Promoters of a Company

The article ‘Promoters of a Company’ elucidates the role of promoters, rights, and duties of promoters in a company. It contains various landmark judgments which establish the legal position of the promoter. The article highlights the importance of a promoter behind the formation of the company and also extensively discusses the liabilities of a promoter. The article contains all the important provisions of the Companies Act, 2013 which deals with the promoters.

Introduction: Promoters of a Company

A company is a form of business organization that is characterized by a separate legal entity, limitation of liability, and perpetual succession. It is a legal device for the fulfillment of the socioeconomic goals of society. Given the intricate formation and working of the company, we may wonder about its convoluted task of inception. It is exactly where the role of the promoter comes into the picture. The promoters are the people who develop the idea of a company, make schemes for its formation, mobilize the resources and personnel and ultimately incorporate the company.

The Companies Act 2013 lays down in detail the rights and duties of the promoters and enshrines necessary measures for the protection of the stakeholders of the company.[1] The given article seeks to scrutinize the position of the promoter in relation to the company from multiple focal points.

Definition of Promoters of a Company

The term ‘Promoter’ is the common parlance used in the corporate landscape. In spite of its frequent recurrence, there has been ambiguity in its definition. The systems of common law failed to define it both legislatively and judicially. It was considered a business term, rather than legal. Justice Bowen defined a promoter, as a person who shoulders business operations of the commercial world, so as to bring a company into existence. Therefore, in a nutshell, the promoter is a person who undertakes operations necessary to incorporate and organize a corporation.

In Bosher v. Richmond Land Co.[2], the court observed the role of promoters and held that he collaborates with the people interested in floating the enterprise, procures subscriptions and shares, and set in motion the machinery of incorporation of the company.

In the case of Twycross v. Grant[3], the court held that the defendants were the promoters of the company from the very beginning as they provisionally chalked out the scheme of the company, found the directors, prepared the prospectus, and undertook all the incidental expenses such as advertising and the printing costs, etc.

The Companies Act 2013, defines promoter in Section 2(69). The act statutorily defines promoters on the basis of its functional aspect. As per the Act, promoter means a person

1. Whose name has been mentioned as such in the prospectus of the company or whose name is identified in the annual returns of the company under Section 92 of the Act.
2. Who exercises either direct or indirect control over the affairs of the company in the capacity of shareholder, director, or any other position as such.
3. Who advises, directs, or controls the Board of Directors and the Board usually acts on such advice.

The proviso to this Section excludes people acting in a professional capacity. A person is said to act in a professional capacity when he does the job of promotion in concurrence to his professional work. The most relevant example is that of a solicitor who may prepare documents for the proposed company on behalf of the promoters. The other example could be an accountant or agent of the promoter who help in the incorporation of a company in their professional capacity.

However, the people acting in a professional capacity may become promoters if they do any work beyond the scope of their professional capacity. So, if a solicitor, for that matter, helps in hiring the personnel for the company or helps in finding the purchaser for the shares of the company, then he would be deemed as a promoter of the proposed company.

It is to be noted that the Companies Act 2013, gives the opportunity to people to become promoters of the company even after its formation. For example, a party may become a promoter by aiding in subscription procurement or any other key promotional activity.

Legal Position of Promoters of a Company

The yardstick to determine the position of a person as a promoter in a company is variable. Whether a given person is a promoter or not depends upon the facts and circumstances of each case. It is a question of fact in each case. It primarily depends upon the role played by a person in the promotion of a business.

The promoters of the company enjoy a key position in the formation of the company. They are responsible right from the idea of inception of the company until its execution and incorporation. The creation of the company squarely lies in their hands. Given their advantageous position in relation to the proposed company, the courts have fixed them with the responsibility of that of a fiduciary agent.

Thus, the position of a promoter in a company is fiduciary in nature and he is akin to that of a trustee of the company. The fiduciary nature of the relationship warrants the relation of trust between the parties i.e. the promoter and the other stakeholders such as the shareholders, directors, management, etc.

The above-enumerated position of the promoters as trustees of the beneficiary company was observed by the House of Lords in the landmark case of Erlanger v. New Sombrero Phosphate Co[4]. The Madras High Court accepted this position of the promoters in the case of Weavers Mill Ltd. v. Balkis Ammal[5]. However, they are not technically trustees in the real sense of words as the company may not be in existence as a legal person. The duty of a trustee emerges from its fiduciary position.

Duties of Promoter

Given the fiduciary position of the promoter, there comes a host of associated duties. The foremost duty of the promoter is to ensure transparency in his transactions. The dealings undertaken in the promotion of the business must be open, honest, and fair. There should be due disclosure of the profits, interest, and the other relevant factors that might affect the interest of the stakeholders of the business.

Accepting a bonus or commission from a person who sells the property to the company is one such act of dishonest behaviour. Disclosure of any such interest should be made to an independent and competent Board of Directors.

In the case of Erlanger v. New Sombrero Phosphate Co.[6], the property of the promoter was sold to the company and, of the five people, who were named as directors, three were entirely under the promoter’s control. The court pronounced that it was incumbent upon the promoter to disclose the fact regarding the promoter’s property to an independent board of directors. There should have been a constitution of an independent board of directors, who could have exercised intelligent judgment on this matter.

However, it is not always practical to constitute an independent board of directors, especially in circumstances where private businesses are converted into limited companies, as in the case of Salomon v. Salomon & Co. Ltd.[7]. Hence, the court observed that there should be due and fair disclosure of the profits and interests to the shareholders of the company instead of the Board of directors.

In the case of Gluckstein v. Barnes[8], the House of Lords observed that such disclosure should be made to the entire body of shareholders and not selectively only to a few of them. This duty of disclosure commences after the incorporation and continues until the profits are fully accounted for.

Liabilities of Promoter

The fiduciary duty of the promoter imposes liability upon him to make full disclosure of the profits, interests, entitlements, and other relevant information, that might affect the interest of the shareholders. However, fraudulent and exploitative practices by the promoters in order to earn undue profits grappled the business environment and affected the interests of the stakeholders of the company, especially the shareholders. In order to curb this rampant malpractice, the Companies Act incorporated stringent provisions, some of which are Section 35, Section 39, and Section 300.

Section 39 enumerates the mandatory amount of minimum subscription necessary for valid allotment. The promoter should ensure that the minimum stated amount of subscription in the prospectus is subscribed by the public and a certain percentage of application money is received. Default to meet this requirement can result in a penalty to the company, its promoter, and the other officers in charge.

Section 35 imposes liability upon the promoter of the company for making misstatements in the prospectus. Section 300 empowers the Official Liquidator to order an examination of the promoter in case of discovery of fraud during the process of formation or promotion of the company, or during the conduct of its business.

Besides statutory and legislative tools, judicial pronouncements, from time to time, have also ensured transparency of the company transactions as regards the activity of business promotion and have imposed heavy liabilities upon the promoters for undertaking unfair trade practices.

Thus, the Companies Act and the other allied acts have made a sincere attempt to eliminate fraudulent malpractices in Companies Promotion.

Rights of Promoter

The promoters have the right to recover all the preliminary expenses incurred in setting up and registering the company from the board of directors. The articles of the company mention the amount to be paid to promoters. Such an amount could be paid even after the formation of the company.

In case of liability arising under Section 35 for misstatement in the prospectus, or any other fraudulent activity under any relevant provision, the promoters are held jointly and severally liable to pay such penalty. However, the promoter who pays for such liability is entitled to recover the requisite proportionate amount from other co-promoters.

The promoter is also entitled to remuneration for the services rendered in the course of incorporation and registration of the company. This remuneration could be in the form of fully or partly paid shares or any other means as such. Such paid remuneration should be mentioned in the prospectus if it is paid within two years preceding the date of issue of the prospectus.

Besides these entitlements, the promoter can also become a director or shareholder of the company, given his key position in the formation of the company. However, his role as promoter immediately terminates after the incorporation of the company and the moment he boards the company as a stakeholder.

In the case of Twycross v. Grant[9], the court observed that the functions of the promoter come to an end as soon as the latch of the company is handed over to the governing body i.e. the board of directors.

It must, however, be noted that the duty of the promoter is to make true disclosure of any undue profit accruing to him to the stakeholders. This does not entitle or restrain the promoter from making any profit, whatsoever, from the business of promotion.[10]

Conclusion

Given the ever-important role of the promoter in light of the inception and working of the company, the Companies Act 2013 lays down detailed guidelines as regards to rights, duties, and liabilities of the promoters. The promoter acts as the fiduciary agent of the company who is entrusted with the task of ensuring transparency in the business proceedings of the company, right from its very promotion to its incorporation and further, thereafter.

Breach of these fiduciary obligations results in hefty liabilities for the promoter. Thus, a promoter should seek to strike a balance between his own personal interests and the interests of the company, in order to ensure the efficiency and effectiveness of the company in long run.

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References

[1] The Companies Act 2013, Available Here

[2] 89 Va. 455 (1892)

[3] (1872) 2 C.P.D. 469

[4] (1878) LR 3 AC 1218.

[5] AIR 1969 Mad 462.

[6] (1878) LR 3AC 1218.

[7] [1896] 11 WLUK 76.

[8] 1900 AC 240.

[9] (1877) LR2 CPD 469.

[10] Omnium Electric Palaces Ltd. v. Baines (1914) 1 Ch 332

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