The legal status of the promoter in India

Critical analysis

A company is a legal body created by a group of people who would conduct and manage a business enterprise, whether it is commercial or industrial work involved. Depending on the corporate legislation of its jurisdiction, a corporation may be set up in various ways for tax and financial liability.

According to Lord Justice Lindley, “a company is a legal entity created when a group of people comes together to invest money or money’s worth in common stock, use it in a trade or business, and split the profits or losses that result from doing so”. From the concept development up till the initiation of a company, there are many processes involved in the formation of a company.

There are four main phases for the formation of a company, the initial phase of a company’s formation is a promotion where promoters of the business idea aid in this phase, which sees the idea of beginning a business become a reality.

The promoter decides on the type of business that has to be conducted after identifying the business opportunity and also determines the financial, technical, and legal aspects of operating the business by conducting a feasibility study. A promoter is an individual who creates an organisation and also shares a fiduciary relationship and fiduciary duty towards the company and is the one who signs a contract on a behalf of the company to be formed prior to the process of incorporation.

The promoters hold a significant role and position and have extensive authority over the creation of a company. It is interesting to note, nevertheless, that he is neither an agent nor a trustee of the proposed business in terms of the law but that does not imply that the promoter has no legal connection to the proposed company.

The company they promote and also the people they persuade to become its sharers are both owed the fiduciary duty by the promoters. The courts have had a difficult time dealing with the promoters, who have appeared on the legal side of the arena during the ongoing incorporation process.

One of the key problems that are followed by this situation is the question of the appropriate legal consequences that should occur when a promoter deals with a third party on behalf of the future corporation that is still non-existent. From the perspective of the promoter, it is quite evident that neither is he the agent of the company nor he’s engaged in any of the official work as such.

On the other hand, he is the authority concluding a legal agreement with a third party on behalf of a non-existent principle. Promoters and pre-incorporation contracts have a lot of legal ramifications.

The issue of liability is one of the most crucial of these and when a promoter signs a contract on behalf of an unincorporated business and the business later fails to fulfill its duties as promised, the promoter may be held responsible for the breach itself. In order to avoid repercussions, the promoters must use extreme caution when signing contracts on behalf of a business that has not yet been formed.

Pre-incorporation contracts often have the additional drawback of being voidable at the company’s discretion. This means that the business can easily cancel the contract if it decides that it does not want to be bound by it. The ability to escape being bound by commitments that it later determines is not in its best interests can be a highly helpful power for a business.

Legal perspective and analysis

The Companies Act of 2013’s Section 26[1] specifies the information that must be included in a prospectus. A promoter could be held accountable for breaking the section’s rules. A promoter may be held accountable under sections 34[2] and 35[3] for any false information in the prospectus provided to a person who subscribes for shares or debentures on the basis of that prospectus.

However, the promoter’s culpability will only apply to the person who received shares when they were first allotted; it will not apply to people who received shares after that. According to Section 300, if the court orders it based on a liquidator’s report alleging fraud in the promotion of the firm, a promoter may be subject to investigation like any other director or officer of the company.

In the matter of PG Electroplast Limited[4], the company and the promoter directors were held liable for non-disclosures in the prospectus and thus for violation of ICDR Regulations and SEBI (Prohibition of Fraudulent and Unfair Trade Practices) Regulations 2003. They were barred from raising capital from the securities market and prohibited from dealing in the securities market[5]

In Prabir Kumar Misra v. Ramani Ramaswamy[6], the Madras High Court ruled that a promoter need not be a shareholder, director, or signatory to the company’s memorandum or articles of association in order to be held liable. Regarding the actions and contracts, he entered into while serving as the company’s agent or trustee during the pre-incorporation period, the promoter is nevertheless liable in civil court to the company as well as to third parties.

The High Court of Rajasthan adopted a common law perspective in Seth Sobhag Mal Lodha v. Edward Mill Co. Ltd[7]. with regard to the responsibility of pre-incorporation contracts. Although the pre-incorporation contract makes the promoter personally accountable under common law, there are specific circumstances in which the promoter may transfer his obligation to the company.

The firm may terminate the contract or, in the alternative, decide to take advantage of it and sue the promoter for damages for breaching his responsibility to the company if the promoter does not fulfil the obligations required of his fiduciary position.

Since, the position of promoter is not yet crystal clear cases and precedents are holding a way to recognition, of the liabilities of the promoter may, may not arise as per seen in the above mentioned cases and vary on case to case basis, the promoter is a mere representative of company who looks into the work before incorporation and usually gets shares in return of it, any profits made during the stage of promotions by the promoter are to be duly given to the company and also he is held personally liable for preliminary contracts till they are approved by the company.

Thus, the promoters, role is bit complicated as he is working for something that isn’t in existence and thus also is put under liability to pay back or compensate in case of making untrue statements to the public.

Conclusion

Any person, or partnership or group of people who takes the essential steps to establish a business is referred to as a promoter. The promoters are in charge of overseeing the company’s establishment; they gather the subscribers, create the memorandum, execute it, and register the business. Therefore, it may be argued that the promoters serve as the company’s mould, giving it shape and direction.

References:

[1] Companies Act, 2013, § 26, Acts of Parliament, 2013 (India)

[2] Companies Act, 2013, § 34, Acts of Parliament, 2013 (India)

[3] Companies Act, 2013, § 35, Acts of Parliament, 2013 (India)

[4] In the matter of PG Electroplast and its Promoter Directors, SEBI, Whole Time Member Order: WTM/SR/IVD/ID-V/08/03/2014

[5] Shruti Nandwana, A need for stricter accountability of promoters in the corporate governance regime in India: In the context of majority shareholding of, ILI Law Review, 91, (2020).

[6] 2010, 104 SCL 174

[7] 1972 42 CompCas 1 Raj, 1969 WLN 498

This article has been authored by Lizansha Birla, a student at the University of Petroleum and Energy Studies, Dehradun.