PROMOTERS LIABILITY UNDER COMPANIES ACT

INTRODUCTION
The formation of a company is a lengthy process. It involves several stages. The first stage in
the process of formation is the promotion. At this stage the idea of carrying on a business is
conceived by a person or by a group of persons called promoters. For incorporating a
company various formalities are required to be carried out. The promoters perform these
functions and bring the company into existence. A promoter conceptualizes the idea of a
company and the purpose of its formation. The promoter acquires and invests the initial
capital for the company. Once all the formalities are completed, the promoter hands over the
authority to the directors. A promoter may be an individual, syndicate, association, partner or
a company as well. Promotion is a term of wide import denoting the preliminary steps taken
for the purpose of registration and floatation of the company. After the incorporation of
association of persons the company comes in existence, and it can start its business
operations as company only after that. The simple reason behind it is that before
incorporation company do no has any legal existence before incorporation, and if the
‘association of persons' enters into an agreement in the name of company before
incorporation; the agreement would be void ab initio. It would be a matter of inconvenience
that ‘an association of persons' cannot perform any official business operation in the name of
company before its incorporation or the issue of certificate of commencement of business;
they may have to make arrangement for office, place of work, worker, etc. In order to do
away with these inconveniences, the promoter can enter into the agreements in the benefit of
‘association of persons' or prospective company; these agreements are known as pre-
incorporation contract. Under the strict principles of contract law, the promoter is solely
liable for the breach of contract. The reason behind is that the promoter is party who enters
into the contract, and not the company. The rule of privity of contract keeps away the
company from pre-incorporation contract.
DEFINITIONS & MEANING OF A PROMOTER:

Lord Cockburn, CJ, in Twycross v. Grant,1observed that “a promoter is a person who

undertakes to form a company with reference to a given object and to set it going and who
takes the necessary steps to accomplish that purpose”.
Another attempt was made by Bowen, L.J., in Whaley Bridge Printing Company v.
Green.2He observed that the term promoter is “a term not of law but of business”, usefully
summing up, in a single word – promotion, “a number of business operations familiar to the
commercial world by which a company is brought into existence”.
In USA, the Securities Exchange Commission Rule 405(a) defines a 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.
Sir Francis Palmer has defined Promoter as “a person who originates the scheme for the
promotion of a company, has the memorandum and articles prepared, executed and registered
and finds the first directors, settles the terms of preliminary contracts and prospectus, if any,
and makes arrangements for advertising and circulating the prospectus and paying the
capital”.
The promoter is usually an industrial expert who, with the help of a big team of experts, does
the entire preliminary work necessary before a company can be brought into existence. He
selects and settles with persons to become signatories to the memorandum and the first
directors; instructs and directs the solicitors to prepare the memorandum, the articles and
other documents necessary to be filed with the Registrar of Companies; finds funds for the
registration expenses and prepares the climate to secure the initial capital for the company.
Where to situate the registered office of the company, from where to get necessary plant and
equipment etc., are other worries of a promoter.
The term Promoter, has been defined under the Companies Act, 2013 under Section 2(69). A
promoter means a person –

1
(1877) 2 CPD 469
2
Pg. 111, [1880] 5 B.D. 109
 (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 theBoard 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 Tengku Abdullah v Mohd Latiff bin Shah Mohd,3Gopal Sri Ram JCA said: "A promoter is
one who starts off a venture-any venture-not solely for himself, but for others, but of whom,
he may be one."
Most of the definitions are in terms of categories of work that the promoters usually perform.
“A promoter is a person who brings about the incorporation and organization of a company.
He brings together the persons who become interested in the enterprise, aids in procuring
subscriptions, and sets in motion the machinery, which leads to the formation itself.”4
“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”.5 The term
therefore has no very definite meaning6. Whether a person is a promoter or not is a question
of fact in each case. Much depends upon the nature of the role played by him in the
promotion of business.
A solicitor is not a promoter7. A person may help in getting a purchaser of the company’s
patent or of shares, or in getting personnel for the company. Any such role may make him
promoter8. “A promoter is one who starts off a venture-any venture-not solely for himself,
but for others, but of whom, he may be one”9.
Promoter’s status
In Weavers Mills v. Balkis Ammal,10 it was held: “As to the exact legal status of promoters,
the statutory provisions, both in England and in this country, are silent in most parts except
for a couple of Sections in the Specific Relief Act, both old and new one. It appears that a

3
[1996] 2 MLJ 265
4
Bosher v Richmond Land Co, 89 Va 455 (16) SE 360
5
Tycross v Grant, [1877] CPD 469
6
Emma Silver Mining Co v Lewis, (1879)4 CPD 396
7
Great Wheal Polgooth Ltd, Re, (1883) 53 LJ Ch. 42.
8
Tracy v Maandalay (1952-53) 88 CLR 215
9
Tengku Abdullah v Mohd Latiff bin Shah Mohd,[1996] 2 MLJ 265
10
AIR 1969 Mad. 462
promoter is neither an agent nor a trustee of the company under incorporation but certain
fiduciary duties are imposed on him under the English Companies Act, 1948 and the Indian
Companies Act, 2013. He is not an agent because there is no principal and he is not a trustee
as there is no cestui-que-trust. It is on this ground that the doctrine of ratification by the
company was regarded as inapplicable to the actual promoter vis-à-vis the company under
incorporation.” In that case, the company after incorporation took possession of the properties
purchased by the promoters on its behalf and improved them showing that the company
adopted the promoters’ contract, and therefore, it was held that the property was of the
company’s.
Where promotion of a company begins and ends are all questions of fact. For being
considered as a promoter, a person need not necessarily be the one associated with the initial
formation of the company, and the association could be at a much later stage when another
person is arranged to be a director, or when the actual capital is raised by way of placement
of shares, or the preliminary agreements are negotiated.

From a common sense point of view, this area continues to remain as a deficiency in
Company Law: the statute is silent on who a ‘promoter’ is, except in connection with civil
liability for misstatements in a prospectus that arises with respect to public companies; and
the Courts have pronounced about their nature, position and duties, not necessarily with
respect to public companies, only to go back to them, in the few cases that they do. No doubt,
it puts a fear in the minds of the promoters to steer clear of being caught, but the overall
picture is far from being clear, generally, it is understood though that those are the persons
who promote their own rather than the interests of the companies they help create and remain
suspiciously elusive.

TYPES OF PROMOTERS11

1. Professional Promoters:
They are experts who specialize in company promotion. They float the company and hand it
over to the shareholders or their representatives. Promotion is their main profession or
occupation.
2. Occasional Promoters

11
Company Law and Practices – by D.P Mittal 2nd Edition
There promoters take interest in floating some companies. They are not engaged in promotion
work on a regular basis. They take up the promotion of some company and once it is over
they go to their original profession. For instance, engineers, etc. may float some companies.
3. Entrepreneur Promoters
They are both promoters and entrepreneurs. They conceive idea of a new business unit, do
the groundwork to establish it and subsequently become a part of the management.
4. Financer Promoters
Some financial institutions, like investment banks or industrial banks, may take up the
promotion of a company with a view to finding opportunities for investment.

STAGES OF PROMOTION12

1. Discovery of business.
The first stage in company promotion is the conception of a new idea. It is the promoter who
conceives the idea of setting up a business. If makes an assessment of the viability of a
particular business.
2. Detailed investigation.
Promoters undertake a detailed investigation of the viability, profitability and future prospects
of the growth of the proposed activity. To assist then in this venture, they seek the help of
specialists such as chartered Accountants, Cost Accountants, Company Secretary, Engineers.
Organizations engaged in market research and other specialized agencies. Specialists are in a
position to make an objective analysis of their own areas which may help the promoters.
Decisions have to be taken regarding the size, location, layout, man power etc.
3. Assembling the factors of production
If the proposed endeavor gives promise of success and the promoter is willing to undertake
the risk of forming the business, steps must be taken to assemble various factors of
production viz, land, labour, capital and managerial personnel. Assembly of resources
involves making contracts for the purchase of material, land, machinery, etc.
4. Entering into preliminary contracts
The promoter enters into contracts with different parties before the registration of the
company. After registration, the company approves these contracts.

LIABILITIES OF A PROMOTER:

12
Guide to Companies Act- by A. Ramaya 15th Edition 2001
COMMENCEMENT OF A PROMOTER’S LIABILITY –
The promoters are liable for only those acts which are purported to have been done for the
company which they intend to float. Their liability commences only after they have started
functioning as promoters and not for earlier acts. This principle has been laid down in the
English case of Ladywell Mining Co. v. Brooks.13 In this case, five persons purchased a mine
for £5,000 with the intention of selling it to a company which was under formation. None of
these persons were participating in the formation of the company at the time of the purchase
and, therefore, had no involvement in the promotion of the company. They sold the mine to
the trustees of the company which was under formation under a contract for £18,000. The
contract was ratified by the company after its incorporation. Four of these five persons later
became the directors of that company. The company therefore sued them for the recovery of
non-disclosed secret profit of £3,000. The Court held that the defendants were not the
promoters of the company at the time of the initial purchase of the mine as they were not
involved in the formation of the company. The Court ruled that the liability of promoters
commences as soon as they have set out for the promotion of the company and it doesn’t
extend to any of their earlier acts.
RELATIONSHIP WITH THE COMPANY
Relationship between a company and a promoter is fiduciary .He is bound to disclose all the
accounts and other contracts he entered into before incorporation of the company to an
independent and competent board of directors so that he may be held accountable for any ill
gained profits and may be held accountable for them before the board. The following are
some of the fiduciary duties that the Courts will insist that a Company promoter has to
observe.
1. Top of the list is not to make a secret profit at the expense of the company
2. A duty to account to the company for the benefit for any property he might Purchase with the
intent of selling the property to Company for a profit later.
3. A duty not to defraud the Company by active concealment of any affairs relating to the
company
4. A duty not to disclose confidential information to outsiders
5. A duty not to hide his personal interests through a nominee.
A Promoter is in a fiduciary relationship with the Company he promotes and as such he owes
fiduciary duties towards it. This means that he is in a position of trust and must at all time act
honestly and in good faith for the Company as a whole. However, the most important aspect

13
35 Ch D 400
of his duty is not to make a secret profit at the expense of the Company. In the case of
Fairview Schools Sdn. Bhd v Indrani14 Mahadev Shanker JCA said, “Promoters have a legal
duty not to make a secret profit out of the promotion of the Company without the Company's
consent and also to disclose to the Company any interests the promoters have in any
transaction proposed to be entered into by the Company”.
There are many cases where Promoters did not remain true to their fiduciary duties. The
bottom-line requirement from Promoters is that they must be transparent in their dealings
with the Company.
There are three remedies in situations where the Promoters have breached the Fiduciary
Duties.
1. RESCISSION
If the Company has entered into a Contract with the promoter and it is later discovered there
had been no transparency, the Company is entitled to rescind the contract. It is irrelevant that
the promoter has made no profit from the contract.S17 Contracts Act states that non-
disclosure amounts to a fraud and by Sect 19 the Contract becomes voidable.
Under Sec 34(1) Specific relief Act 1950 the Company can apply to the Court to rescinded
the contract. Once the contract is rescinded, restitution has to take place. This is where the
Company has to return whatever it received from the Promoter and the Promoter has to return
all monies received from the company.
Erlanger v New Sombrero Phosphate Co15 in this case, Erlanger bought an island containing
phospates for 55,000 pounds. Later, Erlanger promoted a Company and sold the property to it
for 110,000 pounds. All the Directors of that Company were nominees of Erlanger and two of
them were directly under his control. Later the old board was replaced by a new board which
brought an action to rescind the contract with Erlanger.
The Court held that there had been no adequate disclosure of the circumstances of the sale
and the Company was entitled to rescind the contract.
2. RECOVERY OF THE SECRET PROFIT
Gluckstein vs Barnes16 in this case the Defendants bought debentures cheaply in a Company
at a time when the Company was faring very badly. Later they bought over the Company for
140,000 pounds. The debentures were redeemed at full value and they made a good profit.
Here they made a profit of 20,000 pounds. Later still, they formed another company and sold

14
[1998] 1 MLJ 110
15
(1878) 3 App Cas 1218
16
[1900] AC 240
the Company to a new Company at a profit of 40,000 pounds. This profit was disclosed in the
prospectus but not the amount of profit they made on the redemption of the debentures.
(20,000 pounds)
The Court held that there were in breach of their duties as promoters and the Company was
entitled to recover the profit from them. The Company can recover the secret profit even
though they chose not to rescind the contract. The liability of the promoters is “joint or
several”. A Promoter who is found liable may recover contributions from the other
promoters.
3. DAMAGES FOR BREACH OF FIDUCIARY DUTIES.
In the case of Re Leeds & Hanley Theatres of Varieties ltd 17 the Court ordered the Promoter
to pay damages to the Company. The Court held that the Promoters had fraudulently omitted
to disclose the profit made by them on the sale of the property to the Company. The amount
of damages was equivalent to the amount of profit made by the promoters.
LIABLITY FOR PRE INCORPORATION CONTRACTS
Generally under common law, if a promoter entered into a contract before the incorporation
of the company for the company, the promoter will be held personally responsible for the
contract. This rule was laid down on the concept that, a company cannot be held liable for an
act done before its coming into existence. However today there are many exceptions to his
rule under Indian law, American law and the English law (to a very little extent).
a) Comparison of laws
Although under the English Common Law, the American law and the Indian Law recognize
the rule that promoter is personally liable for pre-incorporation contract, American Laws and
Indian laws are much more innovative and effective to solve the problem of Pre-
incorporation Contract. Whereas the English Courts still follow the principle of Kelner v.
Baxter18. Although in UK, Contracts (Rights of Third Parties) Act 1999 brought some relief,
but it is not as broad as the American and Indian Laws are.
Under English Common Law, the ratification or adoption, after the incorporation, did not
release the promoter from liability of pre-incorporation contract. Whereas in American Court
recognize that if the after the incorporation company can ratify or adopt the contract, and this
would bound the company and not the promoter. Indian Law the rule of Kelner v Baxter19 is
applicable but under the Specific Relief Act 1963, section 15(h) and 19(e) promoter can shift

17
[1902] 2 Ch 809. 210
18
(1866) LR 2 CP 174
19
Ibid
his right and responsibility to the company, if it is warranted by the terms of incorporation.
The principle of novation of pre-incorporation contract is applicable in above three counties,
the reason behind is that, the novation replace the old contract with the new contract, so there
is not problem of non-existence of company. Now after the Contracts (Rights of Third
Parties) Act 1999, English laws may also allow company to become the part of pre-
incorporation contract, when it acquire its legal existence.

REWARDS
For the efforts put in by the promoters in promoting the company, the promoters may be
rewarded in the following ways:
 The company may to pay some remuneration for the services rendered.
 The promoter may make profits on transactions entered by him with the company after
making full disclosure to the company and its members.
 The promoter may sell his property for fully paid shares in the company after making full
disclosures.
 The promoter may be given an option to buy further shares in the company.
 The promoter may be given commission on shares sold.
 The articles of the Company may provide for fixed sum to be paid by the company to him.
However, such provision has no legal effect and the promoter cannot sue to enforce it but if
the company makes such payment, it cannot recover it back.

INDIAN LAW (Under 1956 Act)

The Indian law i.e., the Companies Act 1956 does not define a promoter. It mentions only the
liabilities of a promoter. Sections 56, 62, 63, 203, 478, 542 and schedule II of the Act speak
about promoters.
1. Section 56 lays down matters to be stated and reports to be set out in the prospectus. He may
be held liable for the non-compliance of the provisions of this section.
2. Under section 62, a promoter is 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.
3. Besides civil liability, the promoters are criminally liable under section 63 for the issue of
prospectus containing untrue statements. Section 68 imposes severe penalty on promoters
who make untrue and deceptive statements in a prospectus with a view to obtaining capital.
 4. Section 478 says that a promoter may be liable to public examination like any other director
or officer of the company if the court so directs on a liquidators report alleging fraud in the
promotion or formation of the company.
5. A 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.
6. If any promoter is found to be involved in an activity which amount to an offence regarding
promotion, management or formation of a company, the court can bar such a promoter from
taking part in the administration of the company for five years-Section 203.
7. In the course of winding up a company, if it appears that any business of the company has
been carried on with an intention of defrauding the creditors, the court can declare those
people who were knowingly parties to the carrying of that business shall be personally liable
– Section 542.

a) Specific Relief Act 1963

There is some scope for the promoter to shift his liability to company in a pre- incorporated
contract. He can shift to company his liability under the Specific Relief Act 1963 or he can go
for novation under contract law.
Under the Specific Relief Act 1963, section 15(h) and 19(e) are the two important sections
for pre-incorporation contract. Section 15 is about stranger's right to sue if he entitled to a
benefit or has any interest under the contract, although it has certain limitation. Section 15(h)
talks about the company, being a stranger to pre-incorporation contract, has the right to sue to
the other contracting party.
But the necessary condition is that the contract should be warranted by the terms of its
incorporation. This provision clearly negates the common law doctrine, which says that the
company cannot ratify or adopt the pre-incorporation contract. Under this provision promoter
can give his right to sue to sue to the company.
Section 19(e) states that the company can be sued by the other party of pre-incorporation
contract, if the terms of incorporation warrant and adopt the contract. This provision reduces
the promoter of liability of pre-incorporation contract.

b) Novation Of Contract
In the situation of Novation of Contract, the Company can replace the promoter from the pre-
incorporation contract. But one might say that such contract would not be called pre-
incorporation contract, but it should be called post-incorporation contract; because novation
of contract result into a new contract.

ENGLISH LAW
The word promoter is not defined under the English law also. Sec 43, 51 of the Companies
Act, 2006 talks about promoters. They talk about execution and pre incorporation contracts
respectively. According to Chitty on Contract, even in equity the company cannot be held
liable for pre-incorporation contract. Generally, any person who plays a major part in forming
a company or establishing its business (usually the prospective owners or directors of the
company). Where any trading takes place on behalf of the company, before the certificate of
incorporation is issued, any person who purports to act for or as agent of a company before
the company has been formed will be personally liable for any contract they make on behalf
of the company (section 51, Companies Act 2006).
Before the formation and registration of the company, it is not a person in the eye of law, and
because it is an artificial person even after it comes into being, it cannot act otherwise than
through some human agent acting for and on its behalf; and, when it is not in existence in
law, it can have no agent to accept on its behalf any proposals for transactions in the nature of
agreements brought up by the promoter or others. Therefore, if the promoter accepts any
proposals connected with the company under formation though from third parties, it is only
the promoter who is bound but not the company even after ratification of the contracts on its
registration, and no suit lies against the company on the strength of such agreements, nor can
the company enforce such contracts for its benefit.

Some persons, who became directors of the company after its registration, gave instructions
to the Solicitors to prepare the memorandum and articles of association and to register that
very company, which the Solicitors did paying the registration fee from their pocket. In a suit
for the recovery of their costs laid against the company by the Solicitors, it was held that the
company was not liable, Re English & Colonial Produce Co. Ltd.20. It is so because, “where a
contract is signed by one who professes to be signing ‘as agent’, but has no principal existing,
at the time, and the contract would be inoperative unless binding on the person who signed it,
he is bound thereby; and a stranger cannot by a subsequent ratification relieve him from that

20
(1906) 2 Ch 435 (CA)
responsibility.” Kelner v. Baxter.21 In that case, three persons signed a contract on behalf of a
hotel company under formation for purchase of 900 sterling worth of wine. The company was
formed and the wine was delivered to it and consumed, but the company was put to
liquidation before the payment. It was held that the three persons who signed the contract
were liable and no ratification could release them.
“A company cannot by adoption or ratification obtain the benefit of a contract purporting to
have been made on its behalf before the company came into existence”.-Natal Land &
Colonisation Co. v. Pauline Colliery Syndicate22

When the promoter signed the contract in the name of the unborn company adding his own
name to it, it was held “This Company was not in existence and….the signature on that
document, and indeed the document itself….is a nullity.”-Newborne v. Sensolid (Great
Britain) Ltd23. Simply signing the contract ‘per pro’ or ‘for and on behalf of’ the proposed
company does not make the person signing thus an agent and it depends upon the intendment
and purport evident in the contract, Phonogram Ltd. v. Lane.24

U.S LAW

According to Securities Exchange Commission Rule 405(a) a promoter is a person who,

acting alone or in conjunction with another person directly or indirectly takes the initiative in
founding or organizing the business enterprise. Delaware General Corporation Law
(Delaware Code 1956 amended), Ch. 339 section 101(6) – Promoters contract-corporations
can adopt contracts made by promoters for its benefit, although such contract antedates
corporation’s existence25. Sec 101(7) Promoters liabilities-Promoters must account to secret
profits obtained at its expense and surrender for cancellation of shares representing secret
profits26.

SEBI GUIDELINES
Promoter in public offers

21
(1866) LR 2 CP 174 at 183
22
(1904) AC 120.
23
(1954) 1 QB 45
24
(1982) QB 938 at 945.
25
Commissioner of Lewes v Breakwater Fisheries Co. 117 A 823 (Ch Ct 1922)
26
RE Bribeck v Am Toll Bridge Co Cal A2d 158 (Ch Ct 1938)
Under Chapter IV of SEBI (Disclosure & Investor Protection) Guidelines, 2000, in a public
issue by unlisted companies or offers for sale or public issues by listed companies (unless the
company is listed for 3 years or more with dividend payment record for those years), the
promoter shall contribute not less than 20% of the post-issue capital, subject to a lock-in
period of 3 years from the date of allotment. In case of infringement, it appears that the
promoter is liable to be directed by SEBI to refund any money collected under an issue to the
investors with or without requisite interest as the case may be and also being liable to be
slapped with a ban to access the capital market for the specified particular period under para
17.1 (a) and (b) of SEBI (Disclosure & Investor Protection) Guidelines, 2000. Besides, the
company and its concerned officers in charge at the time the offence is committed shall be
deemed to be guilty of the offence attracting imposition of penalty by the Adjudicating
Officer (Divisional Chief of SEBI nominated by SEBI) upto Rs. 5 lakhs, if it involves
implications of insider trading in terms of Section 15G of SEBI Act, 1992, as well as the
award of fine and imprisonment for persons upto one year with or without fine under Section
24 of the Act, on a complaint filed by SEBI in the Court having jurisdiction.

CONCLUSION
Hence, it’s very clear that, for a company to prosper and develop, establishment is just not
enough. Its promotion is also equally important. The promotion of the company should be
done in such a way as to benefit the company. But that does not mean than the company
members of promoters falsify facts with a mala fide intention of securing investments in the
company. A promoter of a company holds a very prime position in the company and is
expected to be in a fiduciary relationship with the company. He must be extremely honest and
loyal the company and must work for the profits of the company pushing aside his personal
profits with company money. For any development made to the company, he can be rewarded
by the company and for any default activities, he can be made liable for those activities and
his contract can be rescinded. In the case of Pre-incorporated contracts, he is personally liable
for all those contracts entered into on behalf of the company without its knowledge and not
ratified later by the company.
Therefore a promoter is a key player in the game of corporate business whose every step is
counted as a lifeline of the company and every bad move can collapse the entire edifice of the
company or him personally.