MAHARASHTRA NATIONAL LAW UNIVERSITY MUMBAI

COMPANY LAW

SIXTH SEMESTER

‘PROMOTERS-DUTIES, LIABILITIES AND RIGHTS’

Submitted to- Prof. Anand Shrivas

Submitted by- Ayaskanta Parida

Enr. No.-2017012
Contents
INTRODUCTION: ..................................................................................................................................... 3
DEFINITIONS & MEANING OF A PROMOTER ............................................................................ 4
STATUTORY DEFINITION ............................................................................................................... 5
DUTIES OF A PROMOTER: ................................................................................................................... 5
DISCLOSURE TO BE MADE TO WHOM –...................................................................................... 6
LIABILITIES OF A PROMOTER:.......................................................................................................... 7
PROMOTER’S LIABILITY IN PRE-INCORPORATION CONTRACTS:.................................... 9
PRE-INCORPORATION CONTRACTS – ..................................................................................... 9
LIABILITY OF PROMOTER CONCERNING PRE-INCORPORATION CONTRACTS – .... 9
RIGHTS OF PROMOTERS .................................................................................................................... 11

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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, numerous
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. Prof. Gerstenberg has defined promotion of a company as “the discovery of business
opportunities and the subsequent organization of funds, property and managerial ability into a
business concern for the purpose of making profits therefrom”.

In order to get the benefits of a ‘corporate personality', it is very necessary for ‘an association of
persons' to become incorporated under the Companies Act, 2013. 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 the party who enters into the
contract, and not the company. The rule of privity of contract keeps away the company from pre-
incorporation contract.

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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.2 He
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 place the registered office of the
company, from where to get necessary plant and equipment etc., are other worries of a promoter.

1
(1877) 2 CPD 469
2
Pg. 111, [1880] 5 B.D. 109

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STATUTORY DEFINITION:

The term Promoter, has been defined under the Companies Act, 2013 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; 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, 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,3 Gopal 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."

DUTIES OF A PROMOTER:
Promoters have been described to be in a fiduciary relationship with the company. This
relationship of trust and confidence requires the promoter to make a full disclosure of all material
facts relating to the formation of the company. The promoter should not make any secret profit at
the expense of the company he promotes, without the knowledge and consent of the company and
if he does so, the company can compel him to account for it.

A promoter is not restricted to make profit but to make secret profit. In Gluckstein v. Barnes4, a
syndicate of persons was forced to buy a property called ‘Olympia’ and re-sell this ‘Olympia’ to a
company to be formed for the purpose. The syndicate first bought the debentures of the old
‘Olympia’ company at a discount. Then they bought the company itself for £1,40,000. Out of this
money provided by themselves, the debentures were repaid in full and a profit of £20,000 made
thereon. They promoted a new company and sold Olympia to it for £1,80,000. The profit of
£40,000 was revealed in the prospectus but not the profit of £20,000. Held, profit of £20,000 was

3
[1996] 2 MLJ 265
4
[1900] AC 240

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a secret profit and the promoters of the company were bound to pay it to the company because the
disclosure of the profit by themselves in the capacity of vendors to themselves in the capacity of
directors of the purchasing company was not sufficient.

DISCLOSURE TO BE MADE TO WHOM –

In Erlanger v. New Sombrero Phosphate Co.5, it was held that the disclosure is to be made to the
whole body of persons who are invited to become shareholders and this can be done through the
prospectus. Thus, the promoters have to ensure that ‘the real truth is disclosed to those who are
induced by the promoters to join the company. The disclosure should be made to the Board of
Directors, and where there is no independent Board of Directors, it should be made to prospective
shareholders as a whole.6 It was held in Lagunas Nitrate Co. v. Lagunas Syndicate7, that profits of
promoters shall be treated as secret unless explicitly disclosed to an independent

Board of Directors, or to all subscribers for shares, at the time of contract with the company is
made by them. The disclosure of profit may be made in several ways, namely, through the
memorandum or articles of association of the company, or by prospectus or by communication to
the Board of Directors of the company which is independent of the promoter.

In Vali Pattabhirama Rao v. Ramanuja Ginning & Rice Factory (P) Ltd8, the promoter purchased
a leasehold interest in the company which he intended to form. However, he first formed a
partnership firm and then converted it into a company. The Court held that the leasehold became
the property of the company from the very first day of the purchase.

In the case of Fairview Schools Sdn. Bhd v Indrani a/p Rajaratnam,9 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."

5
(39 LT 269)
6
Gluckstein v. Barnes
7
(1899) 2 Ch 392
8
(1987)
9
(No1) [1998] 1 MLJ 110

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In Companies Act, 2013 there are no specific provisions regarding the duties of the promoter, but
sections 34 and 35 impose liability for untrue statement in prospectus and for fraudulent trading in
sections 339 and 447.

In addition to his duty not to make secret profit, a promoter is also duty bound to disclose to
company any interest which he has in a transaction entered in to or proposed to be entered in to
buy it. This is even then when he sells his own property to the company raised by him because he
acquired the property before the promotion began10. Such disclosures must be made to the
company and in full. After incorporation of company if a property is received by promoters, he is
trustee of such property and all must be handed over to company in due course otherwise the
promoter may be liable for conversion or misappropriation or breach of trust of property.

LIABILITIES OF A PROMOTER:
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.11 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.

10
Re Lady Forrest (Murchison) Gold Mine Co. Ltd, (1901) 1 Ch. D. 582
11
35 Ch D 400

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The promoter or promoters of a company hold a fiduciary relationship with the company which
they promoted. This fiduciary relationship amongst the promoters and the company gives rise to
certain liabilities on the part of the promoters in various cases. The Companies Act mentions the
various liabilities that can be put upon the promoter in case of default on the part of the promoter.
In case a promoter fails to make full disclosure at the time the contract was made, the company
may either:

• Rescind the contract and recover the purchase price where he sold his own property to the
company,
• Recover the profit made, even though rescission is not claimed or is not impossible;
• Claim damages for breach of his fiduciary duty. The measure of the damages will be the
difference between the market value of the property and the contract price.

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 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 company12, owes a civil and criminal liability for misstatement in prospectus13 ,
disclosures of interests in periodic annual return filed to Registrar and SEBI, disclosure of interests
in notice served in AGM14. 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
company15. He also plays crucial role in corporate mergers, amalgamation and takeovers16. He also
plays very crucial role in winding up of the affairs of the company17. 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.

12
Section 7
13
Section 34 and 35 of Companies Act, 2013
14
Section 102 & 184 of the Act
15
Section 149-152 of the Act
16
Section 230 of the Act.
17
Section 266, 284, 289 & 300 of the Act

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Section 447 to 453 provides for certain offences which are committed by officers of company and
others and make it punishable. Section 447 provides for punishment for indulging in fraudulent
transactions. 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 for
punishment of contraventions of those provisions of the act for which any penalty or prison
sentence hasn’t been sentenced. This section again fixes greater amount of liability in relation with
compliance and corporate disclosures to various authorities under various corporate and Securities
laws.

PROMOTER’S LIABILITY IN PRE-INCORPORATION CONTRACTS:

PRE-INCORPORATION CONTRACTS –
The promoter is obligated to bring the company in the legal existence and to ensure its successful
running, and in order to accomplish his obligation he may enter into some contract on behalf of
prospective company. These types of contract are called ‘Pre-incorporation Contract'.

Nature of Pre-incorporation contract is slightly different to ordinary contract. Nature of such

contract is bilateral; be it has the features of tripartite contract. In this type of contract, the promoter
furnishes the contract with interested person; and it would be bilateral contract between them. But
the remarkable part of this contract is that, this contract helps the perspective company, who is not
a party to the contract.

LIABILITY OF PROMOTER CONCERNING PRE-INCORPORATION CONTRACTS –

Before the passing of the Specific Relief Act 1963, the position in India, regarding pre-
incorporation contract, was similar to the English Common Law. This was based on the general
rule of contract where two consenting parties are bound to contract and third party is not connected
with the enforcement and liability under the terms of contract. And because company does not
come in existence before its incorporation, so the promoter signs contract on behalf of company
with third party, and that is why the promoter was solely liable for the pre-incorporation contract
under the established ruling of Kelner v Baxter18.

18
(1866) LR 2 CP 174, Erle CJ, Willes J, Byles J, Keating J

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Promoters are generally held personally liable for pre-incorporation contract. If a company does
not ratify or adopt a pre-incorporation contract under the Specific Relief Act, then the common
law principle would be applicable and the promoter will be liable for breach of contract.

In Kelner v Baxter, where the promoter in behalf of unformed company accepted an offer of Mr.
Kelner to sell wine, subsequently the company failed to pay Mr. Kelner, and he brought the action
against promoters. Erle CJ found that the principal-agent relationship cannot be in existence before
incorporation, and if the company was not in existence, the principal of an agent cannot be in
existence. He further explains that the company cannot take the liability of pre-incorporation
contract through adoption or ratification; because a stranger cannot ratify or adopt the contract and
company was a stranger because it was not in existence at the time of formation of contract. So,
he held that the promoters are personally liable for the pre-incorporation contract because they are
the consenting party to the contract.

In Newborne v Sensolid (Great Britain) Ltd, Court of Appeal interpreted the finding of Kelner v
Baxter in a different way and developed the principle further. In this case an unformed company
entered into a contract, the other contracting party refused to perform his duty. Lord Goddard
observed that before the incorporation the company cannot be in existence, and if it is not in
existence, then the contract which the unformed company signed would also be not in existence.
So, company cannot bring an action for pre-incorporation contract, and also the promoter cannot
bring the suit because they were not the party to contract.

The Specific Relief Act, 1963 brought forth two new provisions in Section 15(h) and Section 19(e)
Sec. 15(h) provides that, “Where the promoters of company have made a contract for company
before its incorporation and if the contract is warranted by the terms of incorporation the company
may enforce it.” ‘Warranted by terms of incorporation’ means within the scope of company’s
objects as stated in Memorandum of Association. Likewise, sec. 19(e) allows the other party to
enforce the pre-incorporation contracts against the company only if the company had adopted the
same and contract is warranted by terms of incorporation. If no ratification is done the position
remains same as under common law which means the promoter shall be personally liable. If no
ratification or warranty by terms of incorporation the contract takes effect as a personal contract19.

19
Braymist Ltd. v. Wise Finance Co. Ltd, [2002] 2 All ER 333

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In India and England both the statutory safeguards do not recognize rights of promoters under the
statute to enforce pre-incorporation agreements20.

RIGHTS OF PROMOTERS
Under the Companies Act, a promoter is vested with the following rights:

➢ Right to receive preliminary expenses-The promoters are entitled to receive all the
expenses incurred for in setting up and registering the company, from Board of Directors.
The articles will have provision for payment of preliminary expenses to the promoters. The
company may pay the expenses to the promoters even after its formation, but such
payments should not be Ultra Vires the articles of the company. The Articles may have
provision regarding payment of fixed sum to the promoters.
➢ Right to recover proportionate amount from the Co-promoters- The promoters are held
jointly and severally liable for the secrete profits made by them in formation of a company.
Therefore, if the entire amount of secret profits is paid to the company by a single promoter,
he is entitled to recover the proportionate amount from co-promoters.
Likewise, the entire liability arising out of mis-statement in the prospectus is borne by one
of the promoters; he is entitled to recover proportionately from the co-promoters.
➢ Right to Remuneration-The promoter has the right to paid remuneration for the efforts. It
may be fully or partly paid shares. If there is no agreement, the promoter will not be entitled
to receive remuneration.
➢ Disclosure of remuneration paid to promoter-The remuneration or benefit paid to the
promoter must be disclosed in the prospectus, if it is paid within two years preceding the
date of the prospectus.

20
Gower and Davies, Principles of Modern Company Law

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