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UNVEILING THE DUTIES AND LIABILITIES OF PROMOTERS

INTRODUCTION

Under the Companies Act, promoters are individuals or entities who take the initiative to form and organize a company, shaping its early stages and facilitating its incorporation. In other words, promoters are persons who conceive and promote a business idea, undertake necessary arrangements for its incorporation, and set it in motion. In this blog, we will explore the concept of promoters, their roles, responsibilities, and legal obligations providing a comprehensive understanding of their significance within the framework of the Companies Act.

WHO ARE PROMOTERS?

In the realm of corporate affairs, the term “promoter” holds significant relevance and finds frequent usage. The Companies Act itself employs this term on certain occasions to impose liabilities on individuals fulfilling the role of promoters. However, it is noteworthy that neither the judiciary nor the legislature has provided a definitive and precise definition of this term. Consequently, judges have opined that “the term ‘promoter’ is not a term of art, nor a term of law, but of business.” In a general sense, a promoter is an individual who facilitates the process of incorporating and organizing a corporation. They play a pivotal role in uniting individuals who show interest in the enterprise, assisting in securing subscriptions and initiating the necessary steps that lead to the actual formation of the company. In Twycross v Grant[1], CJ Cockburn stated, “A promoter is 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.” Determining whether an individual qualifies as a promoter is a matter of fact in each case. The classification hinges significantly on the specific role undertaken by the person during the phase of promoting business. Once promoters transfer the company’s control to a governing body, such as a Board of Directors, their responsibilities and functions as promoters in the company’s operations typically cease.

Section 2(69)[2] provides a statutory definition of promoter. According to this provision, “promoter means a person:

  1. who has been named as such in a prospectus or is identified by the company in the annual return referred to in Section 92[3];
  2. who has control over the affairs of the company, directly or indirectly, whether as a shareholder, director, or otherwise;
  3. in accordance with whose advice, directions, or instructions the Board of Directors of the company is accustomed to act.”

It is important to note that the proviso to the definition excludes individuals acting in a professional capacity from the scope of being considered as promoters. This implies that professionals like solicitors who assist in the preparation of essential documents on behalf of the promoters for the proposed company are not considered promoters. Similarly, accountants or valuers who provide their professional expertise to support the promotion are not categorized as promoters. However, it is noteworthy that these professionals can assume the role of a promoter if they undertake actions beyond the scope of their professional duties to aid in the formation of the company. For instance, if a professional assists in finding a buyer for the company’s patent or shares, or facilitates the recruitment of personnel for the company, such involvement could potentially classify them as promoters.

DUTIES AND LIABILITIES OF A PROMOTER

The role of a promoter in relation to the proposed company confers significant advantages, creating a position of influence and responsibility. Consequently, the courts have imposed upon the promoter the fiduciary obligations akin to those of a trustee. The promoter is expected to engage in open and fair dealings with the company, akin to the duties of a trustee.

Hence, the primary duty of a promoter is to faithfully disclose all relevant information concerning any property if they incorporate a company with the intention of purchasing their own property and seeking payment from the funds of the shareholder. Failure to disclose any facts pertaining to the nature, value, or personal interest in the property could entitle the company to challenge or seek compensation for any losses incurred. It would be considered a breach of trust if the promoter sells a property to the company without disclosing their ownership, or if they accept a bonus or commission from a party involved in the sale of the property to the company. In short, as a fiduciary agent, the promoter’s foremost obligation is to disclose their position, profits, and interests in any property being bought or sold by the company.

TO WHOM THE DISCLOSURE IS TO BE MADE?

In the Erlanger v New Sombrero Phosphate Co.[4], the House of Lords put forth the suggestion that the responsibility of disclosing pertinent information should rest upon an independent and capable Board of Directors. The case involved an individual referred to as E, who led a group that acquired an island containing valuable phosphate mines for £55,000. Subsequently, a company was established to obtain ownership of the island and operate the mines. E appointed five directors, two of whom were overseas. Among the remaining three directors, two were under the complete control of E. These three directors then purchased the island on behalf of the company for £110,000. After the acquisition, the company issued a prospectus, resulting in numerous individuals purchasing shares. Although the shareholders approved the island’s purchase during their initial meeting, they were not informed of the true circumstances surrounding the transaction. Unfortunately, the company encountered financial difficulties, prompting the liquidator to file a lawsuit against the promoter to recover the profits. Lord Cairns, while rejecting the promoter’s argument that the Board of Directors possessed full knowledge of the facts, stated “If they (promoters) propose to sell their property to the company, it is incumbent upon them to take care that they provide the company with an executive body who shall both be aware that the property which they are asked to purchase is the promoter’s property and who shall be competent and impartial judges as to whether the purchase ought or ought not to be made. They should sell the property to the company through the medium of a Board of directors who can and do exercise an independent and intelligent judgment on the transaction.[5]

However, subsequent experiences have revealed that it may not always be feasible for promoters to establish an independent Board of Directors for the company. This is particularly the case for private companies or public companies where, like Salomon & Co, the company is composed solely of family members. In such situations, the formation of an independent Board of Directors becomes impractical. Nevertheless, in such instances, it becomes imperative for the promoter to disclose their interests and profits to the shareholders of the company.

Merely revealing the facts to a limited number of shareholders is not sufficient. It is imperative to disclose the information to the entire group of individuals who are invited to participate as shareholders. This principle was highlighted by the House of Lords in their well-known judgment in the case of Gluckstein v Barnes[6].

In the aforementioned case, a syndicate of individuals was formed with the purpose of raising funds to acquire a property known as “Olympia” and subsequently resell it to a company. The syndicate initially acquired certain charges on the property at prices lower than the eventually realized amounts, thus earning a profit of £20,000. They purchased the property for £140,000, established a limited company, and sold the property to the company for £180,000, with the syndicate members serving as the initial directors. They issued a prospectus inviting individuals to subscribe for shares, disclosing the purchase prices of £140,000 and £180,000 but not the £20,000 profit. Shares were issued, but the company eventually went into liquidation.

It was held that at the time of issuing the prospectus, the promoters were under an obligation to disclose to the company the profit of £20,000.

CONCLUSION

Promoters play a vital role in the establishment and early development of companies under the Companies Act. Their responsibilities encompass identifying business opportunities, raising initial capital, and assembling the necessary resources. However, with these privileges come significant legal obligations, including fiduciary duties, disclosure requirements, and the avoidance of conflicts of interest. Understanding the role of promoters within the legal framework of the Companies Act is essential for maintaining transparency, promoting good governance, and protecting the interests of the company and its stakeholders. By adhering to their legal obligations and acting in the best interests of the company, promoters can contribute to the growth and success of the businesses they promote.

Author(s) Name: Shruti Pandey (Xavier Law School, St. Xavier’s University)

Reference(s):

[1] Twycross v Grant (1877) LR 2 CPD 469: 46 LJ QB 636: 25 WR 701 (CA)

[2]Companies Act 2013, s 2(69)

[3]Companies Act 2013, s 92

[4]Erlanger v New Sombrero Phosphate Co. (1878) LR 3 AC 1218, 1236: 48 LJ Ch 73: 39 LT 269: 27 WR 65

[5]Ibid

[6]Gluckstein v Barnes (1900) AC 240:69 LJ Ch 385: 82 LT 393: 16 TLR 321: 7 Mans 321