Role of Promoters in Company Establishment

4479 words (18 pages) Essay in Business Law

02/02/18 Business Law Reference this

Last modified: 02/02/18 Author: Law student

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When an individual has an idea for a new business venture, he or she may set about interesting others in the venture and persuade them to contribute capital to a company to be incorporate for the purpose of carrying on the venture. The individual will then be described as ‘promoter’ of the company. In the 19th century, when industrial revolution came and companies flourished, the concept of promoter gained substantial importance like no other occupation, as there were no restrictions on advertising immediately to the public, inviting them to take shares in new companies, some promoters took advantage of their position and of public sympathy and hence defrauded the public on large extent. The role of promoter in establishing a company changed substantially in the 20th century.When, in later years people refused to buy shares in newly incorporated companies, because of their established gullible image and hence hesitated to invest in companies which had no trading history and so disreputable company promoter statured to vanish. With the evolution of stock exchange and the role of susceptible promoters gone, what eventually happened was the profusion of promoters around the globe to start over a company and enhance theirs and other associates economic conditions enhance? Judging for theirhistorical role, it’s clear that,Company promoters play an indispensable role in the formation of a company. A company is born only when it is duly incorporated. For incorporating a company various documents are to be prepared and other formalities are to be complied with. All this work is done by promoters. Gerstenberg has defined promotion as the discovery of businessopportunities and the subsequent, organization of fun and property and managerialability into a business concern for the purpose of making profits therefrom. After the idea is conceived, what promoter does is to make detailed investigations to find out the weaknesses and strong points of the idea, determine the amount of capital required and estimate the operating expenses and probable income. On being satisfied about the economic viability of the idea, the promoters take all the necessary steps for incorporating the company and start changing people’s lives.

Promoters: Who Are They?

When we speak of promoters and their role in company’s establishment, it becomes important to discuss about the company’s entire process of formation. The company’s formation can be divided into four segments. First, is calledPromotion. Second is registration. Third is Floatation and fourth is Commencement of business. Promotion symbolizes preliminary steps taken for the purpose of registration and floatation of the company. The person who undertakes these phases are called promoters. A Company may have more than one promoter.

The activities of a promoter are so varied that no comprehensive definition of the term has ever been formulated, though judges from time to time offered broad guidelines. For example in Whaley Bridge Calico Printing Co vs. Green, Bowen Said:

“The term promoter is a term not of law, but of business, usually summing up in a single word a number of business operations familiar to the commercial world by which a company is generally brought into existence [1] .”

Generally, a promoter is any person who complies with the necessary formalities of company registration, finds directors and shareholders for the new company, acquires business assets for use by the company, and negotiates business contracts on behalf of the company and the like. In order to be regarded as promoter, it is not necessary that the person should be involved in every stage of company’s formation [2] .

When it comes about Indian Turf, the expression ‘promoter’ has not been defined under the Companies Act, although the term is used expressly in sections 62, 69, 76, 478 and 519. Even in English law, no general statutory definition of a ‘promoter’ is available. Section 62 of the Companies Act, 1956 defies the expression ‘promoter’ for a limited purpose of that section only [3] . Section 62(6)(a) defines the expression ‘promoter’ to mean a ‘promoter’ who was a party to the preparation of the preparation of the prospectus or of a portion containing the untrue statement, but does not include any person by reason of his acting in a professional capacity in procuring the formation of the company [4] .

Cockburn C.J., in Twycross vs. Grant [5] described a promoter as “one who undertakes to form a company with reference to a given project and to set it going and who takes the necessary steps to accomplish that purpose [6] .

Promotion: The Alpha and Omega of their Roles

The relationship between promoter and the company that he has lifted must be deemed to be fiduciary relationship from the day of the beginning, i.e. the day, floating of company starts and continues up to the time that the directors take into their hands what remains to be done in the way of forming the Company.

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 [7] . When we speak of their part in the establishment of the company, we need to keep in mind that, it is they who conceive the idea of forming the company, and it is they who take the necessary steps to incorporate it.

They carry out the necessary investigation to find out whether the formation of a company is possible and profitable. Thereafter, they organize the resources to convert the idea into a reality by forming a company. In this sense, the promoters are the originators ofthe plan for the formation of a company.They are the ones who It to arrange or find ones who can arrange the share and loan capital and other financial resources, Promoters are the one who arrange 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 these things have been done, the promoter hand over the control of the company to its director, who are themselves under a different name [8] .

On handling 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. [9] 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 [10] . 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.

Promoters: Their Authorized Standing

The promoter occupiesaweightyabode and has wide powers relating to the formation of the company. It is however interesting to note that he (the promoter) is neither an agent nor a trustee of the company that he proposes to establish [11] . He is not an agent because there is no company yet in existence and he is not a trustee because there is no trust in existence. But that does not mean that promoter does not have any legal relationship with the company. The exact way to describe the legal position of the promoter is that he stands in a fiduciary relationship with the company. Lord Cairns in Erlanger vs. New Sombrero Phosphate has said that “the promoters of a company stand undoubted in a fiduciary position. They have in their hands the creation and molding of the company [12] ” 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 trading corporation.

Promoter: His Obligations When Instituting A Company

The Companies Act, 1956 contains no provision regarding the duties of the promoter. It merely imposes a liability on promoters for fallaciousdeclarations in prospectus they are parties section 62 and 63 to be precise, and for fraudulent trading. The Courts, however have been conscious of the possibility of abuse inherent in the promotion and hence laid down some fiduciary duties towards the promoters.

Not to make any secret profit out of the promotion of the company;

To disclose to the company any interests which he has in a transaction entered into by it.

Promoter’s Onus to UnveilClandestineEarnings

When we express of secret profit it becomes essential to have a distinction between a promoter who enters into a transaction in his or her capacity as a promoter and profits from it, and one who acquired as interest in property before promoting and makes a profit when the profit is sold to the promoted company. In the former circumstance the profit is made in breach of fiduciary duty whereas in the second circumstance the profit is legitimate [13] .

A promoter is not forbidden to make profit but to make secret profit [14] . 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 principal’s agent.The challenging job is to discover who may give the necessary consent on behalf of the company. If the company has been established with a board of directors which is independent of the promoters, the consent may be given by the board [15] , but the if the directors under the influence of the promoters, it is not sufficient for the board to give its consent to the promoters obtaining a profit from the promotion of the company [16] and the promoter must obtain the consent of the persons who provide the company with its initial share capital [17] , either by such persons who give their individual consents, or by them approving the retention of the promoter’s profit by passing an ordinary resolution to that effect at a general meeting. Consent of the retention of profit must some either from the directors or from the shareholders, if the promoter makes discloser of how profit he has made or going to make, and it is insufficient for him to give them information from which they could have deduced that he has made profits. If the company issues a prospectus, disclosure to shareholders may be made in it, and each shareholders subscription for shares on the basis of the prospectus would then be deemed to indicate his consent to the retention of profit disclosed by promoters. Thus, the promoters have to ensure that the real truth is disclosed to those, who are induced by the promoters to join the company [18] .

Promoters Role in Incorporation of a Company

The Job of promoter is not only limited towards, performing certain duties, but surely it extends toward the incorporation of a company. It depends on the nature of the company which is to be established, to arrange their respective persons. More evidence can be found in the Companies act section 12 which states that“Any seven or more persons or where the company to be formed will be a party company, any two or more persons, associated for any lawful purpose may, by subscribing their names to a memorandum of association and otherwise complying with the requirements of this act in respect of registration form an incorporated company with or without limited liability [19] “. Thus the promoters have to get together at least seven persons in the case of public company and two persons in case of private to subscribe to memorandum of association. Following are the functions of promoter in an elaborate manner.

The Important Steps in the Process of Registration

Before proceedings to register a company, the promoters have to decide the following facets:

What type of Company to float: The first thing the promoters must decide is the type of company proposed to be made. Under the Companies act of 1956, Public companies and Private companies are the ones which can be registered [20] .The Companies Act places a great variety of forms of companies at the disposal of businessmen. The requirements of business vary greatly: some people wish to limit their liability, others, while trading as a corporation, wish to be liable without limitation for the obligations which they have undertaken or the money entrusted to them; some businesses are large, others small; in some instances the capital required for the business is provided by the promoters; in others it is contemplated inviting the public to contribute to the capital of the company; and in others again no initial capital is required;. The aim of the Act is to make available a variety of forms of corporate organization so that company promoters may choose the form most appropriate to the purposes which they pursue.

Also, with what amount of capital to put is something to be determined or to be left to the discretion of the promoters. It can be as small or as large as they choose. The material consideration in fixing the amount of capital is: what funds will the company want, and how much in the shape of paid-up shares are the vendors, if any, to get?Promoter’s role in putting the capital is crucial as how much money the company going to commence its business depends on its capability to earn profits. Also, as regards the amount of shares, this is again for the promoters to determine [21] .

Application of availability of name where the section 20 states that a company can’t be registered by a name, which in the view of the central government is undesirable. It is therefore argued that it would be advisable that promoter found the availability of the name proposed from the registrar of companies. The promoters of a company under a proposed name to make an application in form No. 1A, accompanied with fee of Rs.500/- to the Registrar of Companies in which the registered office of the company is to be situated for ascertaining as to whether the proposed name is undesirable within the meaning of section 20 of the act and whether the same is available for allotment,

Preparation of Memorandum and Articles of Association: As in the words of Pennington, the memorandum of association is a document of great importance in relation to the proposed economy [22] . It contains the objects for which the company is formed and therefore identifies the possible scope of its operations. A promoter’s job in under this segment comes which precedes process of registration. Likewise, another important document namely the articles of association which contains rules and regulations related to internal management of the company.

Vetting of Memorandums &Articles, Printing, Stamping and Signing of the same

Under this head, a promoter of company has to get the memorandum and articles of association printed, vetted, stamped and signed. And these documents must be vetted either by Registrar of company or Regional Director [23] .

Preparation of other documents: Under this head, a promoter with a view to fulfill various formalities that are required for incorporation of a company may execute a power of attorney in favor of some professional like Chartered Secretary or Chartered Accountant.

Promoters and Pre-incorporation Contracts

Sometimes, contracts are made even before company is even incorporated, these are called Pre-incorporation contracts.These are those contracts which have been entered into at the time when the company was not in existence cannot bind the company. The persons executed those contracts cannot be called as the agents of the company which is formed aftermath and such contracts cannot be enforced against the company [24] .

Until the passing of the Special Relief Act, 1963 the promoters found it very problematic to accomplish the work of incorporation [25] . Since contracts prior to incorporation were void and also could not ratify, people hesitated to either supply any goods or services for the cause of incorporation. As prior to 1963, the contracts made never bind the company (since a person can’t contract before his existence and also company does not have legal existence either), also if corporation were bound by them it would be subject to many unknown obligations.

Hence, Special Relief Act came as a relief to the promoters, through its section 15(h) of the act, it provides that where the promoters of public company have made a contract before its incorporation and the contract is warranted by terms of incorporation the company may enforce it. The usage of term “Warranted by terms of incorporation” suggest what is needed must be within the scope of company’s objects as mentioned in memorandum. Also, one thing of mentioning here is that it’s only the company which is allowed under the Act to enforce its pre-incorporation prerogatives against the third parties.

Promoters Liability in Pre-incorporation Contracts

The Locus of the promoter under pre-incorporation contracts is something quintessential to discuss. Generally, the company executes separate contracts after their incorporation, but what if they don’t do that and the contract made was outside the purview of the so called ‘warranted’ circle.The position of promoter is worth mentioning of, in those types of scenarios. In the case of Phonogram Limited vs. Lane [26] it was in this case observed that “although a contract made before a company’s incorporation can’t bind the company it is not wholly devoid of legal effect, even if all the persons who negotiated the contracts are aware that the company has not yet been incorporated” The contracts take effect as personal contract with the persons who sense to contract on company’s behalf. [27] Promoters shall be liable to pay damages for the failure to perform the promises made in company’s name. This is even where the contracts says that only the company’s paid up capital shall be answerable for performance [28] .

Promoter: What if he Commits Rupture in his Obligations

When a promoter commits a breach of duties that he owed to the company, the only curative measure there lies is recession of any contract that company made with him or for recovery of any secret profit that he has made over a particular course of time [29] .On the point of Rescission of contract:As far as the right to rescind is concerned, it must be exercised on normal contractual principles, meaning, the company must have done nothing to show an intention to approve the agreement after finding breach involving non-disclosure.

As far as the recovering of secret profits is concerned, if a promoter makes a secret profit or does not disclose any profit made, the company has a remedy against him. This varies according to the circumstances which may be divided into two scenarios:

When the Promoter was not in fiduciary position when he acquired the property: If the property on which the profit was made was acquired before the promoter became promoter, there can be no claim for the recovery of profits as such [30] .

Where the promoter bought property with a view to selling it to the company which he intends to promote under that circumstance, what will take place will be the Rescission of the contract, and if the promoter has made a profit on some ancillary transaction that may also be recovered.

Also, with regard to termination of duties of promoter, they just don’tcome to an end with the incorporation of the company. Promoters duties, continues until the company has acquired which it was formed to acquire, has raised its share capital [31] and board of directors has taken over the management of companies affairs from the promoters [32] .


In the concluding section the entire researcher can do is to comment on the exceptional and arduous role of promoter. Company’s establishment has gained more and more importance in India, especially after the reforms of 1991 took place and Indian market saw penetration of much foreign companies. When we talk of company, what comes to mind are independent directors and auditors? However, there are other third parties involved in following good governance practices. These are lawyers, analysts, bankers, financial institutions, internal auditors and so on. What we tend to forget is the role of the promoter in ensuring good corporate governance. Before delving into the role of a promoter, we should realize that all companies need to exist, thrive and flourish in civil society. Through the establishment of an organization, all promoter does is assisting the people within the society to achieve a set target of economic enhancement in their lives.Promoters should ensure that all transactions with the company by inter-related parties should be at arm’s length and should test the scrutiny as any other contract or agreement does. It is important that all directors, including promoters, be subject to evaluation by the other directors. This will ensure there is transparency with regard to the remuneration fixed for the directors through an independent remuneration committee.Promoter sets high standards by their own attitude in establishing and following governance. The quality at the top will determine the level and attitude to company which is established.While, Promoter do their job, establishes company or may be companies. It is important that the timing in the lifecycle of an organization is appropriate for any corporate governance initiative to be sustainable and real. There is no “one magic formula” to determine the appropriate timing. Promoters, while establishing a company look for a long term investment, when they put the money or gather some other people in investing in the company; they [the promoters] tend to be focus on growth. It’s their foresightedness, which plays a crucial role, however, sometimes, when escapist their attention or focus to very rigorous controls, they tend to develop “fear of outcomes” and don’t progress, and their organizations die a natural death. This approach is natural and understandable but if they can overcome this weakness, then all will happen is development of their company. Once they grow, it becomes obvious that all people employed inside the company will grow and will ultimately bring an economic shift in their livelihoods. The right timing may vary for each company to get established, what type situation is prevailing in the market, the availability of proper capital to set up are all factors which should be kept in mind by a promoter, before he is going to commence promoting. If, these small details are worked up by promoter, the spillover effects of establishing a company can be easily to penetrated down to the last employee in the chain. Each promoter may have his own style of promotion. It is, therefore, best for each promoter to determine what works for him and the company.We can conclude that a promoter, by discharging his role properly and honestly, can be a key differentiator for the company which he establishes, if done correctly and diligently, will bring a win-win for all stakeholders and the society at large.

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