In this blog post, Pramit Bhattacharya, Damodaram Sanjivayya National Law University writes about the role and position of a Promoter of a company. The post dwells into the duties and liabilities of a promoter and also looks into the position of the promoter before the incorporation of the company and after the process of incorporation is complete.
To form a company, there are several steps involved. The first step in forming a company is the promotion. This is the stage where the idea to form a company is conceived. This idea is conceived by the promoter, and he undertakes all the formalities which are required to form a company. The promoter does all the preliminary work which is required to bring the company into existence. It is not necessary that only a person who is associated with the company at the initial period is considered as a promoter. A person who floats the securities of the company and helps them generate funds can also be the promoter.
The definition of the phrase “promoter” has been defined in Section 2 (69) of Companies Act, 2013. The term has been used specifically in Section 35, 39, 40, 300 and 317 of the Act. Section 2 (69) of the Act states that promoter is a person whose name has been mentioned in the prospectus of the company or is identified in the annual returns of the company, or any person who has direct or indirect control over the affairs of the company, whether as a stakeholder or as a director, or on whose direction the Board of Directors act. In simple words, a promoter is a person who performs the various preliminary steps like making the prospectus of the company, floating the securities in the market, etc. but if a person is doing this in a professional capacity, he wouldn’t be considered a promoter.
Types of Promoters
As stated above, a promoter is the one who conceives the idea of formation of a company. An individual, an association of person, a firm or a company, can act as a promoter. A promoter may be an occasional, professional, managing or financial promoter. A professional promoter is the one who hands over the rein of the company to the stakeholders when the company is up and running. Financial promoters are those promoters, who promote financial institutions or banks. Their main aim is to assess the financial situation of the market and form a company at the opportune moment. In the case of managing promoters, they not only help in the formation of the company but when the company is formed, they get managing agency rights in the company. Occasional promoters are those whose main work is to float the company and do all the preliminary work. Although they do not do the promotion work routinely, they may float a company and then go back to their original profession.
Functions of a Promoter
A promoter plays various function in the formation of a company, from conceiving the idea to taking all the necessary steps to convert the idea into reality. Some of the functions of a promoter are-
- One of the main functions of a promoter is to comprehend the idea of formation of the company.
- The promoter looks into the viability and feasibility of the idea that whether the formation of the company will be profitable and practicable or not.
- After the idea has been conceived, the promoter collects and organizes the resources available to convert the idea into a reality.
- The promoter decides the name of the Company and also settle the content regarding the Articles of Association and the Memorandum of Association of the Company.
- The promoter is the one who decides where the head office of the company will be situated. The promoter also nominates people or associations for vital posts. For instance, the promoter may appoint the bankers, auditors and Directors of the company for the first time.
- The promoter also prepares all the other necessary documents which are required to incorporate a company.
Defining the legal status of a promoter can be a very tough job. He cannot be considered an employee, trustee or an agent of the company. The role of the promoter ceases to exist when the company is on the track and is handled by the Board and the Management.
Duties of a Promoter
The promoters who form the company have certain basic duties towards the company. A promoter has a relationship of confidence and trust with the company, i.e., a fiduciary relationship. Keeping this fiduciary relationship in mind, the promoter is under the obligation to disclose all the material facts which relate to the formation of the company. The promoter is also under the obligation to not take any secret profit while carrying out the promoting activities like buying a property and then selling it to the company for profit, without making any disclosure. The promoter is not barred from making profits while dealing with various parties. The only condition is that he is under the duty to disclose such profits and not make any secret profits.
Liabilities of a Promoter
- A promoter has to mention the true facts in the prospectus of the company. If he does not do so, he may be held liable for it. The promoter will be liable for any untrue statement which has been made in the prospectus, and on the basis of that untrue statement any person has subscribed to the securities of the company. The person may sue the promoter if he has suffered any damage.
- Apart from civil liability, the promoter may be held criminally liable also for mentioning any untrue statements in the prospectus. A severe penalty will also be imposed on him if he provides any untrue statement with the view of obtaining capital.
- A promoter can be made liable to a public examination if there are any reports which allege fraud in the formation of the company or the promotion activities.
- The company can also proceed against the promoter in case there is a breach of duty on the promoter’s part or he has misappropriated any property of the company or is guilty of breach of trust.
Position of a Promoter in Relation to the Company- Before and After Incorporation
Prior to Incorporation of the Company
Promoters found it extremely difficult to carry out promotion activities before the Specific Relief Act was introduced in 1963. Before this Act was passed, pre-incorporation contracts of the company were held to be void. Such contracts also couldn’t be ratified. Therefore, people were very hesitant to supply resources for incorporation of the company without any definite contract. Promoters were also very apprehensive about taking personal liability. The introduction of the Specific Relief Act, 1963 made it easier for the promoters to carry out incorporation activities, as the promoters could now enter into pre-incorporation contracts with third-parties.
Section 15 (h) and 19 (e) states that
- The promoter should have entered into the contract for the purpose and benefit of the company
- The terms provided in the incorporation agreement should warrant such contracts.
- The contract should be ratified after the company, and it should be informed to the opposite party.
A contract made between the promoter on the behalf of the company and the third parties will still be considered as a contract between two individuals. The right to ratify a contract does not lie with the company inherently. The authority of ratifying a contract should be given to the company through its memorandum. So a company cannot be sued by the third party if the company does not ratify the contract, even if the contract was beneficial for the company.
In case the company does not have the authority to ratify the contract (because such authority has not been provided in the Articles), or the company does not ratify the contract, then the promoter will be personally liable.
After Incorporation of the Company
After the company comes into existence, and in case it ratifies the contract entered into by the promoter, in such a case the contract will become binding on the company and not the promoter. Section 15(h) and 19 (e) also state that the promoter can transfer his rights and liabilities to the company, provided that such provision is present in the incorporation agreement. Although the promoter is not entitled to any kind of salary and remuneration. But the general trend is to compensate the promoter in lump-sum after the company has been set up. A promoter cannot be asked to be compensated as a legal right. If the promoter is compensated at all, the compensation given to him is on the basis of equity ad fairness. If any shares are being allotted to the promoter of the company, the promoter also becomes a member of the company automatically.
It can be said that a promoter can be an individual, a company, or an association of person which conceives the idea of formation of a company, undertake all the activities which are necessary for the company’s incorporation and brings about the actual existence of the company as a separate legal entity. The promoter nominates the directors, bankers and auditors of the company and also decide the contents of the Articles of the company. The promoter can be called as a molding block who gives basic shape to the company, and his role is of utmost important.