PROMOTION AND INCORPORATION OF COMPANIES

PART I - PROMOTERS
COMPANY LAW
CS EXECUTIVE PROGRAMME

CS NEERAJ VASUDEVAN
 Promotion and formation of Companies
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Incorporation is the process whereby a Company is brought into

existence in the eyes of law. The first step to form a Company is to
known as promotion whereby the persons who are willing to form the
Company comes together to contribute money in the form of capital and
to do all acts required to bring the Company into existence.

Chapter II of the Companies Act, 2013 is ‘Incorporation of Company and

matters incidental thereto’, which contains Sections 3 to 22. The
prescribed Rules of the Chapter II is called Companies (Incorporation)
Rules, 2014.

Incorporation of Companies

Chapter II Companies (Incorporation) Rules, 2014

Section 3 to 22 39 Rules

Promoters
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1. Promoters are persons who conceive the idea of forming a

company and take the necessary steps to incorporate it by
registration, provide it with share and loan capital and acquire for it
business or property, which it is to manage.
 2. The relationship between the promoter and the company that he
has floated is a fiduciary relationship (Re: Erlanger v. New
Sombrero Phosphate Co.) from the day on which he started the
work of floating and it continues till he hands over the same to the
directors.

Fiduciary – An individual in whom another has placed the utmost trust and confidence to
manage and protect property or money. It is derived from the Latin word FIDUCIA
meaning TRUST. Eg : Attorney, Broker, Guardian etc

Definition of a Promoter under Companies Act, 2013

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The definition of a Promoter is newly introduced in the Companies Act,

2013. Section 2(69) of the Act defines a Promoter as –

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

(i) the person or persons who are in control of the issuer;

(ii) the person or persons who are instrumental in the

formulation of a plan or programme pursuant to which
specified securities are offered to public;

(iii) the person or persons named in the offer document as

promoters.

Lydney and Wigpool Iron Ore Co. v. Bird

A person who merely acts in a professional capacity on behalf of
the promoters such as a solicitor or an accountant and who is paid
is not a promoter.

Legal position of a Promoter

AGENT TRUSTEE FIDUCIARY

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.

Duties and Liabilities of Promoters

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Duties :

1) Promoters being in a fiduciary position 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 if he makes profit in disregard to this rule, the Company can
compel him to account for it.

KNOWLEDGE + CONSENT
2) Promoters are not allowed to derive a profit from the sale of his
own property to the Company unless all material facts are
disclosed.

DISCLOSURE

3) If a promoter makes a secret profit or does not disclose any profit,

the Company has remedy against him. Secret profit may be made
by purchasing property or business himself and selling it to the
Company at higher price. The difference between the two price
amounts to secret profits, if he promotes the Company at the time
he buys the property or business.

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 he fails to disclose this fact, the
company is entitled either to rescind the contract or claim
damages for breach of duty of disclosure.

Where the promoter was in fiduciary position when he acquired

the property and when he sold it to the company.

(a) 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

Note _________________________________________________________________
 b) 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, the promoter bought the property with a view to sell it to

the company he promotes, the company may either—

(a) rescind the contract and if he has made a profit on some ancillary
transaction that may also be recovered; or

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(b) retain the property, paying no more for it than what the promoter has
paid, depriving him of his profit; or

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(c) 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.
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Promoters’ duties under Indian Contract Act, 1872
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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.

Ratification of Promoters’ Contract

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As regards ratification of promoters’ contracts, the view taken in Kelner v.

Baxter 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.
 Termination of Promoters’ duties
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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, and the Board takes over the management of the
affairs of the company from the promoters.

Rights of Promoters
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Right to receive
Right to recover Preliminary Expenses.
proportionate amount A promoter has no legal right
from the Co-promoters to claim promotional
expenses for his services
The promoters are held unless there is a valid
jointly and severally liable contract.
for the secret profits made by Without such a contract he is
them in the formation of a not even entitled to recover
company. Therefore if the his preliminary expenses
entire amount of secret The promoters are entitled to
profits is paid to the receive all the expenses
company by a single incurred for in setting up and
promoter, he is registering the company,
entitled to recover the from Board of Directors. The
proportionate amount from articles will have provision
co-promoters. Likewise, if for payment of preliminary
the entire liability arising out expenses to the
of mis-statement in the promoters.
prospectus is borne by one of
the promoters; he is entitled
to recover proportionately
from the co-promoters.
Remuneration of Promoters
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A Promoter must be remunerated for the initiative and effort taken by

him as he puts into starting an enterprise and makes it a going concern.
However he has not right to get compensated from the Company unless
there is a contract to that effect. In fact, the Promoters take
remuneration for his services in the following ways:-

1) The Promoter sells his own properties to the Company for cash or
fully paid up shares at profit, provided that he makes full
disclosures to that effect.
2) He has the option to buy certain number of shares of the Company
at par.
3) He may be given the commission on the shares sold.
4) The Promoters may be given lump sum amount by the Company.

1) P, Q, R and S developed a business plan. To implement the

plan, it was decided that P and Q will incorporate the
Company and R who is a Chartered Accountant will give
professional services to them for the same. It was also
decided that S will provide loan to the Company. The loan to
be given by S was essential to start the business of the
Company. Out of P, Q, R and S, who shall be regarded as
promoters of the Company?