Promoter of a Company

Introduction

A promoter is a person who initiates the company’s incorporation process. The promotion process encompasses the generation of the business idea, incorporation, flotation, and commencement of operations. Promoters are heavily involved in the incorporation process, overseeing almost every aspect of establishing the company.

Company formation requires adherence to legal requirements and coordination with regulators and authorities, necessitating teamwork among various individuals led by the promoters. A company serves as a vehicle for conducting business, typically driven by the goal of maximizing profits.

Promotion

Promoting companies is a multifaceted and complex task. Generally, promotion refers to the process of forming a company. In India, promotion is often carried out by individuals who act as ‘occasional promoters.’ When it comes to promoting private companies, the prospective promoters typically sign a ‘Prior Agreement,’ outlining the terms, conditions, and strategies for establishing the company. This is followed by a ‘Promoters Agreement’ after the incorporation, where they document their capital contributions. In the case of public companies, entrepreneurs are supported by Public Financial Institutions such as LIC, FCI, IFCI, ICICI, and IDBI; which act as ‘institutional promoters’ for government enterprises. Large public companies are usually promoted by major corporations that are shareholders.

LJ Bowell defined Promotion as “‘promotion’ is not a term of law but of business operations familiar to the commercial world, by which a company is generally brought into existence.”^[1]

Promoters

A promoter is essentially the founder or organizer of a corporation or business venture, the individual who initiates the creation or organization of the business. The term is primarily used in the context of incorporation, where a promoter performs the necessary actions to incorporate the business. These actions are later ratified by the formation of the board of directors and their subsequent decisions. The individual who signs the certificate of incorporation is referred to as the incorporator, but the promoter is not necessarily the incorporator of the corporate entity. Promoters undertake initial tasks such as issuing securities in the market and drafting the company’s prospectus to establish the business.

The term is defined in the companies act, 2013 in the following way:

“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:

Provided that nothing in sub-clause (c) shall apply to a person who is acting merely in a professional capacity.^[2]

In National LS Registration Bank v. Vellu Mudliar^[3], it was held that anyone who arranges subscribers, directors, places shares, or negotiates preliminary agreements may be considered a promoter. However, in Tyrell v. Bank of London^[4], the House of Lords clearly stated that a person who acts in a professional capacity on behalf of the promoter, such as a solicitor, valuer, or chartered accountant who is compensated by the promoter, is not considered a promoter themselves.

In the case of Weavers Mills Ltd. v. Balkis Ammal^[5], it was held that the court clarified the definition of a promoter, explaining that a promoter is an individual who takes all essential actions to establish a company, emphasizing the fiduciary duties they owe to the company.

In the case of Chintalapati Srinivasa Raju v. SEBI^[6], it was held that A promoter under SEBI regulations is defined as an individual who controls the company, either directly or indirectly, and is responsible for making specific disclosures.

Types of Promoters

A promoter is an individual or entity responsible for initiating the formation of a company. This role can be filled by a person, a firm, an association of individuals, or another company. Promoters can be categorized into several types based on their involvement and contributions to the company’s establishment:

1. Professional Promoter

A professional promoter specializes in the business of company formation. They possess expertise in guiding the business through its initial stages and subsequently transferring ownership to shareholders once the company is operational and established in the market.

2. Financial Promoter

A financial promoter is distinguished by their investment in the company, providing significant capital or funding and holding a substantial share in the company. They often work with banks or financial institutions, focusing on evaluating market conditions and timing the company launch to optimize financial outcomes.

3. Managing Promoter

This type of promoter not only assists in the company’s formation but also secures management rights within the company once it is operational. Their role extends beyond the initial setup, involving ongoing management and oversight.

4. Occasional Promoter

An occasional promoter primarily focuses on the initial flotation of the company. They do not engage in regular business promotion as they manage multiple enterprises. Their involvement is typically limited to crucial matters concerning the company’s launch and development.

Duties of a Promoter

A promoter holds a fiduciary position with respect to the company, which imposes certain duties upon him. These duties are akin to those of a person acting on behalf of another without an employment contract, such as the obligations not to deceive and to exercise reasonable care and skill. Promoters can be held liable for misrepresentation and fraud in the prospectus. Although the Indian Companies Act, 2013 does not explicitly define the promoter’s duties, Sections 34 and 35 impose liability for false statements in the prospectus, and Sections 339 and 447 address fraudulent trading. Specifically, a promoter’s fiduciary duties include:

1. The duty not to make secret profits.

Promoters hold an advantageous position due to their access to information, business opportunities, and the ability to sell assets during the company formation process. While they may sell their land, intellectual property, or professional services to the company at a reasonable rate and make disclosed profits, they are prohibited from making secret profits. According to Section 34, if any information in the prospectus is untrue or misleading^[7], the promoter can be held criminally liable under Section 447^[8].

In the case of Radhey Shyam Khemka And Another v. State Of Bihar^[9], it was held that The Supreme Court examined the possibility of promoters engaging in fraudulent conduct and the associated legal consequences. It stressed that promoters cannot use the corporate entity as a shield when involved in fraudulent activities.

2. The duty to disclose any interest in a transaction to the company.

A promoter is obligated to fully disclose all pertinent information to the company, including any profits earned and any personal interests they may have in transactions with the company. This transparency is essential to ensure that the company is aware of any potential conflicts of interest. As mandated by Section 26^[10], any profit made by the promoter must be explicitly disclosed in the company’s prospectus. This requirement is crucial for maintaining the integrity and trust of the company’s operations. In the case of Mr. Gopalakrishnan Raman v. Ms. Shanti Gopalakrishnan^[11], it was held that Each promoter has an independent duty to make disclosures in accordance with the regulations. The tribunal observed that even if one promoter acts as an authorized representative, all promoters remain individually accountable for ensuring the accuracy of information related to their shareholdings.

Rights of a Promoter

Promoters are typically the first individuals to conceive the business idea. They conduct the necessary investigations to determine whether forming the company is feasible and profitable. Following this, they organize the required resources to transform the idea into reality by establishing the company.

1. Right of Indemnity

When multiple promoters are involved in the formation of a company, one promoter has the right to seek compensation or damages from the others in the event of a breach of contract. It is crucial to understand that all promoters are jointly and severally liable for the company’s operations and obligations. This means that each promoter can be held individually responsible for the entire liability, as well as collectively with the others.

2. Right to Receive Legitimate Preliminary Expenses

A promoter has the legitimate right to be reimbursed for all expenses personally incurred during the formation of the company. These preliminary expenses can include costs related to registration, documentation, advertising, legal fees, and other necessary expenditures associated with establishing the company. The reimbursement of these expenses is essential to ensure that the promoter is not financially burdened for facilitating the company’s formation.

3. Right to Receive Remuneration 

If a promoter takes on a managerial role within the company, they are entitled to receive remuneration for their services. However, this entitlement is subject to the existence of a formal employment contract that outlines the terms and conditions of the remuneration. Without such a contract, the promoter cannot claim compensation for their managerial duties.

Functions of a Promoter

A promoter in a company undertakes several critical tasks, many of which begin even before the business officially exists. These functions include:

1. Identification of Business Opportunity

The promoter must first identify a promising business opportunity that is likely to be profitable in the future. This could involve exploiting a new area of natural resources or innovating within an existing industry. The promoter often collaborates with technical experts in the relevant field to assess the potential of the opportunity. Once the promoter determines that the business venture has significant growth potential, the idea is further developed.

2. Detailed Investigation or Thorough Research

At this stage, the promoter conducts an in-depth analysis of various factors to evaluate the profitability and long-term sustainability of the business. This includes assessing market demand, availability of raw materials, financing options, transportation facilities, and supply chain logistics.

3. Approval & Selection of Name

After finalizing the business structure, the promoter registers the business under a chosen name, which must be approved by the registrar of companies. The name should not resemble any existing business name and should avoid using words like “national,” “state,” “king,” or “queen.”

4. Determining Signatories to the Memorandum

The memorandum of association (MOA), which serves as the company’s constitution, requires signatories. The promoter selects individuals to be signatories, typically the first signatory becomes the company’s director. The director must provide written consent in the format prescribed by law.

5. Arrangement of Capital or Assets

Just as a human body needs food and water to survive, a business requires sufficient capital. The promoter determines the capital requirements and identifies sources for securing funds, such as bank loans, private equity, or an initial public offering (IPO). To ensure successful capital arrangements, the promoter may engage various financial and legal professionals.

In the case of Vali Pattabhirama Rao and Another v. Sri Ramanuja Ginning and Rice Factory (P.) Ltd. And Others^[12], it was held that the court affirmed that the relationship between promoters and the company is fiduciary in nature. It also ruled that promoters are obligated to act in the best interests of the company.

6. Preparation of Necessary Documents like MOA & AOA

In addition to the Memorandum of Association (MOA), which outlines the company’s charter, promoters must submit several other critical documents to the registrar of companies. These include the Articles of Association (AOA), which govern the internal affairs of the business, the prospectus, and the certificate of incorporation.

Conclusion

A promoter can be an individual, a company, or an association that conceives the idea for forming a company, undertakes all necessary activities for its incorporation, and brings the company into existence as a separate legal entity. The promoter appoints the company’s directors, bankers, and auditors and decides the company’s Articles of Association content. Essentially, the promoter acts as a foundational force, shaping the company and playing a crucial role in its establishment. Promotion is a critical phase in the incorporation process, during which all essential steps to create the company are executed. Therefore, the promoter has a significant influence on both the promotion and incorporation of the company. Under the Specific Relief Act, 1963, Sections 15(h) and 19(e) allow a promoter to transfer their rights and responsibilities to the company if the contract is in accordance with the terms of incorporation, provided that the other party consents to the same.

^[1] Whaley Bridge Co.v. Green 1897 QBD 111.

^[2]Companies Act, 2013, Act No. 18 of 2013, s. 2(69).

^[3] AIR 1938 Mad. 192.

^[4] (1862) 10 CBNS 1; 142 ER 1168.

^[5] 1967 SCC ONLINE MAD 194.

^[6] (2017) 6 SCC 537.

^[7]  Companies Act, 2013, Act No. 18 of 2013, s. 34.

^[8]  Companies Act, 2013, Act No. 18 of 2013, s. 447.

^[9] 1993 SCC 3 54.

^[10] Companies Act, 2013, Act No. 18 of 2013, s. 26.

^[11] Appeal No. 325 of 2015.

^[12] 1983 SCC ONLINE AP 207.