COMPANY LAW

Role, functions, duties and liabilities of

promoters

ANTONY MOSES C
1264
V SEMESTER
 INTRODUCTION: Definition of a Promoter

The term “promoter” is said to be a business, not a legal term. It is not a term of art nor a term
of law but of business1. The term summarises a variety of business operations that is familiar
to the commercial by which a company is generally brought into existence.2 There has been
no definite meaning3 afforded to the term in usage. The Companies Act 2013 defines a
promoter in Section 2(69). A 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
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.
The SEBI (Issue of Capital and Disclosure Requirements) Regulations 20094, defines
promoter in a precise fashion. According to the section, it 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.
Save these definitions, a promoter can only be precisely identified according to the work that
he performs for the company. It can only be ascertained as to whether a person is a promoter
or not depending upon his involvement in the business of promotion. Most definition that
could afforded to the term are in terms of categories of work that promoters usually perform.

WHO IS A PROMOTER?

1
Joseph H Gross, “Who is a Company Promoter”, (1970) 86 LQR 493.
2
Holmes Eric (Property) Ltd, re, 1965 Ch 1052: (1965) 2 WLR 1260: (1965) 2 All ER 333; Whaley Bridge
Calico Printing Co v Green, (1880) LR 5 QBD 109: 18 WR 351: 41 LT 674.
3
Emma Silver Mining Co v Lewis, (1879) LR 4 CPD 396, 407: 40 LT 749; C Thiruvenkatachariar v AT Velu
Mudaliar, (1937) 46 LW 887: ILR 1938 Mad 192: AIR 1938 Mad 154.
4
Last amended on February 12, 2008
Whether a person is a promoter or not is a question of fact in each case. Much depends on the
nature of the role played by him in the promotion of the business. In Twycross v Grant5, the
defendants were held to be the promoters as they found the directors and qualified them,
prepared the prospectus, paid for printing and advertising and the expenses incidental to
bringing the undertaking before the world. A promoter may be an individual, syndicate,
association or partnership which has undertaken to take all the necessary measures to form a
company. A promoter may be a natural person or a company.

Section 2(69) concludes by saying that persons acting in a professional capacity are not to be
regarded as promoters. In Great Wheal Polgooth Co Ltd, re, (1883) 53 LJ Ch 42: 49 LT 20, it
was held that a solicitor who prepares the primary documents on behalf of the proposed
company was not a promoter. A servant or an agent of the promoter is not to be regarded as a
promoter. Similarly, an accountant or valuer who held the promotion in his professional
capacity is not a promoter. But such a person may be deemed to be a promoter if he helps in
the formation of the company by doing an act that is outside the scope of his professional
duty. For example, he may help in getting a purchaser for the shares of the company.

Therefore, a director or officer of the issuer cannot be considered as a promoter. Similarly, a

financial institution, scheduled bank, foreign institutional investor and mutual fund cannot be
deemed to be a promoter. However, such institutions or persons may be treated as a promoter
for the subsidiaries or companies promoted by them or for the mutual fund sponsored by
them.

FUNCTIONS OF A PROMOTER

As stated earlier, who can be called a promoter depends on the functions that he performs for
the company. A promoter is a person who brings about the incorporation and organisation of
a corporation. 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 itself6.
The promoter gets the Memorandum and the Articles prepared, executed and registered, finds
the bankers, brokers and legal advisers, finds the first directors, settles the terms of

5
(1877) LR 2 CPD 469: 46 LJ QB 636: 36 LT 812: 25 WR 701 (CA).
6
Bosher v Richmond Land Co, 89 Va 455: 16 SE 360: 37 Am St Rep 879.
preliminary contracts with vendors and underwriters and makes arrangement for preparation,
advertisement and circulation of the prospectus and placement of the capital.

THE LEGAL POSITION HELD BY A PROMOTER

The Legal position of a promoter is quite clear. A promoter is neither the agent nor a trustee
for the company because it is not in existence. As held by the judges in Erlanger v New
Sombrero Phosphate Co.7, since promoters are involved in the creation and moulding of the
company and have the power to define how and when and in what shape the company shall
come into existence, they stand in a fiduciary position in relation to the company and
therefore, they are required to make full disclosure of the all the relevant facts including any
profit that they may have made from the formation of the company. They also have a direct
fiduciary relationship to those persons who they induce to become shareholders of the
company.8 A relationship that a promoter shares with the company is much similar to the one
shared by the principal and agent or trustee9 and therefore, his dealing with the company must
be open and fair10. Any profit earned by him at the expense of the company must be disclosed
and the company can also compel him to account for it as well.11

DUTIES OF A PROMOTER

The previous Companies Act 1956 contained no provisions regarding the duties of promoters.
Section 62,63 and 542 of the Act only impose liabilities on promoters for untrue statement in
the prospectus and fraudulent trading. Companies Act 2013 contains some provisions
regarding the duties of promoters. The fiduciary duties of a promoter includes:

a) Section 102(4) states that, where as a result of the non-disclosure or insufficient

disclosure in any explanatory statement annexed to the notice of a general meeting , by a
promoter, director, manager, if any, or other key managerial personnel, any benefit
accrues to such promoter, director, manager or other key managerial personnel or their

7
(1878) LR 3 AC 1218, 1236: 48 LJ Ch 73: 39 LT 269: 27 WR 65. Accepted this position of promoters in
Weavers Mills Ltd v Balkis Ammal, AIR 1969 Mad 462, 468-69: (1969) 2 MLJ 509.
8
Lagunas Nitrate Co v Lagunas Syndicate, (1899) 2 Ch. 392.
9
Lydney and Wigpool Iron Ore Co v Bird, (1866) 33 Ch. D. 85.
10
Omnium Electric Palaces Ltd v Baines, (1914) 1 Ch 332: 109 LT 964 (CA).
11
Emma Silver Mining Co v Grant, (1879) 11 Ch. D.
 relatives, either directly or indirectly, the promoter, director, manager or other key
managerial personnel, as the case may be, shall hold such benefit in trust for the
company, and shall, without prejudice to any other action being taken against him under
this Act or under any other law for the time being in force, be liable to compensate the
company to the extent of the benefit received by him.
In the case of default in complying with above provisions, every promoter, director, manager or
other key managerial personnel who is in default shall be punishable with fine which may
extend to 50,000 rupees or five times the amount of benefit accruing to the promoter,
director, manager or other key managerial personnel or any of his relatives, whichever is
more. [Sub-section (5) of Section 102]
The above provision is based on the principle that a promoter 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 that if he does so, in disregard of this rule, the company
can compel him to account for it. In relation to disclosure it may be noted that part
disclosure will also attract the same consequences. Any such secret profit made by the
promoter in connection with a transaction to which the company is a party must be
handed over to the company as the company has the right to affirm the contracts.12 A
promoter is not forbidden to make profit but he is barred from making any secret profit.
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.
b) A promoter is not allowed to derive a 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
repudiate the sale or affirm the contract and recover the profit made out of it by the
promoter. Either way the dishonest promoter is deprived of his advantage.
Section 102(4) makes it clear the disclosure must be made by form of an explanatory
statement annexed to the notice of a general meeting. But previously, in the absence of these
provisions, it was quite uncertain as to whom such disclosure was required to be made. The
House of Lords in Erlanger v New Sombrero Phosphate Co13, suggested that the disclosure
must be made to an independent and competent Board of Directors. However, subsequent
experience showed that it may not always be possible for the promoters to give to the
company an independent Board of Directors. In the case of a private company or public

12
Gluckstein v Barnes, (1900) AC 240.
13
(1878) LR 3 AC 1218, 1236: 48 LJ C 73: 39 LT 269: 27 WR 65.
company, which consists of only family members, it is just not possible to constitute an
independent Board of Directors. In such a case, the opinion evolved in Gluckstein v Barnes14,
wherein it was stated that the promoter must disclose his interest and profit to the
shareholders of the company. But such disclosure, must be made to the whole body of
persons who are invited to become the shareholders.

c) Section 13(8) states that a company, which has raised money from public through
prospectus and still has any unutilised amount out of the money so raised, shall not
change its objects for which it raised the money through prospectus unless a special
resolution is passed by the company and the dissenting shareholders shall be given an
opportunity to exit by the promoters and shareholders having control in accordance with
regulations to be specified by the Securities and Exchange Board.
d) As per section 27(2), the dissenting shareholders being those shareholders who have not
agreed to the proposal to vary the terms of contracts or objects referred to in the
prospectus, shall be given an exit offer by promoters or controlling shareholders at such
exit price, and in such manner and conditions as may be specified by the Securities and
Exchange Board by making regulations in this behalf.
e) As per section 167(3), where all the directors of a company vacate their offices by
disqualification, the promoter or, in his absence, the Central Government shall appoint the
required number of directors who shall hold office till the directors are appointed by the
company in the general meeting.
f) As per section 168(3), where all the directors of a company resign from their offices, or
vacate their offices under section 167, the promoter or, in his absence, the Central
Government shall appoint the required number of directors who shall hold office till the
directors are appointed by the company in general meeting.
g) As per section 284(1) , the promoters, directors, officers and employees, who are or have
been in employment of the company or acting or associated with the company shall
extend full cooperation to the Company Liquidator in discharge of his functions and
duties during winding up by the Tribunal.

DUTIES OF THE PROMOTER: PRE-INCORPORATION STAGE

14
(1900) AC 240.
To bring any company into existence, a promoter has to enter into a number of contracts to
gather resources for the same. But such contracts, though contracted in the name of the
company, shall not be binding on it, because the company has not come into existence. The
contract cannot be binding on the company before it comes into existence.15

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. Moreover, the Specific Relief Act of 1963 of Section
15(h) and 19(e) provide that wherein promoters of a company have, before its incorporation,
have entered into a contract for the purposes of the company, and such contract is warranted
by the terms of the incorporation of the company. But the same has to be accepted by the
company and such acceptance has to be communicated to the other party.

Therefore, a contract between a person and a promoter would be considered to be a contract

between the company and such person only if the company ratifies such contract after its
incorporation, provided the contract is not ultra vires the Memorandum of the company16. But
in cases wherein the contract does not fall within the scope of the company, the validity of the
contract entered into and the position of the promoter fall into question. It was observed in
the case of Phonogram Limited v Lane17, that a contract made before a company’s
incorporation is not wholly devoid of legal effect. Therefore, promoters may be held
personally liable for all the contracts and promises made by them in the name of the
company, until with their consent, the company takes over this liability.18

The duties of a promoter is usually deemed to have come to an end after the incorporation of
the company or when the Board of Directors for the same have been appointed. In reality, the
duties of a promoter continue until the company has taken over the property for which it was

15
A.K.Majumdar, Dr.G.K.Kapoor’s, ‘Taxmann’s Company Law’ (16 th ed. 2013), p.71; Position of a promoter
in India: Crictical Analysis, available at https://www.lawctopus.com/academike/position-promoter-india-
critical-analysis/#_edn20 , last accessed on 30th October 2018.
16
Position of a promoter in India: Critical Analysis, available at
https://www.lawctopus.com/academike/position-promoter-india-critical-analysis/#_edn20 , last accessed on 30th
October 2018.
17
[1982] QB 938.
18
D.R.Patil v A.S.Dimlov, AIR 1961 MP 4 AT 5.
formed to manage and has raised its initial share capital and till the Board takes over the
management of the company from the promoters.19

LIABILITIES OF A PROMOTER

According to the provisions of the Companies Act, 2013, a promoter is subject to the
following liabilities

1. Incorporation of company by furnishing false information:- As per Section 7(6),

where, at any time after the incorporation of a company, it is proved that the company has
been incorporated by furnishing any false or incorrect information or representation or by
suppressing any material fact or information in any of the documents or declaration filed or
made for incorporating such company, or by any fraudulent action, the promoters, the persons
named as the first directors of the company and the persons making declaration shall be liable
for fraud under section 447.

Section 26 of the Act lays down matters to be stated and reports to be set out in the
prospectus. In case of non-compliance with the same, the promoters may be held liable for
the under this Section. Further, as per Section 26(1)(a)(xiv), prescribed disclosures about
sources of promoter’s contribution has to be made in prospectus.

2. Civil Liability for misstatements in prospectus:- A promoter is liable for any misleading
statement in the prospectus to a person who has subscribed for any securities of the company
on the faith of the prospectus. By virtue of section 35(1), where a person has subscribed for
securities of a company acting on any statement included, or the inclusion or omission of any
matter, in the prospectus which is misleading and has sustained any loss or damage as a
consequence thereof, the company and certain persons as mentioned in the said section,
including a promoter of the company shall, without prejudice to any punishment to which any
person may be liable under Section 36, be liable to pay compensation to every person who
has sustained such loss or damage. No promoter shall be liable under this section, if he proves
that the prospectus was issued without his knowledge or consent, and that on becoming aware
of its issue, he forthwith gave a reasonable public notice that it was issued without his
knowledge or consent.

19
Lagunas Nitrate Co v Lagunas Syndicate, (1899) 2 Ch. 392.
3. Punishment for fraudulently inducing persons to invest money:- As per Section 36,
any person who, either knowingly or recklessly makes any statement, promise or forecast
which is false, deceptive or misleading, or deliberately conceals any material facts, to induce
another person to enter into, or to offer to enter into,

a) any agreement for, or with a view to, acquiring, disposing of, subscribing for, or
underwriting securities; or

b) any agreement, the purpose or the pretended purpose of which is to secure a profit to any
of the parties from the yield of securities or by reference to fluctuations in the value of
securities; or

c) any agreement for, or with a view to obtaining credit facilities from any bank or financial
institution, shall be liable for punishment for fraud under Section 447.

4. Contravention of provisions relating to private placement: If a company makes an offer

or accepts monies in contravention of the provisions of private placement as stated in Section
42, the company, its promoters and directors shall be liable for a penalty which may extend to
the amount involved in the offer or invitation or two crore rupees, whichever is higher, and
the company shall also refund all monies to subscribers within a period of thirty days of the
order imposing the penalty. [Section 42(10)]

5. Liability during Revival and Rehabilitation of companies:

i) As per section 257(3), the interim administrator may direct any promoter, director or any
key managerial personnel to attend any meeting of the committee of creditors and to furnish
such information as may be considered necessary by the interim administrator.

ii) According to Section 266 (2), if the Tribunal is satisfied on the basis of the information
and evidence in its possession with respect to any person who is or was a director or an
officer or other employee of the sick company, that such person by himself or along with
others had diverted the funds or other property of such company for any purpose other than
the purposes of the company or had managed the affairs of the company in a manner highly
detrimental to the interests of the company, the Tribunal shall, by order, direct the public
financial institutions, scheduled banks and State level institutions not to provide, for a
maximum period of ten years from the date of the order, any financial assistance to such
person or any firm of which such person is a partner or any company or other body corporate
of which such person is a director, by whatever name called, or to disqualify the said director,
promoter, manager from being appointed as a director in any company registered under this
Act for a maximum period of six years.

7. Failure to cooperate with Company Liquidator during winding up: As per Section 284
(2), where any promoter, without reasonable cause, fails to cooperate with the Company
Liquidator during winding up, he shall be punishable with imprisonment which may extend
to six months or with fine which may extend to fifty thousand rupees, or with both.

According to Section 300(1), A promoter may be liable to public examination like any other
director or officer of the company if the Tribunal so directs on a Company Liquidator's report
alleging fraud in the promotion or formation business or conduct of affairs of the company
since its formation. By Section 340, A company may proceed against a promoter on action
for deceit or breach of duty under , where the promoter has misapplied or retained any money
or property of the company or is guilty of misfeasance or breach of trust in relation to the
company.

10. Criminal Liability for misstatement in prospectus: Besides civil liability, the
promoters are criminally liable under Section 34 for the issue of prospectus containing untrue
or misleading statements in form or context in which it is included or where any inclusion or
omission of any matter is likely to mislead. Section 447 imposes severe punishment for fraud
on promoters who make untrue or misleading statements in prospectus with a view to
obtaining capital. The punishment prescribed is imprisonment for a term which shall not be
less than six months but which may extend to ten years and also a 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. Further, where the fraud in question involves public interest, the term
of imprisonment shall not be less than three years. A promoter can, however, escape the
punishment if he proves: (i) that the statement or omission was immaterial; or (ii) that he had
reasonable grounds to believe, and did, up to the time of the issue of prospectus, believe that
statement was true or the inclusion or omission was necessary.

11. Remedies available to a subscriber deceived by a misleading statement or inclusion

or omission of any matter in the prospectus:—
a) As per Section 37, a suit may be filed or any other action may be taken under Section 34 or
Section 35 or Section 36 by any person, group of persons or any association of persons
affected by any misleading statement or the inclusion or omission of any matter in the
prospectus.

b) He may take proceedings to repudiate the contract and require repayment of his money
with interest.

c) He may, in respect of any misleading statement or the inclusion or omission of any matter
in the prospectus, bring an action against the directors and promoters for the recovery of
compensation.

d) He may, bring an action for damages against the directors and other persons responsible
for failure to disclose matters in a prospectus.

e) He may, in respect of any misleading statement or the inclusion or omission of any matter
in the prospectus, bring an action against directors or those who are responsible for the
prospectus. In addition to directors and promoters the liability under the section also attaches
to person who have authorised the issue of the prospectus. However, the words cannot
reasonably be held to apply to such persons as bankers, brokers, accountants, solicitors and
engineers who merely consent to their names appearing as such in the prospectus.

f) A promoter will be responsible for any misstatement as to an existing fact. A calculation of

future profits is not a statement of fact20. But a misstatement as to purposes for which the
money to be raised and is to be applied is a misrepresentation of a present fact21.

g) If a director's name is misstated in the prospectus, it is an important misrepresentation and

the promoter can be held to be liable22.

h) Sometimes representations which were true when the prospectus was issued, become false
before the allotment is made. In such cases, the fact ought to be communicated to the
applicant otherwise the applicant will not be able to rescind the contract. A promoter/director

20
Bentley v. Black, (1893) 9 TLR 580 (CA)
21
Edgington v. Fitzmaurice, (1885) 29 Ch D 459: (1991-5) All ER Rep 59 (CA)
22
Metropolitan Coal Consumer's Association Ltd., Karberg's case, (1892) 3 Ch 1 (CA)].
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 fraud23.

RIGHTS OF PROMOTERS

A promoter is not entitled to an legal claim to recover preliminary expenses for the services
he may have incurred in the incorporation of the company unless there is a valid contract to
that effect. Without such a contract, he is not entitled to recover such expenses24. But the
promoters are entitled to receive all the preliminary expenses from the Company if the same
is authorised by the Articles of Association of the company. No payments that can be made to
the promoter be Ultra vires of the articles of the company.

The promoters can be held jointly and severally liable for the secret profits made by them
during the formation of the company. If only one of the promoters is held liable to pay the
amount of secret profits to the company, he may recover the same proportionately from the
other promoters. Similarly, if only one of the promoters is held liable for any misstatement in
the prospectus, he is entitled to recover the cost proportionately from the other promoters.

CONCLUSION

The law imposes severe liability on those who undertake themselves to bring about the
creation of a company. This is because, as held by Lord Cairns in Erlanger, “they stand in a
fiduciary position. They have in their hands the creation and moulding of the company. They
have the power of defining how and when, in what shape and under what supervision the
company shall start into existence.” Thereby, these stringent liabilities will continue to exist
so as to protect the interests of the members of the company and society at large.

BIBLIOGRAPHY

23
Brownliey v. Campbell, (1880) 5 App. Cas 925; Rajagopala Iyer v. The South Indian Rubber Works, AIR
1942 Mad 656; (1942) 12 Com Cases 203
24
English & Colonial Produce Company (1906) 2 Ch. 435 CA
Books:

1. Avtar Singh, Company Law (16th ed. 2017)

2. Avtar Singh, Business Law (10th ed. 2017)
3. Institute of Company Secretaries of India, Executive Programme - Company Law
(2014)
Websites:

1. Position of a promoter in India: Critical Analysis, available at

https://www.lawctopus.com/academike/position-promoter-india-critical-analysis/#_edn20 , last
accessed on 30th October 2018.