 Then they do the work of formation of Memorandum and Article of Association.
 The Board of Directors, the bankers, auditors are nominated by the promoter.
 And then they file for incorporation.

In this way, a promoter can be regarded as a founding father of the company. They seek people
to become the first directors of the company. In case the proposed company is a public company,
the promoter’s duty is to get all the articles and the prospectus distributed. They have to recruit a
whole team of bankers, auditors, solicitors to assist them to incorporate a company. In order to
get the first capital issue, they also have to appoint underwriters and brokers. They also have to
buy assets such as land for factory, machinery, the hiring of key employees. Sometimes they
also do a takeover of the existing company before the incorporation of the said company.
6
(1878) 3 AC 1218
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-: Duties of Promoters:-
A promoter stands in fiduciary capacity to company so because of that he owes certain duties to
the company. Promoters’ duties are same as a person who acts on behalf of a person without a
contract of employment namely not to deceive and to exercise reasonable care& skill. He may be
made liable for misrepresentation and fraud in prospectus.

(1) Fiduciary Duties:-

In Indian Companies Act, 2013 there are no clear provision but Sec.34&35 impose liability for
untrue statement in prospectus and for fraudulent trading (sec. 339 & 447). In particular two
duties in fiduciary position are:

1. Duty not to make secret profit

2. Duty to disclose to the co. any interest in a transaction

1. Duty Not To Make Secret Profit:-

A promoter enjoys an advantageous position in relation with access to information, business
opportunity and opportunity to sell in company formation process. He may sell his own land,
intellectual property, professional services at reasonable rate to companies and in that he can
make disclosed profits but he is not allowed to make secret profits. In cases of public companies
in the first Annual General Meeting all dimensions of promotion and all types of pre-
incorporation agreements are investigated so as check whether promotion was done meticulously
and honestly or not and if promoter is found to make secret profit he may be made accountable
for that. However a promoter is allowed to make profit if the same is disclosed.
Gluckstein v. Barnes7
A syndicate of persons bought ‘Olympia’ (an amphitheatre) and sold this to a company
promoted by them and made secret profit of 20,000 £, not disclosed in prospectus. It was held
profit of 20000 £ is a secret profit and promoters are bound to pay it to the company because the
disclosure was not sufficient.

7
(1900) AC 240
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Erlanger v. New Sombrero Phosphate Co.8

A syndicate, of which Erlanger was a member, purchased an island consisting phosphate mines
for 5,000£. A nominee of syndicate sold the property to co. for 1,10,000 £ formed by Erlanger
details of sale were not disclosed to the directors. It was held that the company can rescind the
contract as there had been no disclosure of the profit which was made.

Disclosure To Whom:-

A pertinent question arises that such profits should be declared to whom and how. In this regard
it may be submitted that such disclosures of personal profits may be made to following:

i. Independent board of directors or

ii. Articles of association or

iii. Prospectus

iv. To existing and intended shareholders.

Generally all such disclosures are made in detail in prospectus or offer document. Details of
property, including price purchases from promoters within two years must be disclosed.

(2) Duty To Disclose Interest In A Transaction

In addition to his duty not to make secret profit, a promoter is also duty bound to disclose to
company any interest which he has in a transaction entered in to or proposed to be entered in to
by it. This is even then when he sells his own property to the company raised by him because he
acquired the property before the promotion began. Such disclosures must be made to the
company and in full.

8
(1878) 3 AC 1218
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-: Liabilities of Promoters:-

The companies Act, 2013 in various sections mention about promoter’s role in corporate
governance specially in sections Sec 2(59), 2(60), 7, 26, 34, 35, 42(10), 92, 102, 149, 167, 184,
230, 266, 284, 289, 300, 339, 361.

In section 2(59) & 2 (60) Companies Act, 2013 defines the term ‘Officer’ and ‘Officer in
default’. Section 2(59) defines the term “officer” which includes any director, manager or key
managerial personnel or any

(1)Liabilities Related With Prospectus

Section 269 of the Companies Act, 2013 provides for contents and matters to be provided in
offer document i.e. prospectus. Prospectus is a document which presents the general
information, financial information and issue information before prospective investors so as to
help them to take decision regarding share subscription of the particular company.
In case if the prospectus includes any statement which is untrue or misleading in form or
context in which it is included or where any inclusion or omission of any matter is likely to
mislead then promoters of the company owe civil and criminal liability under section 34 and 35
of the Act and accordingly they shall be liable for punishment under section 447 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. Apart from this the
prospective investors can file a civil suit or any other action for rescission, suit for contractual
breach and damages in section 37 of the Act for misleading information in prospectus.

William Derry v. Henry Peek10.

9
Section 26 of the Companies Act says that Matter to be stated in Prospectus.
10
(1889) 14 AC 337
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Is a case upon which the whole provisions of section 34 and 35 are based. In this case a
company applied to British Board of Trade for license for running tramways by steam power and
in apprehension that they will get the license issued a prospectus to raise capital stating that the
company has been licensed to run tramways by steam-power but actually they did not get. The
directors of the company were not held guilty of fraud.
The Madras High Court in Prabir Kumar Mishra v. Ramani Ramaswamy11 has held that to fix
liability on a promoter. It is nit necessary that he should be either a signatory to the
Memorandum/ Articles of Association or a shareholder or a director of the company. Promoters
civil liability to the company and also to third parties remain in respect of his conduct and
contract entered into by him during pre- incorporation stage as agent or trustee of the company.

Promoters and Pre-incorporation Contracts:-

Sometimes, contracts are made even before company is even incorporated, these are called Pre-
incorporation contracts. These are those contracts which have been entered into at the time when
the company was not in existence cannot bind the company. The persons executed those
contracts cannot be called as the agents of the company which is formed aftermath and such
contracts cannot be enforced against the company.
Until the passing of the Special Relief Act, 1963 the promoters found it very problematic to
accomplish the work of incorporation. Since contracts prior to incorporation were void and also
could not ratify, people hesitated to either supply any goods or services for the cause of
incorporation. As prior to 1963, the contracts made never bind the company (since a person can’t
contract before his existence and also company does not have legal existence either), also if
corporation were bound by them it would be subject to many unknown obligations.

11
(2010) 104 SCL 174
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-: Remedies to Company:-

In cases of breach of duties following remedies may be claimed by the company against the
promoter who stands in fiduciary capacity to company:

1. Rescission of Contract:-
The company can rescind all such pre-incorporation agreements where promoter has made a secret
profit and has not disclosed his material interests in the transactions. The company must have done
nothing to show an intention to ratify the agreement after finding breach involving non disclosure &
misrepresentation. The company is not precluded from rescinding by the fact that the property has
been transferred to it under a contract, or by the fact that promoter has been allotted shares under the
contract. The right to rescind will be lost if the company fails to exercise such right within reasonable
time.

2. To Recover Secret Profit:-

If the promoter has made a secret profit by selling his own property to the company in return for
allotment of shares in it, the company may recover from him the difference of the price at which it
sold the shares and the price at which it bought the property. But this remedy depends on two
situations
(a) If promoter is in fiduciary position as only seller, profit can’t be recovered; which means if the
property on which the profit was made was acquired before the promoter became a promoter, there
can be no claim for the recovery of the profit as such.
(b) The acquisition and selling of property both should be in fiduciary capacity as a promoter then
contract may be rescinded and property may be retained at actual cost depriving the promoter of his
claimed profit.

3. Termination of Duties:-
A pertinent question regarding the duties of promoters may be how long he remains duty bound.
Generally a promoter’s duty starts from the day of conceiving an idea about making a company and
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terminates with the appointment of Board of Directors or with the incorporation of company. In
reality it continues until the company has acquired the property and raised its initial share capital.
Even after floatation or corporate financing in India the promoters fail to separate themselves from
the affairs of the company. They actively participate in corporate governance, management and
operation of corporate affairs. They keep controlling shares in their hand and with the help of person
acting in concert work as head and brain in the company which runs on the rule of majority. They
actively participate in future expansion of company, merger and acquisitions, takeover, buyback,
portfolio management, reduction of capital etc.

4. Remedies to Subscribers against Promoters:-

Subscribers can repudiate the contract and require the money passed under it. In case of untrue
statement in prospectus an action may be taken against directors and promoters of company. If there
is failure or omission in prospectus he may make directors as well as promoters liable. In addition to
promoters and directors all officers of company. Who authorize the prospectus with untrue statement
may be made liable.
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-: Conclusion:-
It can be said the word ‘promoter’ is used in common to address any individual, association or a
company who take necessary steps to create a company and get it going. The promoter
originated for the incorporation of the company from a business idea to make it a reality by
bringing together a business plan by making a memorandum, drafting up of the prospectus,
getting it registered, bringing bankers, auditors and solicitors into the foray and then to look for
subscribers. While doing this he also appoints a board of directors. He has to do all this with
legal compliance. He does all the technical and the non-technical work and also does the
registration of the company.

There is no legal position of a promoter as he only has a fiduciary relationship with the company
as he is neither an agent nor a director or an employee. He cannot make secret profits or else he
will be held accountable. Therefore there are many liabilities on him as he does the duties of the
drafting of the prospectus, entering into pre-incorporation agreements etc and thus if found
guilty there are both civil and criminal liabilities on him.
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-: Bibliography:-

BOOKS:-

(1) AVTAR SINGH (Company law, Sixteenth Edition, Eastern Book Company)

Websites:-
(1) http://lawtimesjournal.in/role-of-promoters-in-india/
(2) http://www.legalservicesindia.com
(3) https://www.lawctopus.com/academike/position-promoter-india-critical-analysis/
(4) https://www.lawteacher.net