Promoter’s Liabilities

PROJECT ON

PROMOTER’S LIABILITIES

_____________________________________________________________________________________

SUBMITTED TO

Mr. Shyamtanu Paul

Faculty, Company Law-I

_____________________________________________________________________________________

SUBMITTED BY :

Faiz Kazi

Roll Number 45

Sociology Major (Sec-C)

Semester V, Batch XI

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CONTENTS

1. Acknowledgements Page 3
2. Objectives Page 4
3. Research Methodology Page 4
4. Introduction Page 5
5. Definitions & Meaning of a Promoter Page 6
(i) Definitions
(ii) Statutory Definition
6. Duties of a Promoter Page 8
(i) Disclosure to be made to whom?
7. Liabilities of a Promoter Page 10
(i) Commencement of Promoter’s Liability
(ii) Promoter’s Liabilities
8. Promoter’s Liabilities in Pre-incorporation Contracts Page 13
(i) Pre-incorporation Contracts
(ii) Liability of Promoter concerning Pre-incorporation contracts
under Specific Relief Act
(iii) Brief comparision Between Indian And Other Countries Law
regarding Promoter's Liabilities for Pre-Incorporation Contracts
9. Bibliography Page 26

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__________________________________________________________

ACKNOWLEDGEMENTS

First and foremost, I am thankful to Mr.Shyamtanu Paul, Faculty of Company

Law-I, HNLU, for allotting me the topic “Promoter’s Liabilities”. He has been
very kind in providing inputs for this work, by way of suggestions and materials.

I would also like to thank my dear colleagues and friends in the University, who
have helped me with ideas about this work. I would also thank the University
Administration for equipping the University with such good library and internet
facilities, without which, no doubt this work would not have taken the shape in
correct time. Lastly, I would thank the Almighty God for providing me the strength
and determination to deal with the topic and work with utmost sincerity on the
interesting project.

FAIZ KAZI
ROLL NO.-45
SOCIOLOGY MAJOR
__________________________________________________________

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OBJECTIVES

(I) To discuss the concept of a promoter & the definitions given by various jurists.

(II) To discuss the duties of a promoter.

(III) To discuss the various liabilities which are incurred upon the promoter.

RESEARCH METHODOLOGY

The Objective of this project is to understand a promoter’s duties & liabilities in various cases.

This Doctrinal research is descriptive and analytical in nature. Secondary and Electronic
resources have been largely used to gather information and data about the topic.

Books and other reference as guided by Faculty of Labour Law have been primarily helpful in
giving this project a firm structure. Websites, dictionaries and articles have also been referred.

Footnotes have been provided wherever needed, either to acknowledge the source or to point to a
particular provision of law. Uniform citation has been followed.

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INTRODUCTION:
The formation of a company is a lengthy process. It involves several stages. The first stage in the
process of formation is the promotion. At this stage the idea of carrying on a business is
conceived by a person or by a group of persons called promoters. For incorporating a company
various formalities are required to be carried out. The promoters perform these functions and
bring the company into existence. A promoter conceptualizes the idea of a company and the
purpose of its formation. The promoter acquires and invests the initial capital for the company.
Once all the formalities are completed, the promoter hands over the authority to the directors. A
promoter may be an individual, syndicate, association, partner or a company as well. Promotion
is a term of wide import denoting the preliminary steps taken for the purpose of registration and
floatation of the company. Prof. Gerstenberg has defined promotion of a company as “the
discovery of business opportunities and the subsequent organization of funds, property and
managerial ability into a business concern for the purpose of making profits therefrom”.

In order to get the benefits of a ‘corporate personality', it is very necessary for ‘an association of
persons' to become incorporated under the Companies Act, 1956. After the incorporation of
association of persons the company comes in existence, and it can start its business operations as
company only after that. The simple reason behind it is that before incorporation company do no
has any legal existence before incorporation, and if the ‘association of persons' enters into an
agreement in the name of company before incorporation; the agreement would be void ab initio.

It would be a matter of inconvenience that ‘an association of persons' cannot perform any official
business operation in the name of company before its incorporation or the issue of certificate of
commencement of business; they may have to make arrangement for office, place of work,
worker, etc. In order to do away with these inconveniences, the promoter can enter into the
agreements in the benefit of ‘association of persons' or prospective company; these agreements
are known as pre-incorporation contract. Under the strict principles of contract law, the promoter
is solely liable for the breach of contract. The reason behind is that the promoter is party who
enters into the contract, and not the company. The rule of privity of contract keeps away the
company from pre-incorporation contract.

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DEFINITIONS & MEANING OF A PROMOTER:

DEFINITIONS:

Lord Cockburn, CJ, in Twycross v. Grant,1observed that “a promoter is a person who undertakes
to form a company with reference to a given object and to set it going and who takes the
necessary steps to accomplish that purpose”.

Another attempt was made by Bowen, L.J., in Whaley Bridge Printing Company v. Green.2 He
observed that the term promoter is “a term not of law but of business”, usefully summing up, in a
single word – promotion, “a number of business operations familiar to the commercial world by
which a company is brought into existence”.

In USA, the 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 initiative in
founding or organizing the business enterprise.

Sir Francis Palmer has defined Promoter as “a person who originates the scheme for the
promotion of a company, has the memorandum and articles prepared, executed and registered
and finds the first directors, settles the terms of preliminary contracts and prospectus, if any, and
makes arrangements for advertising and circulating the prospectus and paying the capital”.

The promoter is usually an industrial expert who, with the help of a big team of experts, does the
entire preliminary work necessary before a company can be brought into existence. He selects
and settles with persons to become signatories to the memorandum and the first directors;
instructs and directs the solicitors to prepare the memorandum, the articles and other documents
necessary to be filed with the Registrar of Companies; finds funds for the registration expenses
and prepares the climate to secure the initial capital for the company. Where to situate the
registered office of the company, from where to get necessary plant and equipment etc., are other
worries of a promoter.

1
(1877) 2 CPD 469
2
Pg. 111, [1880] 5 B.D. 109

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STATUTORY DEFINITION:

The term Promoter, has been defined under the Companies Act, 2013. A 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.

In Tengku Abdullah v Mohd Latiff bin Shah Mohd,3 Gopal Sri Ram JCA said: "A promoter is one
who starts off a venture-any venture-not solely for himself, but for others, but of whom, he may
be one."

3
[1996] 2 MLJ 265

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DUTIES OF A PROMOTER:

Promoters have been described to be in a fiduciary relationship with the company. This
relationship of trust and confidence requires the promoter to make a full disclosure of all material
facts relating to the formation of the company. The promoter should not make any secret profit at
the expense of the company he promotes, without the knowledge and consent of the company
and if he does so, the company can compel him to account for it.

A promoter is not restricted to make profit but to make secret profit. In Gluckstein v. Barnes4, a
syndicate of persons was forced to buy a property called ‘Olympia’ and re-sell this ‘Olympia’ to
a company to be formed for the purpose. The syndicate first bought the debentures of the old
‘Olympia’ company at a discount. Then they bought the company itself for £1,40,000. Out of
this money provided by themselves, the debentures were repaid in full and a profit of £20,000
made thereon. They promoted a new company and sold Olympia to it for £1,80,000. The profit
of £40,000 was revealed in the prospectus but not the profit of £20,000. Held, profit of £20,000
was a secret profit and the promoters of the company were bound to pay it to the company
because the disclosure of the profit by themselves in the capacity of vendors to themselves in the
capacity of directors of the purchasing company was not sufficient.

DISCLOSURE TO BE MADE TO WHOM –

In Erlanger v. New Sombrero Phosphate Co.5, it was held that the disclosure is to be made to the
whole body of persons who are invited to become shareholders and this can be done through the
prospectus. Thus, the promoters have to ensure that ‘the real truth is disclosed to those who are
induced by the promoters to join the company. The disclosure should be made to the Board of
Directors, and where there is no independent Board of Directors, it should be made to
prospective shareholders as a whole.6 It was held in Lagunas Nitrate Co. v. Lagunas Syndicate7,
that profits of promoters shall be treated as secret unless explicitly disclosed to an independent

4
[1900] AC 240
5
(39 LT 269)
6
Gluckstein v. Barnes
7
(1899) 2 Ch 392

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Board of Directors, or to all subscribers for shares, at the time of contract with the company is
made by them. The disclosure of profit may be made in several ways, namely, through the
memorandum or articles of association of the company, or by prospectus or by communication to
the Board of Directors of the company which is independent of the promoter. A disclosure made
to the Board of Directors who were mere nominees of the promoters shall not be a valid
disclosure and the promoters shall be liable for non-disclosure.8

Section 56 of the Companies Act, 1956 requires that the promoter’s profits should be disclosed
in the prospectus itself. The disclosure has also to be made of any interest of the promoter in the
promotion of the company or any property acquired by or proposed to be acquired by the
company during the preceding two years.

In Vali Pattabhirama Rao v. Ramanuja Ginning & Rice Factory (P) Ltd9, the promoter
purchased a leasehold interest in the company which he intended to form. However, he first
formed a partnership firm and then converted it into a company. The Court held that the
leasehold became the property of the company from the very first day of the purchase.

In the case of Fairview Schools Sdn. Bhd v Indrani a/p Rajaratnam,10 Mahadev Shanker JCA
said, "Promoters have a legal duty not to make a secret profit out of the promotion of the
Company without the Company's consent and also to disclose to the Company any interests the
promoters have in any transaction proposed to be entered into by the Company"

8
Section 56, Schedule II
9
(1987)
10
(No1)[1998] 1 MLJ 110

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LIABILITIES OF A PROMOTER:

COMMENCEMENT OF A PROMOTER’S LIABILITY –

The promoters are liable for only those acts which are purported to have been done for the
company which they intend to float. Their liability commences only after they have started
functioning as promoters and not for earlier acts. This principle has been laid down in the
English case of Ladywell Mining Co. v. Brooks.11 In this case, five persons purchased a mine for
£5,000 with the intention of selling it to a company which was under formation. None of these
persons were participating in the formation of the company at the time of the purchase and,
therefore, had no involvement in the promotion of the company. They sold the mine to the
trustees of the company which was under formation under a contract for £18,000. The contract
was ratified by the company after its incorporation. Four of these five persons later became the
directors of that company. The company therefore sued them for the recovery of non-disclosed
secret profit of £3,000. The Court held that the defendants were not the promoters of the
company at the time of the initial purchase of the mine as they were not involved in the
formation of the company. The Court ruled that the liability of promoters commences as soon as
they have set out for the promotion of the company and it doesn’t extend to any of their earlier
acts.

11
35 Ch D 400

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PROMOTER’S LIABILITIES -

The promoter or promoters of a company hold a fiduciary relationship with the company which
they promoted. This fiduciary relationship amongst the promoters and the company gives rise to
certain liabilities on the part of the promoters in various cases. The Companies Act mentions the
various liabilities that can be put upon the promoter in case of default on the part of the
promoter. The various liabilities which a promoter can incur upon himself are:

1. For Non-Disclosure:
In case a promoter fails to make full disclosure at the time the contract was made, the
company may either:
 Rescind the contract and recover the purchase price where he sold his own
property to the company, or
 Recover the profit made, even though rescission is not claimed or is not
impossible, or
 Claim damages for breach of his fiduciary duty. The measure of the damages will
be the difference between the market value of the property and the contract price.
2. Under Companies Act:
 Section 56-
This section lays down matters to be stated and reports to be set out in the
prospectus. The promoter may be liable for the non-compliance of the provision
of this section.
 Section 62(1)(c)-
A promoter is liable for any untrue statement in the prospectus to a person who
has subscribed any shares or debentures on the faith of the prospectus. The
aggrieved person may sue the promoter for compensation for any loss or
damage sustained by him. Any false statement in the prospectus may lead to the
following consequences:-
(a) The allotment of share or debentures may be set aside;
(b) The promoter may be sued for damages and also for compensation;

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(c) The promoter may incur criminal liability and criminal proceedings may be
instituted against him.
 Section 63-
This section makes a promoter criminally liable for the issue of prospectus
containing false or deceptive statements. The punishment under this section may
be for a term which may extend to two years or with fine which may extend to
fifty thousand rupees or with both.12 The promoter may, however, escape
liability if he proves that he had reasonable ground to believe that the statement
was true or the statement was immaterial from the point of view of attracting the
investors.
 Section 478-
If the company is being wound up by the order of the Court and the liquidator’s
report alleges any fraud in the promotion and formation of the company, the
promoter or promoters shall be liable to public examination like any other
officer or director of the company.13
 Section 542-
The Court may restrain a promoter from taking part in the management of the
company for a period of five years if it appears that he has been guilty of any
offence punishable under Section 542 (whether he has been convicted or not) or
while being an officer of the company has otherwise been guilty of any fraud or
misfeasance in relation to the company or committed any breach of duty in
respect of the company of which he is a promoter.14
 Section 543-
Where a promoter has misapplied or retained any property of the company or is
guilty of misfeasance or breach of trust in relation to the company, he can be
sued by the company for breach of duty or deceit, as the case may be.

12
Fine raised from Rs. 5000/- to Rs. 50,000/- by Sec. 23 of the Companies (Amendment) Act, 2000
13
Section 519
14
Section 203(1)

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PROMOTER’S LIABILITY IN PRE-INCORPORATION

CONTRACTS:

PRE-INCORPORATION CONTRACTS –

The promoter is obligated to bring the company in the legal existence and to ensure its successful
running, and in order to accomplish his obligation he may enter into some contract on behalf of
prospective company. These types of contract are called ‘Pre-incorporation Contract'.

Nature of Pre-incorporation contract is slightly different to ordinary contract. Nature of such

contract is bilateral, be it has the features of tripartite contract. In this type of contract, the
promoter furnishes the contract with interested person; and it would be bilateral contract between
them. But the remarkable part of this contract is that, this contract helps the perspective
company, who is not a party to the contract.

LIABILITY OF PROMOTER CONCERNING PRE-INCORPORATION

CONTRACTS –

Before the passing of the Specific Relief Act 1963, the position in India, regarding pre-
incorporation contract, was similar to the English Common Law. This was based on the general
rule of contract where two consenting parties are bound to contract and third party is not
connected with the enforcement and liability under the terms of contract. And because company
does not come in existence before its incorporation, so the promoter signs contract on behalf of
company with third party, and that is why the promoter was solely liable for the pre-
incorporation contract under the established ruling of Kelner v Baxter15.

Promoters are generally held personally liable for pre-incorporation contract. If a company does
not ratify or adopt a pre-incorporation contract under the Specific Relief Act, then the common
law principle would be applicable and the promoter will be liable for breach of contract.

15
(1866) LR 2 CP 174, Erle CJ, Willes J, Byles J, Keating J

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In Kelner v Baxter, where the promoter in behalf of unformed company accepted an offer of Mr.
Kelner to sell wine, subsequently the company failed to pay Mr. Kelner, and he brought the
action against promoters. Erle CJ found that the principal-agent relationship cannot be in
existence before incorporation, and if the company was not in existence, the principal of an agent
cannot be in existence. He further explain that the company cannot take the liability of pre-
incorporation contract through adoption or ratification; because a stranger cannot ratify or adopt
the contract and company was a stranger because it was not in existence at the time of formation
of contract. So he held that the promoters are personally liable for the pre-incorporation contract
because they are the consenting party to the contract.

In Newborne v Sensolid (Great Britain) Ltd, Court of Appeal interpreted the finding of Kelner v
Baxter in a different way and developed the principle further. In this case an unformed company
entered into a contract, the other contracting party refused to perform his duty. Lord Goddard
observed that before the incorporation the company cannot be in existence, and if it is not in
existence, then the contract which the unformed company signed would also be not in existence.
So company cannot bring an action for pre-incorporation contract, and also the promoter cannot
bring the suit because they were not the party to contract.

UNDER SPECIFIC RELIEF ACT –

Under the Specific Relief Act 1963, section 15(h) and 19(e) are the two important sections for
pre-incorporation contract. Section 15 is about stranger's right to sue if he entitled to a benefit or
has any interest under the contract, although it has certain limitation. Section 15(h) talks about
the company, being a stranger to pre-incorporation contract, has the right to sue to the other
contracting party. But the necessary condition is that the contract should be warranted by the
terms of its incorporation. This provision clearly negates the common law doctrine which says
that the company cannot ratify or adopt the pre-incorporation contract. Under this provision
promoter can give his right to sue to sue to the company. In Vali Pattabhirama Roa v Sri
Ramanuja Ginning and Rice Factory Pvt. Ltd this position was accepted.

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On the other hand, section 19(e) states that the company can be sued by the other party of pre-
incorporation contract, if the terms of incorporation warrant and adopt the contract. This
provision reduces the promoter of liability of pre-incorporation contract.

BRIEF COMPARISION BETWEEN INDIAN AND OTHER COUNTRIES LAW

REGARDING PROMOTER’S LIABILITY FOR PRE-INCORPORATION
CONTRACT –

Although under the English Common Law, the American law and the Indian Law recognize the
rule that promoter is personally liable for pre-incorporation contract, American Laws and Indian
laws are much more innovative and effective to solve the problem of Pre-incorporation Contract.
Whereas the English Courts still follow the principle of Kelner v. Baxter. Although in UK,
Contracts (Rights of Third Parties) Act 1999 brought some relief, but it is not as broad as the
American and Indian Laws are.

Under English Common Law, the ratification or adoption, after the incorporation, did not release
the promoter from liability of pre-incorporation contract. Whereas in American Court recognize
that if the after the incorporation company can ratify or adopt the contract, and this would bound
the company and not the promoter. Indian Law the rule of Kelner v Baxter is applicable but
under the Specific Relief Act 1963, section 15(h) and 19(e) promoter can shift his right and
responsibility to the company, if it is warranted by the terms of incorporation.

The principle of novation of pre-incorporation contract is applicable in above three counties, the
reason behind is that, the novation replace the old contract with the new contract, so there is not
problem of non-existence of company.

Now after the Contracts (Rights of Third Parties) Act 1999, English laws may also allow
company to become the part of pre-incorporation contract, when it acquire its legal existence.

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BIBLIOGRAPHY:

 Taxmann’s COMPANY LAW, 16th Edn. 2013

 Dr.N.V. Paranjape’s COMPANY LAW, Central Law Agency, 5th Edn., 2012.
 K.M. Ghosh & Dr. K.R. Chandratre’s COMPANY LAW, Bharat Law Agency, 14th Edn.,
2012

WEBLIOGRAPHY:

 http://www.preservearticles.com/201104085070/complete-information-on-company-
promoters-his-position-liabilities-a-remuneration.html
 http://www.oocities.org/capitolhill/2299/company.html
 www.indiankanoon.org
 http://www.lawteacher.net/contract-law/essays/pre-incorporation-contracts-and-the-
promoter.php

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