Liabilities of Promoters under Companies Act

In this article we shall study functions, rights, duties and liabilities of promoters.

1.Who is a Promoter?

According to Section 2 (69) of the Companies Act, 2013 “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:

Sub-clause (c) shall not apply to a person who is acting merely in a professional capacity.

2. What could be the consequences if promoter fails to make full disclosure of profit, secret profit, etc.

If the company comes to know about the secret profit made by the promoter, the company can rescind such a pre-incorporation contract after its incorporation. If a promoter makes a secret profit or does not disclose any profit made, the company has a remedy against him. The company can recover the secret profit also.

3. What are Pre-incorporation Contracts?

Contracts those are entered into by promoters with parties to acquire some property or right for and on behalf of a company yet to be formed are called as ‘pre-incorporation contracts’ or ‘preliminary contracts’.

Short Notes:

1. Promoter

Usually, the first step to form a company is the process known as ‘promotion’ where a person persuades others to contribute capital to a proposed company before it is incorporated. Such a person is called the promoter of the company.

According to Section 2 (69) of the Companies Act, 2013 “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:

Sub-clause (c) shall not apply to a person who is acting merely in a professional capacity.

Functions of Promoters:

to identify a business opportunity
to perform feasibility studies
to collect required number of persons to form a company
to take decisions on following matters
to get name approved
to appoint professionals
to prepare necessary documents

Other functions include to settles the terms of preliminary contracts with vendors and agreement with underwriters; to make arrangement for preparation, advertisement and circulation of the prospectus and placement of the capital; to arrange for the registration of the company and obtain the certificate of incorporation; to defray preliminary expenses; to arrange the minimum subscription.

Duties of Promoter:

Duty to disclose secret profits
Duty of disclosure of interest

Promoter’s duties continue until the company has acquired the property or business which it was formed to manage and has raised its initial share capital and the Board of directors has taken over the management of the company’s affairs from the promoters.

Liabilities of Promoter:

Liability of promoter under prospectus
Liability of promoters in respect of allotment of shares
Liabilities of promoter at the time of winding up

Types of Promoters:

Professional promoters
Occasional promoters
Entrepreneur promoters
Financier promoters
Institutional promoters

2. Registrar of Company

According to Section 2(75), the term ‘Registrar’ means a Registrar, an Additional Registrar, a Joint Registrar, a Deputy Registrar or an Assistant Registrar. At present, 22 Registrar of Companies (ROCs) is operating in all the major states. However, states like Tamil Nadu and Maharashtra, have more than one ROC.

Registrar of Companies as appointed under Section 396 of the Act primarily have the duty of registering companies incorporated in the respective States and the Union Territories and to maintain a registry of records concerning companies which are registered with them and allows the general public in accessing this information on payment of a stipulated fee.

Functions of the ROC:

To take care of the registration of a company in the country.
To maintain a register of Companies/LLP by entering the names of newly incorporated companies and removing the names of those which are struck off.
To complete regulation and reporting of companies and their shareholders and directors and
To administer government reporting of several matters which includes the annual filing of numerous documents.
To foster and facilitate business culture.
To issue a certificate of Incorporation after authenticating the documents submitted in support for such incorporation.
To ask for supplementary information from any company when necessary.
To file a petition for winding up of a company with the discretion of the government,

Powers of ROC:

Registration of a company formed under Section 3 of the Companies Act is obtained by filing an application with the ROC in whose jurisdiction the registered office of the company is situated under Section 7 of the Companies Act.
Under Section 83 of the Companies Act, 2013 the ROC is allowed to make entries of satisfaction, etc. after receiving evidence that, the debt for which charge is given has been paid or satisfied in whole or in part; or that a part of the property or undertaking charged has been released from the charge or has ceased to form a part of the company’s property or undertaking.
Under Section 206 of the Companies Act, 2013, the Registrar may require any company to furnish information or explanation or produce any document, if after scrutinizing any document or on receiving any information, he feels that such documents are necessary.
Under Section 209 the Registrar is empowered to obtain an order from the Special Court for the seizure of books and papers of the company if upon receiving information or otherwise, he has reason to believe that these books, papers of the company are likely to be altered, mutilated, falsified, secreted or destroyed. The Registrar or Inspector is further allowed to make copies and extracts of such documents.
Under Section 248 of the Companies Act, the Registrar can remove the name of a company from the register if provisions in the Act, are not complied with.

3. Certificate of Incorporation:

After going through the information and papers, if ROC is satisfied that the application for incorporation is in prescribed format, required documents are submitted in prescribed format and such company is authorized to be registered, he places the name of the company in the register of companies maintained by him and issues a Certificate of Incorporation in the prescribed form indicating the date of incorporation.

The Registrar also allocates a Corporate Identity Number (CIN) to the company which is a distinct identity for the company. The allotment of CIN is on and from the company’s incorporation date. Thus, the Certificate of Incorporation may be regarded as the birth certificate of the company because the company comes into existence on and from the date mentioned therein.

The legal effect of incorporation:

The life of the company dates from the first moment of the day of incorporation. Also, a binding contract comes into existence between the company and its members as mentioned in the Memorandum and Articles of Association.
The company becomes a legal person separate from the incorporators from the date of incorporation.
A registered company can exercise all functions of a company incorporated under the Act.
A company can sue and be sued in its own name.
A company has a right to hold and alienate its own property.
The company’s debts and obligations are the liabilities of the company only and cannot be enforced against the individual shareholders.

Conclusiveness of the Certificate of Incorporation:

The certificate of incorporation not only creates the company but also is the conclusive evidence that all the requirements of the act regarding registration have been complied with. ‘Conclusive evidence’ means:

that the fact of incorporation and existence of the company as a legal person cannot be challenged
And that the company is duly registered.
And that the company came into existence on the date mentioned in the certificate.

4. Liabilities of Promoters:

Liability of Promoter Under Prospectus:

Section 35 holds the promoter liable to pay compensation to every person who subscribes for any share or debentures on the faith of the prospectus for any loss or damage sustained by reason of any untrue statement included in it. The liability of the promoters will be unlimited in such a case. The Act amounts to fraud and is punishable under Section 447 of the Act. Section 447 of the Act lays down that any person who is found to be guilty of fraud shall be punishable with imprisonment for a term which shall not be less than six months but which may extend to ten years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud: Provided that where the fraud in question involves public interest, the term of imprisonment shall not be less than three years.

Liability of Promoters in Respect of Allotment of Shares:

When company issues prospectus, all the money received by it from the applicants for the shares is to be kept deposited in a scheduled bank. If entire amount payable on applications for shares in respect of minimum subscription amount as stated in the prospectus has not been received by the company within the prescribed period, all money received by it from the applicants is to be returned to such applicants in the stipulated period.
Default to this becomes punishable under S. 39 with fine which may extend to rupees 1 lakh or rupees 1000 for each day of default, whichever is less.

Liabilities of Promoter at the Time of Winding Up:

In the course of winding up of the company on order of Tribunal, on an application made by the official liquidator, the court may make a promoter liable for misfeasance or breach of trust. (Section 300). Further, where fraud has been alleged by the liquidator against a promoter, the court may order for his public examination.

In Prabir Kumar Misra v. Ramani Ramaswamy [2010] 104 SCL 174 case, the Court held that to fix liability on a promoter, it is not necessary that he should be either a signatory to the Memorandum/Articles of Association or a shareholder or a director of the company. Promoter’s civil liability to the company and also to third parties remain in respect of his conduct and contract entered into by him during the pre-incorporation stage as agent or trustee of the company.

5. Pre-incorporation contract:

Contracts that are entered into by promoters with parties to acquire some property or right for and on behalf of a company yet to be formed are called as ‘pre-incorporation contracts’ or ‘preliminary contracts’. Since the corporation has not been formed yet, it cannot be a party to the agreement. If the corporation is not formed or if it fails to adopt the agreement, the promoters can be held personally liable for any breach of the agreement.

Responsibility of A Company Towards Pre-incorporation Contracts:

The company, when it comes into existence, is not bound by any contract made on its behalf before its incorporation. A solicitor or lawyer, or chartered accountant who on the request of promoters, prepared a company’s documents and spent time and money in getting it registered, could not recover his charges from the company.
The other party to the contract is also not bound. The company cannot ratify a pre-incorporation contract and hold the other party liable.
The agents who contract for a proposed company may sometimes incur personal liability.

In Kelner v Baxter (1866) LR 2 CP 174 case, where the promoter of a new hotel on behalf of the unformed company accepted an offer of Mr. Kelner to sell wine. He supplied wine to the company. But, subsequently the company failed to pay Mr. Kelner, and he brought the action against promoters. The Court held 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. The company cannot take the liability of pre-incorporation contracts through adoption or ratification; because a stranger cannot ratify or adopt the contract and the company was a stranger because it was not in existence at the time of formation of the contract. So he held that the promoters are personally liable for the pre-incorporation contract because they are the consenting party to the contract.

Essay Type Questions

What is meant by Promoter? Explain in brief the position of promoter relating to his rights, duties and liabilities in a Company.

According to Section 2 (69) of the Companies Act, 2013 “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:

Sub-clause (c) shall not apply to a person who is acting merely in a professional capacity.

Functions of Promoter:

To Identify a Business Opportunity: The promoter first identifies a potential business opportunity in form of the production of a new product or service, substitute to existing product or service with a better alternative or updated features or any other such opportunity having investment potential.
To Perform Feasibility Studies: Once the business opportunity is identified, the promoter analyzes and investigate the feasibility of the opportunity.
To Collect Required Number of Persons to form a Company: Next step of the promoter is to collect the requisite number of persons (i.e. seven in case of a public company and two in case of a private company) who can sign the ‘Memorandum of Association’ and ‘Articles of Association’ of the company and also agree to act as the first directors of the company. Usually, the signatories of the memorandum are the first Directors of the Company. However, the written consent of the persons signing the memorandum is required to act as Directors and to take up the qualification shares in the company.
To Take Decisions on Following Matters: In this stage the decision regarding the name of the company. the location of its registered office, the amount and form of its share capital, the brokers or underwriters for the capital issue, if necessary, the bankers, the auditors and the legal advisers are taken.
To Get Name Approved: Next step after a feasibility study of the project, and a decision of a launch a company is made then, the next step is to select a name for the company and get it registered with the registrar of companies of the state in which the registered office of the company is to be situated. An application with three names, in the order of their priority, is filed with the registrar to get the name approved.
To Appoint Professionals: Appointments of the brokers or underwriters for the capital issue, if necessary, the bankers, the auditors and the legal advisers are important because they help promoters in the preparation of necessary documents that are required to be filed with the Registrar of Companies.
To Prepare Necessary Documents: The documents to be submitted to Registrar of Companies for getting the company registered are Memorandum of Association, Articles of Association, consent of Directors and statutory declaration. In this stage, the promoter has to get these documents prepared and printed with the help of professionals.
Other Functions: Other functions include to settles the terms of preliminary contracts with vendors and agreement with underwriters; to make arrangement for preparation, advertisement and circulation of the prospectus and placement of the capital; to arrange for the registration of the company and obtain the certificate of incorporation; to defray preliminary expenses; to arrange the minimum subscription.

Duties of Promoter:

Duty to Disclose Secret Profits: A promoter is not forbidden to make a profit but to make secret profits. He may make a profit out of promotion with the consent of the company, in the same way as an agent may retain a profit obtained through his agency with his principle’s consent. If the company comes to know about the secret profit made by the promoter, the company can rescind such a pre-incorporation contract after its incorporation. If a promoter makes a secret profit or does not disclose any profit made, the company has a remedy against him. The company can recover the secret profit also.
Duty of Disclosure of Interest: A promoter must disclose to the company any interest he has in a transaction entered into by it. He should also give the particulars of his interests in other firms or bodies corporate.

Termination of Duties of Promoter:

Liabilities of Promoter:

Liability of Promoter Under Prospectus: Section 35 holds the promoter liable to pay compensation to every person who subscribes for any share or debentures on the faith of the prospectus for any loss or damage sustained by reason of any untrue statement included in it. The liability of the promoters will be unlimited in such a case. The Act amounts to fraud and is punishable under Section 447 of the Act. Section 447 of the Act lays down that any person who is found to be guilty of fraud shall be punishable with imprisonment for a term which shall not be less than six months but which may extend to ten years and shall also be liable to fine which shall not be less than the amount involved in the fraud, but which may extend to three times the amount involved in the fraud: Provided that where the fraud in question involves public interest, the term of imprisonment shall not be less than three years.
Liability of Promoters in Respect of Allotment of Shares: When company issues prospectus, all the money received by it from the applicants for the shares is to be kept deposited in a scheduled bank. If entire amount payable on applications for shares in respect of minimum subscription amount as stated in the prospectus has not been received by the company within the prescribed period, all money received by it from the applicants is to be returned to such applicants in the stipulated period. Default to this becomes punishable under S. 39 with fine which may extend to rupees 1 lakh or rupees 1000 for each day of default, whichever is less.
Liabilities of Promoter at the Time of Winding Up: In the course of winding up of the company on order of Tribunal, on an application made by the official liquidator, the court may make a promoter liable for misfeasance or breach of trust. (Section 300). Further, where fraud has been alleged by the liquidator against a promoter, the court may order for his public examination.

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