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The formation of a company is not a one-day job. Several steps are needed to fulfil before a company takes its final shape. The role of promoters comes into play at the very beginning of the whole process. Let us move to the steps required for the formation of a company.
The whole process is majorly divided into four steps; Promotion, Registration, Floatation and Commencement of business. Promotion is the stage where a person with the idea of forming a company takes the necessary measures so that it can come into existence. Registration is the second stage where a company is registered under the Companies Act to secure and protect a business. In the third stage of incorporation, the promoter has to come up with a capital structure for the company. The last step is the one where a company is legally approved to run its business. In this stage, the certificate of commencement of business is issued after verifying all the legal documents necessary for the incorporation.
Meaning of the word Promoter
An individual, an association of persons, a company, any of these can be a Promoter. It is a promoter’s brain behind the formation of a company. Promoters come up with the idea, they complete the formalities, raises capital, and bring a company to its existence.
Statutory Definition of a Promoter
Under the Companies Act, 1956, there was no specific definition of a Promoter, though the promoters were referred to in the act, they were not defined. The definition of a promoter makes its place in the Companies Act, 2013. Section 2 (69) of the Companies Act, 2013 establishes a promoter as:
- One whose name has been given in the prospectus or recognised by the company in the annual general meeting as provided in section 92
- The affairs of the company whether directly or indirectly controlled by promoter
- The board of directors of the company is accustomed to act on the advice and direction given by the promoter.
Provided that nothing in sub-clause (c) shall apply to a person who is acting merely in a professional capacity.
The definition in the act makes it clear that a promoter of a company has to go through it all; whether it is the formation of a company or the smooth running of it. So, does promoter holds a legal position in a company? No, he does not.
Legal Position of a Promoter
Under the Companies Act, promoters are not given any legal status. They are not considered as agents or trustees of a company as they hold a position even before a company is formed. Promoters are deemed to be in a fiduciary relationship with the company.
Types of Promoters
There can be the following types of promoters:
- Professional promoters:
Even though these types of promoters are not common in India, but professional promoters are those who specialise in the promotion of a company.
- Occasional promoters:
These are the promoters who are from a different field but take up the position of a promoter for a while. These kinds of promoters do not have long term interest in the company. Example: lawyers.
- Financial promoters:
These promoters are responsible for promoting financial institutions. It is generally seen that these promoters work when the economic environment is favourable.
Duties of a Promoter
There are no special provisions under the Companies Act, 2013 regarding the duties of a promoter. The major duties of the promoters are as follow:-
- He is duty-bound not to make any secret profits.
- He has to disclose any interest in a transaction to the company.
- In case the promoter receives any money on behalf of the company, then it must be returned to the company.
- While working as promoter due diligence and care to be taken and also to made prudent decisions.
Not to make any secret profits
A promoter, being in a fiduciary position, must act in good faith. This position requires him to commit to the company. For him, the interest of the company is first and foremost. A promoter is allowed to make a profit, but he just cannot make it secretly. In the first Annual General Meeting of a public company, every detail related to pre-incorporation is investigated, and if it is found that the promoter has made any secret profit, he is held liable for the same.
Any personal profit that a promoter has made needs to be disclosed to the following:
- Independent board of directors; or
- Articles of association; or
- Prospectus; or
- Existing and intended shareholders.
The disclosures are to be made according to the Issue of Capital and Disclosure Requirements Regulation, 2018 of SEBI (Securities and Exchange Board of India). These disclosures are detailed in the prospectus or offer document of the company.
To disclose an interest in a transaction
Apart from not making any secret profits, a promoter has another duty towards the company he has formed. Any interest in a transaction, earned by the promoter, before the incorporation, has to be disclosed to the company. Even after incorporation, if a promoter acquires any property or enters into any transaction under the company’s name, then it must be handed over in time to avoid any action that can be taken against him.
Other than these duties, in case the office of a director becomes vacant, a promoter also needs to appoint a required number of directors, till the general meeting where the company appoints the directors.
Liabilities of a Promoter
Under the Companies Act, 2013, there are several provisions which deal with the liabilities of key managerial personnel of a company. A promoter being one of them is liable for the following actions, or the lack of some:
- Under section 26, in case of a public company, a promoter is liable to disclose in the prospectus, any litigation or legal action pending against him and the contributions made by him to the company;
- Under section 35, a promoter is liable to pay compensation to any person who has sustained loss because of any misleading statements made in the prospectus;
- Under section 266, a promoter can be disqualified from being appointed as a director in any company for six years if he is found liable of diverting the funds of the company for any purpose other than for the interest of the company.
Specific performance of a contract entered by the promoter
Under the Specific Relief Act, 1963, a party may obtain specific performance of a contract entered by the promoter, before the incorporation of the company. Such contract must be warranted by the terms of incorporation, and the company must have accepted the contract and communicated such acceptance to the other party of the contract. Such contracts are also called as pre-incorporation contract. Mostly in pre-incorporation contracts, promoters are personally liable. This concept of pre-incorporation has been well explained by the court in case Kelner vs Baxter case. In this case promoter on behalf of the unformed company entered into a contract with Mr Kelner to sell wine. Later on, payment was not made to Mr Kelner, and so he filed a case on all the promoters. The court went on explaining that the principal agent relationship cannot be formed before incorporation. No liability will be levied on the company for any pre incorporation contracts either through adoption or ratification. This is so because the company is stranger to contract as it was not in existence at the time of formation of the contract. So, it is concluded that promoters are personally liable for pre-incorporation contracts as they are the consenting parties who had entered into the contract.
The position of a promoter puts him in a place where he knows all the sensitive and crucial information about the company. This is a huge liability, and that is why he is regarded as key managerial personnel so that in case of any default, an action can be taken against him. At the beginning of 2020, Finance Minister Nirmala Sitharaman announced some significant changes to the Companies Act, which included decriminalizing certain provisions and making way for civil action. Even though there will be fines and compensations for any misconduct, it is still beneficial for the company and its ease of doing business.
Remuneration of a Promoter
As the work of a promoter involves skill, energy and sometimes capital as well, he is entitled to reasonable remuneration for his services. In India, it is generally seen that a promoter keeps controlling shares with him and thus, and thus he does not face any difficulty when it comes to remuneration. Also, it should be noted that any remuneration paid to the promoter needs to be disclosed in the prospectus and must be accounted for in the first annual general meeting of the company.
The promoter performs many activities. The promoter is involved in almost all major steps of the company, from drafting the prospectus to the winding up of a company. If a person takes an interest in giving shape to a company and takes all necessary steps, he is considered as a good promoter. India has seen significant development in the establishment of companies, and a promoter plays a vital role in it. A promoter must ensure that a company grows and thrives in a society. Every transaction and every action taken by a promoter needs to be transparent and being in a fiduciary position; it becomes even more important that he looks out for the company. A promoter is behind the idea of the formation of a company, he arranges the capital and assets and is responsible for appointing people to run the company as well; this shows his value in the company, and if he succeeds in planning out the same effect, the society grows with the growth of the company.
Important stages in the formation of the company, Attorney Matters, available at https://accountlearning.com/important-stages-in-the-formation-of-a-company/
RC Agrawal, Promoters of a Company: Definitions, Characteristics and Other Details, Your Article Library, available at <https://www.yourarticlelibrary.com/company/promoters-of-a-company-definitions-characteristics-and-other-details/42057>
Duties and Responsibilities of Directors, Law Teacher, Last updated 7th August 2019, available at https://www.lawteacher.net/free-law-essays/company-law/duties-and-responsibilities-of-directors.php
ePathshala, Ministry of Human Resource and Development
 Kelner v Baxter (1866) LR 2 CP 174
 Nirmala Sitharaman: Govt to decriminalise minor violations of Companies Act, updated on 17th May 2020, The India Express, available at <https://indianexpress.com/article/business/nirmala-sitharaman-companies-act-relaxations-6414093/>