HIMACHAL PRADESH NATIONAL LAW UNIVERSITY, SHIMLA

COMPANY LAW

Critical study of the Position of Promoters in a Company and

their Rights, Liabilities and Duties

Submitted by: Submitted to:

Rajat Chauhan Dr. Pushpanjali Sood

1120202121
BBA LLB
(Fifth Semester)
 ACKNOWLEDGEMENT

I would like to express my gratitude to my project guide Dr Pushpanjali of the Himachal

Pradesh National Law University, Shimla for firstly providing me with this opportunity and
secondly for being there and providing the help required for the completion of this project. I
would also like to extend my gratitude to my University and our Assistant Librarian Mr Arun
Kumar for providing us access to the E-Library and other necessary resources.
 Introduction

In the chronological order of the company incorporation procedure, the promoter is the first
individual. The diversity of actions that go into corporate promotion make it a demanding and
time-consuming task. Promoters for the business are like the parents who give birth to the
business like a child. An idea's creation, incorporation, flotation, and commercial launch are
all examples of promotion. Promoters play a significant role in the incorporation process and
go above and beyond to create a company. The creation of the company requires integrated
teamwork from numerous individuals under the direction of the promoters. This effort is
related to compliance with laws, regulators, and authorities. A firm is a way of conducting
business that is managed with the goal of maximising profit. The mode of operation that
businessmen opt for from a sole proprietorship, Hindu Undivided Family, firm, Limited
Liability Partnership, and Company determines entrepreneurship. Because of a company's
distinct legal existence, restricted liability, wealth management, and corporate finance, we
know that it is the most appropriate legal entity for conducting business and commerce.
Although we are aware that we have a basic right to engage in commerce, which entails a
fundamental right to establish a corporation as well, the law must be enforced whenever
promotion is used for illegal purposes, when promotion scams are carried out, or when a
position is improperly employed.

Promotion & Promoters

The challenge of company promotion is hydra-headed. Creating a business is typically

considered promotion. Promotion in India is often carried out by self-employed people, or
"occasional promoters." In the promotion of private companies, the intended promoters first
sign a "Prior Agreement" outlining the terms and conditions and the manner in which they
wish to establish a company. Subsequently, after incorporation, they sign a "Promoters'
Agreement" in which they detail their contributions in terms of capital pooling. Public
financial institutions like LIC, FCI, IFCI, ICICI, and IDBI encourage entrepreneurs in public
corporations by acting as "institutional promoters" for government enterprises. Major
corporations that are the shareholders typically encourage big public enterprises. In the west,
"professional promoters"—especially investment firms like Goldman Sachs, Bank of
America, Morgan Stanley, Merrill Lynch, Citigroup, UBS, and Deutsche Bank—work to
professionally publicise businesses.

Definition of Promoter

Although it wasn't specified in the Companies Act of 1956, the term "promoter" was
regularly used in a number of sections, including sections 56, 62, 69, 76, 478, and 519. While
defining the phrase "promotion" in Whaley Bridge Co. v. Green, Bowell LJ concluded that it
is not a term of law but rather a term of business operations recognisable to the commercial
world, by which a corporation is typically brought into existence. Promotion encompasses a
broad range of economic activities, both technical and non-technical in nature. Project
planning, feasibility analysis, seeking out technical partnership and cooperation, and
locational research are among the technical. The necessary number of signatories must be
gathered, different legal requirements must be ascertained, and crucial individuals such
business lawyers who prepare papers and sign various pre-incorporation contracts must be
appointed. These are non-technical activities.
Promoters are also mentioned in the SEBI (Substantial Acquisition of Shares & Takeover)
Regulation of 1997. A promoter is described as "a person operating alone or in concert with
other persons directly or indirectly takes the initiative in starting or organising the
commercial enterprise" under Securities Exchange Commission Rule of US405(a).

Definition of Promoter in Companies Act, 2013

The term "promoter" was recently defined in section 2(69) of the Companies Act 2013 as
follows: "Promoter" means a person who is (a) identified by the company in the annual return
referred to in section 92 or named as such in a prospectus; (b) has control over the affairs of
the company, directly or indirectly, whether as a shareholder, director, or otherwise; or (c) on
whose advice, directions, or instructions the Board of Directors of the company acts.
With the caveat that a person acting solely in a professional capacity is exempt from the
provisions of subsection (c).

This definition is the consequence of numerous SEBI rules and court rulings. According to
this definition, a person is a promoter of a company if their name appears on the prospectus
or annual report as a promoter, if they directly or indirectly control the firm's operations as a
shareholder or director, or if they retain power over the Board of Directors. Promoter status is
not permitted for those working for the company in a professional capacity, such as corporate
secretaries, attorneys, merchant bankers, lead managers, etc.

After reading all of these definitions, it is reasonable to assume that promoters are essential to
the establishment of the company. They gather the necessary number of subscribers, prepare
the company's memorandum and articles, apply for incorporation, arrange capital through an
initial public offering (IPO), a private placement, public deposits and debentures, and
external commercial borrowings, appoint the company's first director, establish a registered
office and corporate office, and sign all pre-incorporation agreements on the company's
behalf that are necessary to make production feasible, such as purchasing land for a
manufacturing facility or signing technical agreements.Promoters are capable of carrying out
all such actions in order to locate an enterprise that is warranted by incorporation terms, and
they possess great capabilities to do so.
They are typically the individuals involved in the conceptualization and planning phases of
the company's early stages. It is a reality that someone can be a promoter or not. No
unresolved insolvent may serve as a promoter. Both natural and legal individuals can act as
promoters. A person who offers technical support or help in exchange for cash to someone
engaged in the aforementioned activities is not a promoter.
Promoters’ Activities

A promoter does a range of activities comprising the following:

i. Conceiving the scheme of forming co./suitable company for the business
ii. Assembling the required number of subscribers;
iii. Applying for Corporate Identity Number (CIN), Global Location Number (GLN) &
PAN/TAN to relevant authorities;
iv. Getting documents of the company i.e Articles and Memorandum prepared, executed and
registered;
v. Finding bankers, brokers and legal advisors;
vi. Preparation and circulation of prospectus;
vii. Raising capital via Initial Public Offering (IPO), private placement, debenture or public
deposits or external commercial borrowing;
viii. Vetting and due compliance with laws and regulations relating to corporate financing and
disclosures via annual and periodic returns to Registrar of Companies, Regional Directors,
SEBI, Ministry of Corporate Affairs, Foreign Investment Promotion Board, Serious Fraud
Investigation Office and Reserve Bank of India.
ix. Settling the terms and conditions of pre-incorporation agreements.

Legal Position of Promoters

What is the legal standing of the promoters in the firm, given their significant involvement in the
incorporation of the company? Promoters are not agents since, prior to incorporation, there is no
principal because, in the eyes of the law, the company is non-est (does not exist). As the firm is not a
beneficiary, they are also not trustees. According to Cairns LJ's statement in Erlanger v. New
Sombrero Phosphate Co. Ltd., "The promoters certainly stand in a fiduciary position. They are in
charge of creating and shaping the business.They have the authority to determine when, how, and
under whose supervision it will be formed and start operating as a trading business.

Duties of Promoters

A promoter has a fiduciary duty to the company and is therefore obligated to perform specific
tasks on its behalf. Promoters have the same obligations as anyone acting on another person's
behalf without a formal employment relationship, including refraining from deception and
using reasonable care and competence. He might be held accountable for lying and deceiving
in the prospectus.

Fiduciary Duties

In the Indian Companies Act, 2013 there is no clear provision but Sec.34&35 impose liability
for the untrue statements in the prospectus and for fraudulent trading (sec. 339 & 447). In
particular two duties in a fiduciary position is
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 has an edge when it comes to information access, business prospects, and the
chance to sell during the incorporation process. He is permitted to sell his own real estate,
intellectual property, and professional services to businesses at a fair price, and in doing so,
he is permitted to make acknowledged profits, but he is not permitted to make hidden gains.
In the first Annual General Meeting of public companies, all aspects of promotion and all
varieties of pre-incorporation agreements are examined to determine whether the promotion
was carried out meticulously and honestly or not. If the promoter is discovered to have made
a secret profit, he may be held responsible for that. Promoter profits are permitted, though, as
long as they are disclosed.

In Gluckstein v. Barnes1, a syndicate of persons bought ‘Olympia’ (an amphitheatre) and sold
this to a company promoted by them and made a secret profit of 20,000 £, not disclosed in the
prospectus. It held a profit of 20000 £ is a secret profit and promoters are bound to pay it to
the company because the disclosure was not sufficient.

Again in, Erlanger v. New Sombrero Phosphate Co.2 a syndicate of which Erlanger was a
member, purchased an island consisting of phosphate mines for 5,000£. A nominee of the
syndicate sold the property to co. for 1,10,000 £ formed by Erlanger details of the 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 the
following:
i. Independent board of directors or
ii. Articles of association or
iii. Prospectus or
iv. To existing and intended shareholders.

All of these disclosures are typically fully disclosed in the prospectus or offer materials. The
Issue of Capital & Disclosure Requirements Regulation, 2009 of SEBI requires disclosure of
property information, including price purchases from promoters within two years. The real
truth should be revealed to those who are invited to become shareholders, not just to the first
few shareholders, in situations where it is impossible to find an independent board of
directors, as in Solomon's case.

1
(1900) AC 240.
2
(1878) 3 AC 1218
2. Duty To Disclose Interest In A Transaction

A promoter has a duty to disclose to the company any interest he may have in a transaction
that the company has engaged into or is contemplating entering into, in addition to his duty
not to make a secret profit. This is true even when he sells his own property to the business he
founded because he bought it before the advertising started. Such disclosures must be made
fully and to the company. If the promoter receives a property after the company's
incorporation, he is now its trustee, and any such property must be turned over to the business
promptly to avoid the promoter being held accountable for conversion, misappropriation, or
breach of trust. In most cases, a promoter does not sell such worthless properties to
companies at a high rate because they are their young offspring. However, there are instances
in which he may try to wash his hands of the bad properties by selling them to a company he
has promoted because he has easier access to it.

Remedies to Company

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

1. Rescission of Contract

In cases where the promoter made an unreported profit and failed to reveal his significant
interests in the transactions, the company has the right to revoke any such pre-incorporation
agreements. After discovering a violation including nondisclosure and deception, the
corporation must not have taken any action to demonstrate an intention to ratify the
agreement. The transfer of the property to the company pursuant to a contract, as well as the
allocation of shares to the promoter pursuant to the contract, do not prevent the company
from canceling. If the company does not exercise its right to rescind within a reasonable
amount of time, the right will be forfeited.

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 property3. But this remedy
depends on two situations:

(a) A claim for the recovery of the profit as such cannot be raised if the property on
which the profit was made was bought before the promoter became a promoter. This
is true if the promoter is in a fiduciary position as the lone seller.

3
Bagnall v. Carlton (1877) 6 Ch D 371
 (b) The contract may be cancelled and the property may be retained at true cost,
depriving the promoter of his claimed profit. The acquisition and sale of the property
should both be done in a fiduciary position as a promoter.

Termination of Duties

How long he is still need to do his tasks is a relevant question relating the obligations of
promoters. A promoter's responsibility often begins on the day they have the idea to form a
company and ends with the appointment of the board of directors or the incorporation of the
business. Actually, it goes on until the company has bought the property and raised its initial
share capital. Even after being publicly traded or receiving corporate financing in India, the
promoters are unable to detach themselves from the business's operations. They take an
active part in managing, running, and governing corporate activities. They continue to hold
the deciding shares, and with the aid of others working together, they serve as the brain and
leadership of the business, which is governed by the majority. They actively take part in the
company's future growth through fusions and acquisitions, takeovers, buybacks, portfolio
management, capital reduction, etc.

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.
Due to a series of corporate scams like Satyam, Enron, Sahara, Saradha etc., the new Act was
concerned to plug the loopholes wherein entrepreneurs are abusing corporate personality as
promoters of company. 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 person in accordance with whose
directions or instructions the Board of Directors or any one or more of the directors is or are
accustomed to act. If we see this definition closely though it does not mention about promoter
but because of the definition of term promoter as defined in section 2 (69), the promoter is an
officer of company. Because section 2(59) and 2 (69) have something in common i.e. ‘any
person in accordance with whose directions or instructions the Board of Directors or any one
or more of the directors is or are accustomed to act.’
A promoter holds a better position in corporate governance and has information to crucial and
sensitive information which are undisclosed and he can misuse such information for personal
and vested interests so the new Companies Act holds the promoter liable as officer and
officer in default wherever he contravenes the provisions of the Companies Act and other
corporate and securities laws. A promoter is generally liable for furnishing wrong
information and credentials for incorporation of company4 , owes a civil and criminal liability

4
Section 7.
for misstatement in prospectus5 , disclosures of interests in periodic annual return filed to
Registrar and SEBI, disclosure of interests in notice served in AGM 6. He also plays crucial
role in appointment of first directors of the company, if directors are not appointed by
promoters, they are treated as deemed directors of the company7. He also plays crucial role in
corporate mergers, amalgamation and takeovers8. He also plays very crucial role in winding
up of the affairs of the company9. Companies Act, 2013 under sections 336 to 342 provides
for various offences and punishment there for, committed by officers of companies which
equally covers promoters which comes out during winding up of company. Section 447 to
453 provides for certain offences which are committed by officers of company and others and
make it punishable. Section 447 provides that, “Without prejudice to any liability including
repayment of any debt under this Act or any other law for the time being in force, any person
who is found to be guilty of fraud, shall be punishable 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: Provided that where the fraud in question
involves public interest, the term of imprisonment shall not be less than three years.” It is a
general provision can be applied to any case of fraud and covers a fraud committed in course
of promotion.
Section 450 is of residuary nature which provides that, “If a company or any officer of a
company or any other person contravenes any of the provisions of this Act or the rules made
there under, or any condition, limitation or restriction subject to which any approval,
sanction, consent, confirmation, recognition, direction or exemption in relation to any matter
has been accorded, given or granted, and for which no penalty or punishment is provided
elsewhere in this Act, the company and every officer of the company who is in default or such
other person shall be punishable with fine which may extend to ten thousand rupees, and
where the contravention is continuing one, with a further fine which may extend to one
thousand rupees for every day after the first during which the contravention continues”. This
section again fixes greater amount of liability in relation with compliance and corporate
disclosures to various authorities under various corporate and Securities laws. SEBI under
SEBI Act, 1992 10 is also have enormous powers to prevent such people who are indulged in
fraudulent activities to have access to capital market as issuer, investor or intermediary.

Liabilities Related With Prospectus

Section 26 of the Companies Act, 2013 and ICDR Regulations 2009 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

5
3 Section 34 and 35 of Companies Act, 2013.
6
Section 102 & 184 of the Act.
7
Section 149-152 of the Act.
8
SEBI Takeover Code and section 230 of the Act.
9
Section 266, 284, 289 & 300 of the Act.
10
Chapter IV, Chapter VA, Chapter VI A specially deals with power of SEBI with regard to Capital
Market
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 Peek11 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. Lord Herschell held that, “I think they were mistaken in supposing that the consent
of the Board of Trade would follow as a matter of course because they had obtained their
Act.It was absolutely in the discretion of the Board whether such consent should be given.
The prospectus was therefore inaccurate. But that is not the question. If they believed that the
consent of the Board of Trade was practically concluded by the passing of the Act, has the
plaintiff made out, which it was for him to do, that they have been guilty of a fraudulent
misrepresentation? I think not. I cannot hold it proved as to any one of them that he
knowingly made a false statement, or one which he did not believe to be true, or was careless
whether what he stated was true or false. In short, I think they honestly believed that what
they asserted was true, and I am of opinion that the charge of fraud made against them has
not been established.” But under section 35 general and special defenses are available to such
people who are sued under section 35 for criminal liability. If they are rendering professional
services or they withdrew their consent for authorizing the issue or they are ignorant about
misstatement in prospectus; they shall not be liable.

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 co.
If there is failure or omission in prospectus he may make directors as well as promoters

11
(1889)14 AC 337.
liable. In addition to promoters and directors all officers of co. who authorize the prospectus
with untrue statement may be made liable.

Conclusion

Promotion is related with incorporation of company. It may be of several types. Occasional

promotion, institutional promotion, professional promotion etc. In promotion promoters do
all those compliance which a legal system requires to establish a corporation.

The term promoter was defined as people who do all technical and non-technical activities
which are necessary to establish a corporation. Companies Act, 2013 defines promoters as the
persons whose name appears on the face of prospectus, who controls the affairs of company
or according to whose directions the members of board of directors are accustomed to work.
But the promoter does not include those people who are rendering professional services in
professional capacities.

The promoter performs range of activities including drafting of prospectus, signing

technology transfer agreement, agreement related with procurement of raw materials and
stock in trade, listing, corporate financing, corporate governance, disclosures and winding up
of the affairs of the company.
The legal position of promoters is that he is neither agent nor employee of the company but
he stands in fiduciary capacity. Fiduciary capacity brings two duties of promoters i.e. duty not
to make secret profit and duty to disclose to company. Such disclosures may be made in
Articles, board of directors or in AGM. If he makes secret profit he may be made accountable
or company may sue him for difference of price and damages.

The liabilities of promoters in the Companies Act, 2013, Securities Laws and ICDR
Regulations, 2009 are various. But he owes great amount of duty in relation with drafting
prospectus and he owes a civil and criminal liability for misstatement and untrue statement in
prospectus. Investor also has power to rescind such share agreements where prospectus
contains misleading and untrue contents.

Pre-incorporation agreements are all those agreements which are entered in to by the
promoters on account of company to be promoted. In these agreements the question of
enforcement is a real question as ratification is not possible as company before incorporation
in a non-entity so company may avoid all such agreements and make promoters directly and
personally liable for all such agreements but Specific Relief Act, 1963 provides that if
subjects dealt in pre-incorporation agreements are warranted by terms and conditions of
incorporation then third party and company may enforce such agreements.

Generally being in fiduciary capacity the work of promotion is not a paid work. But
promoters may ask for promotion by articles or separate agreement after incorporation or in
the form of share subscription in lieu of their services.