Introduction
Establishing a company is a complicated process that involves several stages. At the initial “promotion” stage, promoters conceive the idea of starting a business and begin the incorporation process. The term “promoters” has previously been used without a specific definition in Indian company law until the Companies Act of 2013 (“Act”) specified their role and obligations. Contrary to popular assumption, their involvement goes beyond generating initial funding and transferring control to the board of directors. This article provides a comprehensive overview of the role and responsibilities of promoters under the Act. It aims to clarify the legal definition of promoters, their duties throughout the lifecycle of a company, and the specific obligations regarding disclosure of personal interests and profits.
Understanding Promoters
The term “promoter” has been widely used in business and corporate affairs without a precise legal or statutory definition. Even judges have struggled to provide a concrete definition, frequently characterizing promoters based on their actions. The legal definition of promoters traces back to 1877, when Cockburn, C.J., identified them as those who set up a corporation for a specific objective and take the required actions to attain that goal.[1]
In the commercial world, promoters are persons or organizations who actively participate in the formation and establishment of a company. Beyond mere formation, they are in charge of all operational aspects. Promoters, whether individuals, corporations, or associations, have a similar function to “parents” in bringing a business into being by organizing funding and facilitating necessary activities.
Position of Promoter under the Companies Act, 2013
Section 2(69)[2] of the Act defines a “promoter” in three parts. Firstly, if someone is named as a promoter in the company’s prospectus or annual return. Secondly, if they exercise control over the company’s affairs, whether as a shareholder, director, or otherwise. The term “control” within this context is defined in alignment with the SEBI (Substantial Acquisition of Shares and Takeover) Regulations, 2011.[3] Thirdly, if their advice or directions are regularly followed by the board of directors. This classification means that an individual can be considered a promoter even if they were not engaged in the company’s formation or do not hold formal positions such as director or shareholder, as long as they have sufficient influence over the board’s decisions.
Promoters play an important role in the establishment of a business, assisting it on its path to becoming self-sustaining. A person can be recognized as a promoter even if they have a relatively passive involvement in the company’s formation. In the case of National LS Registration Bank v. Vellu Mudliar,[4] it was determined that any individual who assists in the recruitment of subscribers, the nomination of directors, the placement of shares, or the negotiation of preliminary agreements is a promoter. However, in Tyrell v. Bank of London,[5] the House of Lords emphasized that professionals like solicitors, valuers, and chartered accountants who operate on behalf of the promoter and are reimbursed for their services do not qualify as promoters.
Duties and Responsibilities of Promoters
The Act does not expressly define promoters’ duties, although it holds them accountable for misconduct under Sections 34, 35, and 339. Judicial interpretation has clarified these responsibilities, particularly in terms of secret profits and prospectus accuracy.
- Duty to Disclose Secret Profits: Promoters are required to disclose any secret profits derived from transactions with the company. In Gluckstein v. Barnes[6], it was established that promoters must reveal profits from reselling property to the company.
- Prospectus Requirements: Section 26 requires promoters to disclose any legal actions against them in the prospectus, ensuring that all material information is accurate and complete.
- Disclosure of Interests: Promoters must disclose any personal interests in transactions involving the company. They are not required to account for profits from transactions that occurred prior to the company’s creation.
- Disclosure Recipients: If an independent board is impractical, promoters should disclose their interests to all initial shareholders or investors.[7]
Liabilities of Promoters:
- Criminal Liability for Misstatements: Sections 34 and 447 establish criminal penalties for promoters who authorize misleading statements in the prospectus.
- Civil Liability: Section 35 provides for civil compensation for investors who suffer losses due to inaccuracies or omissions in the prospectus.
- Private Placement: Section 42 imposes penalties on promoters for non-compliance with private placement regulations.
- Fraud Examination: Section 300 allows for tribunal inquiries into fraud if reported by the company liquidator.[8]
- Liability for Fraudulent Conduct: Sections 339 and 340 hold promoters personally liable for fraudulent activities or misappropriations during the company’s formation or operation.
Rights of Promoters
- Promoters are entitled to reasonable remuneration for their services in forming the company.
- They have the right to be reimbursed for legitimate preliminary expenses incurred during incorporation.
- Promoters often receive shares in the company as compensation for their efforts.
- One promoter can sue another for compensation due to joint liabilities for false statements.[9]
Legal Position of Promoters in Company Law
Promoters, who play a significant role in the formation and early operations of a company, are expected to act in the best interests of the company and its shareholders. This fiduciary duty mandates full disclosure of any personal interests, profits, or positions related to company transactions, as outlined in Sections 184, 188, and 189 of the Act. These sections require promoters to disclose their interests to the board of directors and obtain approval for related party transactions, ensuring transparency and preventing secret profits.[10] Failure to make these disclosures properly can render the transaction void, with the promoter liable to compensate for any resulting losses. Such undisclosed profits made by a promoter through advantageous positions are termed ‘secret profits.’
In Erlanger v. New Sombrero Phosphate Co.[11] case, Lord Cairns described promoters as being in a fiduciary role, stating that they are responsible for creating and shaping the company. They control how and when the company is established and determine its operations and oversight as a trading entity.
In Weaver Mills Ltd. v. Balkis Ammal ILR,[12] the Madras High Court expanded the scope of pre-incorporation contracts. Promoters purchased properties on behalf of a forthcoming firm, which later took possession and developed them. The court ruled that the company’s ownership of the land was valid despite the promoter not formally transferring it post-incorporation.
In Prabir Kumar Misra v. Ramani Ramaswami,[13] the Madras High Court ruled that promoters do not need to sign the Memorandum or Articles of Association or be shareholders or directors, to be held liable. The court emphasized that promoters, often called the “midwives” of a business, play a crucial role in establishing the company by proposing objectives, forming schemes, arranging registration, and preparing necessary documents. Hence, their liability exists due to their integral involvement in the company’s formation.
In the United States, courts have identified four lawful methods for promoters to engage in transactions with a corporation despite their fiduciary relationship, as illustrated in Old Dominion Copper Mining Co v. Bigelow[14], these methods are (1) full disclosure to an independent, uninfluenced board; (2) disclosure to all original subscribers; (3) ratification by shareholders of the fully established corporation; and (4) the promoter subscribing to all contemplated capital stock.[15]
Similarly, Section 188 of the Act, and Regulation 23(4) of the SEBI (Listing Obligations and Disclosure Requirements) Regulation, 2015, mandate shareholder ratification for related party transactions. A special resolution is required if certain criteria are met, either before or after the transaction. SEBI regulations are particularly stringent, requiring approval from independent directors on the audit committee for transactions exceeding material thresholds. Additionally, Section 102 of the Act specifies further disclosure and procedural requirements to ensure transparency.
Conclusion
Promoters have an essential role for establishing and operating a company in its early phases. The Act outlines their rights, obligations, and responsibilities to ensure that they act fairly and transparently. They must avoid conflicts of interest and disclose any personal benefits. The Act ensures that promoters are accountable for their actions, protecting the company and its shareholders.
[1] Om Prakash Chaudhary, ‘Concept of “Promoters” and its various nitty-gritty under companies act’ (Taxmann, 08 November 2016) <https://www.taxmann.com/research/company-and-sebi/top-story/105010000000013816/concept-of-%E2%80%9Cpromoters%E2%80%9D-and-its-various-nitty-gritty-under-companies-act-experts-opinion> accessed 1 July 2024.
[2] The Companies Act, 2013, s 2(69)
[3] Securities Exchange Board of India (Substantial Acquisition and Shares Takeovers) Regulations 2011, reg 2(e)
[4] National LS Registration Bank v. Vellu Mudliar, AIR 1938 Mad. 192.
[5] Tyrell v. Bank of London (1862) 10 HL Cas 26.
[6] GLUCKSTEIN V. BARNES (1900) AC 240.
[7] Shivam Krishnam, ‘Roles and Responsibilities of Promoters in Company Law’ (2020) 3(2) IJLMH <https://www.ijlmh.com/wp-content/uploads/2020/05/Roles-and-respnsibilities-of-Promoters-in-Company-Law.pdf> accessed 27 July 2024.
[8] Ananya U S and Sriya K, ‘Analysis on the Position, Duties, Rights and Liabilities of Promoters’ (2023) 5(6) IJFMR <https://www.ijfmr.com/papers/2023/6/10125.pdf> accessed 27 July 2024.
[9] Promoters: Their Position, Powers, Duties and Liabilities’ (Module ID 13, E-text on Corporate Law, n.d.) <https://epgp.inflibnet.ac.in/epgpdata/uploads/epgp_content/law/04._corporate_law/13._promoters,_their_position,_powers,_duties_and_liabilities/et/5675_et_13_et.pdf> accessed 27 July 2024.
[10] Agnikanya Bhattacharya ‘Understanding The Position Of Promoters Under Companies Act, 2013: Finding The Truth’ <https://www.legalserviceindia.com/legal/article-8417-understanding-the-position-of-promoters-under-companies-act-2013-finding-the-truth.html> accessed 27 July 2024.
[11] Erlanger v. New Sombrero Phosphate Co (1878) 3 App Cas 1218
[12] Weaver Mills Ltd. v. Balkis Ammal ILR (1969) 1 MAD 433
[13] Prabir Kumar Misra v. Ramani Ramaswami [2010] 104 SCL 174
[14] Old Dominion Copper Mining Co v Bigelow (1909) 203 Mass 159, 178
[15] Promoters: Liability of Promoter to Corporation for Secret Profits’ (1925) 13 (3) California Law Review
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