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May 05
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Posted by:Arunima Bhattacharya
Promoters of Company, their duties and liabilities

The term ‘Promoter’ had previously not been defined in the Companies Act, 1956 and was only clearly explained in the Companies Act, 2013 in section 2(69) (w.e.f 12.9.2013)

The Act defines ‘Promoter’ as:

(69) “promoter” means a person –

  1. 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
  2. who has control over the affairs of the company, directly or indirectly whether as a shareholder, director or otherwise; or
  3. in accordance with whose advice, directions or instructions the Board of Directors of the Company is accustomed to act

Going by the above definition, those people can also be termed as ‘promoters’, in accordance with whose advice, directions or instructions the Board of Directors of the company is accustomed to act. However, a person merely acting in a professional capacity i.e. giving only professional advice to the Board of Directors, shall not be considered as a promoter of the company.

Before a company is formed, there are certain preliminary steps to be necessarily followed, these preliminary steps are carried out by promoters. ‘Promoters’ has not been defined either judicially or in the Companies Act, 1956 but the term has been expressly used in the Companies Act, 2013 in sections 2(69), 35, 39, 40, 300, and 317. They are the first persons who conceive the idea of forming the company with reference to a given object and then to set it going, they take steps to incorporate a company, provide the initial share and loan capital and acquire the business or property that is to be ultimately managed.

According to the SEBI (Issue of Capital and Disclosure Requirements) Regulations, 2009, “promoter” includes those who are in control of the issuer, those instrumental in the formulation of a plan or programmed pursuant to which specified securities are offered to public and those persons named in the offer document as promoters (as defined in sections 2 za & zb of the ICDR).

In a gist, promoter(s) is the person who starts or promotes a business. Their name is so registered in the prospectus and in the annual report of the company. A promoter may be a part of the board (of directors) of the company and may also serve as its Chief Executive Officer (CEO) or Chief Financial Officer (CFO) or in any other managerial capacity.

Focusing on clauses (b) and (c) of the SEBI Issue of Capital and Disclosure Regulations (ICDR) clarifies that if the board of directors and the management of the company acts as per someone’s directions or orders, then that person can be understood to be a promoter.

There are different types of promoters and they can be professional promoters (they handover the company to the shareholders when the company starts) occasional promoters (main interest is the floating of companies), financial (do the task of promoting the financial institutions, generally at the time when the financial environment is favorable) or managing promoters (promoting new companies and then getting their managing agency rights).

A promoter is neither an agent nor a trustee of the company as it is a non-entity before incorporation. However certain fiduciary (founded on trust) duties have been imposed on him under the Companies Act. In the case of Lidney & Wigpool Iron Co. v. Bird (1866), it was observed that a promoter of a company is accountable to it for all the monies secretly obtained by him for it just as the relationship of the principal and agent or the trustee and cestui que trust (a person for whom another is trustee). To understand further the fiduciary position of a promoter, we can look into the case Emile Erlanger v New Sombrero Phosphate CO. (1878) where it was held that a Promoter has the fiduciary duty to disclose all material facts of the company. It is his duty to ensure that the company has an independent board of directors who can exercise independent and intelligent judgment on the transaction, and to make full disclosure to them. If the promoters fail to disclose the profits they are making from entering into a contract, the company can rescind the contract. The Madras High Court in Weavers Mills v Balkis Ammal (AIR 1969 Mad. 462) accepted the position of the promoters as iterated in the Emile Erlanger case.

The promoters are expected to act in such a manner that the interests of the proposed company are adequately protected. Holding a position of trust, promoters are expected to not to make any profits at the expense of the company. However, it is important to clarify that a promoter is not forbidden to make profit but he is barred from making any secret profit. He may retain some profits with the company’s consent in a similar way that an agent retains profit for his services. A promoter cannot be given benefit of negotiations or contracts to the company. If he has purchased some property for the company, he cannot rightfully sell the acquired property to the company he is promoting, at a higher price. Upon discovering such an act, the company may rescind the contract and recover the purchase money. Also, it is the duty of the promoter to not make any unfair use of his position and must take care to avoid anything which has the appearance of undue influence or fraud. Thus, the main duty of a promoter of a company is to “act in good faith”. If he fails to do so, he commits a breach of trust. His dealing must be open and fair.

Since the promoter owes a duty of disclosure to the company, the primary remedy against him in the event of breach is for the company to bring proceedings for rescission of any contract with him or for recovery of any secret profits which he has made. If in case the rescission is not possible, the company is entitled to claim damages against the promoters. In the Madhya Pradesh High Court’s decision in D.R. Patil v. A. S. Dimilov (AIR 1961), it was held that a promoter is personally liable to third parties upon all contracts made on behalf of the intended company, until with their consent, the company takes over liability. According to the provisions of the Companies Act, 2013, the promoter is held liable for fraud according to section 7(6), if he incorporates the company by furnishing false information, for non-compliance of provisions under section 26 where he omits matters to be listed in the prospectus, 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, under section 35(1). If he makes 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.

A promoter doesn’t complete his duty until the company has acquired the property for which it was formed to manage and has raised its initial share capital, as held in Lagunas Nitrate Co. v. Lagunas Syndicate Ltd., and the Board takes over the management of the affairs of the company from the promoters. Even in the event of winding up, the liquidator or a contributory can hold him liable for misfeasance and he can be examined either privately or publicly.



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