Table of Contents
When any individual comes up with the idea to start a new business venture, he or she may set out to persuade others to contribute capital in a company which is to be incorporated for the purpose of carrying on the venture. The individual will then be described as ‘promoter’ of the company. Thus, a 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. However, any person who acts in a professional capacity is not a promoter.
Promotion is a term of wide import denoting the preliminary steps taken for the purpose of registration and flotation of the company. A promoter may be an individual, syndicate, association, partner or company.
Meaning & Definition
A promoter is generally a person 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. Promoter is “a term not of law but of business”.
To be a promoter one need not necessarily be associated with the initial formation of the company; one who subsequently helps to arrange floating of its capital will equally be regarded as a promoter.
The expression ‘Promoter’ has been defined under Section 2(69) in the Companies Act, 2013 as: “promoter” means a person—
- Who has been included in company’s prospectus or is identified by the company in the annual return referred to in section 92;
- Who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise;
- 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 the case of Bosher v. Richmond Land Co., the term Promoter has been defined as:
“Any 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 subscription, and sets in motion the machinery which leads to the formation itself.”
According to SEBI guidelines, a promoter is:
- Any person who is in control of the target company,
- Any person named as promoter in any offer document of the target company or any shareholding pattern filed by the target company with the stock exchanges pursuant to the listing agreement, whichever is later.
In Twycross v. Grant promoter was described as ‘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.’
Essential Characteristics Of A Promoter
There are numerous characteristics of a promoter of an enterprise. A few important ones are noted below:
- The seed of starting a business emerges inside the mind of a promoter.
- He conducts preliminary inquiries and research concerning the viability and future prospects of an enterprise.
- A promoter of a company may be a person or a set of individuals who come collectively for achieving a specific purpose.
- The documentation and different incorporation formalities are conducted by way of the promoter.
- The promoter is required to raise funds for all the vital affairs of the company.
Whether Ratification Is Necessary in a Contract made by a Promoter?
Disclosure by promoters to the company should be through the medium of the Board of Directors. As regards ratification of promoters‘ contracts, the view taken in Kelner v. Baxter LR (1886), 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 & 19 of the Specific Relief 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.
In D.R. Patil v. A.S. Dimilov AIR 1961, 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.
Liabilities Of Promoters
A promoter is subject to the following liabilities under the various provisions of the Companies Act, 1956.
Liability For Non- Compliance
According to Section 56 and Schedule II of the Act which lays down matters to be stated and reports to be set out in the prospectus. The promoters may be held liable for the non-compliance of the provisions of this Section.
Liability For False Statement
Section 62, says that promoter can be held liable for any untrue statement in the prospectus to a person who has subscribed for any shares or debentures on the faith of the prospectus. Such a person may sue the promoter for compensation for any loss or damage sustained by him. In the event of a false statement in the prospectus the following consequences will follow:
- The allotment of the shares may be set aside;
- The promoter may be sued for damages;
- He may be sued for compensation for misrepresentation under Section 62(1)(c) of the Act;
- He may be sued for damages by shareholders who have suffered by reason of his non-compliance with the statutory requirements as to the contents of the prospectus;
- He may become liable to criminal proceedings.
By virtue of Section 203, of the Companies Act, 1956 the Court may suspend a promoter from taking part in the management of a company for a period of 5 years if:
- He is convicted of any offense in connection with the promotion, formation or management of a company; or
- In liquidation, if it appears that he has been guilty of any offense for which he is punishable (whether he has been convicted or not) under Section 542; or while being an officer of the company, has otherwise been guilty of any fraud or misfeasance in relation to the company or of any breach of his duty to the company.
The promoters are criminally liable under Section 63 for the issue of prospectus containing untrue statements. Section 63 imposes severe penalty on promoters who make untrue and deceptive statements in prospectus with a view to obtaining capital. The punishment prescribed, is imprisonment for a term which may extend to two years or with fine which may extend to Rs. 50,000/- or with both.
Liability For Fraud
According to Section 478, a promoter may be liable to public examination like any other director or officer of the company if the court so directs on a liquidator’s report alleging fraud in the promotion or formation of the company.
Liability For Deceit
The company may proceed against a promoter on action for deceit or breach of duty under Section 543, where the promoter has misapplied or retained any property of the company or is guilty of misfeasance or breach of trust in relation to the company.
Liability For 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. 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.
Liability in case of representation true only at time of issue
When representations which were true when the prospectus was issued, become false before the allotment is made. In such cases, 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.
Duties of Promoter & Its Termination
The promoters occupy an important position and have wide powers relating to the formation of a company. The Relationship between the promoter and the company is neither as an agent nor of a trustee, he stands in a fiduciary relation with the company. The Companies Act, 1956, contains no provisions regarding the duties of promoters. But there are following major duties of the promoter which are as follows;
Duty to disclose secret gains
A promoter cannot make either directly or indirectly, any profit at the expense of the company, without the prior knowledge and consent of the company. 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.
In the case Gluckstein v. Barnes, (1900), it was held that if a promoter makes some secret profits in connection with a transaction to which the company is a party and does not make full disclosure of his profits, then the company has the right to affirm the contracts and the promoter should return the profits to the company.
Hence, a promoter is allowed to make a profit out of a promotion but with the consent of the company.
Duty To Disclose
A promoter is not allowed to derive any 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 rescind the sale or affirm the contract and recover the profit made out of it by the promoter.
In the case of Erlanger v. New Sombrero Phosphate Co, 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. Thus, if the promoter wishes to sell his own property to the company, he should either disclose the fact.’
Duty To Act in Company’s Interest
Promoters must aim to prioritize the company’s interest over their personal interests. They must give utmost consideration to the company’s best interest in its formation and all business dealings.
Duty in Regard to Prospectus
It Is the duty of the promoter to provide right and factual Information in a company’s prospectus. Section 62(1) of the Act provides that a promoter is liable to pay compensation to every person who subscribes to the faith of the prospectus for any loss or damage sustained by them due to any untrue statements in the same.
Duties of The Promoter under the Indian Contract Act
Under contract act, the duties of a promoter cannot depend on a contract because at the time the promotion begins, the company is not incorporated, and so cannot contract with its promoters. Thus, the promoter’s duties must be the same as an ordinary person, who acts on behalf of another without a contract of employment, namely, to shun from deception and to exercise reasonable skill and care.
Termination of Promoters Duties
The duties of a promoter do not come to end after the incorporation of the company, or even when Board Of Directors are appointed. Their duties continue until the company has acquired the property or business which it was formed to manage, it has raised its initial share capital and the Board of directors has taken over the management of the company’s affairs from the promoters. When these things have been done, the promoter’s fiduciary and contractual duty ceases.
Compensation & Remuneration of Promoters
It is now undisputed that the promoter performs a valuable service in the field of corporate finance. Possessed with a peculiar knowledge of industrial affairs he is able to judge with a fair degree of accuracy the potential possibilities of a proposed venture. However, the problem regarding the compensation and remuneration of promoters has long perplexed the courts.
The various questions that arise before the courts are—
- How may this compensation be made legally?
- Under what plan may he be compensated, and what assurance is there that the selected arrangement will not be upset by the courts?
The method generally adopted has been one of awarding compensation by giving the promoter an interest in the corporation, either by way of par value stock, no par value stock, or stock purchase warrants. And this is where the parties run afoul of the law.
In the case of New Sombrero P Co. Vs Erlanger, the courts observed that the controversies concerning the compensation of promoters have arisen not so much because of the use of the methods outlined, but because of the abuse of these methods. The court held that, “The burden of showing that the method of his compensation has in no way prejudiced the rights of stockholders or creditors has come to rest upon the promoter.”
It also observed that, ‘No problem arises where the promoter, acting at arm’s length, has made a truthful and complete disclosure of the facts of incorporation, and where an independent board of directors or all of the stockholders with full knowledge of these facts and without collusion have ratified the method of compensation.’
In case of Remuneration, unless a contract is in force, the promoters of the company are not entitled to reimbursement of marketing expenses for their services. They do not have the right to recover even their preliminary expenses without such a contract.
However, recovery of preliminary expenses and registration fees does not normally present any difficulty. When a promoter makes proper disclosure, he may expect to be rewarded for his efforts.
Therefore, when the company is registered, it may (and usually does) pay or agree to pay some remuneration for services rendered.
In Touche vs. Metropolitan Railway Warehousing Company , it was held that the provision in the Articles does not impose any legal obligation on the company towards the promoters but as they or their nominees will usually be the first directors of the company, there is little risk of the power being not exercised in their favor.
In practice, a promoter is remunerated in any of the following ways:
- He may sell his own property to the company for cash or against fully paid shares in the company at an over valuation after making full disclosure to a disinterested Board of directors or to the intended shareholders.
- He may be given an option to buy further shares in the company at par.
- He may take commission on the shares sold.
- He may take a grant of some shares in the company.
- He may be paid a lump-sum by the company.
Promoters play a very important role in developing a business. The fortunes of the promoter are directly linked with the fortunes of the corporation. During the 19th century, when the industrial revolution came and the companies flourished, the concept of promoter gained substantial importance like no other occupation, as there were no restrictions on advertising immediately to the public, inviting them to take shares in new companies. However, the eminence of a promoter is generally terminated when the Board of Directors has been formed and they start governing the company. Technically, the first persons who control the company’s affairs are its Promoters.