A joint-stock company, in today’s times, is one of the most successful ways to become profitable. However, to convert any business into a joint-stock company is a complicated process. It is necessary to promote the business, to register and perform various legal formalities for its conversion and to persuade the public to invest and much more. therefore a promoter is hired to aid the business in these matters. Thus, a Promoter is essentially an individual who originates the idea for the formation of a company and gives the practical shape to that idea with the help of his own resources and with that of others.
Investment promoters look to bring information about the specified investments to the attention of potential investors. They may target domestic or foreign investors, depending on the investment in question. The goal is to locate capital that may have otherwise been invested elsewhere based on the limited knowledge available about the promoted investment opportunity.
However, there is no statutory definition for promoter anywhere in the English law or the Companies Act, but the term is used expressly in Sections 2(69), 35, 39, 40, 300, and 317 of the Company Act, 2013.
As per Section 2(69) of the Act, the term ‘Promoter’, is a person-
“(a). who has been named as such in a prospectus or is identified by the company in the annual return 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:
Provided that nothing in sub-clause (c) shall apply to a person who is acting merely in a professional capacity[i]”
In the USA, Securities Exchange Commission Rule 405(a) defines a promoter as “a person who, acting alone or in conjunction with other persons directly or indirectly takes the responsibility in founding or organizing the business enterprise.”
Role of Promoter
Although to accurately define a promoter may be difficult but the legal position is quite clear. It is interesting to note that so far as the legal position is concerned, he is neither an agent nor a trustee of the proposed company. He is not the agent because there is no company yet in existence and he is not a trustee because there is no trust in existence. But it does not mean that the promoter does not have any legal relationship with the proposed company. His legal position is that he stands in a fiduciary position towards the company about to be formed. Lord Cairns has stated the position of the promoter in the case of Erlanger V. New Sombrero Phosphate Co. [ii] as “the promoters of a company stand undoubtedly in a fiduciary position. They have in their hands the creation and moulding of the company. They have the power of defining how and when and in what shape and under whose supervision it shall come into existence and begins to act as a trading corporation.”
The eminence of a promoter is generally terminated when the Board of Directors has been formed and they start governing the company. Technically, the first persons who control the company’s affairs are its promoters.
The promoters have the role to carry out the necessary investigation to find out whether the formation of a company is possible and profitable. Thereafter, they organize the resources to form a company. In this sense, the promoters are the originators of the plan for the formation of a company. Promoters are the one who arranges for the company to acquire the business which the company is to conduct or the property or assets from which it is to derive its profits or income when he fulfils these things he then hands over the control of the company to its director.
On handing over the control of the company to the directors, the promoters’ fiduciary and common law duties cease, and he is thereafter subject to no more extensive duties in dealing with the company than a third person who is unconnected with it. Thus where a promoter disclosed the profit which he made out of a company’s promotion to the persons who provided it with the share capital with which it commenced business, it was held that he was under no further duty to disclose the profit to persons who were invited to subscribe further capital a year later, and so the company could not recover the profit from him for his failure to do so. Nevertheless, a promoter may remain subject to fiduciary and other duties to the company if he becomes a director or agent of it, but the duties are then owed only in that other capacity.
Duties and Responsibilities of the Promoter
Since a promoter stands in a fiduciary capacity to the company, he owes certain duties to the company. Promoters’ duties are the same as a person who acts on behalf of a person without a contract of employment, namely not to deceive and to exercise reasonable care and skill. He may be made liable for misrepresentation and fraud in the prospectus.
In the Indian Companies Act, 2013 there are no specific provisions with regard to such fiduciary duties, however, Sec.34 & 35 impose liability for untrue statements in the prospectus and for fraudulent trading [iii]. The two particular duties imposed are:
1. Duty not to make a secret profit
2. Duty to disclose to the company any interest in a transaction
Duty Not to Make Secret Profit
Since a promoter has the advantage of access to insider information, business opportunity and opportunity to sell in the company formation process. He may sell his own land, intellectual property, professional services at a reasonable rate to other companies and in that he can make disclosed profits however, he is not allowed to make such secret profits. In cases of public companies in the first Annual General Meeting, all dimensions of promotion and all types of pre-incorporation agreements are investigated so as to check whether the promotion was done meticulously and honestly or not and if the promoter is found to make a secret profit he may be made accountable for that. However, a promoter is allowed to make a profit if the same is disclosed.
In Gluckstein v. Barnes[iv] a group of persons bought ‘Olympia’ (an amphitheatre) and sold this to a company promoted by them and made a secret profit of 20,000 £, not disclosed in the prospectus. It was held that the profit of 20000 £ is a secret profit and promoters are bound to pay it to the company because the disclosure was not sufficient. Similarly in, Erlanger v. New Sombrero Phosphate Co. [v]a group of which Erlanger was a member, purchased an island consisting of phosphate mines for 5,000£. A nominee of the group sold the property to co. for 1,10,000 £ formed by Erlanger and, details of which were not disclosed to the directors. It was held that the company can rescind the contract as there had been no disclosure of the profit which was made. A pertinent question arises that such profits should be declared to whom and how. In this regard, it may be submitted that such disclosures of personal profits may be made to following
- Independent board of directors or
- Articles of association or
- Prospectus or
- To existing and intended shareholders
Generally, all such disclosures are made in detail in prospectus or offer document. Details of property, including price purchases from promoters within two years, must be disclosed according to the Issue of Capital & Disclosure Requirements Regulation, 2009 of SEBI. But in certain circumstances it is impossible to find an independent board of directors like in Solomon’s case [vi], in such circumstances, the real truth should be disclosed to those who are invited to become shareholders and not merely to first few shareholders.
Duty to Disclose Interest in A Transaction
In addition to a duty not to make a secret profit, a promoter is also duty-bound to disclose to the company any interest which he has in a transaction entered into or proposed to be entered into. This includes the sale of his own property to the as he acquired the property before the promotion began. [vii] A complete disclosure must be made to the company in such cases. After incorporation of a company if a property is received by promoters he is the trustee of such property and everything must be handed over to the company in due course otherwise he may be held liable for conversion or misappropriation or breach of trust of property. Generally, a company is a child of a promoter so he does not dispose of properties which are worthless on a high rate but there can be cases where he may try to wash off his hands from bad properties by selling the same to a company promoted by him as he has better access to it.
Remedies available to the company against a promoter
If a promoter makes any secret profit and does not disclose it, in that case, a company has the following remedies available against him.
- Rescind the contract and recover the secret profit made by him
- Retain the property, paying no more for it than what the promoter has paid depriving him of his profit.
- Where the above remedies would be inappropriate, the company may sue him.
Thus it’s evident that the role of a promoter is growing in importance day by day, all over the world. A concept started in early common law is now applicable in various counties. It can be very well said the word ‘promoter’ is used in common to address any individual, association or a company who takes necessary steps to create a company and get it going. Thus the promoter is at the helm of getting a company into existence, moulding it and giving it a shape to help it to come into existence.
[i] Section 2(69) Companies Act, 2013
[ii] (39 LT 269
[iii] Section 339 & 447 Companies Act, 2013
[iv] (1900) AC 240
[v] (1878) 3 AC 1218
[vi] 1897 AC 22.
[vii] Re Lady Forrest (Murchison) Gold Mine Co. Ltd, (1901) 1 Ch.D. 582.
Student, Symbiosis Law School Pune
Rachita is Student at Symbiosis Law School, Pune. She is originally from Chennai and has completed secondary and higher secondary education at Indian High School, Dubai. She is an aspiring lawyer with an avid interest in Intellectual Property Law. For any clarifications, suggestions and feedback kindly find her at firstname.lastname@example.org