ROLE AND LEGAL POSITION OF PROMOTERS OF A COMPANY

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This article is written by Vansh Aggarwal of 3^rd Semester of University School of Law and Legal Studies, Guru Gobind Singh Indraprastha University, an intern under Legal Vidhiya

ABSTRACT

This article undertakes a comprehensive analysis of the role of a promoter in a company which includes but is not limited to, Discovery of a business idea, detailed research, congregating resources and preparing preliminary documents for incorporation of a company along with the definition of the promoter, its functions and liabilities. The article then explores the legal position of a promoter, both before and after the incorporation of a company with the help of judicial precedents and relevant legislation. This is a delightful read and a fair attempt towards equipping you with the knowledge that is required upon the subject matter of the Role and Legal position of a promoter.

Keywords: Promoter, Companies Act 2013, Corporate law, Legal position of Promoter, Role of promoter, Rights, Liabilities, Fiduciary capacity of a promoter.

INTRODUCTION

In recent times, the startup culture has seen unprecedented growth in India with new businesses and startups coming up and people showing a willingness to become job providers instead of job takers. Many people come towards and cooperate towards the formation of the company, namely the founder, co-founder, director, and amongst others the promoter. Promoters play an imperative role in the founding of the company right from scratch. They lay down the foundation of the company. The work includes, but is not limited to making the prospectus of the company, floating the securities in the market, etc. However, it is pertinent to mention that the promoters are not the owners of the company. Owners are the shareholders of the company. They are the helping hand that establishes and run the company. Section 2(69) of the Companies Act, 2013[1] defines promoter and has a holistic definition for the term ‘Promoter’. A bare reading of the same gives us an impression and makes us understand that a promoter is a person who helps an organisation to take its baby steps. There are different types of promoters namely, professional promoters, financial promoters, managing promoters and occasional promoters, which are described below:-

1. Professional promoter – A professional promoter is a person who practices promoting a company as a matter of profession and transfers the ownership to the intended owners after establishing the company.

2. Financial promoter – A financial promoter is a person who serves the functions of a promoter as well as invests in the company financially and has a capital share, which also makes them part owner of the company.

3. Managing promoter – A managing promoter is a person who serves the functions of a promoter as well as gets the managing rights in a company. They are not necessarily the owners but have a say in the managerial decisions of the organization

4. Occasional promoter – An occasional promoter is a person who promotes a business for some time, usually two-three years and then ceases to be the promoter.

What seems to be peculiar about the work of a promoter is the fact that it is very limited to the formation of the company, which is not completely true. A promoter is also responsible for many affairs and the operations of the company.

OBJECTIVES

This research article has a comprehension and analysis of the Roles as well as the legal position of a promoter of a company. The article can be divided into two broad categories for a better understanding of the reader – The Role of a promoter and the Legal position of a promoter. The Role of a promoter includes the definition of a promoter and answer to the question – Who is a promoter? It then explores the characteristics, Functions, Duties and Rights of a promoter which as a whole makes the role of a promoter in a company. The second part i.e., the Legal position explores the legal liabilities of a promoter and the capacity in which a promoter is present in a company. It is pertinent to mention that the scope of this article is limited to the aforementioned topics only and the main objective is to attempt to provide the reader with a comprehensive and holistic understanding of the role as well as the legal status of the promoter of a company taking into consideration the relevant law of the land as well as precedents.

ROLE OF A PROMOTER

Before we discuss the Role of a promoter in a company, it is important to understand who is a promoter to have a better understanding of what a promoter does. The legislation on the same is Section 2(69) of the Companies Act, 2013[2] which can be analysed in three different segments:-

a. A person who has been named as a promoter in the prospectus or is named as a promoter in the annual returns filed by it under section 92[3]; or

b. A person who exercises some control over the affairs of the company either directly or indirectly in the capacity of a shareholder, director or otherwise; or

c. A person on whose advice, proposals, or instructions the Board of Directors typically acts.

The very first part of the section simply explains a promoter as a person whose name is mentioned in the prospectus of the company or the Annual returns u/s 92 filed by the company as a ‘Promoter’. The second part is about the degree of control that a person exercises over the affairs of a company. Such control can arise either out of the position of the person as a shareholder, director or otherwise by way of any special arrangement of the company. It is important to understand the fact a person can be a director or a shareholder but cannot be a promoter and vice versa is also possible. The term ‘control’ is defined under section 2(27) of the Companies Act which defines the same as the right to vote and appoint a majority of directors or the right to control managerial or policy-related decisions. However, the term ‘control’ is still ambiguous and is subject to judicial as well as academic interpretation. The last part of the section defines a promoter as a person who gives his advice, directions or instructions to the Board of Directors of the company. However, it excludes a person who is acting in a professional capacity for the company like an advocate, a chartered accountant, etc. The same has been reiterated by the House of Lords in Tyrell v. Bank of London that a person acting in a professional capacity for a company is not a promoter of the company.

A promoter is a person who makes and clears the way for the incorporation of a company to stand on its own feet. In National LS Registration Bank v. Vellu Mudliar[4], it was said that any person who arranges for directors, members, shares or negotiates preliminary agreement may be called a promoter. There are multiple characteristics of a promoter of a company. Some of them are as follows: –

A promoter makes the scheme and has the idea of the formation of the said company.
A promoter sets the objectives, values and vision of a company
A promoter makes the prospectus of a company, floats the securities of a company in the securities market and aids in the formation of a company in any manner possible
A promoter completes the documentation and other incorporation formalities of the company

A promoter can be a person or a group of two or more persons (association) that act towards or in the interest of the incorporation of a company. A promoter plays a vital role at different stages of a business. It is not possible to comprehend the role/functions of a promoter owing to the nature of the work involved. However, a fair attempt at the same is as follows:-

Identifying the business area or opportunity – The promoter needs to identify the area or domain in which the company would do its business. This can be in any field namely, Finance, Trading, Manufacturing, or something related to natural resources. This also includes deciding the structure of the company and the distribution of work among the different departments.
Conducting market research – The promoter is then tasked to conduct market research and conduct a study to assess the long-term sustainability as well as the profitability of the business.
Selection of Name – The promoter selects the name and gets the same registered under the Companies Act, 2013.
Arranging for directors and chiefs – The promoter then finds the directors and various chiefs for the organisations who will also serve as the signatory to the Memorandum of Association (MOA) which is necessary for the constitution of a company.
Arranging for Capital or long-term assets – The promoter also arranges for the required capital to make sure that the company can enter the market while maintaining sufficient liquidity and ease for the business. Many long-term assets like Machinery, Plant and Building, land, etc are also required in the company which are arranged by the Promoters. The promoters look after the required resources and source them towards the company.
Preparing and completing documents like a Memorandum of Association and Article of Association – These are the documents that are necessary for the incorporation of a company. The same are prepared by the promoter either with the aid of a professional chartered accountant or without the same.
Deciding on the location of the company – A promoter also decides the location of the headquarters of the company as the same is relevant for jurisdictional matters before a court.

With powers comes responsibilities. Every person who has powers in certain regards also has some responsibilities to ensure that the abuse of that power is not permitted. Similar is the position of a promoter who exercises such wide powers to incorporate a company. The law imposes several punishments for any such action or inaction which are mentioned below:-

a. Liability for pre-incorporation contracts – If the promoters enter into a contract before the company exists with any third party, the promoter will be solely liable for any such contract in case of its breach. However, according to Section 15(h) and 19(e) of the Specific Relief Act, 1963, a promoter can transfer his rights as well as obligations towards the company if the same is permitted by the Memorandum of Association.

b. Liability for misstatement in the prospectus – A prospectus is a crucial document that is prepared by the promoters which induces the investors to make the decision to invest or not to invest in the company. Hence, any misstatement in the same attracts Criminal liability under Section 447 of the Companies Act and Civil liability under Section 35 of the Companies Act.

LEGAL POSITION OF A PROMOTER IN A COMPANY

The first and foremost question that comes to the mind of a person in regard to the Legal position in a company is whether a promoter is an agent, a trustee or has any other capacity for a company not in existence. This question has been clarified in the case of Kelner v. Baxter[5], where it was held that the promoter is neither an agent nor a trustee of a future company because no one can become an agent of a person/entity not in existence. The legal position of a promoter with respect to a company that is not in existence right now is not explicitly mentioned even in the Companies Act, 2013. However, this grey area of law has been attempted to be made clear with the help of judicial pronouncements and orders. In the case of Erlanger v. New Sombrero Phosphate Co.[6], It was held that Promoters were deemed to have been placed in a fiduciary position. The same has been reiterated in Weavers Mills v. Balkis Ammal[7]. A fiduciary relation is a relation that is based upon confidence and trust. This doesn’t mean that the promoter doesn’t have any legal relations with the company. The fiduciary capacity of the promoter obliges the promoter not to make any secret profits and to disclose his actions/inactions to the company that can have an impact on the company. Any contract that is entered by the promoter and the same is not ratified by the company after its incorporation will make the promoter liable in his personal capacity only. In the case of Prabir Kumar Misra v. Ramani Ramaswamy[8], the Hon’ble Madaras High Court held that the guilt and the liability of a promoter also depend on the conduct of the promoter and the contracts that he has entered into during the pre-incorporation stage of a company.

The position of a promoter is usually terminated when a board of directors is formed. It will be safe to say that a promoter doesn’t have any substantial legal position in the company but rather a fiduciary position.

However, when a company is instituted, a promoter can transfer his/her legal rights and well as obligations to the company in accordance with the Specific Relief Act and if the Memorandum of Association permits the same. Before the incorporation of these provisions in the statute, it has derived from Howard v Patent Ivory Manufacturing[9], where it was observed by the court that even though the promoter is liable for the pre-incorporation contract in a personal capacity, he can transfer his liability to the company. In the event of winding up of a company, the promoters of the company will be held liable for any litigation or prosecution against the company since it is an artificial person.

RECENT DEVELOPMENTS

In recent times, we can observe the fact that the promoter holding in the companies is increasing. The economic growth of India in the past decade has been largely driven by these promoter holdings. The term promoter holding means that a large or substantial proportion of shares are held by the promoters of a company and are not distributed to the public. This ensures that the power to make crucial business decisions is concentrated with the promoters who can make such decisions. For instance, Reliance Industries, Wipro, and Dr. Reddy’s laboratories are some examples of promoter holdings. The same is observed internationally as well. Recently, a promoter group has also brought 2.2% shares in Adani Enterprises which raises the overall stake to 69.87%[10]. So, it is sufficiently clear how these promoter holdings or family businesses are built from scratch over decades and centuries, in some cases and the operational efficiency of these businesses.

CONCLUSION

In conclusion, we can say that a promoter is a person who helps in the process of incorporation of a company. If a company is a new-born, then the role of a promoter would be tantamount to the parents of that new-born who makes him able to stand and rise in life. A promoter is someone who is associated with a company right from its conception. It is clear that a promoter plays several crucial actions right from the business idea to the stage of a profitable company which is imperative to the existence of the company. The legal position of a promoter is also clear with regard to a company that is not in existence and after a company is incorporated.

REFERENCES

1. https://cleartax.in/s/promoters-of-a-company – as visited on 12.08.2023

2. https://ijirl.com/wp-content/uploads/2022/05/PROMOTERS-UNDER-THE-COMPANY-ACT-2013.pdf – as visited on 12.08.2023

3. https://www.legalserviceindia.com/legal/article-7080-role-of-a-promoter-when-it-comes-to-pre-incorporation-contracts.html as visited on 12-08-2023

4. https://www.northeastlawjournal.com/post/promoters-and-directors-of-a-company – as visited on 12.08.2023

5. https://blog.ipleaders.in/position-promoter-india/ – as visited on 12.08.2023

6. https://lawbhoomi.com/promoters-of-a-company-functions-duties-and-liabilities/ – as visited on 12.08.2023

7. https://lawtimesjournal.in/role-of-promoters-in-india/#_ftn10 – as visited on 12.08.2023

8. https://www.lawctopus.com/academike/position-promoter-india-critical-analysis/ as visited on 12.08,2023

9. https://www.screener.in/screens/144972/promoter-holding-increase/

[1] S. 2(69), The Companies Act, 2013.

[2] S. 2(69), The Companies Act, 2013.